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