bizzXceleration: Performance, Value and Profit

At the end of the lost post we laid down a, perhaps the, challenge for these interesting times:

"As this sorting goes on the real winners will be the firms and industries who have an effective business model or who re-invent one. Finding them will be the interesting challenge. "

So how does one go about sorting things out. Well there's our interesting little mantra of economy - industry - firm but we thought, beyond that, we'd appeal to the words of the Master. Mr. Warren Buffett himself. Now there's several ways to do that from reading any of the several books that've come out, to reading Warren's annual stockholders letters. Which are btw online at the Berkshire web site and entirely worth your time. And he's made several invaluable and wisdom filled visits to the Charlie Rose program. Two other interesting sources are another of our favorite blog sites and the AAII. 

• NotMakingThatUp (Jeff Matthews): this is the last of a ten part series on Jeff's attendence at the annual BRK meeting. Also if you'll search Jeff's site there are several other interesting posts that are well worth your time and attention:Pilgrimage, Part X: On The Cheap
• Another is this introduction to the AAII's Buffett Screen

 We strongly suggest follow-up on those but fortunately modern technology has given us an even better starting point. Back around 1998 Warren made a major appearance at the founding of the Graham-Buffett school of Security Analysis, the speech/Q&A was recorded and now it's posted on YouTube as a 10-part vidclip set. Each of the parts is well worth watching, pondering, taking notes and re-watching. In fact as part of our prep work, obviously in addition to reading the previously mentioned materials, we watched the set twice. Being slow it took us a while to catch on to the "take notes" part as well as the little gems and insights that we've heard no where else.

Parts 1 and 10 have a lot to say about personal values, integrity, doing work that you love and the kind of world we live in. Odd that the world's most successful investor does a pretty good job as a downhome, country-store philosopher, isn't it ? :). The middle parts are particularly interesting for getting Warren's take on understanding and analyzing businesses and making investment decisions. But we'd especially point to Parts 3-5 if you listen to no others.

Now at some point you've probably seen Warren's basic principle's in some business article or heard him on Rose or someplace else. Certainly the AAII article does a superb job of translating those principles into a screening set, within the limits. We'd summarize/paraphrase them roughly as: 1) Understand the business and be absolutely confident in it as a business for the long-haul, 2) view investments as buying a piece of the business and be comfortable not trading them for 10 years, 3) look for companies with sustainable competitive advantages that protect the core value proposition and 4) pick companies with good management. Listening to Warren takes those simple-sounding principles and fleshes them out with examples and discussions that makes them meaningufully operational. Beyond that though we got several surprises that, as long we thought we'd been following Buffett, were eye-openers:

1. Understand the business - everybody's heard the make a decision in 5-10 mins. What's new news to us is that a) he adds develop a circle of competency, say 30+ companies, you really understand and follow and b) it takes a lot of digging and research. It turns out the Warren spent a long...long time and a lot of effort learning how businesses really work, i.e. what their business models are. Since this is our central mantra we were extremely gratified to hear it. 

2. Focus - you don't have that many good ideas, one good one will get you to where you need to go, don't diversify if you're really willing to work at it but instead focus on 6-8 companies, or investment ideas, that your nurse for a long time. If you're just investing in general without the time or interest then diversify, in fact focus on stock index funds. Otherwise if you are looking for above average returns they are the result of work, lots of it, good ideas and focus.

3. Moats - a key strategic principle is for companies to keep growing their moats, that is their abilities to defend their businesses and maintain above average returns. The re-emphasis on this was interesting but what was another major eye-opener were the definitions by example. A moat could be service, cost advantages & price, distribution, patents, etc. All the traditional operating functions that we here think are so important, that are almost entirely ignored by the business & financial press and constitute the sustainble operating advantages of a firm. In other words the Moat. 

4. Breakdowns and Bad Examples - Warren constantly used examples of companies with good businesses and big moats. In passing he mentioned MSFT and technology and why he doesn't invest, the utility/power industry, why he's a member of Airlinoholics Anonymous, P&G, MickeyD's, Gillette and Coke, Coke, Coke and Coke. Now in our books Coke became the perfect counter-example to some of his thinking. They thought they had a never-break business model where all they had to do was sustain in the states and extend it worldwide. In fact after major efforts and a huge bad patch since about '00 they're now recovering.

It turns out that you can indeed put a major business model & moat at risk of destruction. Consider another inadvertent bad example used - Kodak. Coke has dug itself out from under its' own arrogance by re-thinking it's approach to product development and innovation, by realizing that one could indeed saturate the core market and renewing the basic strenghts of its' culture and sanding off, painfully, a lot of the arrogance and learning to adopt and adapt. One could say the same thing for MickeyD's as well.

Now are these exceptions to Warren's model or confirmations ? We'll let you answer that as a take-home quiz but the hint is this. If you pick a good business with a strong culture it's likely to renew itself. :)

Another "little" thing that struck us that hadn't been obvious before but seems clear and simple is how closely Warren's approach, one you get under the covers of the last ten years of press coverage, lines up with the one we outlined earlier: Think Like a Private Equity Guy ? No, Think Like An Owner !

Here's a side by side comparison:

 For a collection of prior posts and readings that pursue these themes try browsing the archive on Enterprise Performance for a collection. Including examples and more tools.

Posted by dblwyo at 02:51 PM | Permalink | Comments (0)

Chant after me: Economy, Industry, Firm. Economy, Industry, Firm. Economy, Industry Firm. That's your new mantra. Understand what the real trends in the Economy are, understand how industries are facing those trends and reacting to them - in particular whether or not their fundamental business models and strategies are able to cope with the trends and then understand how individual firms are behaving. Running with the herd or different model. In Hinduism, at least according to Joseph Campbell, the purpose of chanting AUM is to serve as a mind-body mantra capturing the sounds of the Alpha to the Omega with a final silence indicating that one really can't. Well the chant of the Finance Industry has been Vaule at Risk (VaR) - otherwise known as we can model this. The originator of regression model was the Prince of Mathematicians, Karl Friendrich Gauss. He came up with the technique to correct survey sampling data when he was in charge of surveying for a small German principality (good maps were important for armies, tax collectors and commerce you see, so the 2nd greatest mathematician in known history put his mind to it). The catch is that he was trying to minimize data errors for a well known model - the Earth.

VaR presumes that the estimated parameters can be derived from past historical experience and that the underlying model is known and constant. Both of which presumptions are proving to be very presumptuous. The emerging narrative in the industry is that the sub-prime mess was a Black Swan event - predictable only in hindsight though naturally occurring. Well actually predictable in foresight, and several did though that's now ignored as this new narrative emerges and takes over the standard thinking. And not at all unusual - in fact the same breakdowns that led to LTCC's breakdowns, part of Enron's problems and in fact, going back to Tulip Bulb mania. Fortunately the new narrative is starting to include the idea of actually going back to good old fashioned due diligence instead of taking abstract and artifical models as gospel. 

This is important because a belief in models has been one of the key underpinnings of some major structural shifts in the Finance Industry over the last three decades and associted shifts in the US economy. As we learn to chant our new mantra and mediate on Due Diligence instead of models you might keep the chart in mind. It shows the shares of Profit by source, both in absolute and % terms, in the US Economy. The top sub-chart shows total profits (stacked btw !) and the bottom share %; don't know about you but our view is that the Finance Industry has moved front-n-center as a major driver. The question is was value created or destroyed ?

The weekly readings excerpts below are focused on business, business practices and individual firms. While there are some very interesting stories on Yahoo and MOT that need to be paid attention to the bulk of the stories have to do with problems in the Finance industry and the consequences thereof. Primarily the re-thinking of the business model, which is just barefly started. But also the consequences as bad judgement and poor modeling result in "unintended" consequences for the rest of the economy, e.g. credit is harder to get, the risk of defaults is rising and all those firms who re-leveraged themselves to buyback their stocks at the highest valuations in several years are now going to be struggling to keep themselves together.

This will sort itself out, and painfually. A lot of the buyout firms who helped us into this mess are already building up the stores of dry powder (new funds) to take advantage, i.e. they're going to be looking for buying distressed companies, distressed debt, etc. for $.50 on the $1 ! As this sorting goes on the real winners will be the firms and industries who have an effective business model or who re-invent one. Finding them will be the interesting challenge. 

General & Special

Investing in Better Research Despite occasional good reporting, far too many financial journalists know less about investing than their readers. I had dinner with a friend of a friend the other night and he was telling me about the Rothschild formula for investing. According to him, this involves not participating in the first 20 percent or the last 20 percent of an investment run-up. Instead, it's investing in the middle 60 percent, when risks are low and the direction of the price is determined. As the asset value approaches what appears to be the last 20 percent, you sell and move on to another asset class. As we all know, most amateurs (and, possibly, many reporters) only participate in the last 20 percent. I wondered if the reporter who asked why I was investing millions in stocks was an investor himself. I did my best to explain to him that there are two things professionals invest for: 1) Capital gains, and 2) Cash flow. The problem with much of the financial news in print and on the web, radio, and television is that it comes from journalists who may not be investors. When I listen to most journalists whine and cry about the subprime mess, the slowdown in the economy, and the volatile stock market, I can all but tell that they're not really investors. None of these events really has much impact on professional

Business Practices

Leave Sinking Firm or Try for Rescue A manager who stays may get a chance to take on more responsibility as others bail. Experience handling such crises may be valuable to future employers. Plus, some executives feel a moral obligation to try to save the company and help employees.But staying also can carry big risks. If the executive ultimately loses his post, being associated with a failed or troubled company can carry a stigma in the job market.

Preparing Your Professional Checklist As an executive coach, I find that my clients almost always know what they should do. They, like all human beings, just don't always do it. In the same way the nurses in Dr. Pronovost's research remind doctors to do what they already know they are supposed to, I remind executives. Just as in Dr. Pronovost's research, it works! For example, almost every leader preaches -- and believes in -- the value of synergy and cross-organizational teamwork. Many of these same leaders slip on occasion and blast their cross-organizational colleagues in team meetings. This destructive communication is generally contagious, leads to direct reports joining in the bash-fest, and ultimately undermines cross-organizational teamwork. If these same leaders had a checklist that included No. 5 above, this behavior might not be eliminated but it would greatly decrease.

Business Environment

Market Bloodbath Highlights Cracks in Capitalism Any banker, trader or investor asked to invent the perfect market environment for creating wealth beyond the wildest dreams of avarice would come up with conditions akin to those of the past decade. So what went wrong? The financial community, through greed, stupidity and hubris, has fouled its own sandpit. The era of munificent money- making conditions -- gentle regulation, ever-faster information flows, freely available credit, unprecedented access to global investors and oil-enriched buyers of anything yielding north of zero -- is ending with an almighty bang, not a whimper. Realtors appraised homes at fictitious levels. Lenders granted mortgages to people who couldn't pay. Bankers created Frankenstein instruments they couldn't value. Traders invented prices they couldn't justify. And investors bought securities they didn't understand.

• O Wise Bank, What Do We Do? (No Fibbing Now) But for all its power, the Fed cannot change this troubling fact: trust in much of the financial system — banks, brokerage houses, ratings agencies, bond insurers, regulators — has been severely damaged by the subprime mortgage crisis. And that damage cannot be reversed with a quick cut in interest rates. It is not just a matter of attracting fresh capital from overseas to replace some of the $100 billion lost or written off so far — a figure that is sure to grow. The underlying problem for some of the world’s largest financial firms is restoring confidence, among big institutional investors and 401(k) nest-egg holders alike. That’s what has to happen if the capital markets are to run smoothly over the long term.

Atonement Comes to Wall Street as Guardians of Risk Get Summons From Exile As the subprime crisis has unfolded, spurring at least $133 billion in writedowns and credit losses and claiming the jobs of four chief executive officers, the risk managers charged with preventing those kinds of disasters have largely languished on the sidelines. Banks, emboldened by three years of record profits, failed to heed warnings of their risk managers or give them enough power and data to do their jobs, says Joseph Mason, a professor of finance at Drexel University in Philadelphia who researches risk management…Wall Street firms have long viewed risk managers as advisers, not decision makers. They are there to support the bankers and traders who generate revenue. At JPMorgan Chase & Co., which took a $1.3 billion writedown in the fourth quarter, the risk department for investment banking has 700 employees. Risk managers build sophisticated models to predict potential losses from investments and to set overall trading limits. The bankers and traders are supposed to consider the findings of risk managers in deciding whether to reduce or hedge bets. It doesn't always work that way. For one thing, risk managers often rely on traders to give them the data and formulas they need to do their jobs. That's what happened with collateralized debt obligations -- packages of securities that are based on home mortgages and other loans. CDOs, whose values dropped as much as 100 percent from July to December, don't have readily available market prices because they're thinly traded. In many instances, traders gave risk managers insufficient or misleading information about the pricing models for the securities, making their task more difficult.

Death of VaR Evoked on Wall Street as Risk-Taking Meets Taleb's Black Swan The risk-taking model that emboldened Wall Street to trade with impunity is broken and everyone from Merrill Lynch & Co. Chief Executive Officer John Thain to Morgan Stanley Chief Financial Officer Colm Kelleher is coming to the realization that no algorithm or triple-A rating can substitute for old-fashioned due diligence. Value at risk, the measure banks use to calculate the maximum their trades can lose each day, failed to detect the scope of the U.S. subprime mortgage market's collapse as it triggered more than $130 billion of losses since June for the biggest securities firms led by Citigroup Inc., Merrill, Morgan Stanley and UBS AG. The past six months have exposed the flaws of a financial measure based on historical prices that securities firms use idiosyncratically and that doesn't anticipate every potential disaster, such as the mistaken credit ratings on defaulted subprime debt.

With credit markets in turmoil, many companies are finding it harder to get the money they need to fuel their businesses. With credit markets in turmoil, many companies are finding it harder to get the money they need to fuel their businesses. Small companies with less-than-perfect financial histories -- the majority of American companies -- are being hit especially hard. Even small companies far removed from the world of housing and crumbling bonds, such as Emrise, are finding it tougher and more expensive to borrow.

Sovereign Funds Beat Buffett on Wall Street With Citigroup, Merrill Stake Citigroup Inc. and Merrill Lynch & Co. shareholders, who've held on to the stocks through a 50 percent decline in value, now face having their stakes diluted as sovereign wealth funds snap up convertible preferred shares at terms unheard of 20 years ago. The last time the biggest U.S. securities firms went hat in hand to outside investors was in 1987 when New York-based Salomon Inc. turned to Warren Buffett, the world's most successful stock- picker, for $700 million to fend off an unwanted takeover. Even billionaire Buffett didn't earn a fraction of the premium that state-managed funds in Kuwait, Abu Dhabi, Korea and Singapore negotiated for the more than $21 billion they invested in New York-based Citigroup and Merrill, let alone the equity they'll get in about three years' time. Buffett was paid a 9 percent dividend, 1.75 percentage points more than the U.S. Federal Reserve's overnight lending rate. By contrast, the 11 percent that some of today's investors are pocketing represents a spread of 6.5 percentage points.

Rout in Asia Stifles Deals Several billion dollars in deals throughout Asia have been called off over the past few weeks on the recent market rout, with private-equity buyers pulling back and IPOs being shelved.

Buybacks, Bounces and Splats: Buying High, Selling Low Rather than wait for the weekend Readfest posting there are a couple of sets of interesting stories you ought to be reading now and thinking about heading into the weekend, next week and for the duration. The duration of what you may ask ? Well that's the question - the duration of the current unpleasantness of course. It's apparantly really beginning to dawn on the MSM though not widely that all the pressures for stock buybacks have resulted in attempting to prop up company stock prices have resulted in paying top prices and now, re-financing and re-capitalizing, at lower prices. Though some, including us have been beating that drum for quite a while now.

Industries & Companies

Paying for 'Goldman Envy' Citigroup could face a bigger struggle raising more new capital than Merrill, if the financial firms' latest fund-raising deals are any indication. Why did some banks and brokerage firms get so badly scorched by the subprime debacle and others come through relatively untouched? There are several reasons for this. One is luck. But something else explains a lot of the difference. The losers were infected by what one could call Goldman envy. The winners were more immune to the malady. The snag is that a bank is unlikely to manage things well when it's expanding rapidly and doesn't have experience. It may put the wrong people in place, not institute the right controls and implement the wrong incentive schemes. The banks and brokers with the biggest problems seem to have made such mistakes.

Citigroup's Sue-Me Game of Chicken May Double Enron Creditors' $13 Billion Enron Corp. creditors could see their original payout more than quadruple to as much as $31 billion after a trial against Citigroup Inc. Enron Creditors Recovery Corp., the entity winding up the defunct energy trader's affairs, distributed $13.3 billion, or 36 cents on the dollar, since a bankruptcy plan was approved in 2004. That includes most of $1.73 billion in out-of-court settlements with 10 of the 11 banks creditors accused of aiding the fraud that wiped out the company. They argue that Citigroup, the only lender that hasn't settled, should pay the rest of the claims, about $18 billion. The amount is more than six times the $2.8 billion reserve for Enron, WorldCom Inc. and initial public offering-related litigation that Citigroup disclosed in a Nov. 5 regulatory filing. Evidence at a trial set for April in New York may include an examiner's report citing bank e-mails as evidence Citigroup assisted in the fraud. Testimony against the bank by Andrew Fastow, Enron's imprisoned former chief financial officer, may also be introduced.

Prius Designer Says Toyota-Led Industry Fails to See Doom of Oil Addiction ``This is what the end of the age of oil means,'' says Reinert, 60, who plans the vehicles Toyota will make in a quarter century as national manager for advanced technology at the U.S. sales unit in Torrance, California. ``The car-based culture, the business-as-usual of building cars and trucks, is going to change dramatically.'' Since Henry Ford introduced the moving assembly line in 1913, the world's automakers have relied on a single source of power -- the gasoline-dependent internal combustion engine. Today, the twin threats of $100-a-barrel oil and global warming are convulsing an industry addicted to cheap, abundant petroleum. Auto companies, already hurt in 2007 by the lowest U.S. demand in a decade, are struggling to perfect cars that run on ethanol, diesel, natural gas, hydrogen and household electricity.  They're under the gun from California and more than a dozen other states to cut carbon exhaust by 2020 with vehicles that must get 44 miles per gallon (19 kilometers per liter) of gasoline, about double today's average. Reinert says automakers are endangering themselves by basing sales and profits on the big, fast cars that many U.S. customers say they want in 2008. In five years, as oil shortages and global warming intensify, car companies may be out of step with drivers' demands for fuel-efficient vehicles. Even worse, degrading stretches of the planet like Fort McMurray will only delay --not prevent -- the time when the world must function in a post-peak- petroleum economy.

Sears's Unorthodox Tactics Encounter Stiff Head Winds Since acquiring control of the Sears retail empire in 2005, financier Edward S. Lampert has delighted fans and horrified traditionalists by relying on strategies that don't depend on sales growth. Shrinking per-store sales haven't bothered him, so long as other tactics kept operating earnings strong. Former employees and a wide range of retailing consultants kept predicting ruin, but Mr. Lampert until a few months ago benefited steadily from cutbacks in capital spending, occasional real-estate divestitures and aggressive investment of Sears Holdings Corp.'s cash. The company's soaring stock price seemed to vindicate his unorthodox approach. Not anymore. While Sears shares remain well above Mr. Lampert's original purchase price, they have skidded about 40% since July. Business at the company's 3,800 Sears and Kmart stores keeps waning. At stores open a year or more, sales were down 3.5% during the holiday season. Last week, Sears warned investors that the current quarter's profit will be disappointing. Right now, nobody in retailing is thriving. Mr. Lampert keeps trying to divert attention from Sears's empty aisles.

Yahoo's Ripe for Shake-Up Yahoo chief Jerry Yang recently summarized a plan to turn the company around by becoming the start page for every Internet user across the globe. What Mr. Yang failed to provide, however, was a convincing solution to Yahoo's existential crisis. The Hamlet of the Web won't succeed by simply trying to become a start page. Yahoo is navigating the waters of Internet advertising like a goldfish evading a shark, in the form of Google. Activist investors ought to take heed -- Yahoo is ready for a shake-up. Yahoo, based in Sunnyvale, Calif., has many ingredients that make it a tantalizing target for uppity investors. There's a discredited management team, a corporate strategy in need of a makeover, stock-price underperformance, a large free float with no controlling shareholder, cash on the balance sheet and many moving parts whose values don't appear to be adequately reflected in the Yahoo share price -- particularly its investments in two hot Asian Internet firms. Reports: Yahoo mulling major layoffs

Businesses Still Not Rushing to Vista Many businesses still aren’t rushing to buy Vista. That’s what we’re taking away from Microsoft’s earnings statement and analyst call. While this probably won’t mean trouble for Microsoft, it raises questions for businesses trying to shape their long-term technology strategy. Businesses look like they’re waiting, which makes sense: Microsoft is releasing an updated version of Vista soon, and no one likes to start a big tech project near the holidays. How long will they wait? A Forrester report from November found that more companies were switching to XP, an older version Windows, than Vista. (In its analyst call, Microsoft said businesses continue to “add client products,” words that seem carefully chosen.) Only 32% of businesses will have switched to Vista by the end of 2008 and nearly 60% of companies won’t have upgraded by the end of 2010, according to Forrester. Here’s the thing: The longer businesses wait to upgrade, the closer they’ll get to the release of Microsoft’s next operating system, Windows 7, which will reportedly come out towards the end of next year. And then businesses will face a decision.

Motorola's Brown May Face Razr 2 Flop as Apple's Jobs Scores With IPhone Motorola Inc.'s Greg Brown, in his first earnings report as chief executive officer, may post disappointing sales of the Razr 2 phone after holiday shoppers flocked to Apple Inc.'s iPhone. Motorola probably sold 2 million Razr 2s, the slimmer camera phones Brown is relying on to revive revenue, in the fourth quarter, said Lawrence Harris, a former Oppenheimer & Co. analyst in New York. Steve Jobs's Apple may have sold 2.4 million iPhones. Harris estimated Motorola sold half as many Razr 2s over a similar period compared with the original model, whose 2004 debut started a craze for ever-thinner phones. Motorola, which fell to third place among global phone makers last year, may drop to fourth in 2008.

·         Motorola Profit Plunges, Loss Forecast as Customers Flee to Apple, Samsung Motorola Inc., the biggest U.S. mobile-phone maker, forecast an unexpected loss and said profit fell 84 percent last quarter as customers fled to Apple Inc. and Samsung Electronics Co. Motorola dropped 22 percent in New York trading. That's the biggest decline in almost seven years and puts the stock at its lowest since September 2003, when Chris Galvin was still running the company. Phone sales will drop ``significantly'' in the next three months after plunging 38 percent in the fourth quarter, Greg Brown said today in his first earnings call as chief executive officer. Motorola phones led by the Razr 2, the sequel to the best-selling model, have failed to lure consumers from Apple's iPhone, Samsung's Sync camera handset and Nokia Oyj devices.

Posted by dblwyo at 07:24 AM | Permalink | Comments (0)

The Wild Hunt, this week's whimsy if you will, is supposed to be a hunt across the heavens by eldrich hunters (Odin, ancient kings, etc.) after their prey of choice. Those who see them or hear their horns are supposed to be facing some catastrophe. While things aren't that bad nonetheless for week where a bear market bounce of 8-12% was expected and we got a whimper instead that strikes me as close enough. For a more modern take with a similar message we appeal to Non Sequitar.

Unfortunately, we likely don't have the the option of going back to jail and escaping the storm the Hunt's horns are warning about, to really mix up some metaphors. As you'd expect the basic economic and market news isn't particularly encouraging. And there was enough of it we put up three earlier posts to point to three major areas of concern as well indulge our alleged sense of humor a bit. One area we commented on was the scope and risks associted with buybacks whose conspicuous lack during the turmoil this week indicates how much excess there already was. Another was an extended discussion and assessment of what we thought of the fiscal stimulus package with a collected set of readings,coupled with a vidclip of Rick Santelli calling Jim Cramer on his new pretensions to have been a bear. Preceeded by a summary of our views on the three layers of conern with the economy. We also put up a couple of posts on re-thinking your investment strategy in a possibly very serious bear market which are worth careful thought.

In addition to all those we want to particularly draw your attention to to major "ripples" in the credit market pond that are potentially very serious. One is the potential failure of the bond insurance under-writers and the consequent further huge write-down of bonds on the books of banks. The estimates are that it would take at least $200Bn to re-capitalize these guys but there might be $Ts at risk. The other area where $Ts are at risk is back where it started in the housing market. As more and more mortgages go underwater it's more and more tempting for the holders to just walk away. Which would be a historical first and could lead to massive ($1T, $2T ??) writeoffs in the mortgage market and severely damage the financial system. While many are lamenting this increasing risk it strikes as "turn about being fair play" when so many of those holders shouldn't have been in those houses on these terms; and aside from their own bad judgement and greed, which were rampant, the fraudulant practices of the financial community were and are a major factor. Unfortunately the scope of the damage is such that we need to prevent all that from happening.

When you think of it like this though the picture we posted of partiers in a pool with a floating electrical extension to power the music is not just funny - it's actually a model of self-imposed and potentially self-destructive behavior that captures it all. At least IMHO. Listen - can you hear the sounds of horn ?

General & Special

5 rules for surviving a bear market Some key moves now will help you avoid the worst of this year's market. If the idea of selling low makes you cringe, think about how you'd feel when stocks dropped further. The signs are remarkably clear: A bear market in stocks is on its way, and it's time to bear-proof your portfolio as much as you can. There are five things you must do sooner rather than later -- call them five rules for dodging the worst of the bear -- to protect your portfolio before the bear claws an additional 20% out of your stocks. So what should you do if you agree with me that we're looking at a bear market in stocks? I've got five rules for dodging the worst of the bear.

• Where the bear will bite hardest Gone is the notion that red-hot markets in China and India can keep the global economy from cooling. Next, expect some bear rallies, but don't be fooled by them.
• Bottom Fishing vs Bouncing Bears

Rocks In Ponds, Morons In Pools, Bankers Building CDOs

Economy

Stage II Denial: Recession Downside Risks and Fracture Lines The other interesting set of stories from this a.m. are the ones where various economists are lowering their forecasts for '08; AND admitting that if/when Housing and the Credit Markets continue to weaken that they will expose a lot of fault lines in the economy that could fracture wide open. In some ways we're extremely glad that we've evolved in the last few weeks from "no problem" to the R-word though we'd like not to get as far as "OMG". Certainly the Goldilocks debate is over, we know it's a Cinderella economy and not we're really debating who's going to clean up the mess and how big a mess it'll be. That's actually an extremely important point. The mess is highly likely to be much bigger than anticipated so far though we're making progress on folks grasping that. And what we don't need is for some accidental trigger to tip us over. Just think - how long ago were people dancing on the Street about 5.9% GDP growth without examing it ? The seriousness with which this is being taken is all to the good

• Wachovia: Homeowners just Walking Away, Homeowners With Negative Equity, BofA: Attitudes Changing Towards Default, $1 Trillion in Mortgage Losses?

Cramer's Comeuppance vs Pump Priming Realities Well some more interesting news hot off the press, so-to-speak. One both amusing and  schadenfreudish but also informative. And the other a matter of both public policy and another reality check. The latter is the recent announcement that House leadership and the White House have reached an agreement to pass an economic stimulus package that's actually fairly sensible as well as astounding for its' speed. Though it still has to make it thru the Senate where further wrangling is all to likely. The former is Jim Cramer being called out by Rick Santelli on CNBC for now trying to sound like a Bear when in fact he was not only bullish for most of last year but stayed bullish weigh into the year. Some more readings are below. In one of them Larry Summers lays out the primary criteria for a tax stimulus: 1) quick, 2) targeted with the right instruments and 3) temporary. Another reading is a Brookings survey that takes a deeper dive but is nearly identical. So on that basis what do we think. Well...

Developing Economies Face Reckoning Today's global economic crunch was made in America. But despite hopes to the contrary, the pain will be shared by developing nations from Turkey to Thailand. Developing economies -- where 85% of the world's population lives -- are maturing and are far less fragile than they were a decade ago. But they aren't strong enough to escape the pain of a slowdown in the industrialized world or self-sufficient enough to hold up global growth on their own. Those realities were underscored this week, as stocks in China, India and other parts of developing Asia swooned amid fears of a global recession. Hong Kong's Hang Seng Index suffered its biggest point decline ever on Tuesday, and Indonesian shares dropped more than 7%. While many Asian markets rebounded strongly yesterday, worries persist that developing-world markets remain at risk to the gathering economic storm. Many emerging markets are reliant on exports to rich countries. And while local sources of economic growth, including consumer spending, have taken root in China and elsewhere, they aren't enough to keep developing countries from slowing if their export engines sputter.

• Seeking a soft landing Economists say Beijing's credit tightening may have crested as policymakers weigh up data showing their latest efforts are beginning to impact — just as worries mount for U.S.

The credit crunch sparked by problems with residential mortgages is spreading to the broader economy -- with banks making it harder and more expensive for some small and midsize businesses to borrow. While companies with strong balance sheets still can borrow what they need at good rates, others are beginning to feel the chill. In particular, start-up and smaller companies are finding that banks are setting higher rates, seeking more collateral or lending smaller amounts. This is the way it often unfolds when there is a squeeze on lending. The last significant credit crunch, which ran from about 1989 to 1992, began with a pullback on lending for commercial real estate that then spread to business lending. This time, the problems spread from residential real estate and are being felt by everyone from commercial orchid growers in Florida to makers of heavy machinery. Bank of America Says $230 Billion High-Yield Debt Backlog Isn't Shrinking

Corporate-bond defaults to rise More companies are expected to default on their bonds this year as developed economies slow and credit conditions remain tight, pressures that pushed two North American companies into bankruptcy this week and that promise to keep roiling financial markets, analysts said. In past years, aggressive private equity buyers and fairly lenient lending standards helped struggling corporations stay afloat, he said. Standard & Poor's on Tuesday forecast the default rate on speculative-grade bonds, commonly known as junk bonds, will rise to 3.4% this year - a big move up from last year's rate of 0.97%, which was a 25-year low. Last year only 22 defaults were recorded globally, the lowest default count in 11 years, said the rating agency.

Coal Shortage May Lift Steel Price Mining giant BHP Billiton said it won't be able to meet its commitments to ship Australian-mined coal used for steel, potentially putting further upward pressure on steel prices. The Anglo-Australian miner and its partner, Japan's Mitsubishi Corp., declared force majeure on coking coal shipments from Queensland mines, which essentially means that events outside its control have affected its ability to meet contract obligations. The mines, which have been hit by flooding, produced 58 million metric tons of coking coal last year, nearly half of Australian exports, according to Coal and Energy Price Report, an industry publication. Asian steelmakers are largely dependent on coal from Australia, the world's largest coking coal exporter, to make steel. The stoppage comes as steelmakers around the world have been raising their prices over the last year, including several in recent weeks, in an attempt to recoup high energy, raw material and shipping costs. In the last month, the price for hot-rolled steel, considered an industry benchmark, has increased 5% to $633 a metric ton. Analysts expect production to remain tight and prices to increase further this quarter. Many steelmakers have had some success passing on higher costs to customers, but that means higher steel prices for companies like auto makers and equipment manufacturers. Coal Rises Most in Three Weeks as Power Shortage Shuts South African Mines

Markets & Investing

Grantham Says Shun Stocks, Hold Cash to Ride Out Worst Market in 60 Years Jeremy Grantham, the money manager who oversees $157 billion as chairman of Grantham, Mayo, Van Otterloo & Co. LLC, said investors should shun stocks and hold cash during the worst financial crisis in more than 60 years. ``Don't be a hero. Move to cash and let the other guys fish around for the bargains in the wreckage,'' Grantham, 69, said today in an interview from his office in Boston. ``This is the most important U.S. financial crisis since World War II.'' Grantham said investors should hedge stock positions by selling short the Russell 2000 Index, which tracks the smallest U.S. companies. The Russell 2000 has declined 13 percent this year. In successful short sales, investors sell shares they have borrowed and buy them back at a lower price, pocketing the difference. Grantham said the financial crisis is likely to push the U.S. economy into a recession. Conditions are worse than the savings-and-loan crisis of the 1980s, when the failure of thrifts cost U.S. taxpayers more than $160 billion, he said.

ABN Amro Leads Bears on Stocks as MFS Says 10% Decline Is No Repeat of '03  The last time the Standard & Poor's 500 Index was at least 10 percent below its previous high, in 2003, the world's biggest stock investors were bullish. Not this time. Institutions handling $1.5 trillion, including Baring Asset Management's Andrew Cole, ABN Amro Asset Management's Joost van Leenders and MFS Investment Management's James Swanson, are holding or selling. They say stocks are riskier today than they were during that last correction in 2003, even though valuations are half as much. ``It's a much more dangerous game today,'' said Cole, 44, a fund manager who helps invest $48 billion at Baring in London. ``2008 is going to be a year of preservation of capital. We've got a lot of cash and we're not frightened to say so.''  Cole, whose firm favored shares over bonds or cash in 2003, said in an interview he's ``underweight'' equities this year because evidence of a U.S. recession is mounting. January's decline in the S&P 500, the benchmark for American equities, marked the worst start in the index's history. The Federal Reserve's three interest-rate cuts since September haven't encouraged stock investors about the prospects for the economy.

A logjam of debt commitments remains on banks' balance sheets. That could constrain other lending, including loans to companies with solid credit. Many on Wall Street hoped the new year would dislodge a pileup of debt commitments waiting to be moved off banks' ever-constrained balance sheets. But as February approaches, the logjam is still in place, likely sticking banks with more losses, while squelching lending, too. That could hurt companies with solid credit as well as those buyout loans needing refinancing. The banks now sit on $158 billion in leveraged loans in the U.S., which are credits with a high default risk, according to Standard & Poor's Corp. That pool includes private-equity deals valued at $88.25 billion that have been funded by the banks but not fully syndicated, according to data tracker Dealogic.

Societe Generale Says Rogue Trader at Bank Caused Record $7.2 Billion Loss Societe Generale SA said unauthorized bets on stock index futures by an unidentified employee caused a 4.9 billion-euro ($7.2 billion) trading loss, the largest in banking history. France's second-largest bank by market value plans to raise 5.5 billion euros from investors after the trading loss and subprime-related writedowns depleted capital, the Paris-based company said today. The Bank of France, the country's banking regulator, said it's investigating the situation.  The trading shortfall exceeds the $6.6 billion Amaranth Advisors LLC lost in 2006, and is more than four times the $1.4 billion of losses by Nick Leeson that brought down Barings Plc in 1995. An offer by Chairman Daniel Bouton to resign after the trades were discovered this past weekend was refused by Societe Generale's board, the bank said. The trading loss from European stock index futures wipes out almost two years of pretax profit at Societe Generale's investment-banking unit, run by Jean-Pierre Mustier. The company is suing the trader, who had a salary and bonus of less than 100,000 euros a year and worked at the bank since 2000.

Mortgage bond insurers 'need $200bn boost' America's biggest mortgage bond insurers collectively need a $200 billion (£101 billion) capital injection if they are to maintain their key AAA credit ratings, a figure that dwarfs a plan by New York regulators to put together a capital infusion of up to $15 billion, a leading ratings expert said yesterday. The failure to maintain their AAA ratings will lead to a further round of multibillion-dollar writedowns among the Wall Street banks and other large owners of the bonds... It would also push some of them into receivership… Because it raises the possibility that an insurer may not meet its commitment, loss of its AAA credit rating cuts the value of the bonds it insures. A ratings downgrade also makes it harder for an insurer to write new business, as the market loses confidence in it. Furthermore, many bond investors require that their debt holdings be underwritten by a AAA-rated insurer. Banks May Need to Raise $143 Billion for Insurer Downgrades, Barclays Says

Posted by dblwyo at 11:19 AM | Permalink | Comments (0)

Earlier today a friend commenting on some of the shennanigans in the credit markets had this to say:

What has also been emerging over the last few days that is bewildering, to the point of being scarey, to me, is that, after all this time, the financial institutions still don’t seem to have a good handle on their exposure.  If we have no clear idea of the exposure, then the solution to the problem borders on poke-and-hope.

It should be and more so. Earlier I'd posted on my "rocks in the pond model" plus perverse incentives. And as I argued at the time it's spreading to other asset classes, e.g. corporate debt. The problem is that this paper isn't priceable and as things like bond insurer defaults close in then a lot of the remainder ends up having to be written down further.

 His comment's in bold and my reply is below. Earlier we'd gone thru a couple of posts on the topic of the broadening of the credit market breakdowns into other assets classes and the resulting ripples. And the contagion being spread because of the perverse incentives that went into into consturcting structured debt instruments. All of which you can review as you like in this archive library: CreditMarkets . We won't list all the previous posts and readings but there were a few, or more than. Instead we'd like to present an alternative model of how our august financial institutions have approached things like Risk Management, Structured Debt and good business practice and so forth. In fact maybe we should mention just plain 'ol common sense ? Instead let's summarize things pictorially !

Posted by dblwyo at 01:59 PM | Permalink | Comments (0)

Well some more interesting news hot off the press, so-to-speak. One both amusing and  schadenfreudish but also informative. And the other a matter of both public policy and another reality check. The latter is the recent announcement that House leadership and the White House have reached an agreement to pass an economic stimulus package that's actually fairly sensible as well as astounding for its' speed. Though it still has to make it thru the Senate where further wrangling is all to likely. The former is Jim Cramer being called out by Rick Santelli on CNBC for now trying to sound like a Bear when in fact he was not only bullish for most of last year but stayed bullish weigh into the year. And may we mention his approach ? As in these people know nothing - the famous rant from last Summer. Various flavors of video clips are making the rounds but here's one (hattip...) courtsey of BigPicture. So, first, watch the video. What an amazing world we live in, eh ? This composite was put together in response to this one where Chris Matthews and Cramer are agreeing on how much trouble we're in and how stupid fiscal stimulus is. Probably ought to spend the few minutes needed to watch this one as well. Cramer's calming, his points about the failures of the mortgage insurers are very good and, IMHO, suggest a reasonable policy reponse. And the discussion of fiscal policy totally wrong-headed.

For a little perspective try this post from Greg Maniw's blog quoting, of all folks, Paul Krugman in "Peddling Prosperity" (btw - Greg has recommended/used this is in class and it's as good an intro to macroeconomics that's still relevent today, right now, as any there is. Even my "I hate macroecon" friend likes it :) ). "a strategy of desperation". Some more readings are below.

In one of them Larry Summers lays out the primary criteria for a tax stimulus: 1) quick, 2) targeted with the right instruments and 3) temporary. Another reading is a Brookings survey that takes a deeper dive but is nearly identical. So on that basis what do we think. Well...

1. The tax rebates meet all these tests and are about as clever as can be. We'll see what survives in the Senate. This is highly likely to help. A couple of things to bear in mind. Fiscal stimulus can be quicker than interest rate changes but they complement one another as rate decreases have a powerful but lagging effect. But Fed policy can change nearly instantaneously while the political process is prone to lags and partisanship that result if ideological initiatives instead of sensible ones.

2. The business tax cuts are just such a shibboleth. Businesses hire and spend based on anticipation of future demand. This provision is unlikely to have much benefit. On the other hand if it sped compromise we live in a world of political realities, it's not likely to do much harm. And if the Senate adds on provisions for extending unemployment benefits, fuel subsidies, et.al. that'd be all to the good as adders since they'll take a long time to work thru the system. No harm, no foul.

3. The extension of conforming loan limits from ~$400K to over $600K is somewhat similar as those prices apply in only the major over-priced, over-defrauded and most vulnerable areas, e.g. CA. home Speaker Pelosi. Hm.... They would be dangerous if they caused a return to the bad practices of the past but as it is Housing's headed for aggregate 30% prices decreases, credit is tight, the proportion of stupid mistakes and bad business practices should be largely filterred by Darwinian consequences. If anything it occurs to me, they might actually help smooth and speed up the adjustment process in the stickiest markets. We'll see. Maybe no harm, no foul.

Meanwhile we stand by our immediate prior three posts which might be worth reviewing. Let me conclude with my comment on BigPicture just to a) avoid the re-typing :) and b) go on more record:

Thanks for posting this. Notice that Wesbury was one of Cramer's co-discussants on several clips - how appropriate. Let's hear it for schadenfreude. Do you suppose someone might do a similar composite clip of Mr. Kudlow ? Hmmm...I wonder who could be set opposite him.

Thing that keeps making me shake my head in wonder is that as late as Oct. Cramer and many others were still bullish. Well enjoy the bear market bounce, sell into it and start lining up your inverse bets.

BtW this stimulus package will help insofar as direct payments to consumers go but the tax cuts for business are ideological unsinn and the jumbo extension is a) applicable to a small section of the market and b) won't change the fundamental shift in housing credit nor buying, at least IMHO. But the fundamental problems in the economy are going to be with us for a while. What this does is mitigate the damage and keep it from fracturing all the numerous fault lines that are exposed.

So, bottomlines, enjoy the bouncing bear, use it to re-position your investments, hope that the combination of fiscal and monetary stimulus mitigates the downside and reduces the fault-line exposures and start doing your research for the opportunities that will emerge on the other side of the carnage.

This is the must-read paper, or least must-skim, though it's 30 pp. it's also straight-forward, simple, in English, balanced and fair.

If, When, How: A Primer on Fiscal Stimulus:In considering fiscal policy at this juncture,policymakers
need to answer several questions. Is fiscal stimulus needed? When should such stimulus be provided? And what would constitute effective fiscal stimulus? These questions are not merely technical. The livelihoods and living standards of many Americans are at stake. Fortunately,
economic research provides clear theory and evidence for making appropriate decisions about if, when, and how to craft fiscal stimulus. This paper summarizes the evidence and provides straightforward principles and examples for formulating effective stimulus.

• Two excellent pieces by Larry Summers that kick-started the initiatiave are: 

  Why America must have a fiscal stimulus

  How should the US economy be rescued?

• And least you think support is all one-sided try this from Martin Feldstein saying essentially the same thing: Father of Bush tax cuts: Recession likely

•  And finally Prof. Mankiw's take, which is not inconsistent with the others at all:
• Proposed Fiscal Stimulus: My View I am personally skeptical that the economic weakness is sufficient at this point to justify such a package. Yesterday CBO came out with its forecast, including "growth for the year as a whole of under 2 percent and an increase in the unemployment rate to an average of 5.1 percent." That is similar to the current predictions of some of the best private forecasters, who put near-term growth between 1 and 2 percent. In this environment, I would prefer to rely on monetary policy as the main source of macroeconomic stimulus. If there were a stronger case for a short-run demand-oriented fiscal stimulus, I would view the compromise package announced today as reasonable. But given where the economy is right now and the best forecasts of where it is heading, the fiscal package seems unnecessary as a short-run measure, while in the long run adding to the debt burden without doing anything to improve incentives for economic growth.

Plan to Jolt the Economy Congress and the White House hammered out an economic stimulus package that would put $150 billion into the hands of consumers and businesses while seeking to revive the market for large mortgages. It was a rare display of compromise and speed in a city known recently for partisan gridlock. Both parties were responding to middle-class economic fears, as election-year nerves are frayed by a seesawing stock market, a wave of home foreclosures and a credit crunch. "I can't say that I'm totally pleased with the package, but I do know that it will help stimulate the economy," said House Speaker Nancy Pelosi. Economists said the measures, coming as the risk of a downturn rises, could boost growth this year by between three-quarters of a percentage point and a full point.

Senate Pressured to OK Stimulus Deal A much-anticipated deal between the White House and once-warring House leaders to speed tax rebate checks to workers starting in May has the Senate in a bind over whether to try to add to the measure. Few public developments were expected Friday as lawmakers digest Thursday's announcement of a hard-won agreement between House Speaker Nancy Pelosi, Republican leader John Boehner and Treasury Secretary Henry Paulson that would pump about $150 billion into the economy this year and perhaps stave off the first recession since 2001. The Senate very often wins its battles with the House. But now, with the power of the Bush administration behind them, House leaders are optimistic that their simply drawn measure -- providing rebate checks to 117 million families and $50 billion in incentives for businesses to invest in new plants and equipment -- would prevent the Senate from making significant changes such as extending unemployment benefits. Under the agreement announced by the White House, Boehner and Pelosi, individual taxpayers would get up to $600 in rebates, working couples $1,200 and those with children an additional $300 per child. In a key concession to Democrats, 35 million families who make at least $3,000 but don't pay taxes would get $300 rebates. The bill will go straight to the House floor next week and on to the Senate, where Democrats such as Edward Kennedy of Massachusetts promise to try to add elements such as extending unemployment benefits for workers whose benefits have run out, boost home heating subsidies and raise food stamp benefits.

Prior Posts:

1. Stage II Denial: Recession Downside Risks and Fracture Lines

2. Buybacks, Bounces and Splats: Buying High, Selling Low

3. Bottom Fishing vs Bouncing Bears

Posted by dblwyo at 07:58 AM | Permalink | Comments (0)

The other interesting set of stories from this a.m. are the ones where various economists are lowering their forecasts for '08; AND admitting that if/when Housing and the Credit Markets continue to weaken that they will expose a lot of fault lines in the economy that could fracture wide open. In some ways we're extremely glad that we've evolved in the last few weeks from "no problem" to the R-word though we'd like not to get as far as "OMG". Certainly the Goldilocks debate is over, we know it's a Cinderella economy and now we're really debating who's going to clean up the mess and how big a mess it'll be. That's actually an extremely important point.

The mess is highly likely to be much bigger than anticipated so far though we're making progress on folks grasping that. And what we don't need is for some accidental trigger to tip us over. Just think - how long ago were people dancing on the Street about 5.9% GDP growth without examing it ? The seriousness with which this is being taken is all to the good. And we certainly don't need a sudden market jolt to be the tipping factor; hence the Fed's emergency intervention was a heck of a good brake. But you need to ask would the Fed have moved so fast and hard if things weren't a lot weaker than anticipated ? Would the political mainstream be moving equally as hard on a stimulus package if they didn't see the same thing ? When Summers and Feldstein both tell us it's time to do something that's about as clear a warning bell as anybody should need.

The catch is that, IMHO, the nature of the situation is only slowly dawning. So let's review the argument as we've developed it here over several months. Along with this morning's clippings some excerpts from those prior posts are also below the line.

1. Business Cycle - the economy is a complex cycle where consumer demand leads to business hiring and investment to meet future demand. Both consumer and business spending can be leveraged up by borrowing, etc. The feedback runs in reverse however.

• This has been an abnormal post-war cycle because it's the aftermath of the bust from an investment-led boom instead of the normal consumer-driven cycle. In attempts to forestall a major deflation (yes, that's a D-word) policy kept consumer demand from dropping as far as it would normally.
• This has been the lowest job creating cycle post-war, which means that consumer demand wasn't based on job or wage growth but rather on borrowing against assets, largely houses. In the meantime net net on jobs we're still 2.5 million below keeping up with growth which explains the "malaise" of consumers since the "recovery" began.
• In avoiding a catatrophic downside two associated bubble in housing and credit were created.
• Growth has been visbilty slowing since mid-'06 from our charts because it was based on external stimulus rather than internally generated factors; i.e. it hasn't bridged from pump-priming to organic.

2. That's the top layer of the economic situation. What is likely to exacerbate all this is that the Housing and Credit bubbles have a long way to go to finish unwinding. Again something that's been visible in the data and the charts for quite a while now but has only recently been accepted into broader mainstream thinking. However the extent of the unwinding is much bigger than is being grasped so far. Which means more fault lines are likely to be exposed, weakened and fractured in the months ahead. [UPDATE: Median Home Prices Post First Decline in 40 Years]

3.  The bottom layer is that financial institutions, consumers and businesses are very fragile because of the magnitude of debt on their respective balance sheets and the leverage used to put it there, in one form or another. This creates yet another major fault line that as the stresses grow will be increasingly exposed.

Now we may still get thru all this and if so it'll be a combination of the inherent resiliance of the US economy. And skilled, prompt and forceful policy actions. But it's really been since 1980 or earlier that this many fault lines have been this exposed. Very few people have any experience with the kind of downturn we are at risk of facing. Though our policy makers, and increasingly some of the informed commentators, seem to have an awareness. The purpose of reading history is to learn from other people's experiences. Unfortuantely that doesn't happen as often as we'd like and we all get wise based on our own painful confrontations with reality.

But, to repeat an old riff (or metaphor or whatever) denying reality won't make it go away.

READINGS 

U.S. 2008 Growth Forecast Cut in Half by Merrill Merrill Lynch & Co. cut its 2008 U.S. economic growth forecast in half, saying the country's housing recession has ``spilled over to the rest of the economy.'' The gross domestic product will expand 0.8 percent this year, down from an earlier forecast of 1.6 percent. They estimated the U.S. economy, the world's largest, will grow 1 percent in 2009. The report didn't mention yesterday's unexpected 75 basis point interest rate cut by the Federal Reserve, the first emergency reduction since 2001. The economists wrote that they expected the Fed would start cutting rates ``much more aggressively.'' ``Rising unemployment, $6 trillion in lost housing wealth combined with slumping equity valuations, and the lack of participation from the baby boomers for the first time in three decades likely will result in the worst consumer recession since 1980,'' the economists wrote. ```The healing process takes time as the bad debts get extinguished and balance sheets repaired.''

·         Philly Fed State Coincident Indexes The Federal Reserve Bank of Philadelphia produces a monthly coincident index for each of the 50 states. The indexes are released a few days after the Bureau of Labor Statistics (BLS) releases the employment data for the states.

·         Housing prices to free fall in 2008 - Merrill The worst housing financial crisis in decades is only going to get worse, a Merrill Lynch report said Wednesday. The investment bank forecasted a 15 percent drop in housing prices in 2008 and a further 10 percent drop in 2009, with even more depreciation likely in 2010.By contrast, the National Association of Realtors (NAR) expects housing prices to remain flat in 2008. NAR did cut its home price estimate for the current quarter, however, to a 5.3 percent year-over-year decline, which represents the steepest drop in that price measure on record. But NAR sees an uptick in home prices in the last two quarters of 2008.

·         Recession 2008: How bad it can get The sputtering U.S. economy has gotten everyone from the financial markets to the Federal Reserve to Congress in a panic. But here's a disheartening message for those already worried about economic growth -- it could get much worse. Most economists who believe a recession is already here or at least near are looking for a relatively short and mild downturn, perhaps lasting only two or three quarters. But many of those same economists say they also can envision a worst-case scenario where spending by consumers and businesses falls off sharply, unemployment heads higher than normal during a typical recession and housing and credit market problems worsen.

Weigh the World Works: Understanding the Business Cycle

Well this morning's headlines on durables goods orders and new orders have, along with the geo-political news from Pakistan, sent the markets back down. It may not be entirely clear why this is important let alone how it should be interpreted and applied. Since it's coming onto the end of the year it struck me as a good time to review the nature and structure of the business cycle and what some answers might be to all those questions.

Specifically we'll look at four things:

1. The Nature of Business Cycles
2. The Time-structure and Phasing of the Cycle
3. GDP and Consumption
4. Investment and Acceleration

We also end up with a few recommended readings if you'd like to dig into things a little more on your own. If nothing else think of them as candidates for "putting-you-to-sleep" books :) ! The first thing we'll start with is the linkages in the business cycle and what drives what - which ultimately tells you what data is important and what to look for. Digging in the patterns and structures will help out with getting the interpretations of headlines done a little better as well. We like to think of the business cycle as the "Great Circle (Economic) of Life" [Media file]. Also consider the metaphor which is really more like a model of how everything x-links, interacts and feedsback. Which takes us to the diagram. Oddly enough business cycles aren't as much talked about in your college econ classes though everybody recognizes them and applied economists deal with them all the time. Part of the problem is that modeling them turns out to be very difficult. So we end up with our best pass that's nonetheless consistent with both business and economic theory discussions (readings below).

WtW Part Deux: Patterns, Cycles & Indicators

The prior post laid out the "Weigh the World Works (WtW)"  by putting up a model of the business cycle, it's general time patterns and referenced some background readings along with some prior posts that illustrate the applications. We'd like to continue that line of investigation here by addressing the last of the four key questions. The first on Consumption and the second on Investment. As you probably know Consumption is approximately 70% of the US economy, though far lower a portion of other developed economies and far...far lower of the major developing economies. Investment, taken all together, has run about 14% of the US economy. The engine therefore that drives the economy is consumer spending while investment is the super-charger that acclerates it. That is if businesses anticipate a need for additional capacity thru capital spending and hiring. These in turn feedback on consumer spending by increasing Employment and Wages and so on. Of course that means that the feedback loop can run in reverse just as well. That's why everyone should be so concerned about how well Consumption, Investment, Employment and Real Wages hold up. It also explains why the ability of consumers to sustain their spending thru MEW resulted in a very abnormal spending pattern where Consumption has held up much better than post-WW2 experience would have suggested.

WRFest 11Nov07: Paging Cinderella..Your Coach is Here(Economy)

Speaking of fundamentals it doesn't get more so than economic trends. For the last several months it's been Goldilocks 2.0, as treated by Dr. Ben Pangloss, but it's beginning to look as if it was still Cinderella's economy, the clock is closer to midnight and the pages have announced her carriage. Some of the evolving trends have been visible for some time now, despite the recent quarterly numbers - which were not anywhere near as good as the headlines would have had, as usual.(So, Dearie, What Time IS It, Anyway ?,Reality Checks: the Latest GDP Report and Outlack ?,QR Mary: a Little High-Frequency Data and the Outlook).

Posted by dblwyo at 08:13 AM | Permalink | Comments (0)

Rather than wait for the weekend Readfest posting there are a couple of sets of interesting stories you ought to be reading now and thinking about heading into the weekend, next week and for the duration. The duration of what you may ask ? Well that's the question - the duration of the current unpleasantness of course. It's apparantly really beginning to dawn on the MSM though not widely that all the pressures for stock buybacks have resulted in attempting to prop up company stock prices have resulted in paying top prices and now, re-financing and re-capitalizing, at lower prices. Though some, including us have been beating that drum for quite a while now.

• UPDATE: The WSJ chimes in (bigger excerpt below): Investors can usually count on share buybacks to help stabilize a stumbling market, but it's not happening this time around.
  

Below are seveal readings we've either recently collected and/or gone back and put here on the role of buybacks. Three things greatly.......many g's puzzle us:

1. This has largely resulted, aside from the minor detail of perverse executive incentive programs that cause them to prop up the price while damaging the company, from hedge fund and buyout firm activism. Yet the capital that, for example, the banks squandered over the last several years is now desperately needed to offset what's likely to be continuing massive writedowns. In other words given their supposed financial acumen they put all these pressures on management to do a stupid thing if they understood how the deep structures were playing out. They're going to get hurt as badly as anyone because the cash they could have had in dividends or protecting their investments is gone...gone...gone. So instead of re-deploying it, or putting it under the mattress, it'll never be seen again.
2. As part of this buyback effort not only has "excess" free cash flow been used but many companies have re-leveraged their balance sheets and are much more exposed to the pressures and perils of a downturn than they would be normally. In other words businesses are a lot more fragile than they should be, AND nobody is anticipating this in their outlooks as yet.
3. Denial - while some commentary is appearing the necessary simple analysis combined with the facing of the facts hasn't really started. We've used the Kubler-Ross "Stages of "Denial" analogy several times but this looks like yet another case. The lesson for you is that whatever you read reflects only partial reality, so far.

Business, Buybacks and Fragilities

How banks frittered away billions When you take out your calculator, you see that these firms - Citigroup Merrill Lynch Morgan Stanley and UBS  - have frittered away billions of dollars by selling their stock for much less than they paid for it. The biggest losers in the buy-high, sell-low game are shareholders of Citi, which had raised a total of $20 billion in two deals when Fortune went to press and was looking to raise more. First, that capital is precious when you need it - and you're never sure when you're going to need it, so you'd best keep plenty around. Second, that stock buybacks aren't necessarily good for shareholders, current conventional Street wisdom notwithstanding. The theory, promoted by "activist" shareholders and practiced by my employer, Time Warner, among others, is that buying back lots of stock enhances shareholder value. But as these cases show, buybacks can also erode shareholder value.

The Great Private Equity Cash Robbery of 2007 Well, as far as NotMakingThisUp is concerned, the most obvious thing missing in all of yesterday’s headlines was this: no share buybacks were announced by any major company before, during or after the brief morning sell-off. During the panic of October 1987, grey-beards will recall, the tape was clogged not only with headlines of trading-halts amidst the worldwide rush to sell, but also with a steady stream of share buyback announcements by U.S. companies. Coke, P&G and many others that week and in weeks subsequent to the Crash of ’87 used the substantial cash on their balance sheets to take advantage of the market dislocations that caused even the good stocks to be sold with the bad, and cannily bought their own stock back at deep discounts to its inherent worth. Could it be that the Great Private Equity Cash Robbery of 2007, in which previously healthy companies either “cleared” their balance sheets of cash—to use the euphemism employed by Steve Odlund, the Chief Cash Clearer at Office Depot—by buying back their own stock at bull-market peaks or faced the prospect of having it cleared for them by the Private Equity Cash Robbers?

Investors can usually count on share buybacks to help stabilize a stumbling market, but it's not happening this time around. Many companies bought back shares in recent years, leaving them with less ability to jump back in now. This time around, there are even higher hopes for such repurchases, given that the stock-market rout has made prices cheaper and falling interest rates make it less expensive to borrow money to buy stocks. But most companies aren't biting. Many bought back shares in recent years when they were much more expensive, leaving them with less ability and leeway with their investors to jump back in now.Investment bankers say executives are wary of committing to big, new share repurchases, in part because there is so much confusion about the outlook for the global economy both in the near term and long term. "When we were in a period when capital was plentiful and cheap, it's one thing, but now there are constraints on capital and a reassessment of operating strategies and the use of capital." For the past three years, share buybacks were the rage as low interest rates enticed companies to borrow money to buy back shares, a move that helps increase per-share earnings. Stock repurchases by S&P 500 companies amounted to $586 billion last year, more than double the amount of dividend payouts…

Market Drivers 3 (Buybacks):Investment, Hiring, Nah...Bonus, Bonus, Bonus !

 This started out to be a straight-forward post on the shift from an economically driven market environment to a financially driven one. It's important - and is widely recognized if not diagnosed and analyzed - that "liquidity" is behind a lot of what's been going on. It's turned into a three part set looking at the markets & the economics of liquidity (here ) and on the role of credit and leverage (here). The third leg of the stool that's pumping lots of cash into stocks AND pulling large/huge amounts of stock off the market is corporate buybacks using all that excess case from profits that aren't going into capital spending or hiring. Or dividends for that matter (personally I'd rather get the money back and decide for myself). Just to put it all in perspective, and maybe confirm that indeed things are a little unusual, take a look at the Fed data on "net equity issuance". It looks to me as if it started the '90s in neutral, grew slightly negatively until '98 (from stock options at technology firms ?) and turned back toward neutral. And then started sharply downward in '04 just about the same time the LBO buyout was coindicidently turning sharply upward.

WRFest 30Dec07(Business): Fragilities, Exposures & Soundness If it's not clear at this point we think the economy is slowing and seriously exposed to sudden & sharp disruptions as Housing and the Credit crisis worsen and it becomes more fragile. We also think that the Markets still haven't grasped this nor, definitely, is it reflected in pricing, earnings outlooks or valuations. Even on current course and speed with no major disruptions there's some serious re-thinking that needs to happen, at least IMHO. But if you start looking now and understand what's going on then there are going to be industries and enterprises that weather this storm, if not with style and grace. Finding them will be the trick and the trick to the trick starts with understanding the deeper structural fragilities that have been created by non-organic earnings and liquidity-driven buybacks. Well as is becoming a practice Paul Kasriel has already done the heavy lifting so we'll let his comments and charts speak for us. Here's the key point - on a macro level buybacks, real declines in profits and increased leverage indicate that business enterprises are very exposed to shocks if/when they come. In other words a hurricane will breach the dike and it'll take a well-founded company to manage the floods :). So pay careful attention to Paul's words and charts - think about 'em, 'cause they could be incredibly important.

Rocks, Ponds, Perverse Incentives: More on Credit Contagion

O.K. it's time to answer the question - while waxing eloquent about the credit crisis somebody asked the classic one - "what other asset classes ?". What I think they really meant was what in the bleep are you talking about. Well at the time a quick and dirty reply was ripped off that turned into a longish, well alright maybe more than that, comment on the credit crisis. That comment though was based on a multiple set of accumulated readings plus a little "model" of how the credit crisis is operating that's built up in my head and the occasional chart (previously put up here a couple of months ago ?). So earlier today we reviewed the bidding - to wit some selected readings and resources on the history, structure and nature of the evovling credit problems (here) and a deeper dive on the "rocks in the pond" credit contagtion model (here) which are the background to the reply.

Market Takes: the Stages of Denial

Belatedly this is the post that should have gone up earlier this week or over the weekend but time flies. The charts are thru the end of last week and are still valuable, and the points I want to make still accurate; perhaps more so in some ways. The goal here is to look at the recent market turmoil in light of both economic and financial realities (where the current state of the economy is discussed in Praise Be, the Data Has Saved Us (NOT): New Homes & Orders and financial conditions & Fed policy in  Schadenfreude, Oh Schadenfreude: the Fed vs the Whingers ) Just to keep things in perspective instead of putting up the short-term ("trading") chart first we'll start with the longer-term ("investment") chart. With the side comment that it continues to amaze me how prior to mid-July all was right with the world of Goldilocks and now all the mainstream economists are beginning to accept the slowdown that folks like Kasriel and Roubini have been talking about for months and has been visibile in our charts for a long...long time. The reference to read is either the psycholgy/typology of denial, Denial , or the stages of denial, Kübler-Ross model , where we are arguably still locked into the first stage. Admittedly I'm amusing myself, and hopefully my readers, but there's real merit to the point. What we'll find when we look at the long-time chart of the S&P over the last four years is that, despite relatively weak real economic growth and very poor net job creation, is that the market boom's uptrend has basically not been beached - excuse me, another F-slip. I mean breached. And in the short-run the market appears to be struggling to convince itself that not only is denial correct but the diagnosis is completely wrong, i.e. the post Shanghai-Surprise mini-bubble is entirely correct. In fact various talking heads on bubblevision are arguing that with appropriate selection of strong, defensive sectors, or those with good int'l exposure and good, blue-chip companies that we're in a trading range and one should judisciosly pick from your shopping list at bottoms.

Posted by dblwyo at 07:47 AM | Permalink | Comments (0)

In the spirit of inter-spersing some realtime comments and interesting stories we're going to point to today's appearance by Barry Ritholz of BigPicture on CNBC as well as another story by Jim Jubak. It's a tribute to how big a shock to the system the recent worldwide implosions are and what the likely impacts will be that JJ put up another story so quickly, off-schedule. First, here......'s Barry:

Wheres the Bottom? Looking for the bottom, with Barry Ritholtz, Fusion IQ; Jack Ablin, Harris Private Bank; CNBCs Bob Pisani and Dylan Ratigan

And now for Mr. Jubak's take:

• It will shift the harshest bear market action from the U.S. to overseas markets, as overseas investors discover that their economies are slowing, too.

• It raises the odds of a "bear market rally" in the not-too-distant future. Such a rally would leave the bear market intact and end in another painful market downturn.

• And though the death of this myth is essential to finding the bottom in the current bear market, the final end of the bear still depends on a recovery in the U.S. financial and housing sectors, which now looks unlikely until early 2009.

The danger of slowing economic growth is a months-old story to U.S. investors -- one reason that the major U.S. market indexes are currently flirting with the 20% loss that defines a bear market. But it's something new for investors in overseas markets, many of whom thought that those economies would be immune to a U.S. recession.

We added the emphasis - and the translation is, watch out below.... ! (:<

Notice BtW that both JJ and Barry are both looking for a bounce and both warning it's not gonna be the bottom. An opinion we share big time. Think of it as a selling opportunity to move into shorter-term and more liquid investments (Ritholz mentions in passing that his funds are 40-50% in cash right now ! Now THAT's a hint) 

Posted by dblwyo at 01:47 PM | Permalink | Comments (0)

This should be the last post for last week's stories and links. The primary focus is on traditional industries and companies. Continuing our theme of digging into enterprise performance are several key readings. Let's kick it off with a great story that, IMHO, encapsulates a lot of our notion of speak softly, run a good business, execute well now and lay the groundwork for the future at the same time.

Green Bay's Quiet Football Mastermind Before this season, fans were calling for Mr. Thompson's head. While the Packers had won just 12 of their last 32 games, he did not seem to care. No matter how loudly the fans complained, Mr. Thompson, who avoids publicity and rarely explains himself, continued sending away popular veterans and replacing them with untested college players, some of whom weren't highly regarded by other NFL teams. This year, led by a core of players that helped make Mr. Thompson a pariah, the Packers won 13 games and made the playoffs. What's more, the players he's brought into the league during his career are having an exceptional year -- as the playoffs resume Saturday, nearly 10% of the active players on the remaining eight teams were signed out of college by Mr. Thompson. While pro football is the nation's most popular sport, the brutal economic structure of the league -- where all 32 teams are effectively given the same resources -- has made winning and losing largely a function of management. Winning not only requires ruthless cost control, but it also seems to reward people who are able to make decisions in a hermetically sealed chamber without worrying about what the fans, the media or their own players will think. "I try to keep my eye on the ball, so to speak," Mr. Thompson says.

In addition there are some general business readings: one of those "smart" companies that moved ahead of the slowdown and are well positioned to ride it out and take advantage of the recovery if/when it comes. How many can say that ? Not many. A good example is what's going on in Retail specifically and the broader function of Customer Service - a major source of competitive differentiation that's little developed, invested in or exploited. The MSN article points to some earlier customer service stories you ought to backtrack, particularly since they point to Comcast, Sprint, ATT, et.al. as being terrible at it. Both for its' own sake but also because it's exemplary is the story further dissecting the mis-steps at Sears which are based on wrong-headed views of how to run a retailer. 

We also point to our own earlier posts on the SEEchanges coming in the Innovation(Tech) and Finance industries. Complemented by more readings on the Auto industry, Energy,  and Airlines.

General Business

Moving Ahead of a Slowdown A look how some companies prepared for an economic slowdown. As U.S. jobless claims rise, manufacturing activity declines and consumer spending skids, many executives are beginning to acknowledge that the economy is slowing. But others, like Mr. Zollars, caught cooling signs early and have already trimmed labor costs and inventory levels and made other adjustments. "The best-performing companies plan in advance -- or at least ahead of many of their rivals -- for slowdowns," says Michael Mankins, a partner and consultant at Bain, which has studied which companies best weathered the last downturn in 2001 and why. "They take a bet early on which way the economy is going and quickly identify which costs they can manage aggressively and where they should use cost savings to fund new growth," he says.

'Not my department' costs stores dearly Half of all shoppers encounter 'multiple problems' on typical visits to stores, according to researchers, who found that nothing aggravates like shoddy customer service.  A salesperson with a bad attitude, or one who is not around, may drive shoppers away and ultimately hurt a company's revenue, according to a survey presented this week.Encountering problems while shopping is extremely common -- on average half of shoppers polled encounter multiple problems on any given shopping trip, …Problems at brick-and-mortar stores can lead to a significant decline in a customer's perception of a company, according to the survey of 2,200 U.S. and Canadian …While store-based problems such as parking can present an annoyance, "the problems that matter most and degrade loyalty the most are with salespeople," said Courtney. Common issues with salespeople include having a "that's not my department" attitude or not being around at all, being too aggressive and being insensitive to long checkout lines. On the other hand, if salespeople seem authentic and knowledgeable about the products they are selling, they can create an experience that consumers will remember and make it more likely they will return to the store, Courtney said.

The Marriage From Hell Why Eddie Lampert's failing Sears-Kmart experiment could mean trouble for dealmakers everywhere . For years, money managers like Lampert have been in the ascendancy, taking over all sorts of companies with the idea that they can manage them better or flip them for a quick profit. Financiers are now running some of the most storied names in American business. Mostly, private equity firms have been taking over companies through buyouts. But Lampert-style activist investing has also been in vogue, reenergizing people like Carl Icahn and Nelson Peltz, who champion their strategies for companies and sometimes make takeover bids or grab seats on the board. Many of these financiers insist they are in it for the long term. But in truth, they didn’t have to be. Returns came easily. Companies could be flipped back to the public or another buyer in short order, generating huge gains. But now those tricks are played out. Financial markets have seized up. Cheap financing isn’t available. For the first time, financiers are being forced—gasp—to manage their companies. They have claimed to have expertise in doing this very thing; now they have to prove it. And if Lampert’s experience is any gauge, the challenge is going to be tougher than any of them expect. This year, the cost cutting and slashing of capital spending caught up with Lampert. Net income at the company cratered, dropping 99 percent in the third quarter to $2 million. Sales at stores open a year or more, a key measure of retail performance, have continued to drop at both Sears and Kmart. And in the all-important holiday shopping season, things probably worsened. Sears stock fell nearly 40 percent in 2007. Why Sears Must Engineer Its Own Makeover, Sears Will Reorganize Into Separate Operating Units to Stem Profit Decline

Industries & Companies

WRFest 20Jan08(FinInd): Re-thinking, Re-Thinking, Re-Thinking ? One could argue that any shift of resources into newer sectors helpe the overall economy become more efficient - in the case of the Finance Industry by helping to raise and create capital and more efficiently allocate it. The question we were asking that led to the comment was whether or not the shift of resources into the Finance Industry had gone too far and our implied answer was "hell yes".

WRFest 20Jan08(Tech Bizz): Times They are Changing A constant theme we've been playing is the need to understand the drivers and characteristics of enterprise performance, which argument has been mightily reinforced these last few weeks. Not to mention these last few days. While all this sturm und drang is going on there are some major deep changes happening in the innovation-based industries. Which notion is itself a major one. Notice we didn't just say technology industries ! Innovation is something that all firms should be doing, most don't and will become increasingly important as a foundation for survival. But the innovation-based industries are the ones where product development in fact drives the whole rest of the firm.

Energy downgrades weigh on sector Analysts at Lehman Brothers, Oppenheimer and Morgan Stanley issued downgrades not only of integrated oil major BP, but also other major players such as oil-services giants Schlumberger and Smith International, as well as refining mammoths Valero, Sunoco, Frontier Oil and Tesoro.

Detroit epiphany: Cars Americans want Detroit automakers are rediscovering cars. The question is whether it's too little and too late. Even though light trucks - including SUV's, pickups and minivans - now make up a majority of U.S. sales, sales of compact and midsize sedans are still important. Non-luxury midsize sedans, which generally fetch between $20,000 and $25,000, accounted for more than one-in-five vehicles here last year. And while sales of those models slipped slightly in 2007, they held up better than those segments where Detroit has put much of its attention for the past decade - SUV's and large pickups. Even some Detroit auto executives are admitting that the Big Three made a big mistake betting so heavily on light trucks at the expense of car models. "If your goal is to grow your business, you have to get serious about the small car market," said George Pipas, sales analyst for Ford Motor (F, Fortune 500). "The steady decline in the Big 3 share can be traced directly to the lack of interest in the small car market." As recently as 2000, 53 percent of U.S. car model sales went to the traditional Big Three. In 2001, a majority of Americans looking for car models turned to import brands for the first time, and they haven't gone back. By last year, the three U.S. automakers had only 36 percent of the U.S. car model market, and many of those sales were less profitable fleet sales to rental car companies rather than retail sales to American consumers.

• Big 3 Prepare for Slump Auto executives are voicing increased pessimism about this year, with luxury-car sales showing more signs of weakness.

Chrysler CEO: Seize any opportunity Under a deal announced last week, Nissan will build subcompact cars for Chrysler for the South American market starting next year. That comes on top of several other alliances Chrysler has already struck with other automakers. Chrysler is building a minivan for Volkswagen that will hit the market in the third quarter of this year, and it has an agreement with China's Chery Automobile to jointly produce and export small cars to Western Europe and the United States in the next few years. Chrysler also has an engine alliance with Hyundai and Mitsubishi and it still works closely with Daimler on advanced technology. Chrysler's sales outside North America jumped 15 percent in 2007, to 238,218. But with just 9 percent of the company's sales coming from outside North America, the company is far behind its rivals. Around 60 percent of General Motors' sales come from outside the United States. Chrysler teams up with Nissan

Airline stocks rallied last week on news that Delta Air Lines was mulling a takeover of either United Airlines or Northwest Airlines, suggesting that many investors think airline mergers are a brilliant idea. The rally was an especially strong endorsement of mergers because it was broad — all the big carriers’ shares rose, on the assumption that one merger would lead to another. But close scrutiny of the business rationale for airline mergers suggests that any improved profits from consolidation will likely be short-lived, at best. Any cost reductions, for example, could easily be eaten up by higher wages required to win labor’s support for a deal. And because one big merger could prompt a second — Continental Airlines is expected by many analysts to snap up United, Northwest or another carrier as a defensive gesture against Delta — any advantage provided by a bigger route system might be quickly neutralized. They are unlikely to win over travelers, too. Big mergers could mean less service to some markets, as a newly combined airline might wipe out thousands of jobs by scaling back at smaller hubs. Fliers could expect a surge in delays as combining operations and computer systems would most likely create service meltdowns. Delta Aims for Swift Merger  Delta has opened merger talks with both United and Northwest and hopes to negotiate an agreement with one of the airlines over the next two weeks.

Posted by dblwyo at 01:18 PM | Permalink | Comments (0)

Now that our little side detour to look at the emerging bear is "over" - btw just kidding, from the futures today it's just really beginning - it's time to put up the interesting links and excerpts for the business stories of the week. There are enough we're going to split them into two. This one will focus on Innovation based industries and the next on general business issues and more traditional industries. In fact judging from today's open this is pretty timely :).

A constant theme we've been playing is the need to understand the drivers and characteristics of enterprise performance, which argument has been mightily reinforced these last few weeks. Not to mention these last few days. While all this sturm und drang is going on there are some major deep changes happening in the innovation-based industries. Which notion is itself a major one. Notice we didn't just say technology industries ! Innovation is something that all firms should be doing, most don't and will become increasingly important as a foundation for survival. But the innovation-based industries are the ones where product development in fact drives the whole rest of the firm.

As Josh Limon pointed out the first pill costs $10B while the 2nd costs $1 in the pharmaceutical industry. Similarly in the aerospace business Boeing and Airbus should really have a split P&L. One for the research, development and production behind the first new model. The second for the continued manufacturing, sales and support of the next 1,000. In comparison R&D and innovation do not, as a matter of fact, take up as much of the budget and aren't as critical to the traditional tech industries. Though it is still critically important. So we've collected readings on tech, telecomm, pharma, aerospace and alternative energy under this heading. 

But let's set the table with - why do you care ? Well if this carnage ends in six months as the standard expectation has it who'll you pick to get back in with ? If it keeps going same question, different dates ? On the other hand if you'd read Truth, Justic and the NDX Way and agreed with the conclusions you might have been out of Tech in time to save or short and make money. Consider this post a continuing part of our efforts to dive deeper into business evaluation and rubble sorting (Winners & Loosers: Rubble Sorting). Since we've a little space, and each link deserves it's own post - if not a series, let's try and expand on  the context a bit.

1. Telecomm - on it's 3rd or 4th Perfect Storm. The story below on the iPhone will help explain why the decade+ business model of the big telcos got blown up last year. Another major disruption is the "fat pipe to premise" war between the telcos and cable companies. The result of which is already upending the media & entertainment industries more than they've been since they were shaped at the end of the 19th C (hyperbole ?). Part of the next big storm is the growth of Unified Communications which should be a major innovation for the Telcos but which they're having trouble grasping. Meanwhile MSFT and IBM are going after it big time. Interesting. And then there's the GOOG vs YHOO war where the first's model may be aging while the latter let complacency and lack of innovation and adaptation depreciate its' user base value so severely. And who doesn't seem to be generating any new breakthru thinking either !

2. Technology - meanwhile IBM reported a 12% jump in EPS but when you look at the detailed investor presentation that was 24% YoY but 10% was in revenue growth and buybacks, each. But revenue growth would have been 4% without currancy benefits. And they told me that you buyback shares when they're under-valued not to catch a falling knife in a down market. Me, I'd rather have that cash as a dividend rather than see it go into buybacks and be depreciated completely. Similarly ORCL bought BEA (finally) but BEA has almost completely lost its' clout to IBM in the last few years in the Java arena and ORCL's not done well with its' own middleware strategies (FUSION). Can't say there are many indicators of organic revenue and profit growth let alone long-term innovation here. 

3. Pharma - it's finally dawning on investors that the R&D model which drives Big Pharma is broke as broke can be and no substitute is on the horizon for a long....long time. Which is why you hear a lot of analysts beginning to talk about major downsizings and further consolidations. Drug pipelines are 7-15 years long. Today's problems were laid down in the late 90s and the stock prices have increasingly reflected that.

4. Aerospace - Boeing's been taking it in the neck recently over continued delays in the B787 Dreamliner because of supply problems. That's in addition to market pressures of course. Yet the 787 represents major design and construction innovations that date back almost a decade, based on design innovations in CAD/CAM that go back to the mid-90s. For this plane they've undertaken a huge new operational innovation by outsourcing whole assemblies around the world. That's turning out to be a major headache but I'm pretty confident that they'll solve it. Meanwhile Airbus's big new thing is the A380 which is so big only a few airport can handle it and which is really only profitable on very long-haul int'l routes. Yet as technology advances it becomes more feasible to start flying more and more point-to-point city pairs. Which is perfect for the B787. When this is over, like Apple with its' string of sustained innovation, BA looks like a great investment for the future. 

5. Energy - alternative energy is going great guns but the fact of the matter is that it takes 20-30 years to migrate an energy infrastructure to a new foundation. All this does is nibble around the edges. And that's as long as you don't make silly mistakes like subsidizing ethanol production from corn thereby driving up food prices, not producting fuel at any cheaper prices and neglecting your real alternatives over the next several decades of coal and nuclear. Meanwhile of course these might still be good speculative investments. 

All in all there are going to be real winners and loosers in these industries. Sorting them out takes a bit of work but you'd probably spend that much time reading charts and financials. Why not invest a little in exploring the structure and fundamentals as well. We'll do our best to help. 

The Untold Story: How the iPhone Blew Up the Wireless Industry This 4.8-ounce sliver of glass and aluminum is an explosive device that has forever changed the mobile-phone business, wresting power from carriers and giving it to manufacturers, developers, and consumers. But as important as the iPhone has been to the fortunes of Apple and AT&T, its real impact is on the structure of the $11 billion-a-year US mobile phone industry. For decades, wireless carriers have treated manufacturers like serfs, using access to their networks as leverage to dictate what phones will get made, how much they will cost, and what features will be available on them. Handsets were viewed largely as cheap, disposable lures, massively subsidized to snare subscribers and lock them into using the carriers' proprietary services. But the iPhone upsets that balance of power. Carriers are learning that the right phone — even a pricey one — can win customers and bring in revenue. Now, in the pursuit of an Apple-like contract, every manufacturer is racing to create a phone that consumers will love, instead of one that the carriers approve of.

The cable-TV industry may be seeing some progress in its effort to break the hold Motorola and Scientific-Atlanta have on the market for cable set-top boxes. The cable-TV industry may finally be seeing at least a little progress in its years-long effort to break the stranglehold that two companies have on the $3 billion U.S. market for cable set-top boxes, the device that holds the key to most advanced cable services. Cable operators hope that diversifying will lower their costs and give them the ability to offer a wider array of services, a critical issue right now, given mounting competition from phone companies. Shipments of boxes have been rising in the U.S., reflecting growing demand for advanced services that require them. Demand is expected to level off at around 11 million units by 2009, falling thereafter as the market becomes saturated, predicts ABI Research Inc. But a combination of regulatory pressure, technology advances and market need is beginning to wear down what has been an intractable problem for the cable industry. But operators also have a strategic reason to seek more suppliers. Set-top boxes hold the key to sophisticated video services offered by cable operators, including high-definition channels and interactive offerings like video-on-demand. In the past, operators' ability to roll out new services has been limited by what their box suppliers offered.

Microsoft's Unified Communications Play  Unified communications integrates voice, e-mail, IM and presence. It aims to improve productivity by providing one platform that lets employees communicate using the most appropriate medium. Microsoft's Office Communications Server (OCS) 2007 is the company's flagship UC offering. A revamped version of Live Communication Server 2005, the heart of the product is its IM capabilities. Many employees use public IM clients available from AOL, Yahoo and others. This can present regulatory and compliance problems for enterprises, which makes an in-house system more attractive. OCS sweetens the deal with tight integration of Exchange and Outlook, which extends the presence feature of IM to other mediums. It also adds features such as audio, video and Web conferencing that weren't available in the software's previous incarnation. Users can initiate conferences from their desktop and include employees in the same building or across the country

Trying to Fine-Tune Yahoo Mr. Yang, a co-founder of Yahoo, was picked last summer to run the company in part to end a string of disappointments for Yahoo shareholders. Before his keynote speech was over, Mr. Yang had offered the audience and shareholders a glimpse of what may one day be the new face of Yahoo — a revamped set of online services that company executives hope will help turn around Yahoo’s fortunes. But it was only a glimpse. Mr. Yang displayed a prototype version of Yahoo’s popular e-mail software that had been transformed into a powerful communications hub. It could, for example, tap into social networks to give higher priority to messages coming from senders with close ties to their recipients. And it could use other developers’ programs to help organize a dinner for a group of people. Successfully transforming the Yahoo portal is only one of the challenges facing Yahoo. It must also revitalize its advertising business and find a way to compete more effectively with Google in Internet search, a vital source of revenue. But the portal changes are a critical element of the company’s strategy to hold on to its large audience.

IBM profit jumps 12 percent International Business Machines Corp. on Thursday told Wall Street to raise its 2008 estimates, further boosting a stock that was already buoyed by strong fourth-quarter earnings. That 10 percent revenue gain would have been 4 percent if not for weakness in the dollar. Payments in other currencies now translate into more dollars. That initial release indicated that IBM's broadening international focus was shielding the company from the crisis in the financial industry, which supplies more than one-fourth of IBM's revenue. But Thursday's full report offered more details about IBM's status and offered insights into overall corporate technology spending, which is expected to see slowing growth this year.

Oracle, BEA Systems in $8.5B deal Software giant Oracle Corp. reached a deal to buy rival BEA Systems Inc. for $8.5 billion Wednesday, just months after its initial offer was rebuffed. Oracle agreed to pay $19.375 in cash for each share of BEA, representing a 24 percent premium to where BEA's shares closed Tuesday. Oracle said the deal is worth $7.2 billion, since BEA has $1.3 billion in cash on hand. The deal is expected to close in mid-October."For Oracle, this deal is a very big step towards completing our [goal] of being a strategic software vendor of choice for our customers," Oracle CEO Larry Ellison said during a conference call with investors. Ellison said BEA CEO Alfred Chuang was "a pioneer in middleware," a type of software used by big businesses. With BEA under its wing, Ellison said he intends for Oracle to become a leader in middleware.

The Quest for Supergenes Craig Venter and rival genetic engineers are shaking up science--and venture investing--with plans for man-made organisms designed to pump out fuel and clean up waste. Designer organisms, and the potential to profit from them, are sparking excitement--and debate--among scientists and venture capital investors. Researchers in an emerging field called synthetic biology envision microbes customized with artificial genes to enable them to turn sunlight into fuel, clean up industrial waste or monitor patients for the first signs of disease. Already, scientists are producing strings of man-made DNA, short for deoxyribonucleic acid, which directs the functions of all living cells. Then they splice the manufactured DNA into the genes of existing organisms, reprogramming bacteria to act like microscopic factories churning out biofuels. Venter's experiments are taking synthetic biology a step further by working to build new organisms from the ground up with wholly artificial genes.

Out of the spotlight, solar will thrive Government neglect could make 2008 and 2009 the best years ever for solar companies -- and for those who invest in them. That's right. Long-term prospects for the solar industry are actually brighter because the energy bill that President Bush signed Dec. 19 didn't launch a crash program to expand solar-energy use or even extend solar tax credits that will expire in October. The solar industry had a problem in 2007, and it wasn't a lack of demand. Global solar production, measured by the megawatts of power that solar cells and modules produce once they're hooked up to the grids, climbed 57% in 2004, according to investment bank Jefferies International. And it increased 30% in 2005, 35% in 2006 and a projected 13% in 2007. See a problem there? Young growth industries facing a virtually untapped market shouldn't show slowing growth rates. If solar has the potential its supporters say it does -- and I agree it does -- the industry's growth rate should be accelerating, not dropping. (Global solar installations, which always lag equipment production and which are growing from a smaller base because of that lag, climbed a projected 60% in 2007.) So what happened? Beginning in 2005, demand for silicon from solar-wafer, solar-cell and solar-module makers overwhelmed supply from the companies that provide silicon to the solar and semiconductor industries.

New delay jolts Dreamliner In another embarrassing setback for the 787 program and a blow to the company's credibility on Wall Street, The Boeing Co. will announce Wednesday morning another delay of up to three months, sources told the Seattle P-I. The first flight of the Dreamliner, originally set for late August 2007, might not happen until June at the earliest. Boeing declined to comment Tuesday. But the sources confirmed that the latest delay, which comes on the heels of a six-month delay announced in October, means that no 787s will be delivered in 2008. Airline customers were originally supposed to start taking delivery of the 787 this May. More significant, Boeing has determined that some of its partners -- the linchpin of the new 787 global production system -- can't ramp up production quickly enough for Boeing to meet its critical target of delivering 109 planes by the end of 2009, the sources said. Because airlines pay Boeing most of the money for a jetliner upon delivery, Wall Street has been most concerned about just how many planes Boeing will be able to deliver by the end of 2009. The cost of the 787 delays is starting to add up to serious money. For the first time on a Boeing airplane program, its partners are responsible for manufacturing most of the plane. Boeing workers in Everett assemble the large composite fuselage sections and composite wings that are manufactured in Japan, Italy and elsewhere in the U.S. Ragen MacKenzie analyst Jacobs pointed out that other Boeing jetliner development programs have had their share of serious problems, too. It's just that expectations were so much higher for the 787, he said. "It is becoming more and more evident to me that the 787 schedule was developed from the top down rather than from the bottom up," he said.

Posted by dblwyo at 09:24 AM | Permalink | Comments (0)

Some years back (you might want to know I grew up out West where this was not unusual) I found myself hiking around a Forest Service campground in the early evening when it was already pretty dark. And started hearing bear noises from across the valley. Which is all the encouragement one needs to beat a hasty retreat back toward the "safety" of the campground and the car. On the way back from somewhere up the trail there came the sounds of a large bear snuffling around in the bushes, or so I thought. Scary. Shortly though I heard the sounds of a small bear BEHIND me on the trail. If close bear noises are scary hearing the sounds that tell you there's a pretty good chance of being on the trail between mom and a cub move it up a couple of notches...like 2-3 orders of magnitude. Now to tell the truth I don't know whether that was the case because I made every effort not to test it. One of the decisions in my life that still makes some of the most sense - after all I'm still hear (Freudian typo btw) and not too badly damaged to tell the story.

Well we've been hearing bear noises for some months now. If you've been really smart and disciplined you've acted on the "across the valley" noises. If not then there's a cub behind you and it sounds like mom's in front of you.

But these last few days, or week (Note: not weeks), we've definitely been hearing mom and the cubs. It's time to get off the trail. Fortunately Jim Jubak has put together one of the most sensible columns on re-positioning yourself that's out there. It's below the line along with an earlier column from Tim Middleton. Normally my suggestions are to read this stuff, think it thru and then apply it to your own circumstances. Now my advice is to follow it.

One caveat - watch the technicals, e.g. the Bollinger Bands and the 50-day and 200-day MAs. It's quite likely we'll get a bear market bounce. But once the short-term denial wears off we'll be back in bear country. Now is a good time to get heavy on cash and short-term bond funds. But if there's a bounce my personal opinion is that there will be no better time to get into inverse ETFs or mutual funds. 

Readings

1. 5 rules for surviving a bear market Some key moves now will help you avoid the worst of this year's market. If the idea of selling low makes you cringe, think about how you'd feel when stocks dropped further. The signs are remarkably clear: A bear market in stocks is on its way, and it's time to bear-proof your portfolio as much as you can. There are five things you must do sooner rather than later -- call them five rules for dodging the worst of the bear -- to protect your portfolio before the bear claws an additional 20% out of your stocks. So what should you do if you agree with me that we're looking at a bear market in stocks? I've got five rules for dodging the worst of the bear.

2. 4 ways to recession-proof a 401(k) The bears are lurking. These four strategies -- from the safe to the aggressive -- can help you protect or even grow your nest egg in this downturn.Usually at this time of year, investors are "playing the bounce": buying stocks that got dumped for tax losses in December but otherwise are sound. Don't fall into that trap in 2008. The only thing bouncing around in this market is a bear. We're in a recession, and in a recession, stocks go down. That includes foreign and emerging-markets stocks. So how do you recession-proof your 401(k)? Here are four distinct strategies that range from helping you lose less in this downturn to helping you make more. Some can be hard to implement in a company plan with relatively few investment options. If that's your situation, use other accounts you own -- individual retirement accounts or a taxable account -- to implement the hedges.

Posted by dblwyo at 08:56 AM | Permalink | Comments (0)

Well just in case you were living in a cave, off on vacation or otherwise incommunicado last week pretty well saw the confirmation of a, shall we say, slightly negative outlook for the economy. When the Chair of the Fed and the President of the US both announce that they're going fullbore on fiscal stimulus it's probably time to buy gold, put up the emergency food & water rations and make sure the emergency generator at your cave in the mountains has plenty of fuel :). While it's actually early days yet it's also too late to stop what's coming. What it's not to late to do is arrest the full force of the tsunami and prevent it from creating serious long-term damage. Which is the proper thing to be doing BtW. Particularly since up until the last few weeks the better part of the prognosticating community was in denial (an observation we've been beating to death but aren't quite prepared to give up on just yet). And judging by worldwide markets today, as noted in the prior two posts, some of the other little myths, e.g. de-coupling seem to have bitten the big one as well.

In the links and excerpts below they'll mostly speak for themselves and skimming over them will pretty well give you a flavor for the outlook as well as last week's high-frequency data, e.g. housing starts. We'd like to particularly draw your attention to the two links in the General section and the first link (from today's WSJ no less) that starts the Economy section. Pointing to some recent academic work it highlights how the ripple effects of a bursting Housing bubble combined with a bursting Credit bubble are likely to see a downturn who's severity hasn't been seen for a while. In fact the chances of a downturn on a par with the 1980 downturn, or worse, are the comparisons that come to mind.

What the policy gurus are trying to avoid however is something far worse - something akin to what Japan worked its' way into. So if we get a recession, even a severe one, but manage to contain the worst damage of these bubbles then think of it as chemo-therapy. Painful, debilitating and dangerous. But far from being as bad as the alternatives. 

General & Special

Prepare for a global economic downturn Any assessment of the world economy in 2008 depends on the likelihood, depth and length of a US economic downturn and the magnitude of a global spillover. Any forecast is thus contingent on how we answer the following three questions. Will the financial crisis continue in 2008? Will inflation expectations rise further? Last, will there be a disorderly process of global rebalancing? If we answer all three questions with Yes, we should prepare for a global depression. If the answer is No, the world economy will have another good year. There are many intermediate scenarios as well. I would answer the first question with an unqualified Yes. The financial crisis will probably linger on for most of the year and may get worse before it gets better. The macroeconomic effects of a financial and banking crisis of such scale are not trivial. Economic forecasters frequently underestimate the importance of credit and financial channels. What saved the US economy during the 2001 recession was a booming housing market and the availability of cheap consumer credit. This time many of those mechanisms work in reverse. The third risk is a disorderly unwinding of global imbalances, in particular a collapse in the exchange rate of the dollar against the euro and the yen. That could occur if central banks in Asia, Russia and the Middle East were to shift reserve assets out of dollars on a large scale. On this score, I am more optimistic. What about the rest of the world? Can it decouple? The answer is No. Both Asia and Europe should expect to see a significant reduction in economic growth, too. Asia will be mainly affected through the trade channel, given its reliance on the US as consumer of last resort. The biggest crisis transmission mechanism to Europe is the financial market. But Asia and Europe are in a relatively strong position to avoid recessions. Asia’s economic health will rest crucially on continued financial stability. The biggest current risk to China, for example, would be an implosion of overvalued stock prices. In the eurozone, there are already signs of an economic downturn, but fiscal policy could prove to be an important counter-cyclical stabiliser this time.

Fallout from the global credit crunch has darkened the outlook for the U.S. and global economies since the World Economic Forum last met in Davos. The turnaround promises to create a whole new A-list of stars this year. When the elite of global business gather in Davos, Switzerland, for their annual retreat next week, the mood will be dramatically darker than just a year ago. Since the World Economic Forum last met in Davos, fallout from the global credit crunch has transformed the outlook for the U.S. and global economies for the worse. Power and wealth have shifted from West to East, from major oil companies to petro-governments, and from U.S. banks and hedge funds to the state-controlled investment funds of the Middle East and Asia. The turnaround promises to create a whole new A-list of stars this year in Davos, including once obscure sovereign-wealth-fund managers, formerly boring central bankers and previously ignored bearish economists. "There is a sea change going through business," said Nigel Doughty, chairman of British private-equity firm Doughty Hanson & Co. and a Davos veteran. "The whole landscape has changed, not least because of the decline in influence of Western nation states." Few saw it coming. When Citigroup Inc.'s then chief executive officer, Charles Prince, predicted a "benign" year for the global economy and financial markets last January in Davos, he was in good company. U.S. and European bankers, industry chiefs and political leaders bubbled with confidence as they clinked glasses in the tony ski resort.

Economy

As Woes Mount, Recession Looms The housing crisis and faltering consumer spending are good reasons to fear that a U.S. recession could be worse than those in the recent past. The U.S. has suffered recessions only twice in the past quarter century and both were short and mild. There are good reasons to fear that the looming recession, if it arrives, could be worse. Housing is in the midst of its worst downturn since at least the 1970s. That has led to a meltdown in the mortgage market; with financial firms struggling to make sense of their losses, they are making it harder for even credit-worthy borrowers to get loans. The combination of heavy debt loads, still-high energy and food prices and a weakening job market has households tightening their belts. Consumer spending, long a bulwark of the economy, is faltering. University of Maryland economist Carmen Reinhart and Harvard University economist Kenneth Rogoff agree. They say the current crisis appears on track to be at least as bad as the five most catastrophic financial crises to hit industrialized countries since World War II.

• It's different this time The depressed state of the nation's housing market means Fed interest-rate cuts may not be the tonic this time around.In the past, when the U.S. economy ran into trouble, there were tried and true remedies that policymakers could implement in order to turn things around. However, this is not your father's recession, thus what worked in his day may not work this time around. Yes, fans, this time it really is different. First you have the housing crisis.

• When Summers Speaks, Congress Listens

 Americans Cut Back Sharply on Spending Strong evidence is emerging that consumer spending, a bulwark against recession over the last year even as energy prices surged and the housing market sputtered, has begun to slow sharply at every level of the American economy, from the working class to the wealthy. The abrupt pullback raises the possibility that the country may be experiencing a rare decline in personal consumption, not just a slower rate of growth. Such a decline would be the first since 1991, and it would almost certainly push the entire economy into a recession in the middle of an election year. There are mounting anecdotal signs that beginning in December Americans cut back significantly on personal consumption, which accounts for 70 percent of the economy. Perhaps the strongest barometer over the last 30 days is the performance of the country’s big chain stores. December turned out to be a blood bath for retailers at every rung on the economic ladder, with sales for the month growing at the slowest rate in seven years.

• Home Construction Drops 25 Percent, Consumer Spending Drop Raises New Fears, EconoLog: Consumer Credit Losses Rise, Somber Fed Says Economy Has Lost Punch, Gas, Food Spur Inflation Jump in 2007, More on Housing Starts (!!!)

• ·         Philly Fed Index and Recessions (!!!)
• ·         Employment-Population Ratio and Recessions

Retailers are cutting back on store openings and inventory as sales slide, in what may be the industry's worst slump in 17 years.  Chains are slamming the brakes on store openings, cutting back on inventory and girding for leaner times as consumer spending chills. The speed with which sales slowed during the holidays caught even cautious retailers off-guard, prompting a flurry of profit warnings. And while data on December consumer spending won't be released until the end of the month, plummeting sales suggest consumers are snapping shut their pocketbooks.

CEO confidence hits 7-year low The weakening U.S. economy has driven confidence among the nation's chief executives to a seven-year low, according to the Conference Board's Measure of CEO Confidence. The measure fell to 39 in the final quarter of 2007, sinking lower after falling to 44 in the third quarter of last year. The measure had not gone below 40 since the final quarter of 2000 when it hit 31. The outlook over the next six months is even worse. Currently, 16 percent of business leaders expect economic conditions to improve in the next six months, down from 20 percent last quarter, according to the Conference Board.

The euro zone's economies are diverging as this year's growth outlook darkens, complicating the ability of the ECB to forge a monetary policy that fits the bloc as a whole. The euro zone's 15 economies are diverging as this year's growth outlook darkens, complicating the ability of the European Central Bank to forge a monetary policy that fits the bloc as a whole. Italy, Spain and other Southern European economies so far are bearing the brunt of the strong euro, financial market turmoil and a repricing of risk. By contrast, Germany is enjoying an export boom that is offsetting a tepid consumer economy at home, and France, after several rocky quarters, is showing signs of economic revival. "There's set to be a reconvergence between France and Germany," says Gilles Moec, an economist at Bank of America in London. "The less mature euro-zone economies will have more difficulties coping with the current situation." ECB Survey Raises Economic Worries

• German Investor Confidence Falls More Than Estimated to Lowest in 15 Years Investor confidence in Germany fell to the lowest in 15 years on concern that a U.S. recession will deepen the slowdown in Europe's largest economy.  The ZEW Center for European Economic Research said its index of investor and analyst expectations fell to minus 41.6 from minus 37.2 last month, the eighth straight decline. Economists expected a drop to minus 40, the median of 40 forecasts in a Bloomberg News survey showed. German economic growth slowed to 2.5 percent last year from 2.9 percent in 2006, which was the fastest expansion since the turn of the decade, the Federal Statistics office said today. The Bundesbank predicts growth of just 1.9 percent this year.
• Emerging Stocks May Drop 20% in a U.S. Recession, Templeton's Mobius Says
• The shipping news Respected shipping index falls to a six-month low, adding to worries the global economy is slowing in the wake of a weaker U.S.

Japan Machine Orders Slide as Companies Ready for Global Growth Slowdown Japan's machinery orders fell in November as companies pared spending in anticipation the U.S. slowdown will spread to Asia and hurt exports. Orders declined 2.8 percent from October, when they rose 12.7 percent, the Cabinet Office said in Tokyo today. Wholesale- price inflation quickened in December, a separate report showed, squeezing profits for companies unable to raise prices amid lackluster consumer demand. The Topix stock index slumped 1.3 percent after an unexpected drop in U.S. retail sales added to concern exports to Japan's biggest market will extend three months of declines. Japan has a 50 percent chance of slipping into recession because of weaker exports, Goldman Sachs Group Inc. said last week. ``Fasten your seatbelts, the bad news is yet to come,'' said Hiromichi Shirakawa, chief economist at Credit Suisse Group in Tokyo. ``Demand is weakening and costs are rising. This is the worst possible combination.'' Signs Hint at Recession in Japan

Demand is declining for crude in the world's top industrialized countries, a shift that has upended how the global oil market behaves. For decades, slumping oil thirst in North America, Europe and Japan has sent oil prices lower because these regions accounted for much of the growth in crude consumption. But now, oil prices are hovering around record highs even though demand is declining in the world's top industrialized countries. The International Energy Agency, the energy watchdog for rich countries, is scheduled to release data tomorrow that are likely to show oil use among the 30 members of the Organization for Economic Cooperation and Development fell slightly in 2007 as consumers adjusted their consumption in the face of high crude-oil prices and mild weather.

• Global oil-field output is declining at a rate of about 4.5% a year, a new study concludes. But new projects in the works could make up for the decline.
• Copper May Decline for First Time Since 2001 on Slowing U.S., China Demand

Posted by dblwyo at 06:00 PM | Permalink | Comments (0)

In case closed markets have allowed you to not notice the worldwide headlines are pretty stark with all the major Asian and European markets down. Being lazy enough to not post over the holiday weekend allows us to savor yet another moment or more of schadenfreude but at these levels of pain it's not much fun. Hopefully you're in process, or better yet well along, in restructuring your portfolios for the likihood of some major downturns. BtW - while the world markets were open the futures on the DJIA were down 522, the SP500 was down 60 and the Nasdaq down 76; all in the neighborhood of 4.5%. While there's not a 1-1 match between futures and the actual markets it's close enough for horseshoes and hand-grenades.

Below you'll find the seperate market sections broke out for you reading "pleasure" but take a look at the SP500 charts at the right - which are "only" thru last Fri. Which even before today's actions pretty well ansers the "why do I care" question, big time ! Thru last week the bottom-limit on the four-year trend was busted. It looks to us as if reality is more than setting in, and setting in big time. You'll pretty much find that all confirmed in the readings below but we'd like to particularly point you to a link to a financial advice column on positioning your portfolio for a downturn. While normally our readfest links are things we think you should be aware of this time we'll go farther and endorse at least the general sense of the recommendations. It pretty closely parallels our own portfolio was is heavily weighted toward leveraged inverse funds. We'd also point you to last week's readfest and it's list of prior posts (WRFest 12Jan08 (Economy & Markets): the Non-Sanguine Outlook)

Markets & Investing

A global train wreck How a French banker helped to derail stock markets from Mumbai to Paris. A story with a headline "French regulator sees 'partial decoupling' of U.S. and E.U. economies" doesn't sound like the kind to derail stocks from Mumbai to Paris. Particularly when the losses came Monday, for an article published Friday in the International Herald Tribune, a paper best known for re-printing articles from its parent, The New York Times, in newsstands around Europe. Understandably, the story was slow to get around. But sitting in paragraph nine, there were comments that amount to a profit warning for banks in France as well as those around the world. "I'm reasonably confident that French banks will weather this turmoil without major trouble even though they are clearly, like all banks, in the world still in the process of marking down assets," said Christian Noyer, governor of the Bank of France and a member of the European Central Bank's governing council, Noyer's comments about "marking down assets" were enough to hit banks like Societe Generale, which saw drops of around 8% on Friday and lost another 7% on Monday.

• U.S. stock futures flash red Futures on Dow Jones Industrial Average down around 450 points Though U.S. markets are shut for a holiday, and won't re-open until Tuesday, stock futures plunge as global indexes come unhinged.

History Lessons: Past Recessions In the 1970s and in 2001, recessions were marked by nasty bear markets. In both cases, investors ignored the risks that were building in the market, believing that high valuations were justified, be they on houses or stocks, because prices would continue rising. The earlier recession also featured soaring energy prices. In the more benign scenario, market performance is ugliest before and in the early days of a recession as investors panic about the effects of a downturn on earnings. In the three recessions between 1980 and 1991, stocks turned positive before the recession ended, leading to runaway gains in the months after the downturn. Stocks on the whole rose modestly during those recessions. The 2001 recession was caused by the double whammy of the popping of the technology-stock bubble and a major corporate-profit downturn. Though the labor-market downturn that followed was tough, the effect on economic growth was arguably quite mild. But the stock market's decline was prolonged and ugly. The S&P 500 fell about 8% during the recession and about 49% during the entire bear market, the steepest decline since World War II. The S&P 500 was still down nearly 18% a year after the 2001 recession was over. Typically, stocks are higher 12 months after a recession. The fact that the chain of events stretched out longer than usual may have prolonged the market's agony. That could be a bad omen for today's market, given the slow unfolding of the housing debacle. But the market's decline was largely caused by the tech-stock bubble that preceded it.

Ebolatization Contagion: Credit Mess II Well it's not often these days I find myself citing Paul Krugman though my respect for his skills and acumen as an economist is enormous. Yet his column in today's NYT on the breakdown in credit market regulation as well as the sensibility due to low job creation of '01 Fed policy is so congruent with several of my arguments that it's hard to resist. Only this time he's calmer than usual and he's right talking about the terrible quality of many bank earnings and credit contagion risks. Which is supported by a wonderfully well-written piece from Wolfgang Munschau in the FT this week. And capped by a pointed diagnosis by my favorite financial pundit Jim Jubak who also reinforces a point we've been making for a couple of three months now - the Housing related credit problems are spreading into other debt asset classes, the obvious auto loans, credit cards, etc. But more importantly into high-yield corporate loans (can you say buyout ? buyback ?). Which point is also reinforced by a WSJ story this morning on problem of Credit Default Swaps (which are "insurance" taken out by debt holders who swap a small premium for getting paid back if the bond burns down, excuse me. I mean defaults).

Everyone Loves Yen in Subprime-Infected World of Faltering American Growth Investors and traders are buying Japan's currency even as its broadest rally in eight years threatens to derail the nation's economy. The country relies on exports for most of its growth and has a 50 percent chance of recession, according to Goldman Sachs Group Inc. Automakers Mazda Motor Corp. and Nissan Motor Co. have tumbled more than 10 percent this month on concern that the rising currency will erode earnings. The yen climbed 13 percent against the dollar in the past six months, to 107.57 as of 10:25 a.m. in London. In the second half of 2007, it appreciated against the 16 most-active currencies -- including the British pound, South Korean won and Mexican peso -- for the first time since 1999. This year, the yen will gain 0.5 percent to 107 per dollar and 5.2 percent to 152 per euro, according to the median estimate of more than 35 strategists surveyed by Bloomberg. Frankfurt-based Deutsche Bank AG, the world's biggest currency trader, is more bullish than the consensus, predicting a gain to 100 yen per dollar.

4 ways to recession-proof a 401(k) The bears are lurking. These four strategies -- from the safe to the aggressive -- can help you protect or even grow your nest egg in this downturn.Usually at this time of year, investors are "playing the bounce": buying stocks that got dumped for tax losses in December but otherwise are sound. Don't fall into that trap in 2008. The only thing bouncing around in this market is a bear. We're in a recession, and in a recession, stocks go down. That includes foreign and emerging-markets stocks. So how do you recession-proof your 401(k)? Here are four distinct strategies that range from helping you lose less in this downturn to helping you make more. Some can be hard to implement in a company plan with relatively few investment options. If that's your situation, use other accounts you own -- individual retirement accounts or a taxable account -- to implement the hedges.

Posted by dblwyo at 05:36 PM | Permalink | Comments (0)

Last week, actually the last several, were terrible for the markets. And judging by the carnage in Asia and Europe so far today we can anticipate more trouble as the markets re-open. While it's not clear how much farther we've got to go it looks like a major shift in outlook and sentiment is underway. One which, partly in a spirit of schadenfreude, we've been pointing to for quite a while now. There was so much last week in fact on the spreading credit contagion that we pulled those excerpts out into a seperate post (Ebolatization Contagion: Credit Mess II) to highlight them. A comment on that post asked an interesting and key question:

It's as if you are discriminating between financial sector growth, which I assume you measure in financial terms, and economic value, which I also assume you measure in in financial terms. That is, there is non-value adding financial growth. Am I close to correct here?If so, how do we distinguish between the value-adding financial growth and that which does not add value?

One could argue that any shift of resources into newer sectors helpe the overall economy become more efficient - in the case of the Finance Industry by helping to raise and create capital and more efficiently allocate it. The question we were asking that led to the comment was whether or not the shift of resources into the Finance Industry had gone too far and our implied answer was "hell yes". But it was an answer based on a fair amount of prior investigation on the rapidly rising share of the Financial sector in profits (The Heart of the Matter: Profits vs Earnings ?), on the buyback and buyout manias (Market Drivers 3 (Buybacks):Investment, Hiring, Nah...Bonus, Bonus, Bonus ! plus two prior posts) and on what's turning out to be alleged profits built on leverage and unaceptable risks (Rocks, Ponds, Perverse Incentives: More on Credit Contagion)

In other words, as write-downs continue, we're arguing that most of the Finance Industry profits that were booked in the last several years will disappear. And that disappearnce is reflected in the poor outlooks for many of the major companies AND their need to re-capitalize. Taking these arguments and investigations all together it seems reasonable to argue that indeed to much money went into bad investment ideas, that capital was very inefficiently allocated and, as a result, the overall health of the economy will be badly damaged.

And, further, that the industry itself is going to have to re-think its' business models which increasingly appear to be badly....badly broken. The readings, links and excerpts on the continuation sustain this argument and extend it. But to anticipate what we think is happening is at least two things.

First, the industry needs to re-think and a new set of business models has yet to make an appearance. And second, as a consequence, despite all the folks who're starting to argue that all the catastrophes have been priced into the stocks of the Financials we're a long way from seeing a bottom grounded in fundamental realities. If and when we recover economically we're likely to see a major bounce in Financials based on that argument. In fact we're likely to see some bounced that will be trading opportunities before then. But not investing opportunities. Until the industry re-thinks itself it won't be well-grounded IMHO. The trick as an investor will be to watch the evolution of the reconstruction of the industry and then invest. 

We covered some of these points in an earlier readings collection on the Industry ("Interesting Times" for the Finance Industry: Readings & Resources) which is worth reviewing as well). One of the stories there that encapsulates the situation and provides a nice historical overview is this:

Wall Street doesn't want you After an era of innovation in financial services that benefited the middle class, The Street has abandoned individual investors in favor of big institutions and wealthy private traders. It's time for big changes. Wall Street doesn't care about the individual investor anymore. We're not profitable enough. Look at the billions the financial industry has made in recent years from trading, buying and packaging mortgages and credit cards, financing buyouts and selling ways to reduce risk. That kind of business drove operating income at Goldman Sachs) to $14.6 billion in 2006 from just $3.3 billion in 2002, a 340% increase, and at Merrill Lynch to $10.4 billion in 2006 from $2.3 billion in 2002, a 350% increase. Until they blew up, that is. It's not just that Wall Street's newest inventions -- collateralized debt obligations and asset-backed commercial paper and the like -- are irrelevant to the stuff we care about, like having enough for retirement. Wall Street's actions seem positively dangerous to our goals. It wasn't always this way. For 20 years, beginning in 1975, Wall Street produced a wave of innovation for middle-class investors that brought more and more people into the financial markets. The revolution began in 1975 with the invention of cash-management accounts at Merrill Lynch. From our position in time, it's hard to remember that there once was a day when all we had were savings and checking accounts, and that the two were so rigidly separated that you couldn't write a check from an account that paid interest

 If any of this makes sense to you it's a good opportunity to apply the thinking and tools for analyzing industry/company performance we sketched in another post as well:Winners & Loosers: Rubble Sorting

The bottomline - we're not anywhere near a bottom, the industry has broken itself, there are good operators who will get out of this mess and innovators who will come up with the next wave of ideas and business models. In other words there will be significant opportunities in the Finance Industry over the next several years but they ain't here yet. But it's never to late to start investigating and building a little shopping list for when things start to turnaround !

Good luck and good hunting ! Keep your powder dry for now.

READINGS 

Bubble Trouble First came the bursting of the tech-stock bubble, now the bursting of the housing bubble. The bursting of a bubble in finance -- and the pay of those who helped make the tech and housing bubbles possible -- can't be far behind. it might be good for the overall economy. Finance has had a remarkable run. It has been one of the fastest-growing industries in the U.S. (and Britain), and has attracted an increasing share of the country's, and the world's, talent. Today, roughly $1 in every $13 of employee compensation in the U.S. goes to those working in finance. The value added by finance -- a measure for calculating the industry's contribution to the economy -- rose to 4.4% of gross domestic product in 1977 from 2.3% in 1947... Its work force grew commensurately, with employees that were only slightly more educated than the typical American worker, and their compensation grew at roughly the same pace as that of other workers. After 1980, finance kept growing, reaching 7.7% of GDP by 2005. But the nature of the industry's work and work force changed. "From the 1980s onward, the financial sector grows by increasing the value added and compensation of its employees faster than in the rest of the economy," Mr. Philippon says. Workers in finance are increasingly highly skilled and educated.

Deal Fees Under Fire Amid Crisis At every level of the financial system, key players -- from deal makers on Wall Street and in the City of London to local brokers like Mr. Schmidt -- often get a cut of what a transaction is supposed to be worth when first structured, not what it actually delivers in the long term. Now, as the bond market wobbles, takeover deals unravel and mortgages sour, the situation is spurring a re-examination of how financiers get paid and whether the incentives the pay structure creates need to be modified. This week, Congress asked three prominent executives to testify about their pay packages. Upfront commissions and fees are well established on Wall Street. Investment banks get paid when billion-dollar mergers are inked. Firms that create complex new securities are paid a percentage off the top. Rating services assess the risk of a new bond in return for fees on the front end. Critics argue this system can give people a vested interest in closing a deal, regardless of whether it turns out to be a good idea over time. In various forms, a similar pay structure exists at the top of the financial world, where executives can reap lucrative pay packages, even if deals made on their watch later go south.

• Will Banks Drop Flashy Stuff? Merrill Lynch becomes the next bank to offer a confessional to investors today. As the parade of write-offs continues, it's time to ask what lies ahead for Wall Street after it cleans up its current mess.

What Does Goldman Know That We Idiots Don't?: Michael Lewis In retrospect, the most intriguing subplot in the collapse of the subprime mortgage market has been not the size of the losses but their distribution. Wall Street firms have a talent for getting themselves into trouble together. They all were long Internet stocks when Internet stocks collapsed and they'll all be long North Korean credit-default swaps whenever North Korea gets hot and then crashes. What's odd about the subprime crash is Goldman Sachs Group Inc. A single firm took a position contrary to the rest of Wall Street. Giant Wall Street firms are designed for many things, but not, typically, to express highly idiosyncratic views in the market. Enter two smart guys who trade Goldman's proprietary books to argue to the CEO and chief financial officer that the subprime market feels soft and that Goldman should short it. This they do, in such massive quantities that they more than offset the long positions in subprime held throughout the rest of the firm, leaving Goldman short the subprime market and in a position to make billions when it crashes. End of story. And it's a good story. But consider what it implies. Their own traders and salespeople in subprime mortgages and related securities had put Goldman in exactly the same position as every other Wall Street firm: long subprime mortgages. The only difference between Goldman and everyone else was that Goldman had, in effect, an entirely separate enterprise, sitting on top of the firm, with the power to reverse the judgment of its own supposed experts in various markets. They were able to do this, apparently, without ever saying a word about it to their own traders. Instead of telling the fools trading subprime mortgages that they are wrong, and that they should unwind their positions, they simply offset their trades.

Citi rediscovers the consumer As Citigroup revealed another big write-down and a cash infusion from overseas investors on Tuesday, the results of its troubled consumer business underscored the multiple challenges the bank will face in 2008. Weaker consumer credit and rising loan-loss provisions devastated its consumer division and ate up solid gains made by well-performing business units, and Citigroup said it's moving to set aside $5.1 billion to cover increasing loan losses and accelerating delinquencies on credit cards and auto loans. "We had losses in our U.S. consumer business, up over $4 billion, and these numbers completely overwhelmed record performance in many, many of our other large businesses," Chief Executive Vikram Pandit said on a conference call. Analysts, noting that Citigroup's bread-and-butter consumer business provides more than one-third of the firm's recent profits, said keeping that side of the company strong -- and its capital reserves healthy -- is a must if the bank has any hope of riding out current turmoil in the markets and the economy. "The reserve build signals that tougher times are ahead in the U.S. consumer channel, which has accounted for 30%-40% of Citi's recent profits," Goldman Sachs analyst William Tanona wrote in a research report. In step with that long-term philosophy, the firm said it will quickly divest itself of nonperforming assets in an attempt to shore up capital and limit its risk. It is a strategy that could be particularly welcome to many investors who are skittish after the bank's wild ride on Wall Street, as Citigroup shares dropped 7.3% to $26.94.

Posted by dblwyo at 09:53 AM | Permalink | Comments (0)

Well it's not often these days I find myself citing Paul Krugman though my respect for his skills and acumen as an economist is enormous. In fact ALL of the books he wrote in the 90s explaining economics vs pundits vs policy are not only worth your time but are still accurate and applicable today - with a little adjustment here and there. Somewhere IMHO he drifted over the dark side of shrill punditry and substituted arm-waving for the kind of careful reasoned analysis he so severely critisized others for failing to provide.

Now it appears he's drifting back to the middle - or perhaps there's a good Paul and a bad Paul ? In any case you'll take my point that my citing Herr Krugman has been a tad unusual for several years. Yet his column in today's NYT on the breakdown in credit market regulation as well as the sensibility due to low job creation of '01 Fed policy is so congruent with several of my arguments that it's hard to resist.

Lest you think I'm kowtowing though below are an excerpt from Paul's column along with several others, including a pointer to a Cramer rant on BigPicture, that speak (loudly) to the same issues. Only this time he's calmer than usual and he's right talking about the terrible quality of many bank earnings and credit contagion risks. Which is supported by a wonderfully well-written piece from Wolfgang Munschau in the FT this week. And capped by a pointed diagnosis by my favorite financial pundit Jim Jubak who also reinforces a point we've been making for a couple of three months now - the Housing related credit problems are spreading into other debt asset classes, the obvious auto loans, credit cards, etc. But more importantly into high-yield corporate loans (can you say buyout ? buyback ?). Which point is also reinforced by a WSJ story this morning on problem of Credit Default Swaps (which are "insurance" taken out by debt holders who swap a small premium for getting paid back if the bond burns down, excuse me. I mean defaults).

Finally we let David Wessel wrap up with a classic question - as the financial sector has grown did it add value to our economy ? And does it still do so ? To which we'll add - and how 'bout in the future in light of all the rest of this ? 

Just for the record here are some prior posts, not just for "told ya so" but also because some of the mechanisms underlying these stories are laid out within the limits of my abilities to understand and explain. Severe as they are. So take heed and take warning - and it ain't just me this time around.

• More on the Credit Crisis: the Rocks in the Pond "Model",Rocks, Ponds, Perverse Incentives: More on Credit Contagion
• Credit Mess and the Fed: Understanding the Strategic Posture
• The Fed & the Credit Mess: Readings II
• Let's Blame Uncle Alan: Fed Policy and the Credit Crisis

 UPDATE: Apparantly great minds think alike or read the same news sources. It turns out BigPicture beat me to the punch on this topic and our friend at CalculatedRisk also has had a go or more:

• Counter-Party Risk

• S&P: Bond Insurance Losses Likely Much Higher, Ambac Not Pursuing Stock Sale

This is not merely a subprime crisis If this had been a mere subprime crisis, it would now be over. But it is not, and nor will it be over soon. The reason is that several other pockets of the credit market are also vulnerable. Credit cards are one such segment, similar in size to the subprime market. Another is credit default swaps, relatively modern financial instruments that allow bondholders to insure against default. Those who such sell such protection receive a quarterly premium, based on a percentage of the amount insured. The CDS market is worth about $45,000bn (€30,500bn, £23,000bn). This is not an easy figure to imagine. It is more than three times the annual gross domestic product of the US. Economically, credit default swaps are insurance. But legally, they are not, which is why this market is largely unregulated. But as insolvency rates go up, so will be the payment obligations under the CDS contracts. If insolvencies reach a certain level, one would expect some protection sellers to default on their obligations.

So the general health of this market crucially depends on the rate of insolvencies. This in turn depends on the economy. The US and Europe are the two largest CDS markets in the world. It is now widely recognised, including by the Federal Reserve, that the US economy is heading for a sharp downturn, possibly a recession. The eurozone, too, is heading for a downturn, but possibly not quite as sharp.

Default Fears Unnerve Markets The turmoil on Wall Street is beginning to rock a foundation of the financial system: the ability of institutions to make good on their many trades with one another. Today, a struggling bond insurer, ACA Financial Guaranty Corp., will ask its trading partners for more time as it scrambles to unwind more than $60 billion of insurance contracts it sold to financial firms but can't fully pay off, according to people familiar with the matter. The problem is that the insurer itself is teetering -- with repercussions across the financial world. Some of its trading partners, called counterparties, already are writing off billions of dollars because of its inability to pay. With many bond values falling and defaults rising, especially in the mortgage arena, some institutions involved in these trades are weakened. This has investors and regulators worried that, through such swaps, some market players could spread their own problems to the wider financial system. Cramer Rant, Version II

The next banking crisis on the way Write-downs for high-risk, high-yield corporate debt, known as 'junk,' could dwarf losses in the mortgage mess. And that's when this financial crisis will finally hit bottom. The banks and other financials have more losses from the subprime-mortgage mess on their books that they haven't yet confessed. Worse, the mortgage debacle has spread to other types of debt, with banks and other financial companies reporting mounting losses in their credit card and auto loan portfolios. And worst of all, the next big leg of the crisis -- the one I think will mark the true bottom -- has just started. As the economy slows, the default rate is rising for corporate debt, especially for the high-risk, high-yield corporate debt called "junk" by many of us. That's opening a Pandora's box of potential write-downs that could dwarf the losses in the mortgage market. If that's true, it would push off the kitchen-sink bottom until the second or third quarter of 2008, depending on how bad the economy gets and how long it stays in the dumps.

Don’t Cry for Me, America  Although we won’t have the kind of financial death spiral Argentina experienced, the next year or two could be quite unpleasant. For reasons I’ll explain later, it’s unlikely that America will experience a recession as severe as that in, say, Argentina. But the origins of our problem are pretty much the same. And understanding those origins also helps us understand where U.S. economic policy went wrong. All of this was right, except for one thing: U.S. financial markets, it turns out, were characterized less by sophistication than by sophistry, which my dictionary defines as “a deliberately invalid argument displaying ingenuity in reasoning in the hope of deceiving someone.” E.g., “Repackaging dubious loans into collateralized debt obligations creates a lot of perfectly safe, AAA assets that will never go bad.” In other words, the United States was not, in fact, uniquely well-suited to make use of the world’s surplus funds. It was, instead, a place where large sums could be and were invested very badly. Directly or indirectly, capital flowing into America from global investors ended up financing a housing-and-credit bubble that has now burst, with painful consequences. As I said, these consequences probably won’t be as bad as the devastating recessions that racked third-world victims of the same syndrome. The saving grace of America’s situation is that our foreign debts are in our own currency. This means that we won’t have the kind of financial death spiral Argentina experienced, in which a falling peso caused the country’s debts, which were in dollars, to balloon in value relative to domestic assets. But even without those currency effects, the next year or two could be quite unpleasant. What should have been done differently? Some critics say that the Fed helped inflate the housing bubble with low interest rates. But those rates were low for a good reason: although the last recession officially ended in November 2001, it was another two years before the U.S. economy began delivering convincing job growth, and the Fed was rightly concerned about the possibility of Japanese-style prolonged economic stagnation.

Bubble Trouble First came the bursting of the tech-stock bubble, now the bursting of the housing bubble. The bursting of a bubble in finance -- and the pay of those who helped make the tech and housing bubbles possible -- can't be far behind. it might be good for the overall economy. Finance has had a remarkable run. It has been one of the fastest-growing industries in the U.S. (and Britain), and has attracted an increasing share of the country's, and the world's, talent. Today, roughly $1 in every $13 of employee compensation in the U.S. goes to those working in finance. The value added by finance -- a measure for calculating the industry's contribution to the economy -- rose to 4.4% of gross domestic product in 1977 from 2.3% in 1947... Its work force grew commensurately, with employees that were only slightly more educated than the typical American worker, and their compensation grew at roughly the same pace as that of other workers. After 1980, finance kept growing, reaching 7.7% of GDP by 2005. But the nature of the industry's work and work force changed. "From the 1980s onward, the financial sector grows by increasing the value added and compensation of its employees faster than in the rest of the economy," Mr. Philippon says. Workers in finance are increasingly highly skilled and educated.

Posted by dblwyo at 08:07 AM | Permalink | Comments (2)

A friend and I were discussing the current situation, or "mess" as he calls it and he asked a very pertinent and simple question. Also a very difficult one yet as crucial as it is hard. While I'm not sure an easy answer will roll forward here there are some approaches. Here's the original question:

"Now, I have an interesting and difficult question for you to work around.  Can you propose what kind of scenarios we might see in the resolution of all the mess?  Who will wind up being the biggest losers? the biggest winners?"

First, let's change the scale and take a couple of different looks at enterprise performance and then ask some questions. Now all of a sudden an entirely different picture emerges where BA is  far and away the best performer, on both sub-charts. Despite it's recent dip due to B787 Dreamliner delays. At the same time, if you look at the top sub-chart, the only one of these bellweathers that has come even close to matching the performance of the SP500 is GE. As noted C has dropped big time, ~ 60% so far. And neither PFE nor WMT has done well with declines since '04 of -30% and -15% respectively. So what's going on here ?

Well we have several mantras we like to apply and hope to persuade you to, if not adopt, at least think-thru and be aware of. And which we'll use as our template for further discussions. The three (& there are likely more but let's stick with three for now) are:

1. Economy to Industry to Firm analysis: no firm is entirely immune from general trends and the more it's one of the pack the more that's true. Conversely a true innovator, e.g. Fedex in its' heyday, can defy the overall trends if it's establishing a new business model, industry or solution.

2.Timeframe: back in my days in corporate planning one of the great puzzlements was how major initiatives that had huge payoffs failed to move the market. And conversely how irrelevent short-term data caused it to jump all over. Businesses move in three timeframes.

• Short-term where the run what they have with who they are, say over 12-18 months.
  
• Intermediate-term where major shifts, investments and adaptations take place, say over 18-36+ months. So, for example, a decision by Frito-Lay to go to Europe is a major strategic effort. Whether it pays off or not depends on how well suited the fundamental DNA of the company aligns with the new market. As WMT found out to its' great chagrin its' model wasn't well-adapted to Europe or Japan but seems to be working better in China and Latin America.
• Long-term where major innovations in product, markets, business model and/or strategy take place. Apple's recent "firing on all cylinders" success is based on executing well on all fronts but becoming the champion at sustained product innovation that adds value. BA is another good example because its' great success if based on major innovations in design, manufacturing, go-to-market and operations that date back years, if not decades.

3. Enterprise Characteristics: when you get to looking at an individual firm then you have to ask three fundamental questions. First, what's the Business Model and Strategy. Next, what are the operational capabilities, in all timeframes, and are they aligned with the BM etc. And third, what's the Management System - that is can they ensure that we they think they want to do is what they actually do do. GE seems to be as good as anybody in the world at this while Citi appears to give new meaning to the words miserable failure. For each of these example firms we lay out a partially filled in table of the major question areas to investigate.

Here's a couple of things to think about. How much of this sort of thing do the Street analysts do ? Or do they just extrapolate this quarter off into infinity ? And, since we start with the BM and Strategy - for each of these companies how well is it working now ? We'd argue that BA's model has shown superlative returns and will do so again in the future while Citi, as many have argued, has never managed to convert it's story (it only gets to be called a business model when it's working at least partially) into operational delivery. Yet GE which is in most ways much more complicated seems to have mastered the art of making a huge, multi-group, many-division conglomerate enterprise function. And the distance between medical equipment and aircraft engines is a lot farther than that between investment banking and consumer banking, vast as those differences might be to "inside baseball" cognoscenti.

So there's the first two+ questions you can ask for any company - how well is their model working ? And can they make it work ? And where's the information ? On that latter question look around you. MickeyD's recovery based on changing its' model was headline news several years back and any casual skim would tell you something is going on. In the same industry when Howard Shulz broad-sided Starback back last winter it told you that their BM was on the verge of breaking. Lo and behold here we are. And you could have made money going both ways on both companies but a relatively quick investigating of these questions.

Posted by dblwyo at 12:17 PM | Permalink | Comments (0)

Forgive me the title but surely somewhere on late night TV - soon itself to be a fond memory as on-demand replaces broadcast of course - the adventures of the plucky stalwarts of Grand Fenwick(The Mouse That Roared) will not have been in vain. We're not so sure about the markets but the riff is because the flash news buelletin that greeted us was Dow Roars Ahead 100 Points. Of course at the time the actual number, however temporarily 100+, was playing around in the 70-80 point range. Which leads to an interesting question of just what's going on.

There is apparantly an interesting meme making it's dangerous way about the land of the talking heads that recessions if and when they arrive don't necessarily lead to major stock market problems. While I've never heard the like let us both disabuse that one and several associated ones. The standard being that the markets are a discounting mechanism that's forward looking. To some extent we'll leave you to make up your own mind by taking a look at the accompanying chart. 

The first sub-chart shows YOY% changes in GDP and the SP500 and IMHO it would be generous to say the S&P is much of a leading indicator. If you recall on earlier post on anticipating downturns where we explore changes in Wages and Employment the second sub-chart pokes at that a little (the intermediates of PCE, GDP and IndProd are left out since at this scale they're over-lapping and clutterred). Some of the major turning points are highlighted but be careful to note that the markets are pretty volatile. However we'll also point to the contrast since '00 when W+E held with a sharp market drop as the boom went bust and the very recent sharp downturn in W+E accompanied by one in the markets.

What we think we're looking at recently is a SEE-change in the markets where thruout this decade we've largely been in a financially driven market based on liqudities and leverages, displayed in the carry trade, in buybacks and buyouts (the 3- part series which explored that ended here and will take you to the other parts).

In the first sub-chart the 1-year SP500 has the 50Da MA moving down thru the 200Da. Which is usually a pretty strong tecnical signal.

Even more interesting the Euro/Yen exchange rate is no longer moving synchronously with the S&P, where it has been thruout the year. In fact the E/Y rate has been a strong indicator for the last several years since exported Japanese savings have been a major driving force in the worldwide asset boom. Providing the initial rocket fuel if you would or at least part of it.

The way we read that is that a financially-driven market is shifting to a more fundamentally driven market. Which sort of takes us back full circle to the first chart. 

By the way you'll find similar assessments at:

• BigPicture: Equities, Earnings and Recessions:
• CalculatedRisk:S&P 500 Index, Year-over-year Contraction
• Northern Trust: The S&P 500 and Economic Recessions (who kicked all of us off on this)
  

Posted by dblwyo at 09:47 AM | Permalink | Comments (0)

As part two of the week's interesting stories we'll focus on the business outlook. Just to continue with our story of attending a panel on the LBO industry outlook, with a mid-market emphais, we'll mention that the panel concluded with a live case study. This was a small manufacturer and distributor of a branded set of healthcare cleaning supplies with about $80 of annual revenue and $11M of profits. Quite a tidy little business with low capex requirements, some reputation, low debt and some real adjacent market opportunities. It also helps to know that the founders were in their late 60s and most management was in the 55-65 range. In other words we have a small company with an excellent track record, superb financials and some interesting opportunities. The three panelists were sr. execs from a finance company, a PE buyout firm and a private hedge-like fund focused on alternative investments. The question is what would you pay and how much debt and, most especially, what key questions would you ask. Without reviewing them in detail the questions were very sound in terms of overall EBITDA multiples and debt ratios. There were two interesting things. First off the panelists, while fairly aggressive, were much more conservative than the winner LBO firm's bid which in turn was very aggressive on the debt side for the financing. The second nobody asked the key operational questions: 1) what drives the financials in terms of market, customers and operating capabilities, 2) what happens in a slowdown, how well will those numbers hold up in other words, 3) if you buy it and leverage it up how much does that increase the risk factors and 4) what are the capital requirements to go after the growth opportunities presented to justify the multiples suggested, let alone on offer from the actual acquirer. Now these guys are a lot better at their jobs than I'll ever learn to be. They quickly and efficiently analyzed (it was a short case study after all) the financials as presented. But nobody, and I repeat nobody, asked the fundamental strategic and operating questions. Which, for readers following along at home with this blog, will now know makes us extremely nervous in general and, given the fragilities we've discussed, more so in this case.

There's an interesting WSJ column in today's In the Lead which summarizes the 'run the company aspects' in a way:

Moving Ahead of a Slowdown  A look how some companies prepared for an economic slowdown. As U.S. jobless claims rise, manufacturing activity declines and consumer spending skids, many executives are beginning to acknowledge that the economy is slowing. But others, like Mr. Zollars, caught cooling signs early and have already trimmed labor costs and inventory levels and made other adjustments. "The best-performing companies plan in advance -- or at least ahead of many of their rivals -- for slowdowns," says Michael Mankins, a partner and consultant at Bain, which has studied which companies best weathered the last downturn in 2001 and why. "They take a bet early on which way the economy is going and quickly identify which costs they can manage aggressively and where they should use cost savings to fund new growth," he says.

As we mentioned the mid-markets have done better thru '07, which to put it in perspective was a great year overall, than the large buyout firms. But are they a lagging indicator ? There doesn't seem to be much awareness of nor commitment to the mantra of economy - industry - firm analysis we support. The real question here is how widespread is that attitude ? As opposed to the examples in the WSJ story. We suspect, so far, that it still represents the dominant thinking. 

Just for some perspective here are some key prior posts that bear on these issues:

We Can See Clearly Now: Retrospect/Prospect

• WRFest 30Dec07(Business): Fragilities, Exposures & Soundness 
  

Ganesh Filter II: Clear-seeing Algorithims for an '08 Plan

Ganesh Filters III: Analyzing Businesses Blueprints

Seeing thru Maya: Piercing the Veils of Delusion

 General

Business

Who Do You Trust? That's an intriguing question. It applies to personal relationships and business matters alike. I suspect the recent slippage in mainstream media readership has been a function of a loss of trust. This question has repercussions for other corporate relationships you may have, too. Consider: Apple (AAPL) can get away with a snafu like the iPhone pricing issue, because it has earned the trust, even the adoration, of its users. Could you imagine having that trust with Microsoft (MSFT)? Dell used to have that trust, but frittered it away, as they moved from one of the best to much worse customer service in the PC space. AOL also -- they've decayed, become a garbage service for the clueless. (AIM remains mostly worthwhile). Google (GOOG) has earned my confidence, and -- so far -- has not given me any reason to reconsider that trust. Yahoo (YHOO) still has some residual trust -- but its waning fast. I still use Yahoo as a home page, but their inattentiveness to some of their properties is shameful. They have a very, very brief period to right the ship, or their long horrific slide into irrelevancy will be irreversible. Yahoo has frittered away so many good properties, I find it embarrassing. (WhoTF is advising them?)

ALL BUSINESS: Cost Cutting Nightmare Corporate leaders who think they can slash expenses without customers noticing might want to give Circuit City Stores Inc.'s top brass a call. The electronics retailer is living the nightmare of cost-cutting gone bad. The Richmond, Va.-based company has been in a downward spiral since it announced last spring that it would lay off thousands of experienced workers it candidly said it could replace with cheaper new hires. Too bad that service matters in that corner of the retail market. Shoppers quickly noticed and fled -- leaving Circuit City's sales and profits plunging. Its same-store holiday sales, reported on Monday, fell 11.4 percent. And its stock is now about 80 percent below where it was the day before it made the staffing announcement. It's a business school case study being written before our eyes. Companies everywhere should remember this management mishap as they wrestle with cost cuts of their own amid slowing economic growth, rising inflationary pressures and a fatigued consumer. Staffing changes are just one way for companies to curb expenses and preserve or juice up profits. They also could start closing stores or slashing product lines. Regardless of the actions they take, they better know how their customers will react and consider the message they are sending to the public,

CEOs on the hot seat in 2008 Going into 2008, there are plenty of contenders whose jobs would appear to be or should be on thin ice. Not to mention early candidates for this column's annual Worst CEO of the Year award. Some, in fact, were finalists last year. The easiest indicator is stock price. But that, alone, is hardly a reason to ding someone. Stock price, after all, is the one thing a CEO can't control and doesn't take into account long-term strategies or broad economic sluggishness. But it is a clue that something may be off, especially if the price has plunged or has performed poorly against peers.

As the nation's economy cools, some well-known companies are stumbling in painful ways. Rushing to the scene are lots of experts with advice about sustaining or repairing a corporate reputation in tough times. Starbucks is switching chief executives and struggling to reconnect with customers. Circuit City Stores is trying to right itself amid skidding sales and a more than 70% drop in its stock price last year. And the pharmaceutical industry seems to have lost its ability to develop meaningful new drugs. What's gone wrong? The details vary but, in each case, companies with longstanding records of success are acting as though their trusty playbooks suddenly have vanished. Rushing to the scene are lots of experts with advice about sustaining or repairing a corporate reputation in tough times. Their tips may seem obvious, or even preachy in boom times. But when the economy stalls, nervous bosses are more eager for help. Besides, this is too alluring an area for management consultants and public-relations specialists to ignore. Reputation consulting offers plenty of face time with CEOs, as opposed to less glamorous work counseling operating units.

• Alcoa profit up on unit sales Alcoa Inc., the first of the Dow industrials to report this earnings season, posted Wednesday a 76% surge in fourth-quarter profit, benefiting from the aluminum giant's move to sell off its packaging and consumer businesses in December. Excluding a favorable restructuring adjustment and a tax benefit stemming from the business sales, earnings would have come in at 36 cents a share.
• Profit Gains in U.S. May Hit Six-Year Low on Subprime Loans, Holiday Sales, Citi, Merrill said to seek more cash

How to Unbreak the Banks The business model for big U.S. banks is broken. If banks and Wall Street don't act, regulators will. And if regulators don't, House Financial Services Committee Chairman Barney Frank and the other Democrats in Congress will. Let us count the ways. One: Bankers no longer scrutinize a would-be borrower to decide whether he is good for the money. Instead they "originate and distribute" loans. Two: New and improved rules for global governments to monitor banks -- known as Basel II, for the Swiss city where such things are negotiated -- rely heavily on banks' ability to build computer models to monitor the risks they are taking. Those models have lost credibility. Three: Ratings companies, principally Moody's and Standard & Poor's, made this mess possible by stamping the triple-A label on securities that turned out to be anything but supersafe. The fault is partly with them. But the fault also lies with government, which enshrined the rating firms' role in law and limited competition among them. Banks and Wall Street could devise a better business model. But they'd best hurry. If they don't act, regulators will.

·         How the smart money got it wrong The past 12 months may go down in some circles as the era when alternative energy caught a spark or the era in which the term "subprime" went prime time. But in the history of investment management, 2007 will go down as the one in which some of the brainiest, battle-tested value managers in the country got absolutely shellacked. Smart money? Not so much. A review of the one-year results of value-focused funds with some of the best long-term records shows that a virus of total stupidity savaged their ranks as one after another bought into banks, credit card providers, home builders and retailers at bargain-basement prices that seemed too good to be true -- and were.

·         Banks Plead They Can’t Follow Rules What a choice for the banks to face: report big losses or claim that they are not sophisticated enough to comply with an accounting rule that has been on the books for more than a decade. It’s no wonder they would rather leave the argument to a trade association.

• Bank of America May Acquire Countrywide After $2 Billion Stake Slumps 57%, Feds Seem to Favor Countrywide Buyout, Updated: The Real Story on Countrywide…., BoA in Talks to Buy CountryWide Financial , Countrywide's sins: How you'll pay

Can Starbucks get groove back? With his company facing tougher competition along with a sluggish rate of growth, Starbucks visionary Howard Schultz had seen enough. Starbucks shares are trading near 52-week lows, battered by concerns of oversaturation of stores in the U.S., slower traffic at its stores, growing competition from McDonald's Corp. and value-conscious consumers clobbered by higher gasoline and food prices. The stock is down 48% over the past year. In other words, Wall Street is struggling to put a value on Starbucks' earnings growth rate. Most investors don't think Starbucks can match the 30% annual rate it achieved over the past decade. And that has crushed the stock over the past year. Starbucks trades at around 20 times its projected earnings for 2008. For Stepherson, that's still pricey. He's looking for an earnings multiple in the midteens. In his return to the chief-executive post, for starters, Schultz plans to slow the pace of U.S. store openings, shutter a number of underperforming stores, and accelerate global expansion. Also on the table: overhauling the management structure and seeking to reconnect with customers. Schultz didn't put any figures on store closings or expansion. More specifics are expected Jan. 30.

Auto Makers Gear Up for Detroit Show As the big auto makers get ready for the Detroit auto show, they are wrestling with a disconnect between childish dreams and mature reality For more than a decade, the formula for success in the U.S. auto market was to sell fantasies of power and ready-for-anything functionality. That meant trucks and more trucks, and cars that got bigger, heavier and more powerful each year. That business model still has a lot of momentum, and can't be turned on a dime. That's why GM will have in Detroit both a ZR1 and the latest concept iterations of its "E-Flex" hybrid car technology -- made famous by the Chevy Volt concept last year. That's why Ford will showcase both a new generation of its hulking F-150 pickup truck and a concept for a tiny, European scale "B" Car that represents the sort of vehicle Ford will need to sell here in the future. That's why some of the big European brands will be pushing aside the big, high performance, premium-gas swilling sedans that have been their standard bearers through the years to make room for compact, four-cylinder crossovers and vehicles powered by diesel engines. Changing strategies on the fly looks messy and incoherent when you have to put on annual product shows for consumers. But messy change beats getting run over as consumers stampede in a new direction. During 2007, just three segments of the market grew, as defined by Autodata Corp.: Small cars, small sport utility vehicles and "crossovers," which are SUV's built on the underpinnings of cars. The old profit spinners -- midsize and large SUVs and pickup trucks -- all slumped, as did sales of minivans and large cars.

The differing fortunes of auto-parts suppliers Delphi and Dana show the importance of union relations in a bankruptcy-law turnaround, especially where labor's support can be coupled with a large equity investment. Auto-parts suppliers Delphi Corp. and Dana Corp. entered bankruptcy court about two years ago citing similar problems: labor costs that were rising at the same time that vehicle production at Detroit's three auto makers was falling. Dana is poised to escape Chapter 11 this month with exit financing and all-star directors in hand. But Delphi, which filed for protection five months earlier, plods on. It still must raise $5.2 billion in a tight credit market if it hopes to exit bankruptcy proceedings by the end of March, its stated goal. The differing fortunes of these companies show the importance of union relations in a bankruptcy-law turnaround, especially where labor's support can be coupled with a large equity investment.Dana's exit strategy has been aided by an investment plan launched by a private-equity fund recruited by its unions. In contrast, Delphi's chief executive officer, Steve Miller, has been in a grudge match with the head of the United Auto Workers since taking the reins in 2005.

Toyota Stock May Be a Buy Toyota Motor may well have had a landmark 2007, yet its shares slid 24% during the year. Now, some analysts say 2008 could be a good time to give the stock another look. When full-year sales figures become available, they might show that Toyota unseated General Motors as the world's largest auto seller on an annual basis. Toyota led after six months, then GM retook the lead at the nine-month mark. For Toyota, selling more than 9.3 million vehicles globally couldn't keep its stock from falling. Contributing to that drop were weak sales in the U.S. amid higher fuel prices, the subprime-lending crisis and a steep decline in housing sales. Another factor hitting Toyota's results was the strengthening of the yen against the dollar; a rising yen decreases the value of earnings repatriated from overseas markets when calculated in yen. And for 2008, economic forecasts for North America -- where Toyota got more than 36% of its revenue in the fiscal year ended March 2007 -- remain gloomy. Nonetheless, some analysts say Toyota's shares have fallen too far in recent months. They say the stock's fall hasn't taken into account the car maker's strong growth projections in the emerging markets of China, Russia and India as well as its record of cutting costs to offset the U.S. slowdown. Toyota Takes Texas as Tundra Sales Gains Destroy Last Bastion for Detroit

GM, start your turnaround The season always seems to be winter for GM. Yet for the first time in years, signs of warming are emerging. Wagoner is feeling good about the automaker's progress, especially in the troubled heart of its business: making and selling cars in North America. GM's latest new-car launches - Buick Enclave, Cadillac CTS, Chevrolet Malibu - are getting enthusiastic reviews and generating strong sales. The new products are giving GM (GM, Fortune 500) a much-needed image boost in the marketplace, while Wagoner has been making huge cuts in costs on the factory floor. By slashing both the hourly and salaried workforces, boosting productivity, and reducing health-care costs, he has cut $9 billion (or 22%) out of GM's fixed operating costs. And following years of patient negotiation, he reached a historic agreement with the United Auto Workers to push responsibility for retiree health care off GM's books, a burden that has been adding about $1,400 to the cost of every car and truck GM builds in North America. Three years ago Wagoner put his big plan into operation when he personally took charge of product development, manufacturing, and marketing and sales for North America. His decision to put his reputation - and perhaps his tenure as CEO - on the line finally put some steel behind GM's repeated promises to become more competitive. By setting a few clear and easily understood performance targets, Wagoner has led GM to within a neck of catching up in labor productivity and cost with its No. 1 competitor, Toyota.

McDonald's Takes On Starbucks McDonald's plans to install coffee bars at its nearly 14,000 U.S. locations starting this year, its biggest menu addition in three decades. The effort to poach Starbucks customers aims to add $1 billion to the fast-food chain's annual sales. McDonald's is setting out to poach Starbucks customers with the biggest addition to its menu in 30 years. Starting this year, the company's nearly 14,000 U.S. locations will install coffee bars with "baristas" serving cappuccinos, lattes, mochas and the Frappe, similar to Starbucks' ice-blended Frappuccino. Internal documents from 2007 say the program, which also will add smoothies and bottled beverages, will add $1 billion to McDonald's annual sales of $21.6 billion. The confrontation between Starbucks Corp. and McDonald's Corp. once seemed improbable. Hailing from very different corners of the restaurant world, the two chains have gradually encroached on each other's turf. McDonald's upgraded its drip coffee and its interiors, while Starbucks added drive-through windows and hot breakfast sandwiches. The growing overlap between the chains shows how convenience has become the dominant force shaping the food-service industry. Consumers who are unwilling to cross the street to get coffee or make a left turn to grab lunch have pushed all food purveyors to adapt the strategies of fast-food chains. It also shows how the chains' efforts to adapt to a changing market have had drastically different results on their bottom lines. McDonald's is entering the sixth year of a successful turnaround, while Starbucks has begun struggling after years of strong earnings and stock growth. Still, the new coffee program is a risky bet for McDonald's. It could slow down operations and alienate customers who come to McDonald's for cheap, simple fare rather than theatrics. Franchisees say that many of their customers don't know what a latte is. The program attempts to replicate the Starbucks experience in many ways -- starting with borrowing the barista moniker. Espresso machines will be displayed at the front counters, a big shift for a company that has always hidden its food assembly from customers. McDonald's says it wants customers to see the coffee beans being ground and baristas topping the mochas and Frappes with whipped cream.

Starbucks, Threatened by McDonald's Coffee, Brings Back Schultz as Chief Howard Schultz was peddling a unique idea when he turned a Seattle coffee-bean roaster into a chain of U.S. cafes called Starbucks Corp. Now he is returning to lead a company battered by the competitive landscape it created. Investors responded by sending the shares up the most in almost two years in U.S. trading. Starbucks trained customers to demand better-tasting coffee. In the process, it spawned thousands of mom-and-pop imitators and enticed even McDonald's Corp., the world's biggest restaurant company, to open coffee counters. By bringing back its visionary leader eight years after he stepped aside as chief executive officer, Starbucks is telling shareholders the challenges run deeper than labor costs or a drop in consumer spending. Schultz, who returns after Starbucks reported its first quarterly drop in U.S. customer visits, called the chain's problems ``self-induced'' and said Starbucks hadn't introduced enough ``exciting'' products.

What does it take to build the world’s cheapest car?

Four Wheels for the Masses: The $2,500 Car For Tata Motors of India, which will introduce its ultra-cheap car on Thursday, the better question was, what could it take out?  The company has kept its new vehicle under wraps, but interviews with suppliers and others involved in its construction reveal some of its cost-cutting engineering secrets — including a hollowed out steering-wheel shaft, a trunk with space for a briefcase and a rear-mounted engine not much more powerful than a high-end riding mower. The upside is a car expected to retail for as little as the equivalent of $2,500, or about the price of the optional DVD player on the Lexus LX 470 sport utility vehicle. The downside is a car that would most likely fail emission and safety standards on any Western road, and, perhaps, in India in a few years, when the country imposes tougher environmental standards. But Tata is not looking to ply California’s highways. Instead, the company wants to provide four-wheel transportation for the first time to people accustomed to getting around on two, including hundreds of millions of Indians and others in the developing world. Even so, the “People’s Car” (a nickname, since Tata has kept the real name under wraps, too) may ultimately affect what many people drive around the world, since it is part of a broader trend among carmakers to try to build less expensive cars. “It’s basically throwing out everything the auto industry had thought about cost structures in the past and taking out a clean sheet of paper and asking, ‘What’s possible?’” said Daryl T. Rolley, head of North American and Asian operations for Ariba, which helps supply parts to Tata, BMW, Toyota and other carmakers. “In the next five to 10 years, the whole auto industry is going to be flipped upside down.”

New Year's Flop Tech stocks are proving to be the biggest disappointment of the new year. Technology companies have big sales overseas, where growth has stayed strong, and sell mostly to businesses, so they are less vulnerable to slowdowns in consumer spending. Now, however, tech stocks are suffering the brunt of the stock market's recent beating. Behind the problems: a round of profit-taking and disappointing earnings projections because of a slowing global economy and cuts expected in sales to financial companies, which are among tech's biggest buyers and are struggling with big losses.

Apple, Google, Technology Companies Slide on Concern Over Consumer Demand Weakness in the U.S. economy figures to take a bite out of the technology industry's growth rate in 2008, when analysts expect tech spending to slow around the world. The picture is not exactly dire: A forecast released Thursday by analyst firm IDC calls for the worldwide information-technology market to grow 5.5 percent to 6 percent in 2008, the lower end of what has become a usual range. In the U.S., the market is expected to expand 3 percent to 4 percent. Those growth rates are softer than this year's 6.9 percent worldwide expansion and 6.6 percent growth in the U.S., according to IDC. Just a few months ago, IDC was expecting the U.S. tech market to grow 5.5 percent in 2008. The company pushed its estimate down to 3 percent to 4 percent as the mortgage crisis heightened and rising high oil prices enhanced the prospect of a recession next year,

Intel's Otellini Says New Home Video, Music Gadgets Spurring Chip Growth Otellini is relying on Intel's experience in ratcheting up the speed of processors to make future phones more like personal computers. In 2006, he decided to scrap predecessor Craig Barrett's $5 billion effort to sell chips that run the communications features of phones, after failing to wrest sales from Texas Instruments Inc. and Qualcomm Inc. Intel, the world's largest semiconductor maker, plans to release its package of mobile chips, called Menlow, in the first half. Facing slowing growth in PC sales, the Santa Clara, California-based company is once again turning to the market for mobile handsets, which outsell computers by more than 4-to-1.

AT&T Falls Most in Five Years as CEO Cites `Softness' in Consumer Business AT&T Inc. dropped the most in almost five years in New York trading after Chief Executive Officer Randall Stephenson said slowing economic growth led to ``softness'' in the home phone and Internet businesses. The shares fell 4.6 percent, helping to spark a broader decline in U.S. stocks, after Stephenson said AT&T is disconnecting more home-phone and high-speed Internet customers for failing to pay their bills. The disconnects in the home-phone business, which accounts for about a fifth of sales, have put more pressure on Stephenson, who became CEO in June. Last year, he relied on the popularity of wireless handsets such as Apple Inc.'s iPhone to fuel growth, helping to make up for losses of home-phone customers. AT&T lost 468,000 primary home-phone lines in the three months ended in September, Stephenson's first full quarter since taking the CEO job. The company ended the third quarter with about 32 million primary residential phone lines, a 3.9 percent decline from a year earlier.

Blockbuster thinks digital Chief Executive Jim Keyes told investors Wednesday that Blockbuster Inc. will look more like an "entertainment convenience store" over the next three years, with a greater emphasis on digital delivery thanks to the company's recent acquisition of video-download service Movielink. Blockbuster is working on a flash-memory product that could allow movies to be seen more easily on portable devices, and is testing other technologies that would facilitate portable viewing, the executive said. Ultimately, Blockbuster will offer rentals that allow viewers to download movies straight to the TV, Keyes added. Rival Netflix Inc. and LG Electronics said last week that they're developing a set-top box that will allow consumers to stream movies and other content directly from the Web to high-definition TVs

Posted by dblwyo at 10:30 AM | Permalink | Comments (3)

Yesterday morning had the pleasure of hearing an '07 review and '08 preview on the mid-market buyout situation. Interesting on several fronts - '07 was generally good but the last half of the year not so and the end of the year looked like it started tanking. Lots more to be said but the thing that really struck me was a) again, how unanticipated the downturn was and b) how little anticipated and factored in foreseeable future pains are. Part of that of course is that panelists have to be conservative, let alone the audience. And to be fair everybody but everybody is seeing a tough year with tighter standards, less available financing, lower multiples, lower debt & more equity. A return of sense and sensiblity if you would.

All of which works if you believe in the U-shaped outlook for the economy and markets. With two caveats - what folks aren't factoring in is that the outside arm of the U is still going to be around 2% which will be pretty darn low and slow. For years if you believe the Fed. And the second thing they're ignoring is the fault lines of fragile consumers, banks and businessess. Where the longer we spend in a weak environment they more likely they are to fracture.

Bottomlines: 1) it's going to be a tough year, 2) the best outlook is still being under-estimated for its' foreseeable impacts and 3) the fragilities and fracture lines of downside risk are not being hedged. BtW - the first two excerpt/links are on denial and mistakes and seem to perfectly capture, IMHO, my sense of things past and things to come. With those notes let me also point you to three prior posts from this week that reinforce and take a deeper dive those themes.

• Seeing thru Maya: Piercing the Veils of Delusion
• Weally, Weally, Twuly Mr. Market: Consumers vs Denial Again
• Truth, Justice and the NDX Way: More Tech Outlook Reflections

 And, finally, this is OT but there's a wonderful campaign going on to increase our support for our service mean and women. OT for a blog on business, economics and markets but there's more to life:

GRATITUDE: the Gratitude Campaign

General & Special

5 Stages of Market Grief One of the most intriguing things I find about the market is how the collective psyche sometimes resembles a singular entity. In particular, I have been fascinated by the commentary we have heard from some quarters regarding deep and obvious flaws in the present macro environment. I spent a lot of time over the holidays  (skeptically) reading commentary from various pundits. There was something strangely familiar in the absurdly erroneous observations, but I couldn't place my finger on what it was. Until Friday. I don't know who or what actually triggered my memory, but it finally dawned on me what the parallel was: The Kübler-Ross model of 5 stages of grief. For those of you who never took any psych in college, that is the process by which Humans deal with grief and tragedy. It was introduced by Elisabeth Kübler-Ross in her 1969 book "On Death and Dying". This has become well-known as the "Five Stages of Grief". Reviewing recent market commentary, it appears that the investors, traders and pundits alike have been working their way through each of these 5 stages.

Fed's Poole: Five Mistakes Poole started by saying there are no new lessons here, we are just repeating old mistakes. I'd start any list of mistakes with lax underwriting standards and the lack of regulatory supervision. The complexity and opacity of the new instruments (and methods of doing business) go a long way to explain the mistakes Poole lists for investment professionals. Each person - mortgage broker, rating agency, securitizer, investor - was only looking at their piece of the puzzle. I think Poole is focusing on the wrong mistakes. Kohn is much closer to the actual causes. We can debate the impact of low policy interest rates, but a clear failure was the lack of oversight. A number of people saw the problem coming, see Fed Shrugged as Subprime Crisis Spread, but a few people in key positions failed to act, even when it was obvious that there was a systemic problem. If we are relearning old lessons, perhaps we should remember that some oversight is good, and ideologues are dangerous to our economic health.

Economy

• Recession Just a Matter of Semantics?, Investment Patterns, Economic indicators take a turn for the worse , U.S. Will Escape Recession as Consumer Spending Holds Up, Economists Say, Economists: U.S. May Already Be in Recession

• The national vacancy rate for office buildings rose in the fourth quarter of 2007, the first increase in four years.
• The number of people working part-time hours because of slower business conditions rose 9% to 2.8 million in 2007.
• Pending Home Sales Index, NAR Housing Market "Bottoms"

• Weakest holiday season in years Many stores suffer big sales misses in December, but Wal-Mart and Costco benefit from cash-strapped consumers shopping for discounts.
• Recession pain likely to linger Many economists who hope for only a short downturn for economy worry weak recovery could hurt nearly as much as the slump.
• Consumer Goods Feel Pinch The credit squeeze has been big and bad financial news for months, but now it is hitting consumers -- and consumer-goods companies -- in much of the world.

Bernanke Signals Deeper Rate Cuts, Emphasizes Faltering Economic Growth Federal Reserve Chairman Ben S. Bernanke signaled he has resolved months of debate over the competing risks of slower growth and faster inflation, and is ready to make deeper interest-rate cuts. The central bank faces the most challenging moment of Bernanke's two years in office as both of the Fed's goals are under siege: unemployment is at a five-year high, while prices are also climbing. Until now, the deliberations produced non- committal statements from the Fed, which used ``uncertainty'' to describe the outlook in December.

Economic Confidence in Europe Falls to 21-Month Low; Inflation Accelerates European economic confidence fell in December to the lowest in almost two years, as orders weakened and soaring prices for food and energy pushed up inflation. An index of executive and consumer sentiment in the euro area slipped to 104.7, the lowest since March 2006, from 104.8 in November, the European Commission in Brussels said today. A separate report showed producer-price inflation accelerated in November to the highest in almost a year. Growth in Europe's services and manufacturing industries is slowing and confidence is weakening after borrowing costs rose in the wake of the collapse in the U.S. subprime mortgage market. Still, the European Central Bank has held off cutting its key lending rate as inflation soars to record levels above its 2 percent ceiling. Producer prices increased an annual 4.1 percent in November, according to today's data, the most since they rose by the same margin in December 2006. The increase was above the 3.3 percent of October and the 4 percent median forecast in a survey of 21 economists by Bloomberg News. A third report today showed that unemployment in the euro region remained at a record low of 7.2 percent in November.

• U.K. Retail Sales Rise at Slowest Pace in 21 Months; House Prices Decline, Marks & Spencer shocker

It has been five years since the Japanese economy started expanding again, after a slump of more than a decade. But the use of temporary employees is keeping the country's economy from gaining momentum. Five years ago, Japan chugged back into expansion mode after a decade long slump. Yet its economy remains lethargic, its consumer spending anemic, its corporations cautious about capital spending and its stock market fragile. With the rest of the world battered by continuing credit problems emanating from the U.S., the state of the world's No. 2 economy -- key to world economic health -- is an increasing concern. Such worries have sparked a heavy selloff in Japanese stocks in recent months. The benchmark Nikkei stock average tumbled 4% Friday, the first trading day of the year, after falling 11.1% in 2007, its first losing year in the last five. One reason Japan's rebound hasn't gotten traction: companies' growing reliance on temporary workers, who earn less -- and spend less -- than full-time employees. Companies across Japan have gone on a binge of hiring temps in the past few years. They earn about two-thirds of what full-timers do and can often be hired and fired with just a few days' notice. More than a third of the people in Japan's labor force are categorized as "nonpermanent" workers: part-timers, temps on fixed-term contracts and people sent to companies by temporary-staffing agencies. That compares with 23% in 1997 and 18% in 1987. Goldman Cuts Japan Growth Estimate, Says Recession Risk at `Danger Level'

China's Trade Surplus Narrows; Slowing Exports Signal Economy May Cool China's trade surplus narrowed for a second month as export growth slowed, signaling that the fastest economic expansion in 13 years may have peaked. The surplus for December shrank to $22.7 billion from $26.2 billion in November, the Chinese customs bureau said in a statement on its Web site today, lower than the $24.4 billion median estimate of economists surveyed by Bloomberg News. Exports grew at the slowest pace in two years, indicating that recent yuan gains, the cooling global expansion and cuts to export-tax rebates on polluting industries are beginning to bite. For 2007, the trade gap surged 48 percent to a record $262.2 billion, giving U.S. and European officials ammunition to keep calling for faster appreciation of the yuan. The policy is designed to slow the rate at which cash has been funneled into building thousands of factories, many of which may become idle should export demand dwindle too fast. Policy makers are trying to prevent the economy from overheating in the face of risks that global growth will stall and slash demand for Chinese-made goods. ``If exports slow in China, you'll see a lot of overcapacity, you'll see margins collapse, you'll see deflation and you'll see a lot of non-performing loans,'' said Huang Yiping, chief Asia economist at Citigroup Inc. in Hong Kong. A 1 percentage point slowdown in the U.S. would trim China's export growth by 4 percentage points and reduce gross domestic product by 0.5 percentage point, according to Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong. Morgan Stanley forecast last month that growth in China's shipments abroad may slow to 16 percent in 2008. Imports will increase 18 percent, the investment bank predicted.

Markets & Investing

Crisis Journalism: Summing Up the Credit Crunch in a Word The level of crisis in the securities and investment banking industry is at its highest since records began, according to the Financial News annual Crisis Index. The Crisis Index soared 295% last year, making it one of the best-performing indexes of any asset class in the world in 2007. At the same time, levels of fraud and scandal slumped last year, with both indexes falling 43%. The Financial News family of indexes measures references to collapse, crisis, fraud and scandal in articles in Financial News and on Financial News Online each year. To create each index, the frequency of mentions is rebased to 100 starting in 1998 to reflect the three-and-a-half fold increase in the number of articles published by Financial News in the past decade. Last year, the word “crisis” appeared in 692 articles, an increase of more than five times over the previous year. The Crisis Index leapt from 25.5 to 100.8, overtaking for the first time the base of 100 in 1998, the year of the Russian crisis and the collapse of hedge fund Long-Term Capital Management. The surge was driven by the subprime crisis in the U.S. that spread into international financial markets. More than 71% of all mentions of crisis referred to the credit crisis. The Collapse Index also enjoyed a strong year, rising 39% after the number of references to vehicles collapsing nearly doubled to 454.

It's Another Losing Hand for Wall Street The next test for corporate debt markets starts this week. On Thursday, banks arranging the buyout of Harrah's Entertainment by two private-equity shops are expected to begin trying to sell as much as $9 billion of loans tied to the takeover. The banks, including Bank of America and Deutsche Bank, have agreed to supply about $20 billion of debt financing to pay for the casino operator's takeover by Apollo Management Group and TPG. Because investors have become wary of holding this debt, the banks will likely need to carry most of it themselves. Wall Street bankers had hoped that easy credit, which disappeared more than six months ago, would have reappeared by now. Last year, they promised to underwrite hundreds of billions of dollars of buyout debt, with the expectation of passing that debt on to investors. Then the credit markets went awry and the banks got stuck holding much of the debt. The yield on "leveraged" loans, the sort Harrah's will attempt to sell, has surged as banks have sought to make the debt more appealing to squeamish investors. Early last year, yields stood at less than 2.5 percentage points above the benchmark London interbank offered rate, according to S&P. They have since surged to nearly 4.5 percentage points over Libor. Banks, having promised lower rates to their corporate customers, are now taking losses as they make up for some of the difference. According to Mr. Donnelly, banks have a pipeline of more than $150 billion of leveraged loans that need to be cleared, not to mention junk bonds that need to be sold. It has been easy to forget this corporate debt mess the past few months -- banks and investors have been preoccupied with the subprime-mortgage crisis. If the Harrah's sale stumbles, it will be a stark reminder that the debt overhang from the buyout boom is far from over.

·         Junk Bond Defaults to Rise Fivefold in 2008 From 26-Year Low, Moody's Says

·         The Biggest Private-Equity Fund-Raising Year Evah , Buyout Firms’ Exit Options Narrow as New Year Begins

·         Banks' losses could reach a quarter-trillion dollars, analysts say

·         The Danger from Bear Stearns New CEO

Yen Advances as Decline in Stocks Spurs Investors to Reduce Carry Trades The yen rose against 15 of the 16 most-active currencies as a decline in Asian stocks spurred investors to cut holdings of higher-yielding assets funded in Japan. The Japanese currency gained versus the British pound and the Canadian dollar as investors cut so-called carry trades on concern the global economy will cool. The euro climbed against the dollar and reached a record high against the British pound. Traders bet the European Central Bank will keep its benchmark interest rate on hold at 4 percent and the Bank of England will lower its 5.5 percent key borrowing cost today. In carry trades, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread. The risk is that currency moves erase those profits. Goldman Sachs Group said there's a 50 percent chance Japan will slip into recession and cut its 2008 growth estimate for the world's second-largest economy. The world's largest securities firm still predicts the dollar will weaken against the yen this year as the U.S. enters recession.

Posted by dblwyo at 10:08 AM | Permalink | Comments (0)

The Gratitude Campaign is an effort by Seatlite Scott Truitt to find a simple way to let our military folks apprecite what they're doing for. Irrespective of your own politics or how you feel about Iraq or the War on Terror in General they're putting it on the line for us. And doing their duty as they were asked to do their duty.

"Greater love hath no man than a mother cat dying to defend her kittens"

Robert A. Heinlein 

I doubt that many of us can appreciate what it's like to be downrange without being there, even if we know someone who's been in the real. But the dedication, hard work, risks and repeated going "In Harm's Way" our service folk are giving all that we can ask of them.

Here's the Web Address URL:

http://www.gratitudecampaign.org/index.php 

I also doubt that many realize the level of cohesion and performance displayed by these folks under repeated tours and constant stresses. Their performance is unusal, exemplary and with few precedents in history to the best of my knowledge.

So let us all set aside politics to express our appreciation for what our fellow citizens are doing with their citizenship in support of the Republic.

VAYA con DIOS to them all.

Posted by dblwyo at 12:42 AM | Permalink | Comments (0)

There were four major stories/columns+ that appeared today, at least so far, that caught my eye as deserving a post. Even a particularly long one. The first was a WSJ story about how Tech has been taking it in the neck and why, a second was the "surprisingly" bad holiday sales results, another was a fantastic Wessel column on banks broken business models, and the last was a "Business Insight" post on the changes and challenges at Dell, Starbucks, etc. They're all worth your time, we cite them on the continuation and hopefully explore them in more depth. But as you read them maybe you'll have our reaction. None of them are really great surprises - indeed we've talk about each one way or another for some time here. Each was in fact a surprise. And each has been visible for a long time.

The Buddhists (& the Hindus) talk about Maya the "Veil of Illusion" and suggest that we don't see the real world underneath the surface. Now for a while, and still, there was a tendency in the West to do some sort of mystical mapping between quantum physics and so forth to suggest that was what's being talked about. Or alternatively it was a mystical point and to be dismissed. In any case the critics, pro and con, took it as arm-waving philosophy.

When you dig into the propositions are much simpler, harder and useful. What they really mean is that we tend to look at the world as prisoners of a whole host of assumptions and presumptions - to see the world as we'd wish it to be instead of how it is. Hence we view the world thru a distorting veil of delusions brought about by our own bad thinking.

The recommended cure is to both learn to see the world and to learn how to think. To see the world the primary tool is to learn how one thing leads to another and that to another and so on in a cause-and-effect chain. Or if it's complex enough web of linkages and feedbacks. In other words Maya is not mystical it's talking about having a bad model and not knowing how, or choosing not to, fix it. Which is the other part of the prescription - learn how to think and make up your own mind. The Buddhists call that "Right Thinking".

Well the common thread running all throughout the four stories, or at least so it seems to me as it finally dawned, was each was the result of distorted thinking, bad models and delusions about what was really going on. Delusions all the worse for having gotten so much intellectual and emotional investment that the commitment to denial was pretty pronounced. The problem with Reality is that sooner or later the tide comes in, water doesn't run up hill, business cycles cycle, profits decline and bad due diligence and poor operating performance get their entropic rewards. 

Actually with Prof. Ben's announcement that they're going to do everything they can to prevent a recession, though it's too late to stop it and now the goal is to mitigate it before it cracks all the fault lines we've been talking about (just yesterday and for months now was it :) ), we may have a fifth good example. Watching the markets gyrate back and forth where's the surprise ? And what changes about the underlying realities ? As you skim the readings and links below ask yourself that.

1. New Year's Flop Tech stocks are proving to be the biggest disappointment of the new year. Technology companies have big sales overseas, where growth has stayed strong, and sell mostly to businesses, so they are less vulnerable to slowdowns in consumer spending. Now, however, tech stocks are suffering the brunt of the stock market's recent beating.

• And as it happens we just did a riff on Techs which points to prior posts as well: Truth, Justice and the NDX Way: More Tech Outlook Reflections
  

2. Weakest holiday season in years Retailers reported deep declines in their December sales Thursday, reflecting a 2007 holiday shopping season that is turning out to be one of the weakest in years. Perkins, who tracks same-store sales at 43 retail chains, said combined November-December sales rose 1.7 percent, their weakest gain since 2002.

• Hmmm, ditto on consumer spending outlook. You'd think we planned the whole thing. It's really not a conspiracy, just veil-piercing, trust me. Weally, Weally, Twuly Mr. Market: Consumers vs Denial Again. And for fun here's a prior on real retail sales: Reality Bites: Real Retail Sales and Consumption
  

3.How to Unbreak the Banks The business model for big U.S. banks is broken. If banks and Wall Street don't act, regulators will. And if regulators don't, House Financial Services Committee Chairman Barney Frank and the other Democrats in Congress will. How the smart money got it wrong But in the history of investment management, 2007 will go down as the one in which some of the brainiest, battle-tested value managers in the country got absolutely shellacked.

• Above are the link to Wessel's story plus another from Jon Markman followed by a link on the history of the Finance industry and have they've broken their business model by focusing on "trading" rather than by focusing on innovating for custome  value by Jim Jubak.
• And our take on the Finance Industry. Interesting Times for the Finance Industry 

Banking on the founder’s mojo.  Both Dell, Inc. and Starbucks are facing fundamental shifts in their markets. PCs and coffeehouses were around long before these companies started ramping up their efforts, but Dell and Starbucks took advantage of — indeed, created — new market models. For Dell, that meant fast, direct delivery of customizable PCs; for Starbucks, it meant the rollout of chic and consistent Seattle-style coffeehouses on the McDonald’s model of “one on every corner.” Both of these models were new when they were rolled out. Now the business models aren’t new.

The category on Enterprise Performance has a set of readings and some dedicated posts on the subject. And let me add my little riff posted as a comment on the post.

Well it’s more than just these three who need to re-think their business models. Check out Wessel’s ‘broken banks’ column in today’s WSJ for why these difficulties are so widespread. This also ties back to earlier issues on performance. If you think about a framework there are four steps: Idea->Business Model + Strategy, 2)Strategy -> Ops Performance [2a)Mkt/Sls, 2b)heavy-lifting,e.g. mfg. 4)Mgt System (Budgets, Opplan, Leadership). Innovation and adaptation can/should/must happen at all levels. In the long-run performance is about renewing the BM and translating it into delivery.Aside from your examples another good one is Schwab. But the sine qua non is facing reality. A friend heard Dell at the last major Gartner meeting and found him obscure and disingenuous (being polite). In other words Dell’s mode is badly broken because it’s saturated it’s markets and they aren’t facing the need to revamp. At the same time in focusing on op cost savings they destroyed a major part of the model - outstanding customer service - by putting their own internal agendii ahead of the customer’s benefit. Dell needs to clean up its’ act big time, adapt the existing BM to new markets, and lay the groundwork for a new BM. All this in an orderly, proficient, military manner (GSygt T. Highway). While disingenuosness prevails it’s unlikely. Schwarz on the other hand seems to get it. And he has the McD’s example. Go back to Schwab who re-invented the core BM three major times and executed each well.

Posted by dblwyo at 12:29 PM | Permalink | Comments (0)

Once more into the breeches dear friends, once more. For safety, profits and returns ! (BtW - a friend has pointed out that breeches (trousers, breeks) should have been breaches (hole-in-the-wall) but aside from the typo the Freudianism might be more accurate. And funnier. Or not - think about it because blowing holes in in the walls and getting our pockets picked are both pretty accurate descriptions :) ).

My pique is provoked this morning by reading another decent but not necessarily well-grounded story on Wall. St. economists take on the consumser spending outlook. Of course we're alright as long as Employment holds - despite the fact that last week's surprise wasn't any kind of surprise if you've been following things. The story that triggered my ire is from Bloomberg:

U.S. Will Escape Recession as Consumer Spending Holds Up, Economists Say The U.S. will skirt recession as consumer spending slows without collapsing, a survey of economists showed. Economic growth will average 1.5 percent in the first six months of 2008, matching the fourth quarter's pace, according to the median estimate of 62 economists surveyed by Bloomberg News from Jan. 3 to Jan. 8. The rate of expansion would be the weakest since the last nine months of 2001. ``It's soft economic activity that feels like a recession, but we probably won't have one,'' said Mickey Levy, chief economist at Bank of America Corp. in New York. ``The state of the consumer is clearly softening, but spending is not declining. That's very important.'' The Federal Reserve will cut interest rates more than previously anticipated, economists said, triggering a reacceleration in growth by the third quarter that will keep the economy from stalling. Economists put the odds of a recession developing within the next year at 40 percent, according to the median estimate. Nine of the 47 economists responding to the question put the odds at about even and five said the economy would contract.

 By this time you might have the toolkit to pick this apart by yourself but let's dig in anyway. Consumer spending changes lead the overall economy it's true, though typically by only a few months to a quarter or so. But, as we've gone on about before (Business Cycle, Cycle Structure, High-frequency Indicators), consumer demand is a function of wage and job growth and borrowing capacity. While those posts covered a fair amount of ground two things apply here: 1) Consumer demand can be forcasted by looking at Wage and Employment changes, and GDP & Investment are largely lagging variables, i.e. if you think business spending is bad now just wait. And, oh yeah aside from the "normal" slowdown the full impact of Housing and Credit has yet to be seen and Banks, Consumers and Businesses have all taken on incredible leverage and are very vulnerable.

So the key here is what are Wages and Employment doing. 

Well as we showed the most straight-forward way to address that question is by looking at the sum of YOY% changes in both variables. Which we do in the three-part chart at right. The whole chart compares YOY% changes in real consumer spending to the sum of those same changes in Wages and Employment. The bottom sub-chart takes the series back to 1964. We use different scales with W+E on the r.h.s. so you can see the coherence in timing and structure. The middle sub-chart zooms in a bit and looks at basically the last whole boom and bust cycle from '94 to date. There three "aberrations" that you should pay attention to; two of which are about to bite us. During the late '90s consumption held up instead of going down because of the stock value boom. Similarly the Housing boom let MEW be our banker from '03 forward. Which means of course we've robbed out any future demand expansions. The third little problem is that last year's drop in oil prices droppd inflation big time and kicked up real wages. Oddly consumption continued its' slow decline - which suggests that as the housing bust set in those were offsets. BUT from the beginning of '07 there's been a sudden, steep down in W+E which accelerated VERY sharply recently. The first sub-chart zooms in yet again to recent monthly data and you can see this third aberration bigtime. Now tell me again how consumer spending is and will hold up ?

The really interesting two questions here are:

1. Are the denizens of the Street just not looking at this data ? After all we just had both Summers (the Democrat) and Feldstein (the Republican), both of whom are about as competent macroeconomists as it gets, say identical things. To wit - the recession dangers are very high and we need a stimulas package now not to avoid the worst but to mitigate it.

2. And second, given that this sort of cold-eyed analytical look at the underlying realities seems to be escaping the scrutiny of the street, then things might turn out much worse than the anticipated two quarter slowdown and recovery to below par growth. In other words it's time to start thinking thru your strategies now and positioning yourselves if and when, come mid-year, things don't turn around as expected.

Judging by Mr. Market's continued nervousness over the last few days these points haven't escaped a lot of people though. Or put another way - all those folks telling you these are buying opportunities. Think very carefully about that. 

Posted by dblwyo at 11:50 AM | Permalink | Comments (0)

And perhaps, to be both fair and honest, we should add Schadenfreude. If you look at the chart it shows the relative six- and three-month performances of the NDX, AAPL, GOOG, and RIMM. Now we've been warning for some time that that the markets have "fluffed" or "bubbled" up over their long-term trends, irrespective of the underlying economic fundamentals.Most recently here. And that techs in particular and the big techs most especially had exaggerated that fluffing process considerably. Well those chickens came home to roost big time last week with a drop in the NDX since last Mon. of about -8%, along with similar drops in AAPL and GOOG coupled with an -18% drop in RIMM. Whee....are we having fun now or what ?

Our argument has been basically the logic that a slowing economy meant slowing capex spending which meant lower tech demand and investment. A thesis which is beginning to be reflected on a worldwide basis with last week's downgrade, for example, of INTC as well. To that we should have added another - which is that there's been a dramatic shift in some tech dynamics as companies like Apple make major efforts to enter what amounts to the Consumer Electronics industry. Which falls under the sector heading of Consumer Discretionary - a sector even more hardhit than any but Financials.

Now we need to be a little careful here. All three companies are genuinely excellent operational performers with some distinct differences. RIM appears to be still a dominant player in smart-phones for the business sector and also to have gotten a major halo uplift from the iPhone, which opened up the "smart phone" appeal to a much wider audience. Google continues to be a great company which continues to achieve superb results in its' core business. Please note though that in terms of long-run value that it hasn't had any, that we can find, major new innovations that have driven increased penetration of new markets. Though it continues to introduce and testfly many new inventions none have established new markets. Apple on the other hand continues to demonstrate a relatively rare combination of strategic innovation - defined as delivery new products and solutions to markets that actually solve customer problems and provide new value as opposed to just introducing new technology per se. And to couple that with continued operational performance and delivery.

Nonetheless the bloom is indeed off of these roses for reasons we've waxed poetic about, repeatedly in fact, before. Barry Ritholz posted a delightful and insightful assessment of the gap between fundamentals and market perceptions today that compared much of the thinking going on by Mr. Market as fitting Kubler-Ross's well-known stages of denial (an analogy we've also used before).

5 Stages of Market Grief One of the most intriguing things I find about the market is how the collective psyche sometimes resembles a singular entity. In particular, I have been fascinated by the commentary we have heard from some quarters regarding deep and obvious flaws in the present macro environment. I spent a lot of time over the holidays  (skeptically) reading commentary from various pundits. There was something strangely familiar in the absurdly erroneous observations, but I couldn't place my finger on what it was. Until Friday. I don't know who or what actually triggered my memory, but it finally dawned on me what the parallel was: The Kübler-Ross model of 5 stages of grief. For those of you who never took any psych in college, that is the process by which Humans deal with grief and tragedy. It was introduced by Elisabeth Kübler-Ross in her 1969 book "On Death and Dying". This has become well-known as the "Five Stages of Grief". Reviewing recent market commentary, it appears that the investors, traders and pundits alike have been working their way through each of these 5 stages.

As the recent unpleasantness, as they say, continues to work its' way forward that's a worthwhile model to keep in mind. And not just for tech but for all the other sectors, industries and firms. On the continuation you'll find another interesting excerpt on the overall outlook for tech spending that resonates with these points. 

Posted by dblwyo at 06:42 PM | Permalink | Comments (0)

Now that we're moving beyond the holidays it's time to ask how businesses will react to the acclerating deterioration in the macro-environment. And the decline in the markets where implicit valuations are likely to take a big hit as a result. Rather sad in light of the amounts that have gone into buybacks and the damage to balance sheets that result from increased borrowing to support those buybacks. As things beging to work out it's likely that these mounting pressures will increase the level of bankruptcies, pressure profit margins and in general make things more difficult.

Earlier this week, just to test the waters, I posted a question on LinkedIn to see if there's any shared widespread concern with these issues. If you're on LI you can take a look over there though it's early days as yet. We'll see how the response go. But the gist of my inquiry was this:

As the economy continues to deteriorate what do you think the impacts on corporate performance will be ? And how well positioned do you think major companies and industries are ?

Later amplified by suggesting that a) most companies have weakened balance sheets and are therefore more fragile and b) haven't taken the opportunity of the last several years to revamp their strategies, improve their operations or otherwise better posiiton themselves.

If you have any opinions please feel free to chime in, either in the comments or on LI. On the topic, and to help set the background up some more, we'd refer you to our prior posts on the macro-environment (& the balance sheet situation) as well as the approaches and prior readings on business performance evaluation. After the continuation we provide our usual list of decent industry and business links to help contribute to your thinking :).

In our 'umble opinions enterprise performance will be an increasingly critical challenge in the next few years, though it always is. Now it could become critical. And, as we hope we've made clear, things don't look any too rosy ! 

Business

Investors May See Dividends Disappear With credit markets continuing their downward spiral, investors could see their dividends disappearing in 2008. Dividend cuts or suspensions will continue to pick up among financial services firms in 2008… Higher yields indicate the company might be distributing more cash to investors than it can afford. Drastic dividends cuts or outright suspensions are likely steps if companies are struggling with earnings or other cash needs. Since early July, credit markets have been in a free fall, mostly due to rising defaults on mortgages, especially subprime loans given to customers with poor credit history. Silverblatt said if the credit markets continue to deteriorate and the economy further weakens, the problem is likely to expand into other areas, such as the consumer discretionary sector. Additionally, companies that would normally increase dividends each year could also put those plans on hold, Silverblatt said. More dividend cuts are likely to come as well. Many analysts are even predicting the nation's largest bank, Citigroup, will have to slash it dividend to preserve capital.

Citi and J.P. Morgan Predict a Buffet of Defaults  A wave of defaults from companies as diverse as the fare on a Buffet restaurant’s menu could be on the horizon. With credit flowing to practically any company in need of cash in recent years, the rate of defaults for U.S. high-yield companies fell to just 0.34% in December, according to a J.P. Morgan Chase analysis. The J.P. Morgan analyst, Peter Acciavatti, predicts that is about to rise drastically, to 4% by the end of 2009, and he isn’t alone. As BreakingViews points out today, Citigroup expects the default rate to surge to 5.5%, as easy credit becomes a distant memory. Those skeptics who say such predictions have time and again proved premature got a wakeup call Wednesday. That is when Tousa, the homebuilder, disclosed that it missed interest payments on $485 million in debt.

• Model behaviour OK, people have been predicting gloom for years. But that may be because their models failed to take account of looser covenants. Citi has a new model that predicts US high yield defaults hitting 5.5% by 2009 – even without a recession. Europe won't be that different.

'Desperate' Discounts for Retail After the most disappointing holiday sales season in five years, retailers are turning to "desperation discounting" to rescue bleak holiday sales. From early bird specials to new "power hours" and savings of up to 80%, chain stores such as Macy's and Kohl's (KSS) are trying a variety of tricks to resuscitate spending. Retail experts say that hoping for a full recovery from dirt-cheap prices may be wishful thinking, though gift-card sales could help ease the pain.

Retailers shop for winning ideas  The year 2008 won't be a stellar one for retailers, but analysts say merchants can still chart profitable growth in a downbeat sales environment if they cozy up to their customers like never before. Serve the customer better than ever before. The retailer that offers superior customer service will hold on to its shoppers even when spending starts to slow down in 2008. Open up the shopping box. Retailers have to develop a multi-channel shopping experience that extends beyond setting up a Web site. Fix the staffing conundrum. Because retailers experience a lot of turnover, PMA's Carlson said companies have to do a much better job in regularly training their staff. Sell solutions and not just products. Goel said there's a two-part advantage to this. Services are another source of sales. By being higher-margin, they also boost retailers profits.

Stonyfield stirs up yogurt market Now majority-owned by the French food giant Group Danone (GDNNY), Stonyfield generated about $300 million in revenues last year. Its yogurt is the No. 3 brand in the United States, behind Yoplait and Stonyfield's sister brand Dannon. It's quite a growth story for a company that began in 1983 with the families of Hirshberg and his friend, Samuel Kaymen, milking seven cows on a farm in Wilton, New Hampshire. Hirshberg, who is now 53, says that Stonyfield has lots more growth ahead, as does the organic food business, which accounts for about 3 percent of the U.S. food industry sales. "I think it's clear that organics are going to be 10 percent," Hirshberg says. "I actually think it's going to be 50 percent in my lifetime. Farmers make more money with organics. Retailers do better. Biologists are now linking cancers to agricultural chemicals, and the average schoolchild now knows that we are what we eat. I think we are on the cusp of a revolution." Maybe, although there's lots of debate (which we won't engage in now) about whether eating organic food is actually better for your health.

GM, Ford, Toyota, Nissan Report December Sales Drops; Honda Ekes Out Gain General Motors Corp., Ford Motor Co. and Toyota Motor Corp. said December U.S. auto sales fell, as consumers reined in spending to cap the worst year in a decade for car and truck demand. Toyota moved up to second in annual sales, pushing Ford from the spot it had held since 1931. GM's December sales of cars and light trucks dropped 4.4 percent from a year earlier. Ford's total tumbled 9.2 percent and Toyota's slid 1.7 percent, while Nissan Motor Co. reported a 2.4 percent decline and Honda Motor Co. had a gain of just 14 vehicles.

GM, Ford Win Praise, Not Sales, as New Lineups Fail to Attract Consumers General Motors Corp. and Ford Motor Co. just wrapped up one of their best years for vehicle quality and critical acclaim -- and one of their worst in sales. GM sold more than $21 billion in assets and Ford pledged collateral for everything from its plants to the trademark Blue Oval logo to raise $23.4 billion to pay for new models amid losses at the companies that totaled $14.6 billion in 2006. The cash has helped the automakers produce critically acclaimed models such as the Chevrolet Malibu sedan from GM and Ford's Edge sport-utility vehicle. Succeeding in those changes means building better vehicles as well as overcoming buyers' more-favorable views of Toyota and Honda brands, which have led U.S. quality and safety measures for much of the last decade and dominated ratings such as those in Consumer Reports magazine. Models like the Ford Taurus sedan, which Kelley rates as an affordable, good-quality vehicle, ``don't seem to be clicking with buyers,'' Nerad said. ``The perception of poor quality was established over a long period of time, and now they have to get people into the dealerships again,'' he added. Carmakers Offer Some Bright Spots Among the Duds, Expensive Wheels: The Most Overpriced Vehicles

J&J WAS Right! And ask yourself who really knows more about Guidant and what it will take to restore its franchise and take advantage of the medical and demographic trends upon which the premise of the deal itself rests? Is it the folks at J&J who, metaphorically speaking, spent over a year roaming the House of Guidant, peering in the attic, ripping up floorboards, checking the plumbing and inspecting the roof? Or is it the outsiders at Boston Scientific, who drove by a house they had thought of buying three years ago, before the price tripled, but had passed on it—and now, admiring anew what they saw, found a friendly set of bankers and started bidding? “Gutsy” may be the right adjective for the bid-‘em-up folks at Boston Scientific—they’ve proved themselves full of that quality in years past. Time will prove whether “stupid,” “desperate,” “naive” or, perhaps, “brilliant” are better.

Will consumers still be spending? This year, the commonly stated mantra for expectations is "evolutionary, not revolutionary," meaning we're most likely to see products that, at best, offer incremental improvements over existing ones compared to more ground-breaking developments. That could be a problematic sign. After all, consumers seemed to ignore everything from soaring gas prices to mortgage foreclosures in 2007 to continue plunking down money on the latest tech gadgetry. Whether they can continue to do is an open question that seems increasingly doubtful. Debate reins in the markets over whether the U.S. will go an economic recession this year. Investors are nervous. Technology stocks started out 2008 with a thud. Lead by a spike in oil prices and downgrades of some major semiconductor stocks on Wednesday, some of the recent high-flyers in tech were dragged down as well. At least two recent analyst reports talked about "nowhere to hide" in the volatile technology sector. This was after a pretty stunning 2007. According to Standard & Poor's data, tech stocks in the S&P 500 soared 15.54% for the year. Technology was among the higher performing sectors for the year, ranking fourth after energy companies, utilities, and materials. As consumers have helped keep the broader U.S. economy chugging away, they have also led the way in spending on technology products over the past few years, versus their corporate counter-parts, company IT managers.

PCs Take a Stylish Turn PC makers have begun a radical overhaul of their machines' appearance, spurred in part by the success of Apple's innovative products, as well as a consumer shift toward notebook computers.Spurred in part by the success of Apple Inc.'s innovative products, as well as a consumer shift toward notebook computers, PC makers have begun a radical overhaul of their machines' appearance. They're racing to replace boring boxes with sexy silhouettes that will differentiate their products, entice new buyers and command higher prices.In the process, they're hoping to compensate for factors over which they have little control, such as software options. Unlike Apple, famous for its easy-to-use operating system and other original programs, PC makers largely rely on Microsoft Corp. for the underlying software. And that company's latest version of Windows, called Vista, has been panned by some reviewers, despite healthy sales. The new focus on looks -- underscored by exhibitors at the Consumer Electronics Show, which opens Sunday in Las Vegas -- is forcing PC makers to re-think how they manufacture, whom they hire, how they advertise products, and where they sell them. Why all the action now? Though PC sales are surging throughout emerging economies, PC makers need new ways to spur consumer demand in the U.S. and other mature markets. By wooing buyers who care little about technical features, they hope to better tailor PCs to specific users -- including women, students, PC gamers and sports fans. It won't be easy. Producing new shapes and materials can raise costs and require tricky changes to production lines. Dell, which introduced its painted Inspiron laptops last summer, initially ran into problems with dust contamination that delayed shipments and angered customers. Moreover, it's unclear if most consumers will pay a premium for style. Companies that focus too much on fashion over function could end up with costly misses as trendy designs fall out of favor with fickle consumers.

Lenovo Puts Style in New Laptop After years of targeting business users with its conservative, black ThinkPad laptops, the personal-computer company is going after everyday consumers with a flashy new notebook line called IdeaPad. The product line, which includes red aluminum-alloy cases, beefed-up gaming features and halo lighting, is part of a major strategic shift for Lenovo, as it tries to compete head-on with the likes of Hewlett-Packard Co. and Apple Inc. in selling PCs directly to consumers in the U.S and other developed countries. But as Lenovo takes aim at consumers, it is looking at a crowded, competitive market. Lenovo's new IdeaPad notebooks look like the hipper cousins of the ThinkPad line, which Lenovo inherited from International Business Machines Corp. in 2005, when the Chinese company purchased the personal-computer arm of IBM. ThinkPad has a reputation for strong engineering and durability, and Lenovo is trying to capitalize on IBM's engineering legacy with the IdeaPad line. In China and India, Lenovo is well-established in the consumer market, where it controls roughly 30% and 22%, respectively, of consumer sales. But in most of the developed world, Lenovo has been dependent on sales of ThinkPads to businesses. Lenovo, which has an 11% market share for PCs sold to businesses world-wide, is eager to boost sales to consumers since that's the fastest growing segment of the PC industry.

What Does Eveillard Know About Comcast That the 35% Decline Doesn't Show? Comcast Corp.'s 35 percent decline in 2007 makes the stock look cheap to Jean-Marie Eveillard, manager of the $22 billion First Eagle Global Fund. The biggest U.S. cable network is worth $30 a share, says Eveillard, who buys stocks he deems inexpensive relative to potential earnings and sales growth. That's 73 percent higher than yesterday's closing price of $17.34 in Nasdaq trading. Eveillard disputes the view of Marsico Capital Management and Janus Capital Management, who invest in companies they expect to grow faster than their peers. They dumped Philadelphia-based Comcast in the second half of 2007 amid concerns that new federal restrictions and competition from phone companies will hamper revenue gains. During the same period, investors with styles similar to First Eagle, including Wellington Management Co. and Dodge & Cox, were jumping in, according to regulatory filings. Comcast ``is not going to disappear,'' said Eveillard, whose First Eagle has returned 15 percent annually in the past decade, third out of 620 global funds that invest in both stocks and bonds, according to Morningstar Inc.

Posted by dblwyo at 03:59 PM | Permalink | Comments (0)

If the employment numbers this last week were surprising and the market's response was simply shocking  the real shock and awe is what happens when you look at overall market performance. The first sub-chart shows the SP500 one year performance. Notice that, on a much fairer basis than a simple calander year, that it's flat at best. More importantly when you look at the second sub-chart something really interesting pops out - for the first time despite all the volatility this is the first time that the downturn has broken thru the upper bound of the long-term trend over the last four years. That tells us a couple of things. First, all the prior dipsy-doodles were gyrations caused by market repurcussions of credit problems or market internals. THIS time it's caused by economic fundamentals finally penetraing the event horizon of awareness and sentiment. It also might make one question how well grounded all the fluff has been since the rise of the market above the l.t. trend since earlier this year doesn't appear to have been grounded in economic realities.

Those same realities appear to be penetrating assessments of other markets as well. In the next chart take a look at the six-month and one year comparisons of Emerging Markets (EEM), Europe (IEV) and Asia (EPP) as well as the R2K and Nasdaq. Particularly notice that the mid-year speculative bubble in EM markets not only appears to be deflating but the way to have bet since the beginning of Nov. is down. Doesn't look like there are too many safe havens abroad any more does it ?

And on the other side of the house if we take a similar look at individual sectors, which are split into those doing worse than or better than the SP500 composite, a similar conclusion seems to be justified. At least on an overall basis. You will of course reach your own interpretations but, aside from energy (XLE) each of the other sectors that was fairly strong appears to be weakening, especially after this last week. That includes Technology (XLK) and Industrials (XLI), which we've been expecting by looking at economic fundamentals. Though Utilities (XLU) appears to be holding up alright as a combination of inflation hedge and income source.

We'll have to see how all this plays out of course but it looks to me as if we may begin to be hovering on the cusp of a SEE change in market outlook. One where sentiment begins to absorb and reflect more of the deeper problems in Structure and Fundamentals. Below the continuation you'll find our standard collection of interesting story links, including our own earlier post that was an end-of-year summary on the last year and the outlook.

Markets & Investing

Ganesh Filter II: Clear-seeing Algorithims for an '08 Plan Our constant theme is that is possible to filter, interpret and analyze the swirls of confusing data around us with the right tools and careful, calm thinking things thru. Learn what the data is, how to structure it, what it means and how to interpret it. Well we're certainly not the only ones to take that approach. Yesterday's end-of-year review summarized our major outlook on the Economy, Markets, Housing and the Credit Markets. It also concluded with a pointer to how to analyze an invididual business using our comprehensive enterprise performance framework. In an earlier post a friend asked so what would you do, smart guy ?

Your 'safe' money isn't so safe U.S. brokerages reveals that most are invested in the same sort of dubious paper that has rocked the financial world in the past six months. Although many money market funds have the word "cash" in their names -- leading investors to think that they are no more risky than a handful of paper money -- many are thinly veiled bets on the deteriorating mortgage market, a bet that has gone very bad for Wall Street, to the tune of hundreds of billions of dollars. The question now is how bad it could get for these supposedly safe funds. Yet a little detective work reveals that the 4.5%-plus annual yields on money market funds -- where most of the cash in brokerage accounts resides -- doesn't come from rock-solid U.S. Treasury bonds or bank certificates of deposit. Instead, the yields have been generated by a relatively new brand of mortgage-focused investment companies called special investment vehicles, or SIVs, that lately have been withering in value.

Leveraged Loans Lose $28 Billion Since June as Carlyle Group Gets Punished For investors stung by $28 billion of losses on high-yield, high-risk loans, it's payback time. Creditors are making borrowers from Carlyle Group's LifeCare Holdings Inc. to casino owner Tropicana Entertainment LLC increase the interest on their debt by an average 0.83 percentage point to change the terms of their loans, the highest price since at least 1997, according to data compiled by Standard & Poor's in New York. The penalties are four times higher than six months ago, S&P said. A total of 179 North American companies have a high risk of default or may need to change details of their debt agreements, Moody's Investors Service said. Lenders are taking advantage of the distress to recoup losses after the collapse of the subprime mortgage market caused $551 billion of so-called leveraged loans tracked by S&P to fall below 95 cents on the dollar, from 100 cents before June.

Asset-Backed Paper Rises First Time Since August as Borrowing Costs Fall For the first time since the August freeze in the credit markets, companies issued more IOUs backed by collateral as the cost to borrow in the short-term debt fell to the lowest in 22 months. Commercial paper backed by mortgages, credit-card loans and other assets rose $26.3 billion to a seasonally adjusted $773.8 billion for the week ended Jan. 2, the Federal Reserve in Washington said today. The 3.5 percent increase, the biggest gain in at least seven years, snapped a 20-week losing streak that began as losses from subprime mortgages caused a retreat from all but the safest government debt. Yields on the paper due in 30 days posted their biggest weekly decline in at least a decade as investors became more willing to hold the debt. Discount Rate Spread Narrows, Asset Backed CP Increases, Did Fed move work? Sign of credit relief, Credit Derivatives Markets Are Headed for Worst Week in Almost Two Months

Posted by dblwyo at 03:34 PM | Permalink | Comments (0)

And I am too. Shocked, simply shocked. Not that the reported Payroll job increase was only 18,000 when the consensus was for 70K, itself a very weak number. Moderately surprised at that. No I'm simply shocked that everybody, judging by incontrovertible and objective evidence in the form of a 2.5% drop in the SP500, 3.8% drop in the Nasdaq and a 4.3% drop in the NDX, was apparantly shocked. More decline in one day than a month long mild correction, eh ? And if you dig into the numbers private, non-gov't job creation was actually -13K to boot. Makes you wonder what's going to happen when the Census Bureau's Birth/Death small-business adjustment model is revised. Just for the record new jobs in '07 were over 80% accounted for by the B/D model. Which is necessary but misses turning points.

Let me explain why I'm shocked, though savoring the schadenfreude and the uptick in my investments. My shock is encapsulated in the chart on employment trends, which we've been discussing here since the beginning of the year, reporting on frequently and have always reached the same conclusions, repeated here. Job growth has been decelerating for some time, has been below the magic of 150K/month new jobs require to breakeven and non-organic job growth indicates a weak economy. NONE of which points has apparantly made it into ANY of the main financial or related economic research shops. Think about that very carefully indeed - the best minds in the business, paid much money and with $B's riding on their analysis has apparantly seriously investigated readily available data and used it to make investment decisions. What else might they have missed ? What's going to happen when rude, crude reality makes another undeniable appearance ? Likely to be even less pretty IMHO.

Consider yet another look at things that's potentially even more alarming in the chart at left. It shows the level of unemployment (r.h.s.) and YOY% change in the unemployment % (l.h.s.). Note by the way that the scales are inverted so that an increase in unemployment results in a drop in the graphs. 

Now we'll admit that this is a new indicator on this blog but it's consistent with the older ones. Just perhaps more revealing. The upper sub-chart shows the numbers since Jan00. Notice that the YOY% change is showing a sharp drop which in fact is yet another harbinger of recession.

The second sub-chart shows the same indicators back to 1980 so you can get a feel for how good an indicator of economic health it is. Notice also that the YOY% change in the rate is a leading indicator for actual increases in unemployment in general. Definitely doesn't bode well for the outlook either, does it ?

Below you'll find the usual collection of worthwhile story links to economic news. They cover the current macro-situation and observations therein plus specifics on employment, consumer debt, housing and the dollar. Also some interesting links on continued oil pressures. 

Economy

In the Land of Many Ifs For months, the American economy has been assailed by a wave of troubling news, from plunging housing prices to the soaring cost of oil, provoking gloomy talk of a possible recession. Yet so far the economy has found a way to shrug it all off and keep growing. How much longer can the expansion carry on? As a new year unfolds, analysts expect a verdict soon: Either the negatives finally metastasize and drag the economy down, or a fresh source of growth emerges, helping to sustain consumer spending despite the ongoing worries about housing and tight credit.

·         Top economist says America could plunge into recession Losses arising from America’s housing recession could triple over the next few years and they represent the greatest threat to growth in the United States, one of the world’s leading economists has told The Times. Robert Shiller, Professor of Economics at Yale University, predicted that there was a very real possibility that the US would be plunged into a Japan-style slump, with house prices declining for years.  Professor Shiller, co-founder of the respected S&P Case/Shiller house-price index, said: “American real estate values have already lost around $1 trillion [£503 billion]. That could easily increase threefold over the next few years. This is a much bigger issue than sub-prime. We are talking trillions of dollars’ worth of losses.” Recession May Be Near in U.S. After Jump in Jobless Rate, Economists Say

·         2008 outlook: Fasten your seatbelts Wall Street's top forecasters have some good news and bad news for 2008. Many think stocks will head higher but that unemployment will rise and the overall economy will slow. In other words, 2008 is going to look an awful lot like 2007. Despite falling housing prices and the subprime mortgage meltdown igniting fears about a broader economic slowdown, stocks are still on track to finish higher in 2007. For 2008, experts said investors need to be prepared for more woes in the slumping housing market and a slight rise in unemployment. So even though the financial headlines for 2008, particularly the ones about the housing market, may be as scary as the ones from 2007, many investors and consumers could do reasonably well. Just like in 2007. How they got housing wrong

• Caution: Job losses ahead Economists say recession fears could lead to weak employment in 2008 as companies may become more cautious about adding workers. Employment in U.S. Increases Less Than Forecast; Jobless Rate Climbs to 5%

·         Consumers late payers on most loans since recession  Americans are falling further behind on consumer loans, with late payments rising to the highest level since the nation's last recession in 2001, data released Thursday show. In its quarterly study of consumer borrowing, the American Bankers Association said the percentage of loans at least 30 days past due rose to 2.44 percent in the July-to-September period from 2.27 percent in the previous quarter. The delinquency rate, which covers eight loan categories, was the highest since a 2.51 percent rate in the second quarter of 2001. Late payments on some types of loans rose to levels not seen since the 1990s.

·         New Year Brings Another False Dawn for Housing The Fed staff expects the drag from housing to weigh on economic growth throughout 2008 and 2009. Hopes for a bottom dashed again.

·         Dollar Drops as Speculation Grows Fed Will Cut Interest Rate by Half-Point, Treasury Two-Year Note Yields Fall to Lowest in Three Years on Jobs Report

Oil's surge adds to the pressure on the U.S. economy. Oil prices only briefly touched $100 a barrel yesterday, but a prolonged stay at that level could soften the world's strong economic growth and threaten a U.S. economy already weakened by an ailing housing market and increasingly cautious lenders. Higher oil prices would also test the progress made by many of the world's industrialized economies toward greater energy efficiency since the oil shocks of the 1970s and early 1980s. Economic forecasting firm Global Insight says that, in the U.S., each $10-per-barrel increase in oil prices raises gasoline prices by roughly 19 cents a gallon, cuts growth in consumer spending by a third of a percentage point, reduces employment by 100,000 and adds one-half percentage point to consumer price inflation. Those factors combined will subtract two-tenths of a percentage point from the already slow 1.1% pace of growth the firm expects for the first half of 2008, the firm says. $100 oil may be just the start It's getting harder and more expensive to find new oil deposits, and global demand is growing. But there's so much speculation in crude oil that a bubble may be forming. OPEC Producing Adequate Oil, Can't Be Blamed for Record Price, Khelil Says

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

The prior posts surveyed the general economic and market situation and the investment performance situation. Here we'd like to continue that theme and fortunately ran across several interesting sources and stories that reinforce the argument. Links and excerpts are continued below the line. A fascinating WSJ article finally extends the enterprise value argument by looking at current results vs future performance expectations. The graphic example points at MickeyD's but please take note that it was strategic re-thinking and operational improvements that led to changes in future value, current valuations and stock improvements.In other words the way to translate our model of enterprise performance assessment is now explicitly linked to stock performance. But,we'd strongly emphasize, the key is the performance improvements, not pandering to short-term street expectations. Below are some equally fascinating links to analyst expectations which seem, in this light to be wildly mis-judged, to the liklihood of very large increases in corporate bankruptcies and, fresh today, two financial columns that outline strategies that conincide exactly with our overall outlook, sector analysis and individual performance analysis. We also provide linkages to applicable prior posts.

Just to explore this whole topic we ran an interesting experiment on LinkedIn by posting a question on expectations on enterprise performance. So far the response has been rather small - which may be a sampling problem. We'd also suggest that it's serious awareness problem. And, as today's headlines illustrates, early warnings are easy to ignore. The "surprise" downturn in Employment has been visible for months yet everyone is shocked, simply shocked :). Anyway if you can get to linked in check out the question for yourselves. Better yet leave your comments on your expectations here !

For another perspective we'll point to the performance of the SP500 over the last several years, especially PE Ratios (for why they're excellent indicators of eventual long-term performance try here or here. Anyway if you'll pop up the chart at left you'll a "stunning" climb in EPS coupled with a more than stunning compression of PE rations. Now you ask why might that be - could the market have figured out that earnings and profits are in fact not organic, are held up by buybacks and buyouts and not likely to be sustainable ? We'd argue that's a fair assessment and, willy-nilly, that any investment you're considering should be subject to the same value questions. How are they doing now and why ? And what are the likilhood of future improvements ?

Those are the questions that put you on the path to finding value investments that'll provide strong returns. And the heart of the discipline is seeing clearly what's coming, how performance is related and evaluating current strategic position and operational capbilities as well as future ones. Suitably adapted of course for sectors or other asset classes :).

Good luck and good hunting ! 

The Future Is Now Executives have become increasingly sophisticated at analyzing the value of current operations to help them manage the goal of increasing shareholder value. But they still need to supplement the tools used for value-based management with one that can analyze their company's future value. By the early 1990s, companies were increasingly zeroing in on whether business operations were adding value. Value-based management tools remain popular today, among them EVA, or economic value added, which takes after-tax operating profit and subtracts from it a charge for the capital employed to generate that profit. However, a variety of academics and consultants have pointed out the limited usefulness of EVA and other value-based performance measures, particularly given a propensity toward current-period and short-term, backward-looking performance evaluation. For example, EVA fails to quantify the increased value a company might realize in the future through, say, higher levels of investment in programs aimed at increasing brand loyalty, developing talent, generating patents or bolstering research-and-development capabilities. True value-based management requires executives to look both backward and forward. How important is future value to share prices in concrete terms? As an example, an analysis by AssetEconomics Inc. of the companies in the Russell 3000 Index as of May 2003 found that future-value expectations represented 59% of their overall enterprise value -- the market value of a company's equity plus the net value of its interest-bearing debt obligations. In 12 of 22 industry groups analyzed, future value made up more than half of enterprise value. In our research on a select set of major retailers, we saw a downward trend for future value in the industry as a whole. From 1998 to 2006, most of the retailers continued to invest heavily in new-store openings, fueling an increase in the companies' current value. Future value, however, didn't keep pace with the growth in current value. Best Buy Co. is an instructive exception to the industry trend. . Best Buy then launched its "customer centricity" strategy, which was designed to pinpoint the most profitable and fastest-growing customer segments in each store. A similar lesson can be found in McDonald's Corp.'s ability to renew investors' confidence in recent years. In the ensuing turnaround initiated by a new leadership team, increasing same-store revenue became the new focus of top management. Doing so meant renewing the brand through marketing and advertising. It also involved a radical change in the product assortment, with an expanded menu including salads, snack wraps and new sandwich and burger options. Video: The concept of future value

• WRFest 30Dec07(Business): Fragilities, Exposures & Soundness If it's not clear at this point we think the economy is slowing and seriously exposed to sudden & sharp disruptions as Housing and the Credit crisis worsen and it becomes more fragile. We also think that the Markets still haven't grasped this nor, definitely, is it reflected in pricing, earnings outlooks or valuations. Even on current course and speed with no major disruptions there's some serious re-thinking that needs to happen, at least IMHO. But if you start looking now and understand what's going on then there are going to be industries and enterprises that weather this storm, if not with style and grace. Finding them will be the trick and the trick to the trick starts with understanding the deeper structural fragilities that have been created by non-organic earnings and liquidity-driven buybacks. Well as is becoming a practice Paul Kasriel has already done the heavy lifting so we'll let his comments and charts speak for us. Here's the key point - on a macro level buybacks, real declines in profits and increased leverage indicate that business enterprises are very exposed to shocks if/when they come. In other words a hurricane will breach the dike and it'll take a well-founded company to manage the floods :). So pay careful attention to Paul's words and charts - think about 'em, 'cause they could be incredibly important.
• Corporate Earnings: A 2008 Bright Spot?  After a disappointing 2007, profits are expected to rebound in the coming year. But there's a lot that could go wrong If you're looking for a prime example of the stress and strain on the economy from a tumultuous year, look at corporate profits. A year ago, analysts were expecting a great 2007. Earnings for the Standard & Poor's 500-stock index were expected to jump 14.5%, according to Reuters Estimates, after a similar performance in 2006. Boy, were the forecasters wrong. Reuters Estimates, which compiles the predictions of thousands of equity analysts, expects earnings to rise only 2.6% in 2007. That number could be reduced as financial firms prepare to report billions of dollars in writedowns from the year's credit crisis. By the time fourth-quarter earnings are released in the next month or so, Goldman Sachs (GS) predicts, 2007 earnings will rise just 0.7% from 2006 levels. However, despite the disappointing 2007, and despite the turmoil in the housing and financial markets and the fears of an economic slowdown, many analysts remain surprisingly optimistic about profits in 2008. S&P 500 earnings are expected to spike 15.7% in 2008, according to Reuters Estimates. A weak 2007 makes the year-over-year comparison that much easier.

Citi and J.P. Morgan Predict a Buffet of Defaults  A wave of defaults from companies as diverse as the fare on a Buffet restaurant’s menu could be on the horizon. With credit flowing to practically any company in need of cash in recent years, the rate of defaults for U.S. high-yield companies fell to just 0.34% in December, according to a J.P. Morgan Chase analysis. The J.P. Morgan analyst, Peter Acciavatti, predicts that is about to rise drastically, to 4% by the end of 2009, and he isn’t alone. As BreakingViews points out today, Citigroup expects the default rate to surge to 5.5%, as easy credit becomes a distant memory. Those skeptics who say such predictions have time and again proved premature got a wakeup call Wednesday. That is when Tousa, the homebuilder, disclosed that it missed interest payments on $485 million in debt.

• Model behaviour OK, people have been predicting gloom for years. But that may be because their models failed to take account of looser covenants. Citi has a new model that predicts US high yield defaults hitting 5.5% by 2009 – even without a recession. Europe won't be that different.

Is '70s-style stagflation returning? Inflation is rising and the economy is decelerating, but those problems don't add up to that nasty combination of stagnant growth and out-of-control price increases. Yet.So how do you position a portfolio as we go into 2008? Remember that stagflation is possible but not certain. Investors who pay attention to the financial news out of the big banks should be able to keep their portfolios a step ahead of any shifts in the economy's direction. Fortunately, many of the investments you'd make to combat stagflation should work pretty well in 2008 even if all we get is a slowdown spread over a few quarters and a step up in inflation. Commodities and energy. Gold, of course. Growth stocks in sectors of the economy that will grow even if the economy slows. And any defensive growth stock with enough pricing power to raise its prices fast enough to stay ahead of inflation.

10 market predictions for a glum '08  It'll be a year of stock upheavals, especially in banking, but with great bargains along the way. For investors, the new year will be defined by a titanic struggle between governments' efforts to flood the world's faltering financial system with cash and banks' efforts to hoard it all for themselves. Commercial banks are stashing instead of using the cash infusions because leveraged mortgage bets gone bad are shrinking their capital bases faster than central banks and foreign investors can refill them. So what are the prospects for investors in this unhealthy environment? Here are the surprises that I see lying ahead:

Prior Postings

Think Like an Owner 

Another Trip to HD's Woodshed , Tesco in the US

An Ichan-like Inventory of Performances , Business Performance Readings

Strategic Outlook for US Industries , Tech Industry Outlook, Finance Industry Status, Retail Industry Performance 

Markets, Earngins & PEs

Review the Bidding: EPS Growth Analysis 

Market Drivers (3): Buybacks and Market Drivers (2): Buyouts 

Posted by dblwyo at 03:32 PM | Permalink | Comments (0)

Our constant theme is that is possible to filter, interpret and analyze the swirls of confusing data around us with the right tools and careful, calm thinking things thru. Learn what the data is, how to structure it, what it means and how to interpret it. Well we're certainly not the only ones to take that approach. Yesterday's end-of-year review summarized our major outlook on the Economy, Markets, Housing and the Credit Markets. It also concluded with a pointer to how to analyze an invididual business using our comprehensive enterprise performance framework. In an earlier post a friend asked so what would you do, smart guy ?

While we're not quite sure we're prepared to analyze that just yet we do have some suggestions and 'rules-of-the-road" for you to consider. Aside from the pay attention to reality. We'll repeat - almost all of the problems in '07 were predictable, predicted and worked out as predicted. They were almost all poo-poohed as well until they became too obvious and painful to pretend otherwise.

So here are a few "rules" and below you'll find a select set of readings and links we highly recommend as ammo for your thinking as you consider the year ahead:

1. Understand where the economy is going and focus on the fundamental implications for your job, investments and activities.
2. In selecting a target investment think first of the sector trends - a deeper dive on fundamentals if you will. A good company in a bad industry will be problematic and conversely.
3. Do a deep (enough) dive on the strategy, business model, operations and management system to understand how well the target is likely to perform in the circumstances you think are coming.
4. When we say target it could include an asset class, e.g. bonds, real estate, equities, etc. Or it could be a sector or theme, e.g. dividend and income. Or it could be a particular company - which it certainly must if, as we urge, you're paying attention to the outlook for your own livilhood !

The readings below provide Doug Kass's 20 Surprises for '08 which are very thoughtful, well-grounded and thoughtful. And buttressed by his superb track record in '07. They also provide Barry Ritholz's baker's dozen of rules you wished you'd paid attention given those surprises. We suggest you bump them together and decide how you want to be positioned if/when the various scenarios play out. Finally a selection of our favorite financial columists provide various guidelines to selecting targets (Jim Jubak, Jon Markman, Tim Middleton). As it happens they're all from MSN Money and so readily accessible.

 We'd suggest reviewing our end of year stuff, use it as basis for working thru Doug's surprises and evaluate those using Barry's rules. Along the way take a look at the assets, sectors and particular selections reccommened by the favorite three. Use their stuff as a starting point to screen and do a deeper dive. And if you don't want to go to a detail level then focus, as an example on sectors & trends, and go with asset classes, mutual funds and ETFs.

Good luck to you in this coming year ! 

Kass: 20 Surprises for 2008 These are not intended to be predictions but rather events that have a reasonable chance of occurring despite the general perception that the odds are very long. I call these "possible improbable" events. The real purpose of this endeavor is to consider positioning a portion of my portfolio in accordance with outlier events -- with the potential for large payoffs. After all, Wall Street research is still very conventional and based on "groupthink," despite the reforms over the past several years. Mainstream and consensus expectations are just that, and in most cases they are deeply embedded into today's stock prices. If I succeed in at least making you think about outlier events, then the exercise has been worthwhile.

13 Things You Wish You'd Known in 2007 Talk about a roller coaster ride. 2007 presented investors with many surprises -- and quite a few expected problems -- ranging from subprime mortgage defaults to term auction facility to sticky inflation. Agriculture boomed, the Fed surprised, homebuilders collapsed and Google (GOOG) and Apple (AAPL) were unstoppable. As we launch into 2008, now is a good time for us to look back and reflect upon what lessons 2007 provided us. For those who paid attention, there were many insights to be gained, even wisdom to be attained. Some of these we learned through observations; others, we learned the old-fashioned way (painfully). What follows is a mix of fundamental, economic, technical and even philosophical lessons that those savvy CEOs, fund managers and individual investors who were paying attention picked up in 2007. My hope is that you will glean something worthwhile from the misfortune of others.

50 stocks for a new year StockScouter, MSN Money's stock-picking tool, identifies companies poised for gains. January's list is well represented by companies that help feed, heat or heal people. Jon Markman

• Jim Jubak Please note that Jubak's Picks recommendations are for a 12- to 18-month time horizon. For suggestions to help navigate the treacherous interest-rate environment see Jim's Dividend stocks for income investors. For picks with a truly long-term perspective, see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
• Tim Middleton Get more from your 401(k) in 2008 Don't waste time with big, bland funds that don't deliver. Here are three mistakes to avoid and three ways to make your money earn more.

Posted by dblwyo at 12:39 PM | Permalink | Comments (0)

Now that we're past New Years and off to such a "good" start with the market it might be time to cast our minds back to this time last year and use that as an aid to look forward. We'll let the Hindu deity Ganesha set our tone - partly because it's amusing, partly because how many elephant-headed deities are consulted about the market and partly because his job includes being the deity of obstacles. Both removing and setting them. And it look like he's provided us quite a set to play with for the coming year. He's also the patron of arts and sciences and the deva of wisdom and intellect. Which would seem to make him perfect for the current situation. A good summary of the situation and outlook comes from today's NYT:

In the Land of Many Ifs For months, the American economy has been assailed by a wave of troubling news, from plunging housing prices to the soaring cost of oil, provoking gloomy talk of a possible recession. Yet so far the economy has found a way to shrug it all off and keep growing. How much longer can the expansion carry on? As a new year unfolds, analysts expect a verdict soon: Either the negatives finally metastasize and drag the economy down, or a fresh source of growth emerges, helping to sustain consumer spending despite the ongoing worries about housing and tight credit. 

Which contrasts nicely with this recent WSJ article - which to be fair doesn't represent the general tenor of recent reporting but reports on a certain mind set and makes a perfect counterfoil:

Stock Bulls Five Cheers If the stark scenario of a recession were to unfold, stocks likely would extend their fourth-quarter declines, which were capped by Monday's 101.05-point loss in the Dow Jones Industrial Average in the year-end session.Of course, the resiliency of stocks (the Dow did rise 6.4% for the year) also could mean investors don't think the worst-case scenarios are a sure bet. At least, that is what the optimists think. Here is a rundown of five events those last bulls standing say could surprise the bears this year: 1) Stocks Rally, 2) The Housing Market Stabilizes, 3) Consumer Spending Remains Solid, 4) Corporate profits accelerate, and 5) Economic Growth accelerates.

 Now to be honest the whole story strikes me as tongue-in-check, intentionally or not. It is nonetheless a good checklist to consider, either by refuting or confirming it. But at the heart of the matter, and where we need Ganesha's aid, is that it requires a clear-headed look at how things are working, what the trends are, how folks are interpreting and reacting and where the deeper currents are likely to take us. If you'll cast your mind back to this time last year, as we did a bit in the last post, the expectations were for a 10% market or so, earnings growth and in particular a bottoming of the Housing markets and recovery in Homebuilder stocks.

Here's our key point: everything that happened this year was already in train and analyzed by a lot of folks who based their work on, call it Ganesha's Stance: what did the data tell us. Our view is that we need to take a similar look this year because the risk factors are higher and the downside risks are greater. Below the line we summarize our viewpoint and outlook and point to prior posts that expand the evidence and argument.

We think our look needs to be on three levels. The first being the overall economic situation, the next the critical housing and credit market components and the third the structural failities that may get exposed to pressure if things turn south.

Overall Situation

Actually the best outlook for the next several years for economic growth is the Fed's, published in their last minutes. They are expecting GDP growth of 1.8-2.5, 2.4-2.5,  2.3-2.7, and 2.5-2.6% this year thru 2010 in contrast to 2.5, 3.9, 3.2 and 3.3% over the last four years. In other words the best of the coming three years is anticipated to be about equal to the worst of the prior four ! Yet the analyst community expects EPS growth in the 15.7% range, largely due to a second half uptick. One must confess to being fascinated by their logic - whatever it might be.

• The Fed's views are consistent with our own assessment, and go much farther outyear regarding the slowmotion slowdown. Slowmotion Slowdown, GDP Component Changes.
• But much of the excerpts from the WSJ, NYT, et.al. don't couch their analysis with due respect for the lag structure of the business cycle, nor what drives what.WtW Part Deux: Patterns, Cycles & Indicators,Weigh the World Works: Understanding the Business Cycle
• Nor are the recent high-frequency indicators being widely recognized and incorporated in much of the thinking. WTWW Part 3: Jitterbugging - the High Frequency Indicators

Housing and Credit Markets

Central to the "health" of the economy, such as it might be, is no further trouble in either Housing or the Credit Markets. In other words a growth recession is the best we can expect over the next three years, as best we can analyze and interpret the data. The extent of the housing problems, the lags in sales, prices, etc. and the consequences for the economy are still not widely grasped but our expert in the area, CalculatedRisk, has done a superb job of reviewing the bidding. And we've collated three of his key charts together to try and put a macro-perspective on thing. Housing: Retrospect & Prospect

Similarly, although we can't point to any independent work that covers the waterfront as yet, we'd argue that the scope and extent of the credit problems are still widely under-estimated because they are all too likely to spread from mortgage related debt investment to other classes. Something which is just beginning to come over the event horizon on Wall St. and in the mainstream press. Rocks, Ponds, Perverse Incentives: More on Credit Contagion,Greasing the Skids or the Gears: Credit Repairs Working ?

The overall weakness in the economy doesn't necessarily have to tip over into a recession, though in most quarters it will be hard to tell the difference. But that low growth means it's more exposed and fragile and therefore more prone to tip. If we're right about the lurking problems, which we repeat, are already visible and baked into housing and the credit markets, and also right about the extent that they are not being appropriately grasped then the forces that might create those tipping pressures are already in place. We'll have to see.

Fragilities and Risk Factors

The thing that we find truly worrisome is that Households, Businessess and Banks have all taken on a level of debt and leverage more appropriate to a robustly growing and healthy economy. As a result if things do get a little dicey, as they say, there's liable to be quite a bit of collateral damage. While we discussed this in an earlier post the real detail is in Paul Kasriel's latest economic outlook and Econtrarian - which we strongly urge everyone to read. WRFest 30Dec07(Business): Fragilities, Exposures & Soundness , Xmas Cheer ? - Disingenousness, Conundrums and Early Warnings

So the next question is what to do ? In general any particular stock or other investment will reflect the overall economic situation, the conditions of its' industry and the specifics of the company involved. Unless you're Warren Buffett making value-oriented decisions right now looking for major returns in 10 years is a pretty risky proposition. On the other hand these pressures will expose the strong and the weak companies and the good ones will get carried down in terms of strock price along with the rest. Which means that they, and a lot of other assets and investments, may be fairly cheaply purchased if and when the dust settles.

Now is the time to start looking and as a starting point may we suggest: Think LIke an Owner.

But in any case good luck and good hunting in the New Year ! 

Posted by dblwyo at 02:26 PM | Permalink | Comments (0)

Well it's New Years Day, traditionally a time for celebration, football and convivial congenialty. Let me wish everything for you then that you wish for yourself, now and in the New Year. It's also traditionally a time to look back (retrospect) look forward (prospect) and resolve - that is to decide where things are headed and you'd like to be.

Perhaps the key thing in retrospect we'd like you to think about is two critical points:

Now we ask you in thinking of Prospect and Resolution what data, tools and analysis is available to you to improve your thinking. We'ver tried to provide as complete a tool kit as we can manage on other issues in prior posts and will follow up later on but let us put this quote to you, from of all sources of wisdom, the Buddha ! :) From Paul Ferrell's recent Marketwatch column:

Remember Buddha's advice: "Believe nothing, no matter where you read it or who has said it, not even if I have said it, unless it agrees with your own reason and your own common sense." You are the only "expert" you can trust: All brokers and money managers, newspapers, magazines, online and newsletter pundits, all television anchors, and every other special-interest guru is "selling" you something. Don't buy "it."

 Below you'll find some charts we've "borrowed" from CR to summarize our interepretation of the Housing outlook and it's relationship to the Economy. Hopefully in a way that allows you see and judge for yourself. Just to put a point on it we'll ask you to look at, carefully review and more carefully think about the chart at right on the Homebuilder's stocks over the last two years. Notice the ear-marked period when "everybody" was convinced things were recovering.

UPDATE (1/1/08 @22:30): couldn't resist in my late night browse of the WSJ (can I rest my case now ?):

Stock Bulls' Five Cheers The market's optimists are increasingly treated like wallflowers at a high-school dance. Upbeat views are scoffed at as out of touch with reality. "Haven't you seen the latest housing numbers?" the skeptics howl. Pessimism has become so prevalent that investors may have a hard time remembering that stocks posted a respectable advance in 2007.

The housing market stabilizes. A bottom in the housing market remains a distant fantasy for many investors. Still, some argue it may not be as far away as the skeptics think. One indicator: stocks of home builders.

Now let's dig into the strategic outlook for Housing and the implications for the Economy based on our friend CR's charting and strategic outlook.

I'm not truly sure that it needs much interpretation but let's try anyway. The second sub-chart shows Residential Investment (RI) as a % of GDP. Notice that a) it stayed in a predictable range for a long-time and b) rose out of that range in the late 90s boom but c) bubbled beyond the limits with the credit-enabled housing bubble in the last few years. Most importantly notice that EVERY downturn in the economy has been triggerred by a downturn in RI. Which if it falls to historical norms, let alone bottoms in proportion to previous experiences, has a long way to go.

In the first sub-chart you can New Home Sales as a major component and leading indicator of the overall Housing cycle. Here you can particular see the late 90s upturn and the bubble. But what should leap out at you is the severe downturn as it "falls off a cliff".

The thing that has caused so much mis-perception about Housing is that it has a lag structure and that structure stretches out over quite a few quarters and years. In other words we've got a long way to go before Housing normalizes. More importantly Prices don't reach a bottom, nationally or in local markets, until long after RI picks back up. You can do your own comparisons but let me ask/suggest. If RI doesn't bottom until late '08 or middle'09 won't that mean that prices will keep falling for several years afterward ?

What implications does that have for mortgage holders being under-water ? For loses on mortgage-based debt instruments ? For the economy in general.

Think about it, please ! 

Posted by dblwyo at 10:08 AM | Permalink | Comments (0)