bizzXceleration: Performance, Value and Profit

The prior post carved out a bunch of interesting international economic stories though linking them to a general US perspective. As part of broadening our perspectives we ought to consider how business in the world is changing. We've been saying for several years that the re-emergence of China and India back onto the stage of the world economy is really the biggest structural change we've seen since the early 19th C. Back around 1820 or so did you know that they were the two largest economies ? And further that various indicators of per capita income and general health and welfare put them ahead, particularly China, who up until ~ 1830 could have made a case for being perhaps the most successful socio-political system for the longest period of time. Or at least had a heck of a good argument.

Well various folks are giving lip service and now more to that. For example both Jim Rogers and James Fallows have moved to China as have a lot of ex-pats but it's not entirely clear to me that people appreciate how we're evovling toward a multi-polar world - their attention is deficient if you will. Not that most don't know and acknowledge that the BRICS are important but they still think of it as a bi-polar link. WRONG ! In a multi-polar world the other nodes can link with each other. So after the break you'll find some fascinating stories about major business news from China and India - some among many we'll point out. For example did you know that a major reason Lucent, Nortel, Ericsson, et.al. are still struggling despite being in the midst of a new internet-driven telcom equipment buildout is that Huawei the Chinese manufacturing has been increasingly competitive with cheaper products with approximate quality. BtW - telecomm tech and gear is rocket science if you don't think these guys are moving up the value-ladder quickly !

But check out the first excerpt which provides a general perspective. 

A Rising in the East By the year 2030, 361 million Chinese -- more than the entire current population of the U.S. -- will meet the World Bank's classification for middle class: the people who "buy cars, engage in international tourism, demand world-class products, and require international standards for higher education." China may be, in this sense, a bellwether. Analysts at CLSA Asia Pacific Markets estimate that, by 2010, 50% of Southeast Asia's population will live in the region's cities, many having moved there only recently in search of better jobs and better lives. According to Nielsen Co.'s most recent global survey of consumer confidence, the Asia Pacific region generally is the most optimistic in the world. India in particular, after Norway, is home to the world's most upbeat consumers. Such hopefulness tells us something new. Westerners are well aware that China and India -- not to mention Singapore, Taiwan, Hong Kong and South Korea, the so-called Asian Tigers -- have undergone a process of modernization, raising their standards of living by exploiting, to varying degrees, the dynamics of a modern capitalist economy. But there has been a shift, too, in the way that the people of Asia view themselves and their future. Such a shift, Kishore Mahbubani argues in "The New Asian Hemisphere," will have profound effects on Asia's approach to the rest of the world and, just as important, on the world's approach to Asia.

Mr. Mahbubani, dean of the Lee Kuan Yew School of Public Policy at the National University of Singapore and a former senior diplomat, attributes the region's economic growth to a kind of free-market domino effect that began in the 1860s, when Japan began to adopt the economic practices of a modern industrial society. Over time, he says, the "seven pillars of Western wisdom" -- free-market economics, meritocracy, pragmatism, a culture of peace, the rule of law, an emphasis on education, and a willingness to pursue advances in science and technology -- have helped to give many Asian countries a new (and newly competitive) structure. But old habits die hard. Singapore, for instance, may be among the world's least corrupt countries, but its neighbors cannot even begin to make such a claim. Many Asian elites, Mr. Mahbubani concedes, wish to preserve traditional systems of privilege and legal inequality, but they know that "it is impossible to build a modern society and a modern economy without a modern rule of law. This is the pill that all Asians will have to swallow, bitter though it may be in the early years of application."

Developing Countries

China May Unveil Plan to Shake Up Telecoms China may unveil long-awaited plans for a restructuring of its massive telecommunications industry as early as next month, state-run radio reported. If the plan proceeds as outlined in the brief report yesterday, it would consolidate China's six big state-run telecom operators into three, with the surviving entities allowed to offer a full-range of services instead of being divided among fixed-line, mobile and other offerings now.Such a move, which analysts have been predicting in recent months, also could pave the way for the government to issue licenses for advanced, "third-generation" cellular services -- another long-awaited move that could unlock new orders for global equipment vendors. The restructuring plan would affect some of the world's biggest listed telecom carriers, including China Mobile Communications Corp., parent of Hong Kong- and New York-listed China Mobile Ltd., which boasts more users than any other wireless operator. The parents of two other listed companies, wireless carrier China Unicom Ltd. and fixed-lined operator China Netcom Group Corp. (Hong Kong) Ltd., would likely be merged, while the parent of China Telecom Corp. would absorb one of two wireless networks now operated by Unicom, the radio report said.

China Power-Grid Suppliers Glow The freakish storms that ravaged much of China late last month had a silver lining for at least one group of companies: those that make power-transmission equipment. These companies are likely to get a short-term boost as China repairs hefty damage to its electricity grid. And longer term, analysts say, the business should benefit from tens of billions of dollars in planned government spending to upgrade the grid to handle the booming Chinese economy. Some of the sector's biggest companies are multinationals, though two Chinese suppliers are gaining market share. Tebian Electric Apparatus, based in the western territory of Xinjiang, was already the world's third-largest producer by output of electric transformers after ABB of Switzerland and Siemens of Germany in 2005, the latest year for which data could be obtained. Baoding Tianwei Baobian Electric, based in Hebei province, is also a big producer of transformers -- critical parts of a power grid that perform tasks such as adjusting voltage.

Tata's global alliance At India’s DefExpo defense show this week, Tata announced a string of tie-ups with foreign manufacturers from the United States, Israel and Europe that set it apart from other emerging Indian defense manufacturers like Larsen & Toubro (L&T) and Mahindra & Mahindra. Tata group is becoming well known around the world for its low cost car, its bids for the Jaguar and Land-Rover brands, and for taking over Europe’s Corus steel company. Now it is emerging as the Indian market leader in a new area – defense equipment. The company is transferring India’s proven ability to produce low-cost software and international-quality auto components and cars to the defense and aviation industries, persuading companies like Boeing (BA), European Aeronautic Defense & Space Company and Israel Aerospace Industries that they can benefit by buying from India.

Resources Shine in India In many economies, investors pursue growth plays in technology, retail and telecommunications shares. In India, there is a new growth sector, and it is one that may not readily come to mind: shares linked to mineral resources and agricultural commodities. As India's once-hot stock market has rapidly cooled, many bellwether stocks -- such as Bharti Airtel, India's largest wireless operator, and information-technology titan Infosys Technologies -- are languishing. India's benchmark Sensitive Index, having risen 47% last year, closed Friday at 17349.07, down 15% since the start of the year. That could help other, lower-profile stocks come into fashion, some analysts contend, especially as iron-ore and food prices are rising globally. Many resources-related and agricultural-commodities companies are at an earlier stage in their development than India's bigger and better-known industries, analysts say. The sector has also been more affected by unpredictable short-term government policies, such as export restrictions or import duties, meant to control prices in the domestic market. Moreover, not many mining and commodities concerns are listed. India's resources sector "remains highly untapped considering its huge potential," says Ketan Karani, vice president for research at Kotak Securities in Mumbai. India has substantial reserves of minerals such as bauxite, iron ore, copper and zinc, but the commercial exploitation of these riches remains at a relatively low level. Much of the sector is still state-controlled, and political, social and environmental opposition often stymies efforts to develop new mines, given that many prospects are in tribal or forested areas. But with a surge in the demand for steel -- for which iron ore is a key ingredient -- and other metals from China and India itself, India's mineral production and exports have been increasing significantly in recent years.

Posted by dblwyo at 10:00 PM | Permalink | Comments (0)

We can talk about interesting weeks and too much news but regarding the latter the word tsunami come figuratively to mind. Especially as the talking heads and punditocracies oscillate back and forth on us. So given all the interesting stories we not only want to split them up but also want to parse them into more digestible chunks and keep some perspective. The word of the week is stagflation but to summarize it simply and clearly nonsense.

Yes the economy is turning down and yes we've been generally been labeled bearish and yes it's likely to get worse. But neither unemployment or inflation are likely to get as bad as the '70s. It's going to be painful and unpleasant to be sure. AND ripple around the world bet let's set the base case here. And as a reminder as you read the news clips after the break keep the chart to the right in mind which shows the various cycle alternatives and where we're at. [The detail explanations and more readings are in this previous post].

The first set of readings include source names like Krugman, Summers, Roubini and Wolfe who by and large converge on "this is going to hurt but not real bad". Now to be fair there are serious downside risks of which the most dangerous is that we stumble into something deeper and that cracks the fault lines in the financial and credit markets. Which is the most dangerous risk and could be beyond painful.  Speaking of perspectives there are a couple of other things to bear in mind about the status of the international economy.

The rest of the readings review the lessons from Japan's political and policy failures that led to a "lost decade". That's the danger we need to worry about and the Fed is doing everything they can to avoid it. However the aftermath of all the cumulative screwups over the last nine years will be with us into the next administration. We strongly suggest you use grounded economic policy as a major decision-making criteria for picking your candidate - if we can fantasy that good economic sense is an option of course.

The other fantasy that's been put to bed is the decoupling notion but what's still not come out is that the coupled downturns may also put pressure, perhaps severe ones, on the developing economies of China and Russia especiallly. Thought Brazil, India, et.al. won't be immune. So two final excerpts point to some of the major fault lines that are beginning to show. Another thing to start factoring into your long-range business, investing and other plans, e.g. if somebody offers you a job which depends on the health of these economies you'd better have a failsafe option.

General & Special

Don’t Rerun That ’70s Show If history is any guide, we should be looking at an extended period of economic weakness, probably extending well into 2010 or beyond. Will the next president be the second coming of Jimmy Carter? Given Thursday’s economic headlines, full of dire warnings about the return of 1970s-style stagflation, you might think so. Realistically, though, the parallels between the problems facing the U.S. economy now and those of the late-1970s aren’t that strong. That’s the good news. The bad news is that the economy probably will look similar to, but worse than, the economy that undid the first President Bush. And it’s all too easy to see how the next president could suffer a political fate resembling that of both the elder Mr. Bush and Mr. Carter. That said, I don’t believe we’re really facing anything comparable to 1970s stagflation. For one thing, we’re less dependent on oil: America has more than twice the real G.D.P. it had in 1979, but consumes only slightly more oil. For another, there’s no sign of the wage-price spiral that once drove inflation into double digits — in fact, wage growth has been declining even as inflation rises. What’s much more likely is that we’ll have an economy like that of the early 1990s, only worse. The difference is that the problems look a lot worse this time: a much bigger bubble, more financial distress, deeper consumer indebtedness — and sky-high oil prices added to the mix. So if history is any guide, we should be looking at an extended period of economic weakness, probably extending well into 2010, and quite possibly even longer. Can the next president do anything to avoid that outcome? In terms of straight economics, the answer is a clear yes. To this day, it’s not clear what Mr. Carter could have done differently: stagflation is a problem with no good solutions. But weak spending is a treatable condition. A serious fiscal stimulus plan — one that emphasized public investment and aid to Americans in economic distress rather than across-the-board tax rebates, which many people won’t spend — could do a lot to ease the country’s economic pain.

Politically, however, it’s hard to see this happening.

• Summers on Stagflation Inflation must be monitored carefully, but were a long way away from the stagflation of the 70s, says Lawrence Summers, former Treasury Secretary and former Harvard University president.

• America’s economy risks mother of all meltdowns, Washington’s rescue cannot end crisis

• Who Are These People Surprised by Economic Data? The WSJ on gross domestic product and initial jobless claims: "Stocks fell Thursday after weaker-than-expected economic readings and earnings reports underscored the potential for a recession." Weaker than expected? WTF? I keep hearing people talk about this "negativity bubble" -- but from where I sit, the media, traders, analysts are still too optimistic -- perhaps way too optimistic. We have had 4 rallies over the past few weeks of nearly 200 Dow points in a given day. That doesn't sound like excessive pessimism to me. Ask yourself this: Is the greater fear getting stuck with stocks that move lower -- or missing any rally?

INTERNATIONAL ECONOMY 

Lessons from Japan's 'Lost Decade' Washington and the financial sector would do well to study the past — to avoid repeating the errors of 1980s bad-loan crisis in Japan. With profits at U.S. banks and thrifts at a 16-year low in the fourth quarter and U.S. consumer expectations at a 17-year low in February, financial headlines often read more like history lessons. As American banks dig out from under their mountain of bad debt, analysts say policymakers would do well to remember Japan's string of mistakes as it grappled with its own bad-loan crisis, after the late 1980s bubble economy burst and left financial institutions burdened with massive levels of bad loans. The bungled cleanup plunged Japan into its so-called "Lost Decade" of stop-and-go recession. There are no quick fixes, say bankers. And counting on one could well make matters worse. "Lessons of what not to do from it are far more plentiful than the what-to-do sort," said James Malcolm, now a London-based strategist at Deutsche Bank. He was a Tokyo-based economist with a different investment bank at the height of Japan's crisis in the late 1990s. "Basically, it's inevitable that people want a quick and painless fix, but the reality is, it's going to be slow and painful so you've got to provide a supportive policy environment, and push forward with restructuring the markets." It's critical that U.S. banks and government policymakers face up to facts, analysts say. Recent data make it hard not to.

Policy challenges mount for China But making investment bets on the stated policy of the People's Bank of China requires much more than just a leap of faith. After being told to expect lending curbs as bank reserve ratios were hiked to 15%, instead loans grew at blistering 16.7% year-on-year in January, up from December's 16.1%. Put another way, China's commercial banks lent 803 billion yuan or two thirds of their lending quota for the first quarter in January. This has left investors and analysts scrambling for answers. Has the tightening policy been ignored, abandoned or is plain not working? Have we gotten to the stage where policy by dictate is now a blunted instrument as China's newly commercialized banks chase profit? Official word remains that there has been no policy shift and there is likely to have been some front loading of loans, but more answers are needed. The NPC meeting in March is expected to provide some more policy detail.  In the meantime, the fiscal, trade and lending policy challenges facing China's leaders are piling up whither growth, inflation, exchange rate? On the one hand, Beijing is facing renewed calls to relax spending and trade policies. The construction, transport and agricultural sectors hit by the recent monster snow storm that caused $15.4 billion in damage need emergency funding. Meanwhile exporters are feeling the pain of a weaker U.S. market and rapidly appreciating yuan squeezing margins even though China racked up another strong trade surplus in January. On the front page of the South China Morning Post over the weekend was a story of factories fleeing the Pearl River Delta as new labor contract laws added to existing financial strains. One estimate said 10,000 processing factories could leave this year. Meanwhile, the gorilla in the room for Beijing is still inflation. This week, January inflation data will be released and is expected to top 7%.

• Crash course The long slump in China

Putin Makes Medvedev Suffer Inflation Jolt as Wage, Price Pressures Mount The shadow of inflation is threatening Russian President Vladimir Putin's economic legacy and complicating the decisions facing chosen successor Dmitry Medvedev. Russia's prosperity is built on nine successive years of expansion, a sixfold increase in average incomes and almost $500 billion of currency reserves. They contribute to Putin's inability to contain consumer-price growth, which overshot its target in every one of his eight years as president except 2003. Medvedev, 42, the likely winner of the March 2 election, must find ways of containing inflation that accelerated to 11.9 percent in 2007. Failure to do so may trigger unsustainable wage demands, squeeze consumer spending and dent company profits. At the same time, Medvedev will have ``no real tools'' for meeting an annual inflation target of 8.5 percent, said Anton Struchenevsky, an economist at Moscow's Troika Dialog brokerage. Monetary policy isn't effective because, 17 years after the collapse of the Soviet Union, Russia hasn't developed a fully fledged consumer-credit market. Mortgages are few and credit-card use is in its infancy outside the biggest cities.

Posted by dblwyo at 04:10 PM | Permalink | Comments (0)

On the theory that if you're going to take the trouble to analyze somebody's work and comment you might as well post the work instead of restricting it. Today's WSJ had an interesting "Ahead of the Tape" pointing out that other than Financials earnings were holding up well. Reasons for which we've discussed extensively before.Grading the Takehome: Bottoms, Earnings & Outlooks,Review the Bidding, Count the Cards: EPS Growth Rates,Have You Seen the Elephant ?: More on Earnings. These are btw worth reviewing in their own for some differentiated perspective on the earnings outlook from what you may be hearing on bubblevision. Now we may be wrong but at least we've laid out the argument with data and our feeble attempts at logic. Feel free to disagree but given stories like this you should have an alternative toolkit for compare and contrast.

The parts that caught our eye was the discussion of how well Tech earnings are doing and how poorly their stocks are in general. Here are some relevent excerpts with our 4-Part assessment of some fundamental problems after the break.

 Earnings Slump Still Confined:Technology earnings have been an important, and potentially overlooked, bright spot. In the latest earnings season, the technology sector has been the Best in Show. But tech stocks have been treated more like mutts.Fourth-quarter earnings of technology companies in the Standard & Poor's 500-stock index are on track for a 26% increase from the prior year, according to Thomson. That makes it the best performance of any sector in the index. Even computer maker Dell, which has struggled to compete with rival Hewlett-Packard, is expected to report healthy operating earnings growth today, at 36 cents a share, up from 30 cents a year ago, a 20% gain.There have been some scares, but 76% of tech companies beat analyst estimates for the fourth quarter, according to Thomson.
Taken together, tech earnings have been 5% higher than expected. Yet the tech-stock-focused Nasdaq Composite index hasn't benefited much. Though it has recovered 2.5% from its late-January low this year, it lags behind the S&P's 5.4% rebound and the Dow's 6% comeback. And the Nasdaq is still down 18% since Oct. 31.Could investors be missing an opportunity?

 BtW just by way of compare and contrast consider the following headline from Bloomberg: Dell Profit Misses Estimates as Retail Expansion Falters; Shares Decline.

Not to mention Sprint, et.al. But we'll pick up all that coverage in the next Readfest. 

Posted by dblwyo at 06:44 PM | Permalink | Comments (0)

Well the markets are down so far today on yet another testimony induced swing, just as yesterday they swung upwards (which made the 4th day in a row for a "Tale of Two Fantasies" to triumph experience and analysis, but that's another topic). Actually the Chairman was stunningly clear and, in our interpretation, entirely conistent with our assessments which we want to re-draw your attention to. Particularly since data and events have been bearing us out and are likely to continue to do so. Below the line you'll find an excerpt from a WSJ econblog post summarizing his testimony yesterday which is well done. You'll also find a selection of CNBC vidclips showing not only the testimony but the questioner,which is often even more interesting. That's all below the break.

The WSJ summary focues on the economic information while much of the testimony, while covering that ground, really focuses on the credit mess, the regulatory breakdowns and the institutional failures in the Finance Industry and regulatory communities. If you haven't the time to listen too all of these at least listen to the opening one with Rep. Barney Frank. Among other things you'll hear and intelligent and informed man who displays a good understanding of the problems and causes and is already thinking about how to approach them. Most of the other Congressment display similar smarts. Which should be encouraging as should their convergece on similar diagnosis.

But let's set the context and review the bidding a bit - almost all of which is consistent with both Bernanke's testimony and the questions. Let's put it another way - all the things we've been talking about here for weeks and months ared dead on what the most responsible parties see. Yet none of this is being reflected in broader understandings, particularly on the Street. As Barry Ritholz put it...surprise, surprise, WTF do you mean surprise !

1. The economy is slowing though the Fed hopes for an uptick later in the year their l.t. outlook is for below trend growth thru 2010 ! They recognize all the weakness and risks to the downside as well as growing inflationary problems. Those problems will be reduced as the economy slows and it's a tradeoff they are accepting.

• Housing continues to worsen and the outlook is NOT clear. IOHO we've got a long way to go as we've previously mentioned.
• Credit markets are badly damaged and the contagion is NOT contained.

2. The primary reason for the breakdown in the credit markets is that the people creating the loans (the originators) passed them onto to others instead of keeping them. The others (the distributors) in their turn re-packaged the loans into various synthethic investments which where very...very highly leveraged and passed on to more links in a chain of re-packages and distributors.

• The Origin-Distribution model DID provide more access to capital to a wider range of users BUT did not disperse, share or reduce risks. In fact it seems to have increased them thru a viscious feedback cycle of perverse incentives in the finance industry and regulatory failures to adopt fast enough to these new instruments.
• Because the chain of financial actors created a situation where the reward was based on maximizing the flow of deals (originations) instead of the solvency and soundness of the origination they made their money by lowering standards of prudent business practice to nearly nothing at every link in the chain.
• These deficiencies need to be addressed with major regulatory overhauls because the Finance industry has proven the reverse of reliably self-governing. In fact, we would argue that, in fact, they enshrined s.t., narrow interest thinking as an idol and made demonstrably bad strategic decisions that will haunt the players, the markets and the economy for a long time.
• These institutional breakdowns in the Finance industry have been recurring regularly for amost a decade in one major screwup after the other and demonstrate poor strategy, bad business practice, major leadership failures and terrible corporate governance in the sense of sound management systems and practices.

Analysis of Major Themes in Bernanke’s Testimony Here is a look at Federal Reserve Chairman Ben Bernanke’s statements in today’s congressional testimony on major economic themes, followed by commentary from economists.

·  Monetary Policy

Bernanke: A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of downside risks to growth, stressed financial conditions, and inflation pressures. In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast. Although the FOMC participants’ economic projections envision an improving economic picture, it is important to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks.

Comment: The takeaway message is that further easing is probable, and there was nothing in the tone of this testimony to shake market expectations from the 50bp cut in the Fed funds target (to 2.50%) that is expected on March 18. Essentially, the FOMC’s strategy is to “cut and hope”, trusting that lower short term interest rates will help the economy regain its footing, and that incipient inflation pressure will prove to be short-lived. While not a perfect strategy, it is probably the only viable course at the moment, and it is one that is already well-discounted by financial markets. –Joshua Shapiro, MFR Inc.

·  Inflation

Bernanke: Consumer price inflation has increased since our previous report, in substantial part because of the steep run-up in the price of oil… The higher recent readings likely reflected some pass-through of energy costs to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices… The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1% and 2.4% (the central tendency of the projections). A key assumption underlying those projections was that energy and food prices would begin to flatten out, as was implied by quotes on futures markets… Further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month.

Comment: The [Fed’s] 2010 central tendency forecasts for inflation seem to show a de facto inflation target. This helps to explain why the Fed seems less concerned about the near term inflation outlook, about which they have little control, and more concerned about the medium-term outlook which shows a modest deterioration in their “target” inflation rate since October. –Drew Matus, Lehman Brothers

·  Housing

Bernanke: The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and closely related industries.

Comment: Global Insight is projecting that the downside risks to growth mentioned by Bernanke will become more apparent as the first quarter progresses… The huge drag to growth from negative dynamics in the housing market, which recently have showed no signs of abating, will become more apparent in upcoming reports on real growth. These indicators point in the direction of a “mild recession” in the first half of 2008. –Brian Bethune, Global Insight

·  Risks

Bernanke: The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further.

Comment: Although the words stagflation and recession appear nowhere in Bernanke’s testimony, the discussion of downside risks to the growth outlook and upside risks to a higher inflation outlook have both a stagflationary and potentially recessionary feel about them. –Bear Stearns

CNBC Vidclip Selections

Bernanke on Economic Growth

Bernanke on Risk Rep. Spencer Bachus, R-Ala., asks Fed Chairman Ben Bernanke about the price of risk.

Bernanke on Mortgage Regulation Rep. Tom Price, R-Ga., asks Fed Chairman Ben Bernanke about the lack of regulation in the mortgage market.

Posted by dblwyo at 12:36 PM | Permalink | Comments (0)

Well spreading the news excerpts does give us some chance to slice and dice 'em. Here we'll focus on the technology news, some of which we've either already mentioned and/or have been covering for a few weeks now. Primarily that the various analyst shops (Forrester, Gartner, et.al.) have abruptly lowered their spending outlooks for '08. Below you'll find the first outlook that anticipates a negative growth rate for Q208. Bear in mind these surveys are based on bottom-up work talking to IT departments so they reflect reality on the ground but a reality which tends to lag big picture economic cycles. By combining that with our top down look at macro-trends you get a bookend perspective - and those trends have been suggesting declining capex outlooks for a while now. So when John Chambers shows up on CNBC and says things are going well he's talking about the quarter just past and the sales activity and order stream he can see right then. NOT an outlook - keep that in mind.

The other little thing we thought we'd insert into our discussions is a way to sort and filter the tech news as the jumble of acronyms floats by. So we're going to introduce you to the infamous "stack" picture of how all the pieces in the tech industries fit together. Then to show what it's worth talk a little about some industry examples, e.g. Oracle's merger spree and then try to apply it to this week's stories. You'll have to judge whether this is useful or not.

Thinking in "Stacks" 

If you'll take a look at the picture on the right we provide a very simple version of the infamous stack, which you may have heard folks refer to. The stack is all the things you need to make a computer (or a phone for that matter work). Simple but a powerful sorting hat because it'll tell you who's in what House and how they're linked. The PC on your desk incorporates the top four layers. Likely an Intel/AMD processor which then has to have a bunch of other chips, power supply etc. IBM's announcement today of a major new mainframe will define the new large-scale server standard for some time. To make that PC or server work you need an Operating System (OS) which on your PC is likely Windows but on the server is something called MVS, or Multiple Virtual System. All this hoorah about Google's huge server farms and virtualization software - well the big guys have been doing it for three decades and your life depends on it in the sense that most banks, airlines, etc. are running on very large servers.But all the OS does is let the machine talk to itself it's what's called Middleware (MW) that sits between the machine and the applications that lets interesting things be done. So when Oracle buys BEA what you're seeing is a further consolidation in the MW space where BEA was the first provider of a Java application "server", i.e. a software machine commercially even though Java was created by Sun. Unfortunately BEA wasn't able to match IBM's inventiveness over the last decade and has lost those wars. In fact if you take IBM's analysts reports apart their growth engine for several years, for profits as well, and anticipted to be in the future is software. And when they say software they mean middleware. Finally the thing you talk to is the application - though you can debate for example whether or not a spreadsheet is an application or middleware in a sense. But when somebody talks about ERP, CRM, Sales Automation, etc. etc. they're talking about big bundles of code sitting on top of the MW that actually process the data, talk to the user and get things done.

Using the Stack: a Little History 

Just as a little bit of history Oracle got it's start in life as a MW company by introducing the first commercially viable relational database management system (DBMS) which was invented by IBM but...well you've heard that story. Now though IBM's DB2 is the dominant player, at least in some circles. As the DBMS market matured though Oracle moved up the stack to start creating business applications using their database software. An approach many mimiced or had done first in other forms. But building an application on top of a DBMS is easier, faster, higher quality and more flexible than building all the functions into the application. So when you heard about all those ORCL acquisitions in the last several years, e.g. J.D. Edwards that was one big application company with some o.k. applications buying a smaller one with great apps. Here's the rub though - they're technically incompatible. What Oracle did was buy markeshare in a maturing (slowing market). And now faces the problem of either continuing to invest in all those incompatible application portfolios or re-write them to a common standard. Which'll take billions in either case. And bear in mind they're making most of their money these days off of maintainence fees instead of selling new apps. SAP on the other hand continues to grow itself organically with judicious acquisitions to fill in small holes. It's also gotten a major leap ahead of Oracle by building it's own middleware so that it can re-develop its' ERP suites on a common and sharable platform. Meanwhile Oracle's me-too project "Fusion" isn't going so well. 

We could go with either or both companies or switch to HP, MSFT, Dell, Intc, etc. stories. Or talk about the Telecom Wars, Verizon, ATT vs each other or the cable guys. The convergence of voice and data that allows the big Telcos to migrate from their old switched network to the new IP networks but at the same time opens them up to competition from the cable guys. Or we could compare HPQ vs IBM vs Dell and find out that they play in very different parts of the stack and in very different markets.

But as you read the stories below you can use the stack to analyze and interpret each one of them. And should because it fits that little piece into a larger whole. 

Interpreting the News

The first except talks about slowing spending which we don't really need to interpret but just for fun we'll call it the shrinking stack sydrome. Where it's important though is the reactions in the markets where the major players in the tech stocks are not only getting hit but hit hard because too much hot air got blown into their balloons - as in this'll never end. But the stack and the size of the market pie change all the time so, for example, the story about toys which are increasingly using embedded chips to become more intereactive and controllable thereby opening up a whole new set of end-markets for the tech guys as well as finding new avenues for the toy makers who were running out of one more warm fuzzy (maybe). Since the toys also now connect to computers (what does that say about culture change) with 2 year olds in front of them...well ?

As some of these technologies have changed they've cause other industries to change enormously as well - Media & Entertainment will never be the same again though it's not clear what it will be. The forms, content, applications etc. are still in an accelerating rate of flux. A couple ofthings to remember though...first off this exact thing happened before. The Media businesses got locked into their old "stacks" and thought they world would never change. Newspapers were defined as we still know them in the late 19thC - notice that when they first went online they imitated that layout. The only challenge they faced was the introduction of whole new stacks, radio and TV, which didn't seem to do too much damage though print journalism shrank considerably as TV caught on. Now they're all having to move to the same stack and nobody's coping very well.

The ripples from all this show up in the news stories where the Yhoo/MS merger war is really a strategic debate about what's the best way to turn Internet eyeballs into advertising money. Notice that paying for media access, where you're paying for the large set of resources that gather, report, write, edit, etc. the content which will NOT go away, is a model invented by old...old media. So this debate is over whether or not putting ads around content you want to see (display) or as the result of a search is the best model. Several of the next stories fit right into this line of inquiry - two on the NYT and whether or not it has a future.

The story on the wireless firms offerring flat rates is a big.....big deal, in at least two ways. First off it means that the "old" fixed line into your home might be going away and secondly that they're anticipating new forms of competition they're not telling you about from VoIP on wireless data networks which could replace their proprietary and expensives ones over time. And the other "Pipe War" is the ones between the cable companies and the phone companies over who gets to control your house because you sure don't need two fat pipes.

Technology Industries Readings

Corporate IT Spending Goes Negative Overview: ChangeWave’s latest corporate IT spending survey points to a negative growth rate for 2nd Quarter 2008 – and confirms U.S. business spending has already entered into a recession. A total of 2,013 respondents involved with IT spending in their organization participated in the survey, conducted February 11-15, 2008. 2Q 2008 IT Spending: Nearly one-in-four respondents (23%) say their company’s IT spending will decrease (or there will be no spending at all) in the 2nd Quarter – 3-pts worse than the previous ChangeWave survey in November 2007. Only 15% say spending will increase – an unprecedented 9-pt drop from previously. A Picture of Negative Growth: As seen below, the percentage projecting decreased IT spending for 2nd Quarter 2008 is far greater than the percentage projecting an increase. You have to go all the way back to August 2001 to find the last time a ChangeWave corporate IT spending survey projected negative spending growth.

• Three of the Nasdaq Four Horseman Are Limping Apple (AAPL), Google (GOOG) and Baidu (BIDU) -- three of the NASDAQ FOUR HORSEMAN -- have been coming up gimpy since their FusionIQ timing sell signals (triggered at much higher levels several weeks ago). These stocks have fallen precipitously since those Sells.

Small world increasingly a virtual one The furry animals of Webkinz helped jumpstart the craze two years ago, and now, "I'm seeing every single toy down to pre-school," that connects to the Internet, said Jonathan Samet, publisher of the Toy Book and Toy Insider. Kids play differently than even five years ago, and it's evident at the American International Toy Fair, which kicked off Sunday. With kids sitting behind computers as early as 2 years of age, technology is playing a larger role in toy designs, with toy makers creating a number of virtual worlds to nurture pets, create fashion shows, race cars, and dress dolls. Internet plug-in toys make a physical toy virtual with a USB port that connects to a PC or a special pass code that comes with a toy and is typed in at a specific Web site. The larger U.S. toymakers, Mattel Inc., Hasbro Inc., and Jakks Pacific Inc., all have something for 2008, whether it's a new product or a refresh of a popular toy. Mattel is making Barbie more virtual, while Jakks and Hasbro are pushing further into the pet kingdom.

Microsoft's play for ad display Courting of Yahoo is a $44.6 billion bet that plain, old display advertising will rebound online, yield bonanza. Is there a method to Microsoft Corp.'s madness? The answer most often is yes. In the case of Microsoft's courting of Yahoo Inc. to the tune of more than $40 billion, the software giant could reap huge benefits in plain, old display advertising on the Internet. Market demand for such ads, Yahoo's forte, are expected to grow sharply for several reasons. Faster broadband connections open up the potential for "rich" media -- defined as video or anything other than just static display. Further, companies that have resisted Internet marketing in the past have started to, sometimes grudgingly, warm to the medium. They're often more comfortable with display or video advertising compared with search ads, which are links generated through Web searches. In many instances, companies find display advertising more conducive to their purposes. As a result, they're likely to stick with that method as they make the shift to online campaigns.

Open ware policy Microsoft reiterates it's moving toward opening software to outside developers. Microsoft Corp. on Thursday responded to continued regulatory scrutiny by reiterating promises to make information about its products more easily available to software programmers, while vowing not to sue those who use such information for noncommercial purposes. The move underscores an ongoing shift for the tech behemoth, as it has sought recently to present its technology as increasingly open to outside developers and compatible with competing products. It also comes only days before delegates from an international standards body are scheduled to convene in Geneva to discuss Microsoft's Open XML file format, which has been derided by critics as insufficiently accessible. Rivals have long complained that Microsoft has jealously guarded its intellectual property, while elbowing competitors out of the computer-software market. That's raised the ire of antitrust officials, particularly in Europe.

Netscape founder on newspaper deathwatch Andreessen has always been a blunt, plainspoken guy. He grew up in a tiny town in Wisconsin, and although he moved to California in 1993 to make his fortune, he maintains a Midwestern intolerance for pretense (and, apparently, fancy lunch spots). He's a legend in Silicon Valley for having founded and sold, by age 36, two billion-dollar companies: Netscape Communications (unloaded on AOL (TWX, Fortune 500) in 1998 for $4.2 billion) and Opsware (a server-management company that HP (HPQ, Fortune 500) bought last year for $1.6 billion). Now he's going for a three-peat: But Andreessen keeps circling back to the media business. I used to think he was obsessed because his browser stuck a shiv in old media, but it goes back further than that. One of his first hacks as an undergrad at the University of Illinois in 1992 was diverting cable to his SGI workstation so that he could watch CNN. Most of the 30 investments he's made since are in media-related startups. Then he went back to his computer and launched a kind of fatwa that was immediately broadcast in the echo chamber of the blogosphere. "I can't take it anymore," he wrote on his blog (blog.pmarca.com). "I hereby inaugurate my New York Times Deathwatch, which will continue until the last Sulzberger has left the building." The piece goes on to rip apart the Times' business strategy top to bottom, attacking everything from the techno-illiteracy of its board of directors (which boasts experts in marsupials and snack cakes but almost no expertise in the Internet) to its recent per-copy price hike. "When you have an obsolete, inconvenient physical product that nobody wants in an era of universal online access, the appropriate strategy is clearly to raise the price," he snarked. (He's not the only one gunning for the Times. A coalition of hedge funds just bought up 10% of the company and wants to install four of its own candidates on the board.)

From Gray Lady to gossip sheet Western civilization may have ended Thursday when the highfalutin New York Times lowered itself to the rank of shrill tabloid with its piece on John McCain. The Times published a front-page story suggesting -- wink, wink, nudge, nudge -- that the presumptive Republican favorite's campaign staff tried hard to keep lobbyist Vicki Iseman away from McCain during his 2000 run for the White House. McCain's people were concerned that her proximity to the Arizona senator might spark suspicions. I don't know what the Times hoped to accomplish when it ran this story. It had worked so hard to climb out of the shadow of Jayson Blair, the former Times reporter who fabricated many stories and became a poster child, along with the Times, for journalism's ills a few years ago. Thirteen months ago, Times Executive Editor Bill Keller couldn't disguise his satisfaction when he told me that he felt "a little vindication" after the 2006 elections because the Times had been attacked like a "pinata." Now, the Times is back under a cloud. The Times violated a basic tenet of journalism: Either you have the story, or you don't. If you have the goods, put the story on page one and shout about it from rooftops. If you don't, delete the flimsy, unsupported stuff. Like my professors at the Medill School of Journalism used to preach: When in doubt, leave it out.

Wireless Firms Offer Flat Rates There's some good news for people who spend a lot of time on their cellphones. Three of the nation's largest cellphone companies are rolling out plans that charge a flat rate for unlimited calling, a significant departure from the traditional model, in which consumers purchase "buckets" of minutes. The new plans cost more than most traditional options and are aimed at the heavy user, a customer that wireless carriers compete fiercely to land. The new plans are a sign that cellphone companies are willing to experiment with the minutes-based model that has underpinned the industry for years. The carriers are increasingly looking at voice as a commodity and viewing data services like text-messaging and Internet access as the major sources of revenue growth.

Posted by dblwyo at 01:16 AM | Permalink | Comments (0)

Well the Markets have bounced up three days in a row, at the last minute and on some fantastic (and the emphasis is on the "fantasy" part) news that Ambac was going to be rescued, save it's rating and, today, that IBM is buying back $15B. Given that Ambac apparantly has several '00s of $Bs in exposure a $3B rescue doen't seem like it saves the day. As for IBM it throws off so much cash that what else is it going to do ? It's not growing the company in either revenue or profitability after all. A tightly run ship who's financial health is beyond impeccable so it won't need those funds when the crap really hits the fan but we still have to wonder if that's the best use of it.

Meanwhile back in the real world the economic news is unremittingly bad and accleratingly worse from inflation to Housing. Here's an interesting interview by Barrons/WSJ with Robert Shiller which we strongly urge you to watch. Below the line you'll find both some other charts that put what he's saying in context (courtesy of our e-colleague CalculatedRisk of course) plus some collected readings.

Schiller had a lot of simply fascinating things to say about both how bad it is and how much worse it's likely to get, in that low-key and restrained academic fashion that makes it hard for the intervier get soundbites. But this one really....really tried. We counted at least four major times where the question is what our lawyer friends call leading, i.e. a setup, telling the interviewee what the expected comment is. The first setup which we couldn't believe it was so distortionate was asking whether we werent' seeing price declines slow or stop. What Shiller replied was a) in fact the rate of decline was accelerating as b) people's psychology and expectations come more into line with reality. And c) that all he hoped for was that not that they'd stop declining but that the rate would stabilize or slow. He went on to add d) that housing was way overbuilt, the peak was like nothing we'd seen since '51 (remember WW2, vets and the VHA ?). And as a consequence e) we likely had a long way to go since this boom had been going on since the early '90s and would have as far to run down. Now stop and think about all that for a moment, a K-R Moment as in Kubler-Ross. You know denial, anger, acceptece. These days I'd settle for getting as far as anger since everybody keeps looping back to denial.

If this is the thinking on the street you know why were're trapped in a sideways market looking for the Messiah of the 2nd Half Recovery to come save us while the news just keeps going on. In the sense that bad news is being ignored and teensy, tiny little pieces of good news push up the market you'd have to say that it's all priced in, right ? Of course what's priced in is not the realities that some of us see all around us though. 

Now our friends over at CalculatedRisk have their own appreciation of how things are going. In particular they just put up some interesting charts on housing inventories and inventory seasonal patterns which we've combined here with another of his charts on the Case-Shiller housing prices on a YOY basis. Which you'll please notice are a) negative and b) sharply sloped downward; that's Shiller's downward acceleration thing you know. The other thing you need to know is that the inventory patternas are normalized so each year starts at a 100 where that 100 is based on the prior year's end. Housing inventories are normally pulled off in the Winter and put back on as the sales season starts up. What you see is two things. First in '06 and '07 built up relatively far more than in previous years. And this year is starting with an even larger uptick.

Just to set the stage we'll also re-post (posted here) an earlier composite chart we borrowed from CR that lays out the strategic BigPicture so you can get a better idea of what it all means. The first part shows the relationship between New Home Sales and recession. It also makes very clear Shiller's comment about the length of the boom and the abberational size of the boom. The 2nd part shows ResInvest as a % of GDP with CR filling in an extrapolation. Now IOHO that's conversative since it doesn't capture the need to work off all the excess inventories that have been built up. In other words the downturn here could be as unique and large as the bubble;in fact shouldn't it be ? The 3rd part shows how long after downturns bottom it takes for prices to reach their floors and start creeping up again. Given that we're really just seeing the pscyhological adjustments begin that suggests we've got a very long way to go.

As far as we can tell NONE of these realities are reflected in the consiousness of more than 90% of the commentators yet there they are in about as simple a graphical form as you can get. Talk about getting stuck in denial !

READINGS

S&P/Case-Shiller Home Prices Fell 9.1% in December Home prices in 20 U.S. metropolitan areas fell in December by the most on record, reflecting the deepening housing recession, a private survey showed today. The S&P/Case-Shiller home-price index dropped 9.1 percent from a year earlier, after a 7.7 percent decrease in November. Nationwide, home prices fell 8.9 percent in the fourth quarter from a year earlier, the biggest decline in 20 years of record keeping. Prices may fall further as would-be buyers hold out for bargains and foreclosures add to the glut of unsold properties, extending the worst housing slump in a quarter century. Shrinking home values and credit restrictions threaten to reduce consumer spending and push the economy into a recession. ``Home prices are headed lower,'' Michael Moran, chief economist at Daiwa Securities America Inc. in New York, said before the report. ``With demand soft and inventories still high, there will be pressure on prices to keep declining.'' December's drop was the 12th monthly decline in a row and the biggest since the group began keeping year-over-year records in 2001.

• Existing Home Sales and the Economy Existing home sales fell 0.4% in January to its lowest level in a decade but still better than expected. Dean Barber, of the Barber Financial Group, and CNBCs Rick Santelli and Diana Olick share their insight. January Existing Home Sales, More credit costs seen weighing on banks, brokers.

·         Home Foreclosures in U.S. Surged 90% in January After Mortgage Rates Reset Bank seizures of U.S. homes almost doubled in January as property owners failed to make higher payments on adjustable-rate mortgages. Repossessions rose 90 percent to 45,327 last month from the same period a year ago, RealtyTrac Inc. said today in a statement. Total foreclosure filings, which include default and auction notices as well as bank seizures, increased 57 percent.

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

Literally back in the real world. Despite all the on-going storms and thunder there is a real world out there of real companies not involved in financial engineering; though subject to (victimized by ?) it. Again there was a huge amount of relevent news that's going to impact a lot of things. Below you'll find our selected excerpts with stories from the oil, airline, steel, auto, retail and aircraft manufacturing. They're all interesting but a couple or three are harbingers.

Exxon is getting to the point where it's not replacing its' reserves - partly from increased problems with accessing foreign fields but also because of the increased difficulties in finding new, large fields that are economic. Think about that one for a while.

Meanwhile various mearger frenzies continue including the airline industry (which we waxed on at some structural detail) and continued evolution of the worldwide steel industry, Mittal in particular. The Auto industry just moves from one "challenge" to another. A couple/three interesting stories there as well - from Ghosn's naming it recession to an interesting story on Hyundai's Superbowl Ads to Chrysler's increased off-shoring of engineering and R&D. Now those last two we think are particularly important because they not only represent increased globalization but sophistication in both directions. In fact IOHO the Hyundai ads were the best ones on the Superbowl - not for viewer entertainment but from getting bang for the bucks. Everybody laughed or cringed at the others but  Hyundai's a) served notice that they were seriously in the game and were credible and b) got the biggest response that way from viewers. The next time you're in a parking lot test this yourself - see the Mercedes lined up next to a Bimmer next to a Lexus next and so forth down to a Hyundai. That bridges $120K to $20K but we don't see that much difference in fit and finish let alone features and quality. Hmm...indeed. 

Traditional Industries

Is Exxon Mobil Going Dry? Like the rest of its big oil brethren, Exxon Mobil is having a difficult time replacing its reserves. The Texas titan barely replaced the amount of oil and gas it produced last year -- its worst showing ever. If Exxon boss Rex Tillerson can't reverse the trend, his company could run dry within a generation.

Airline Merger Frenzies (II): Network Structure, Costs and Strategic Outlook There have been three interesting (or more) stories on the rapid airline feeding/merger frenzy that's bubbling up before our eyes as the result of intractably higher fuel costs. Like every other strategic initiative since '00 this one too will NOT fix the underlying problems. Which won't stop the mergers nor prevent the financial community from providing the liquidity ammo necessary to bring it about on the theory that it will. Earlier we'd posted a first pass (Airline Merger Frenzies (I): Deep Cost Structure, Restructuring & Outlook) explaining how the hub-n-spoke network route structure was the deepest underlying factor in airline's lack of profitability and failures, since the end of WW2 btw, to earn their cost-of-capital. Excerpts from the three stories are below but here's an excerpt from a strategic assessment we wrote in '04 both predicting the consolidation and its' likely failure.

The M&A Forge (WSJ '06) Flush with cash and anxious to take advantage of interest rates that are still near historic lows, corporate and private equity buyers turned 2006 into one of the most explosive years on record for both the number and size of transactions -- a total deal volume of about $4 trillion. Why in most industries do you find some companies thrive doing deals while so many others stumble? Beyond Mittal in the industrial sector, witness the acquisition success of Nestlé in food, Cisco in technology and the Royal Bank of Scotland in financial services, to name just a few. Our research shows that the most successful opportunists share a set of characteristics that they have consciously developed over time. The winners tend to make mergers and acquisitions central to their strategies; they study and learn from their mistakes; they nurture M&A as a core competency; and build a team to preserve institutional knowledge. They tend to focus mostly on small and medium deals, not blockbusters. And when they do pursue megadeals, they only do so when it is both strategically and organizationally appropriate.

Mittalic magic Lakshmi Mittal built the world's biggest steel firm from scratch—at internet speed. The answer was neither: Mittal Steel was a company from everywhere and nowhere, which helps to explain why its integration with Arcelor to form ArcelorMittal, the world's largest steelmaker, went so surprisingly smoothly. Most mergers fail: from AOL Time Warner to DaimlerChrysler, the corporate landscape of the past decade is littered with wrecks. Just as surprising was the way in which Mr Mittal managed to overcome opposition to the deal from the business establishment and the French government—and has now gone on to increase profits in the new firm's first full year.

Ghosn Says US Auto Market in Recession The head of Nissan Motor Co. said even if the United States is not in recession, its auto industry is. "We are very lucid on the situation of the industry that there is a recession in the United States, at least in the car market," Chief Executive Carlos Ghosn told reporters, saying automakers face rising costs for iron ore, precious metals, aluminum and other materials. "These represent risk for the industry," he said. Ghosn, who is also president and CEO of Renault SA of France, expressed optimism that the market will improve. The American auto market "will not stay in recession for a long time," he said. U.S. car and light truck sales totaled 16.1 million vehicles in 2007, the worst year in a decade, and sales are expected to slip this year as well. Ghosn said the cost of raw materials, increasing for the fourth straight year, must come down. Earlier, Ghosn told students at Seoul's Korea University that global automakers need to focus on emerging markets. During a visit to South Korea to meet local Nissan and Renault officials, Ghosn said growth in countries such as Russia, China, India and Brazil will be key.

Hyundai Super Bowl Advertising Yields Highest Positive Impact on the Brand Hyundai's Super Bowl advertisements did the best job of boosting brand opinion according to two leading marketing research firms. The Nielsen Online MegaPanel Survey, post- game study showed that 43 percent of respondents had improved their opinion of the Hyundai brand -- the highest of any automotive advertiser. In addition, in comScore's 2008 Super Bowl post-game survey, Hyundai garnered a 45 percent increase in net brand improvement, the highest figure of any Super Bowl advertiser.

Chrysler Begins Engineering Overhaul Six months after taking the helm at Chrysler LLC, Chief Executive Officer Robert Nardelli is beginning to move forward with his first major reorganization at the auto maker: a broad shake-up of its engineering operations. In coming months, Chrysler will expand operations at engineering centers in China and Mexico and will prepare to open others in India and Eastern Europe as part of a push to internationalize a company heavily dependent on its home market in North America. Mr. Nardelli is betting the overseas centers will help Chrysler cut engineering costs and move it forward in sourcing parts and selling vehicles in big developing markets. Chrysler has been slow to move engineering work abroad, a cost-saving measure that other auto makers around the world are increasingly adopting.

Wal-Mart Evades Global Woes as Net Rises Fiscal fourth-quarter profit rose 4% at Wal-Mart Stores Inc. as cost-cutting and strong international gains helped the world's largest retailer sidestep many of the troubles dogging its rivals in a soft U.S. market. The Bentonville, Ark., retailer felt the drag from energy and housing earlier than many of its department-store and grocery rivals, and began paring its U.S. store-expansion plans, trimming inventories, and boosting marketing efforts that emphasized low prices. Better marketing and fewer markdowns in the final quarter lifted gross margins to 23.5% from 23% a year ago despite a broad retail slowdown that triggered losses elsewhere. U.S. same-store sales, a measure of market-share gains, rose 1.7%, compared with a 1.6% gain in the same-quarter last year. Wal-Mart's Strong Earnings Can't Beat Back the Doubters

• No Satisfaction at WMT (CNBC vidlink) Although Wal-Marts sales stand out among other struggling retailers, its not keeping its customers happy, with Adrianne Shapira, Goldman Sachs; Claes Fornell, University of Michigan Business School; and CNBCs Melissa Francis.

Posted by dblwyo at 05:00 AM | Permalink | Comments (0)

Last summer George Magnus of UBS asked whether or not we were at a Minsky moment. That is a situation when leveraged borrowing had progressed from sound borrowers (who can repay) to speculative borrowers (betting on cash flow) to Ponzi borrowers (guess !) and we were about to proceed with the reverse unraveling. As the previous and many other posts here have argued not only wasn't the credit market contagion NOT confined to sub-prime, or even housing-realated, markets but there were many rocks and then boulders which would topple into the ponds of the credit markets. And the effects would be self-reinforcing as the various ripples from those topplings impacted not just adjacent markets but distant ones as well. In this recent FT 3-part interview George updates his outlook and it is anything but sanguine, in the modern sense of the word. The old sense of sanguinary was bloody - as in the aftermath of a major battle. We use it in that sense. The vidclips can be reached thru clicking on thru the picture and we HIGHLY recommend that you do so. The interview is pretty non-technical but the numbers and consequences are startling.

Below the line we've gone back over the last several months posts and collected up a bunch of the critical readings related to these issues. Including one that introduces the original Minsky Moment phrasing (BTW - for the record the person who really first started talking about Minsky-like problems was Paul McCulley of PIMCO and he did it back in '06.) We also re-list the links to our prior posts on the credit crisis, perverse incentives and the "rocks in the pond" model.

While it's tempting with short-term satisfactions to indulge in some schadenfreude we'll postpone that for this evenings scotches...yes that's plural. This is too severe a problem, spreading too rapidly to be fully savored (our previous labeling was Ebolatization of the credit contagion and we used the movie of the same name as our model. That still seems to be accurate IOHO !).

BTW - this is a 3-part interview and you really should watch all three, you really...really should. And HT to Barry Ritholz for posting this before we got to the FT today as well. Anyway if you'll listen to all three you'll hear George pretty well - we actually exactly - concur in that marvelously understated British way with our take on the credit markets, the economic outlook, the worldwide slowdown and the market's lack of awareness. Or that's what we think we heard. You decide - because you will one way or another !

READINGS

Are We at The Peak of a Minsky Credit Cycle?  It is always risky to call an equity market peak and the beginning of a bear market in equities; so I will not try to do that. But leaving aside equity valuations, it increasingly looks like we are at the peak of a credit/debt cycle, in the US and globally. Specifically, the crucial macro question that we should ask ourselves today is whether we are at the peak of a Minsky Credit Cycle. Or as the UBS economist George Magnus – an expert of financial instability - put it: “Have we reached a Minsky moment?” In his view periods of economic and financial stability lead to a lowering of investors’ risk aversion and a process of releveraging. Investors start to borrow excessively and push up asset prices excessively high. In this process of releveraging there are three types of investors/borrowers. First, sound or “hedge borrowers” who can meet both interest and principal payments out of their own cash flows. Second, “speculative borrowers” who can only service interest payments out of their cash flows. These speculative borrowers need liquid capital markets that allow them to refinance and roll over their debts as they would not otherwise be able to service the principal of their debts. Finally, there are “Ponzi borrowers” cannot service neither interest or principal payments. They are called “Ponzi borrowers” as they need persistently increasing prices of the assets they invested in to keep on refinancing their debt obligations. The other important aspect of the Minsky Credit Cycle model is the loosening of credit standards both among supervisors and regulators and among the financial institutions/lenders who, during the credit boom/bubble, find ways to avoid prudential regulations and supervisions.

Our Risky New Financial Markets Tremors from America's quaking subprime mortgage market have spread throughout the financial world. This latest disturbance in global financial markets is neither isolated nor idiosyncratic. It points to deeper, enduring changes in the structure of our markets -- changes that have profoundly altered the behavior of market participants in ways that tend to encourage risk-taking beyond prudent limits. Just as troubling is the failure of official policy makers to effectively rein in such excesses, leaving our financial system vulnerable to similar turmoil in the future. The principal structural driver behind this and similar financial tribulations is the massive growth of financial markets, combined with a plethora of new credit instruments. By any measure, current financial activity -- new financing or secondary market trading volume -- dwarfs the past. The outstanding volume of nonfinancial debt now exceeds nominal GDP by $15 trillion, compared with $6 trillion a decade ago. Traditional credit instruments such as stocks, bonds and money-market obligations have been joined by a long and diverse roster of new obligations, many of them extraordinarily complicated. Along with the arcane tranches of mortgages that recently garnered attention are a myriad of financial derivatives, ranging from those traded on exchanges to tailor-made products for the over-the-counter market.

Some major prior readings: Weekly Reader 19Aug07: Markets & Investments

The Minsky Moment Twenty-five years ago, when most economists were extolling the virtues of financial deregulation and innovation, a maverick named Hyman P. Minsky maintained a more negative view of Wall Street; in fact, he noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze. Wall Street encouraged businesses and individuals to take on too much risk, he believed, generating ruinous boom-and-bust cycles. The only way to break this pattern was for the government to step in and regulate the moneymen.Many of Minsky’s colleagues regarded his “financial-instability hypothesis,” which he first developed in the nineteen-sixties, as radical, if not crackpot. Today, with the subprime crisis seemingly on the verge of metamorphosing into a recession, references to it have become commonplace on financial Web sites and in the reports of Wall Street analysts. Minsky’s hypothesis is well worth revisiting. In trying to revive the economy, President Bush and the House have already agreed on the outlines of a “stimulus package,” but the first stage in curing any malady is making a correct diagnosis.

Posted by dblwyo at 12:14 PM | Permalink | Comments (0)

Earlier we put up a readfest (WRFest 23FEb08(Business Strategy): What the Future May Hold ?) focused on business strategy, including a view of our strategic concept/context chart. Judging from the performance of the Finance Industry as a whole most of the arguments we made were and will continue to be ignored. But as stakeholders (investor, employees, suppliers, customers) we don't think you. Eveventually and ultimately. Now the WSJ has kindly joined us in our finger-wagging prescience with a fascinating story about strategic awareness really matters. Rather then wait to put up a shorter excerpt we're posting a longer one now. There are many lessons and examples cited here. The question for you becomes - as a stakeholder - do you know where your stake is tonight ?

UPDATE: More credit costs seen weighing on banks, brokers Analysts at Goldman Sachs cut estimates for the nation's top banks and brokers Monday and said these major institutions would likely report write-downs of between $1 billion and $12 billion for soured real-estate loans and related exposures.  Goldman's estimates of new write-downs ranged from $1.4 billion it expects for Bear Stearns Cosall the way up to a whopping $12 billion projected for Citigroup Inc.

The Coming Leveraged Debt Write-Downs

Subprime Lessons Hit Home for CEOs  Executives far from Wall Street are finding lessons in the subprime-loan meltdown. Among the insights: Don't chase a boom without planning for the bust and ensure that incentive systems don't encourage excessive risk.

As mortgage lenders imploded and stock prices swooned last summer, a light bulb went off for Tim Houlne, chief executive of a Texas call-agent provider: "Bubbles always burst." Mr. Houlne's realization attests to how, far from Wall Street, executives in other industries and their advisers are finding management lessons in the subprime-loan meltdown. Among the key insights: Don't chase a boom without planning for the bust. Make sure subordinates feel safe delivering bad news. Ensure that incentive systems don't encourage excessive risk. And don't gloss over complicated details.

"Every five to 10 years, there's a mess of this sort," says Richard Coughlan, a management professor at the University of ichmond. "Leaders would do themselves a great service if they would study the failures of the past and learn from them." By contrast, in the finance industry, many firms continued to pursue subprime-related business long after the first signs of a housing slowdown.

That's a familiar pattern to veterans of the technology boom of the 1990s and the ensuing bust. During the boom, telecom companies rushed to install miles of fiber-optic lines based on predictions of an exponential need for capacity… Instead, he suggests that executives plan new initiatives before the current wave crashes. Toyota Motor Corp. did this well during the 1990s, Mr. Kanazawa says. While Toyota and its peers chased the then-hot sport-utility market, Toyota also developed its hybrid Prius. Its 2000 U.S. launch ran counter to conventional wisdom at the time. But as gasoline prices rose, Toyota's move looked prescient.

Jim Bradford, dean of Vanderbilt University's Owen Graduate School of Management, sees another lesson in the subprime woes: Make sure subordinates feel comfortable delivering bad news -- promptly. It's possible that earlier strong warnings of mounting subprime problems may have helped top bank executives react better. Mr. Bradford speaks from experience. Before entering academia, he was CEO of glassmaker AFG Industries, a unit of Japan's Asahi Glass Co. He tried to foster a candid environment by also praising and promoting people who disagreed with him or who brought him bad news. That candor helped thwart disaster at least once.

Posted by dblwyo at 11:18 AM | Permalink | Comments (0)

We've ended up splitting our regular news summaries into multiple parts because of the number of valuable stories. Not just splitting Econom, Market and Business but in turn we'll end up splitting business itself into four parts, of which this is the the 2nd. The prior post looked at the strategic context and even provided a graphical chart to conceptualize all the multiple factors that any business must face, in general and specifically at these times.

These particular story excerpts focus on the Finance Industry and build on prior posts on the general conditions in the Economy, Market and, most...most especially, the Credit Markets. The bottom line is that a) the credit markets continue to experience a widening crisis whose end is not in sight. In fact whose details and working out are not at all clear. So, b) we think it's fair to consider that the Finance Industry as a whole is in as severe an emerging crisis as the Housing industry. Without the same level of broad understanding or consensus.

One that will, eventually, force serious re-thinking of the strategies, product offerrings, company structures and operating principles. Yet at the same time, given past history, who's corrective measures will be temporary pallative fixes because the Industry, despite it's vaunted "free-market" principles is in fact dominated by near-term and short-sighted thinking. Which tells us that, as investors, we can look forward to continued downtrends in these firms. And recurring cyclic opportunities to ride up and down with these cycles.

None of which is good long-term news. 

UPDATE: for anybody who thinks the bad news is over we suggest listening to this Bloomberg vidclip of Meredith Whitney's outlook for Cit and the Finance Industry. She expects that Citi will have to start selling it's highest quality assets, upto and including Smith-Barney, to raise capital to offset more writedowns. Her slashing of earnings estimates is startling:

Whitney of Oppenheimer Slashes 2008 Citigroup Forecast: Video

If you can't see the video trying searching the Bloomberg site. Meanwhile here is the associated story: Citigroup May Post First-Quarter Loss, Whitney Says

Finance Industries

Fear and loathing, and a hint of hope Not all is lost for the structured-finance business. But it faces further discomfort before it can start to recover some of its past sheen. Securitisation has greatly enhanced the secondary market for loans, giving originators, mainly banks, more balance-sheet flexibility and investors of all sorts greater access to credit risk. Both have embraced it. By 2006 the volume of outstanding securitised loans had reached $28 trillion. Last year three-fifths of America's mortgages and one-quarter of consumer debt were bundled up and sold on. Though few bankers worked in structured finance, it was a huge earner, accounting for 20-30% of big investment banks' profits before the crisis … Alongside the banks, the “gatekeepers” who were supposed to lend stability and credibility to the new originate-and-distribute model of finance have also been found wanting. Rating agencies' models underplayed the risk that loans from different lenders and regions could turn sour at the same time. Bond insurers, too, misjudged the risks lurking in CDOs. That failing has undermined the worth of their guarantees and strained their own credit ratings—and hence financial markets.

Mid-Market M&A Outlook: Spreading Downturn ? Being somewhat connected into the mid-market (that's smaller firms) M&A/Buyout market and community it's something I follow and every once in a while something really interesting comes across my desk. Now we've discussed before that the implosion in large deals might be spreading into the mid-market (circa Jan08) based on anecdotal evidence that the deal flow began drying up in late Dec07. Now some much harder data has crossed our desks from OEM Capital. OEM is a specialist in mid-market M&A for the technology space and has an enviable track record, and sterling reputation. They track activity in that space montly and from their data we can begin to see the downturn spreading. If you're interested check out their web site and see if you can subscribe to their monthly newsletter. An excellent if dry information source.

LBO Executives Gather in Germany as Takeovers Vanish, Fund Returns Decline Carlyle Group founder David Rubenstein and TPG Inc.'s David Bonderman will join a meeting of about 1,500 executives from the leveraged buyout industry in Germany this week, as funding for takeovers vanishes and returns deteriorate. At last year's Super Return conference, executives toasted an unprecedented $713 billion of acquisitions with a reception at the Frankfurt Zoo, where they were entertained by a dance troupe and challenged to find the glass of champagne containing a real diamond. That was four months before the U.S. subprime mortgage market started to collapse, leaving banks with a backlog of about $230 billion in buyout loans and reducing their appetite to fund any new takeovers. Two preferred routes to generate quick returns, selling assets to other buyout firms or taking dividends from investments, also withered in the credit drought. ``The industry made its fortune on the debt bubble and now it's got to harvest it,'' said Jon Moulton, the managing partner of Alchemy Partners, who will give the conference's opening address in Munich tomorrow. ``Returns will go to hell in a hand- basket.'' Only three months ago, Johannes Huth, Kohlberg Kravis Roberts & Co.'s European chief, stood up in front of a conference of private equity executives in Paris and reassured them that bankers would resume lending in January. ``Slightly wrong there, I think,'' Moulton said. ``We've got at least a year of very tough credit markets. Banks are short of capital.''

A painful fix for the credit crisis Splitting the debt insurers in two -- an idea the banks hate -- would be drastic medicine. But for the financial markets, it's the only relatively fast-acting antidote available. It's the end of the beginning for the credit crisis: There are now plans to split up the companies that insure bonds and derivatives based on mortgages and buyout loans. What that means for you and me is that the credit crunch -- which has hobbled the stock and bond markets and is causing the U.S. economy to grind to a halt -- would be over in 2008 rather than producing a Japanese-style lost decade. The breakup plans also would lead to tens of billions more in write-downs from banks and other investment companies that have already written down tens of billions. And I'd expect the likely losers from these plans would fight them tooth and nail in the courts. It could be years before all the litigation was settled. But confirmation that a big insurer like Ambac Financial Group (ABK, news, msgs) is well along in talks to pursue this kind of breakup will provoke a rush to the exits by investors and institutions. They know prices for risky debt aren't going to get any better and could indeed get a whole lot worse. That giant whoosh you'll hear is the sound of somewhere between $50 billion and $125 billion in losses getting flushed down the toilet by the end of 2008. And that's a good thing. This drastic medicine is the only remedy that would put the financial markets on a relatively quick path to health. Anything else promises to stretch this crisis out for years and years and keep the U.S. economy grinding along in low gear.

Posted by dblwyo at 08:23 AM | Permalink | Comments (0)

Have you ever stopped to really think about what makes a business work ? Obviously it's a central question here but have you really wondered ? Well it's intellectually fascinating - really few things are that complex, with so many moving parts and challenges. A mix of chess, poker and rock climbing because it takes brains, thought, discipline, skills, people judgement and ability to manage stress and risk. More clearly it really...really matters to people where things are going badly or poorly...just ask all those auto workers laid off, the Yhooites about to loose their jobs because of executive short-comings or all those folks in NYC about to suffer even worse. For every millionaire Ibanker laid off there's likely to be hundreds who feel the effects. But it's even more than that - big business has been the engine that's driven our economy and society since the late 19thC. Small businesses create more jobs but the repostitories of big change, for good or ill, or are when innovations are turned into US Steels, the Pennsylvania RR, Ford or GM, GE, Pfeizer, Intel, IBM, Microsoft,..., etc. etc. [If you're interested in exploring this more and understand how much the rise and fall of big business shapes the world around you we HIGHLY recommend two book:Big Business and the Wealth of Nations, Inventing the Electronic Century: The Epic Story of the Consumer Electronics and Computer Science Industries ]. Just as an analyst, investor, employee or other participant you'll learn a lot.

Recently a lot of executives have been complaining though about the headwinds surrounding them and making it hard to do their jobs. Well as my old sailing instructor said, "you've got to sail where you can to get to where you want to go". Think about it - it's both eminently practical and more Zen than it first seems. Headwinds are part of the game, it's what you do with them that makes or breaks you. A point we've tried to capture in the chart above. Headwinds are the things going on in the world - the changes and trends in the Economy, how the markets effect that and so forth. But even more broadly how Technology impacts your company and how Social and Political changes and events define your environment. The ecology in which you must survive. You can be a predator or a rabbit - but you can't choose the ecology. You can choose just how fast, tough, mean and agile a rabbitt you are though. And be a lazy, mangy and decrepit predator not long for the world. What can't be done is NOT choose !

We mention all of this by way of introducing the following excerpts - the first of which is a survey of key strategic issues from Booz, Allen. While we don't necessarily agree with them all, especially their resolution, the point is that this is a checklist that's not bad to start with. Or if you like, how you play the chess game is up to you but the board and the rules are what you have to work with. And this begins to sketch them out. That big picture piece is complemented by two strategic pieces on things companies can manage - Product Quality and Innovation. Both of which are vital to survival, let alone prosperity. Yet both of which have been complainably badly done for a long time.

Somebody who's literally writing the book on how to do it right by balancing Strategy, Execution and  Leadership is Mark Hurd at HP. There's great interview excerpt below though in our 'umble opinions the writer missed the key points. Fortunately one of our favorite business blogs had a really good series of posts fleshing it all out. Finally there's a good example of $B are beginning to flow into Green Technology, beginning another major wave of product and industry innovation though it's a long ways off. Maybe by the time those guys are turning into big companies we'll have stopped burnng down the barn to catch the rats ? Any bets ? Ferris, Ferris, ...Ferris Buehler ?

General Business

Signals for the Coming Year Change may be certain, but for a business decision maker, some changes have more impact than others. Here are eight trends that will make the greatest difference in 2008. Decision makers are inundated these days with possibilities. There are myriad opportunities to seize, hundreds of competitive threats to avoid, and the constant awareness that any relevant trend — the price of oil, the popularity of a new interactive medium, the viability of an overseas market — may shift dramatically at any time. That’s why the first step of an effective strategy is separating signal from noise: recognizing the most telling indicators of the trends that will have real impact in the coming year. Fortunately, some signals have extra clarity and resonance right now, even amidst the cacophony. We think eight critical trends will be most important in the coming year that apply to every sector. They’re not sending the most obvious signals — indeed, they’re important precisely because many leaders are overlooking them. But we think they deserve attention.

Inconsistent Product Quality Can Really Hurt: Lessons from Other Industries  In general, RSR’s survey respondents are responsible for consumer goods management. Whether at the end of the retail ecosystem, or just a tick or two up the value chain, our audience’s products wind up in the hands of a consumer. But what about other industries? Do other industries have the same kinds of problems? A window into that question was opened on February 13, when the Wall Street Journal reported this news item: (…) Yikes. These respondents reported similar persistent problems: 95% reported inconsistent product quality as one of their top 3 business challenges, and 90% reported difficulty in achieving compliance to specifications. The solutions to these challenges were clear to our respondents: 98% reported post-production audits and 90% highlighted factory audits as key top-three ways to overcome these challenges. Technology enablers play a critical role in performing these audits and inspections: 95% of respondents highlighted the importance of Supplier Management technologies. In other words, this quality thing, it’s serious. We have chanted the mantra “people do what’s inspected, not what’s expected” for several years now. It remains true. Outsourced manufacture has enabled enterprises of ALL kinds to improve their bottom lines by reducing costs. But outsourced manufacturing clearly puts an onus on the outsourcer to check and re-check factories – regularly, irregularly, frequently and carefully.

Freeing Ideas from Their Silos The Army’s bureaucracy has taken hits over the years for impeding the ability to communicate essential knowledge quickly throughout the organization. To address that concern, the Army developed the CALL network in 2006, a surprisingly supple Web-based collaboration system through which new bottom-up concepts like the Fort Drum door hooks are disseminated instantly to those who can benefit from them. The Army’s success should serve as a lesson to the private sector. Most companies are awash in insights and ideas that emerge from specific situations but that could apply broadly across the organization to solve problems, promote efficiency, and even generate revenue. The trouble is that these valuable ideas get stuck in the silos of their origination and are never used to their full potential. As the Army discovered, however, implementing such a system must begin by addressing two challenges: identifying the right people and processes to serve as the foundation of the network, and, on a larger scale, working around deep-rooted behaviors and sensitivities while slowly changing the culture.

Give Me Your Black Sheep My Stanford colleague Hayagreeva "Huggy" Rao and I did a rollicking two-hour interview with Brad Bird over at Pixar headquarters last week.  Bird won an Academy Award for directing The Incredibles and is the odds-on favorite to win another one for directing Ratatouille.  I will talk more about this compelling interview in the future, but to give you taste, one of the most striking moments happened when Bird explained that he was brought to Pixar partly because senior management was worried that the company would become too complacent after three big hits: Toy Story, A Bugs Life, and Toy Story2.  To help fight against such complacency on The Incredibles, Bird wanted people to work with people who weren't satisfied with how things were done and so -- to staff the film-- he requested "Give me your black sheep."

Hewlett-Packard CEO: We can do even better It's just that the CEO who may be the best big-company operator in the country is all about making uncomfortable observations that so far have ended up being the right call for his company: Market share isn't the best goal to shoot for; even good businesses need to be examined carefully (especially their cost structures); and strategy and execution trump vision any day of the week. He boils down the CEO's responsibilities to three tasks: setting strategy (not offering a vision); aligning operations and modeling ways to execute on the strategy; get the best team to help the CEO. "There are a thousand distractions that keep you from doing that," he says. But that's where the focus needs to be.

• Mark Hurd’s 3-minute management clinic.

• “Change or Die”: Possibly my favorite business-magazine article ever.

• The power of naive questions.

• More on the checklist: the victory of common sense.

Billions of investment dollars flow to climate change, clean tech Institutional investors are committing billions of dollars to investments in climate change and are embarking on a bold new action plan to raise the profile of energy efficiency and clean technologies around the world. Nearly 50 leading U.S. and European investors representing more than $8 trillion of assets met on Feb. 14 at the United Nations to lay out a timetable for their commitments to global climate change and to call on governments and other investors to act with their money as well. The group says its investment commitments will boost energy efficiency and clean technologies as well as require tougher scrutiny of carbon-intensive investments that may pose long-term financial risk. That means investments in industries that are heavy carbon emitters are under threat. By raising the specter of divestments due to risk these investors are firing a warning shot.

Posted by dblwyo at 06:03 PM | Permalink | Comments (0)

The last Readfest boiled down the dilemma to the Street's apparant consensus being that it was time to go bottom-fishing verses the question of where we're at in what kind of a business cycle (we might also mention, again, that this has been a very different kind of cycle and NOBODY has factored in the consequences into their strategic thinking yet). Now that's the classic dilemma that's always with us of course but this time it's moved from background to foreground because of a widespread sense that we are at a cusp point where we're going to change from one regime to another.

A central and critical question we've taken two major passes at in the last week, both with our own postings and charts plus some key article excerpts. One that particularly got a lot of attention is Martin Feldstein's WSJ editorial warning that if this does tip it will likely because as bad or worse than anything we've seen since 1980 because of the differences in the Housing and Credit Market situations. Which is really a debate at which business cycle we're on, i.e. it's shape, and where we're at - which is discussed in an earlier post excepted below. Along with a post trying to summarize all the risks factors, their status and likely future course in one chart. If you look at nothing else read those.

In addition you'll find excerpts on the Fed's lowering of it's outlook, which was already low, and the Housing market, which is beginning to look like it's in a feedback loop where bad news triggers more problems leading to more bad news. There's also some interesting excerpts on the situation and consequences for parts of the Int'l Economy, particularly China and on the situation with supplies. In this case growing problems with finding oil that's readily accessible, affordably developable and not subject to the vagaries of ill-behaved governments (think Chavez or Nigeria). And with agricultural commodities which are beginning to enter their own boom and as a result are hurting the world's poor and beginning a shift from world-wide disinflation to inflation. 

US Economic Cycle

Our Economic Dilemma Although it is too soon to tell whether the United States has entered a recession, there is mounting evidence that a recession has in fact begun. Key measures of economic activity stopped growing in December and January or actually began to decline. The collapse of house prices and the crisis in the credit markets continue to depress the real economy. The sharp reduction in the federal funds interest rate and the new fiscal stimulus package may, of course, be enough to avert a downturn. Many forecasters still predict that the economy will just slow in the first part of this year and then rebound after the summer. But the hope that monetary and fiscal policies would prevent continued weakness by boosting consumer confidence was derailed by the recent report that consumer confidence in January collapsed to the lowest level since 1992. If a recession does occur, it could last longer and be more painful than the past several downturns because of differences in its origin and character.

Debating the Business Cycle: Alternatives, Risks & Catastrophes Yesterday we put up a post trying to summarize our sense of the congeries of problems (the problem portfolio as it were), what they are, what stage their in and likely to be and how they're likely to play out .The key starting question was whether or not the Economy was at a slipping point. In an earlier post on the alternate views of the Business Cycle we posted a graphic representation of the situation, what the different paths were/are and which are most likely. And discussed the policy challenges. We've also updated that original graphic to reflect a little something we neglected to mention - namely where are we at. Which, along with these story excerpts goes a long way to making our key point here. Reasonable people can debate whether or not we're in a Recession and will be for some time. What is absolutely clear is that the Economy is slowing. AND that the rate of slowing is increasing. AND that the risk factors of tipping over into something more severe are high to very high. No pleasant reading for sure but necessary - and we've never considered it our purpose to deny reality (other than in our personal live of course where fantasy is the rule :) ).  Updates, Refreshes and Gurus: Feldstein on Facing Realities

Filterring the Non-Linearities: Sorting the Risk Factors A few posts back we jokingly referred to the various reactive posts that went up last week because of the flood of important news stories. Those included real retail sales, Buffett's buyout offer for the bond insurers, GM's really terrible earnings and more. In trying to make sense of that swirl we referred to all the "non-linearities" where one thing was linked to another. We thought it might be helpful to have a single point-of-view where all that discombubulation was brought together in one place so here it is. The chart below looks at the major problem categories and then briefly summarizes their status thru several stages. First stage is the basic situation, second is the next level of concern and impact and so on. Each cell here probably deserves its' own post, and in fact has already gotten several. But then we'd back to multiple inter-twining issues and seeing the whole picture where everything's linked to everything else would be difficult. Maybe even impossible. Let's see if this helps. Click on the graphic for a larger picture of course.

Fed Officials Cut '08 Growth Projections to Range of 1.3%-2.0% Federal Reserve officials cut their forecasts for economic growth this year by about a half percentage point and raised unemployment projections after the housing recession and financial-market turmoil deepened. Fed policy makers now expect U.S. gross domestic product to increase by 1.3 percent to 2 percent in 2008, compared with the 1.8 percent to 2.5 percent they predicted in October. The fourth-quarter jobless rate will be between 5.2 percent and 5.3 percent, up from a range of 4.8 percent to 4.9 percent in the last forecast. Inflation, excluding food and energy, will run at 2 percent to 2.2 percent this year, compared with 1.7 percent to 1.9 percent projected in October. Total consumer prices will rise by 2.1 percent to 2.4 percent; the FOMC projected an increase of 1.8 percent to 2.1 percent three months earlier. Fed Saw Need for `Relatively Low' Rates for Some Time, Fed Sees Rate Low `for a Time,' Then Chance of `Rapid' Reversal

Housing Cycle in Vicious Circle Housing is caught in a loop where one problem creates behaviors that make it worse. For example, falling home prices give borrowers incentive to walk away from mortgages. The trick for policy makers is to break the negative-feedback cycle. Economists have a term to describe what it means when things keep going from bad to worse: negative-feedback loop. One day's problems create a broad set of behaviors that only make the problems worse. Consider housing. As home prices fall, more families see the values of their homes decline to less than the amount of money they have to pay back on their mortgages. That gives them an incentive to walk away from their mortgages and leave their homes empty, which puts more downward pressure on home prices, drawing more households into the loop. Housing turmoil, in turn, causes consumers to pull back, hurting the broader economy, which puts more downward pressure on home prices. Banks, worried about mortgages going bad, tighten lending standards, shutting some new buyers out of the market and further depressing home prices. Negative-feedback loops can be pernicious when an economy depends heavily on borrowed money.

• Housing Starts in U.S. Near Lowest Since 1991 as Slump Enters Third Year

Yield Curve Concerns, Keynesian Fixes, Broken Models: Shifts in the relationship between U.S. government bonds with different maturities are semaphoring a warning that inflation may accelerate in the world's biggest economy even as growth deteriorates. The two-year Treasury note yield has more than halved since Sept. 18, the day the Federal Reserve started cutting its key interest rate. The current yield of about 1.92 percent is far enough below the Fed's 3 percent rate to suggest investors expect additional moves from the U.S. central bank. It's a different story at the other end of the yield curve. At about 4.6 percent, the 30-year bond yield is only 15 basis points lower than it was when the Fed downshifted into easing mode. As a result, the yield curve has steepened, driving the gap between the two- and 30-year securities to its widest level since July 2004 at about 268 basis points. So-called breakeven rates, which measure the yield gaps between those Treasury bonds that pay returns tied to the inflation rate and those that don't, are starting to signal a change in the inflation outlook. The gap between five- and 20-year breakevens has widened to 65 basis points, the most since at least August 2004 and more than double the 2007 average. While slower growth is likely to restrain consumer prices past the turn of this decade, Fed policy may be stoking the fires of future inflation.

International Economies

Central China blazes own path China’s economic ”miracle” has so far been largely confined to the country’s east coast. This is mainly due to the ease of shipping export goods manufactured in the Pearl River and Yangtze River deltas out of ports in Shanghai, Ningbo, Guangzhou, and Hong Kong. Facing wide regional income disparities, the central government is looking for ways to spread of economic development into places like Anhui and Jiangxi – two inland provinces that sit nestled like twin ice-cream scoops in the bowl of rich coastal provinces such as Jiangsu, Zhejiang, Fujian, and Guangdong. In the next five years, central China will grow rapidly, in part by imitating east China’s development model - Jiangxi and Anhui are already capturing the low end of export-processing industries crimped by rising input costs on the coast. But mimicking east China’s export-led approach will not be central China’s main growth engine. Instead, Anhui and Jiangxi aim to become “China’s China” – suppliers of low-cost goods to the rest of China (especially its wealthy east coast) just as China as a whole supplies low-cost goods to the world.

China Inflation Is Fastest in 11 Years as Snowstorms Drive Up Food Prices China's inflation accelerated to the quickest pace in more than 11 years after the worst snowstorms in half a century disrupted food supplies. Consumer prices rose 7.1 percent in January from a year earlier, the statistics bureau said today, after gaining 6.5 percent in December. That was more than the 7 percent median estimate of 23 economists surveyed by Bloomberg News. Food prices soared 18 percent after blizzards paralyzed transport systems and destroyed crops. The government faces the challenge of curbing inflation without derailing the expansion of the world's fastest-growing major economy. Soaring prices have the potential to lead to social instability, as illustrated by the Tiananmen Square protests and crackdown of 1989. The World Bank estimates 300 million Chinese people live in poverty. In the 1990s, China swung between deflation and an annual inflation rate as fast as 24 percent in 1994. Central banks across Asia face the choice of tackling slowing growth or rising inflation. Lehman Brothers Holdings Inc. last week cut its forecast for 2008 growth in the region, excluding Japan, to 7.3 percent from 7.6 percent and raised its inflation estimate to 4.6 percent from 4.2 percent. China's government may use more currency gains and curbs on bank lending to restrain price increases. It has also imposed food and energy price controls. So far, the government is letting the yuan gain at a faster pace versus the dollar than it did last year. The currency has climbed 2 percent after rising 7 percent in 2007. A stronger currency would push up export prices and make imports cheaper

Bernanke's Rate Cuts Force Asia to Turn Back to Price Controls, Subsidies Under Bernanke's chairmanship, the Federal Reserve's steepest interest-rate cuts since 1990 are limiting his Asian counterparts' options to curb inflation. Instead of raising their own borrowing costs or letting their currencies appreciate faster, governments are resorting to regulating meat and egg prices in China, stockpiling cooking oil in Malaysia and subsidizing utility bills in Indonesia and the Philippines. Such measures may backfire. Artificial price curbs and subsidies only feed more demand for oil and other commodities, and ultimately will make it harder to contain inflationary pressures worldwide… Stockpiling, subsidies and price controls do nothing to rein in excess demand in Asia's fast-growing economies, which is already pushing up food and energy costs worldwide. The G-7 in Tokyo said governments should avoid steps to artificially lower energy prices. The Fed's rapid rate-cutting leaves Asia's policy makers with few good alternatives. China and other export-driven economies have tried to limit the appreciation of their currencies to keep their goods competitive in world markets, at the cost of higher inflation at home.

Other Factors

Finding oil: A global challenge The oil is out there. The hard part is getting it to consumers. Tight supplies and rising demand for crude. As a result, executives said, the industry faces serious challenges getting oil to market. The consensus among participants at the conference is that the world has enough oil to meet growing demand, but that the industry must focus more attention on harvesting the oil. Rising income of consumers has propped up demand even as crude prices have spiked five fold in the past six years. Runaway growth in oil use in India and China - the two countries are expected to boast a combined 1.2 billion vehicles by 2050, up from 20 million a few years ago - is expected to push demand above supply sometime between 2015 and 2020, Hess said. A small but growing number of analysts disagree with Hess' assertion that there is enough oil in the ground. They say production of oil has peaked or will peak soon, followed by a slow but steady period of decline that could cause major social unrest. Oil executives, while acknowledging that crude deposits are ultimately limited, said that new technologies should keep crude production rising for at least several decades. But much of what remains lies in remote places, Albers noted. He said producers have to work closely with countries that hold a significant chunk of the remaining supplies.

Wheat Shreds Goldman, USDA Forecasts as Global Demand Drives Record Prices The biggest rally in the history of wheat trading defied even some of the best conventional wisdom, humbling forecasters from Goldman Sachs Group Inc. to the U.S. government. Wheat has more than doubled since May, reaching a record $11.53 a bushel on Feb. 11 and driving up costs for everything from Eggo waffles and Italian pasta to Pakistani flatbreads and Japanese pastry. This month the world's biggest securities firm scrapped projections for a price drop within 90 days, and the U.S., the biggest exporter, said it would ship 23 percent more than originally estimated before summer. Wheat set a record 16 times since September, resonating around a world that relies on the grain more than any food crop except rice. Exporters Argentina and Russia halted sales or raised taxes to protect dwindling reserves. Pakistan boosted imports as inflation in January rose 12 percent, the most in 33 months. Farmers aren't keeping pace with the diets of a burgeoning middle class in India and China. The Department of Agriculture predicted Feb. 8 that U.S. stockpiles for the 12 months through May will drop 40 percent to the lowest since 1948 as global production lags behind consumption for the seventh year in eight. Droughts and rain damaged crops in Australia, France and the U.S. last year, thwarting bets that higher prices would reverse the trend by encouraging bigger harvests.

Posted by dblwyo at 12:00 PM | Permalink | Comments (0)

That is the question, isn't it ? Depending on who you believe we may have a bit to go but it's time to start doing some valuation and fair value pricing and taking some risk. Or it's time to really batten down the hatches. A large part of the answer to that question boils down to where's the economy going and with it, profits and earnings. We'll pick that up next post or so. So in the meantime let's focus on the Markets & Investing topics. Start by taking a look at the chart on the right. Take a good, long look and we'll come back to it.

There was another flood of markets news this week, so much in fact that we yet again put up some interim readfest postings, largely with accumulating news on the credit markets, which these days are the market news. Pulling a little self-referencing (my techie friends call it recursive or strange loops) our final collection for the week not only includes those earlier posts summarized but we also pulled one or two of the key articles out that really think you ought to pay attention to. In fact we'll call out two. Jim Jubak's tracing the very recent history of the credit crisis since ~ Jan. 22nd and the Economist article looking at the long-term outlook for the securitization industry - the short and the long of it as it were.

While all this sturm und drang is swirling around us the talking heads are talking about getting back in. We'll further draw your attention to two other summaries. One, again from Jubak, that is as good an explanation of estimating a stock's fair value as we've seen. Which is the tool you should be using to bottom-fish rather than arm-waving. Speaking of which the next summary is one of ours which lays some alternative investment strategies and how to adjust them given your level of aggressiveness, time & energy and risk tolerances and so forth. Worth every penny - for which you're paying nothing we remind you :) !

Take another look at the chart now and let's talk a bit about it. But first if you'd like another break try this:

Charting the Market Discussing todays market action, with Robert Balentine, Wilmington Trust Investment Management; Randy Lert, Russell Investments; and CNBCs Maria Bartiromo.

We've been repeatedly contrasting our view that we're on the lip of the business cycle curve with the street's apparent consensus that this will be a mild downturn. Which is now fully priced into valuations and earnings outlooks ! The difference between those two views lies at the heart of the dilemmas and given all the conflicting advice and comment you're hearing probably helps the confusion. And, IOHO, shows up in the chart. Beautiful looking chart isn't it ? Borrowed from our friends at Stockcharts.com of course.

The middle is the SP500 1YR daily chart with 50- and 200-day MA plus the volume in the background. The top is something called the MACD Histogram and the bottom another fun stat called the Accumulation/Distribution Line. Now it's not clear that we understand all this but we'll take a shot - always bearing in mind that man's mind is a pattern-seeking tool and the technicians are the worst. So what we try to notice first is that over most of '07 we really got a sideways market with some fairly wild and wide swings - which got wilder and wider as the year wore on and the agita factor got bigger. Then along about Oct/Nov those swings started to turn into a downtrend though it was hard to see that for a while. But in your minds eye draw a line connecting the highs and see what you get (we didn't because the chart's already too busy). Now if you try that one more time you'll notice that all of a sudden at the change of the year it really tipped over. If you draw another top-top line it gets pretty steep and scary. Now here's the interesting thing - if you draw a line in the last few weeks connecting the lows they look to be flattening out - in fact the lows & highs almost look like a high-school penant or one of those state-fair flags, right ?

Which we take to mean that the "smart" money think we're consolidating around this level on the markets. Now the MACD stuff is just the difference between two short-term moving averages on the stock price so it kinda tells you what the momentum is in a certain direction. Notice that while the state fair pennant is narrowing down that the momentum is moving up. Yet at the same time the 50-day MA is still diving away from the 200-day. Another take is the A/D Accumulation which is really price move X volumen (not quite but close). It's, in our simple minds, an indicator of the force behind the momentum, really mixing metaphors. Put another way Mr. Market and the "Smart" money really....really...really want this to be all over and done. Just fix it as they say. But the bad news just keeps trotting out. In fact the last 20 mins of Fri. market was perfect - down pretty seriously all day as earlier euphorias faded and the news that there might be a rescue plan for AMBAC saved the day. The DOW for example reversed almost 200 pts ! Whew glad that's over. 

 Here's one more fun little fact (from tables in the investment planning post) that's worth pondering. Between Jan00 and Dec07 the return with reinvestment on the SP500 was 3.5%. And adjusting for inflation it was 0.7% ! Stop and think about that...let's see..99,00,01,02,03,04,05,06 & 07, but not 08 to date. That's NINE years. Let me try that one more time:

FOR THE BETTER PART OF A DECADE STOCK MARKET RETURNS HAVE BEEN FLAT, i.e. ~ 0 !

Investing

How to bottom-fish for stocks Here are some calculations to help you decide when the risk of buying a stock is worth it. If you'd rather not attempt the math, don't worry -- I'll do some of it for you. Tired of trying to figure out if the Jan. 22 low was the bottom for stocks? Whether the recent rally will hold or turn into a massive bear trap? Whether to buy now or wait until, well, until who knows when? Today, I'm going to put you out of your misery and tell you when it's time to buy.  No, I'm not going to call a bottom for the stock market as a whole. (Cue the boo birds.) I don't think anyone is in a position to do that. What I'm going to do instead is show you how to calculate a fair-value price for an individual stock and how to use that to figure out when to buy. This method won't tell you when a stock has hit its absolute bottom, but it will tell you when the price is low enough and the potential return high enough to justify the risk of getting in too early. It's not about calling a bottom but learning how to bottom-fish.

This One's for Jay: Investing Strategies for a Dicey Market Obviously our view is that there's a long way to go to bring valuations into line with the business cycle and enterprise performance outlooks but we've been wrong, or at least badly timed, before; and surprised of course that the Universe didn't fit our "model" :). But all in all it seemed like a good time to translate the thrust of our arguments into some investing strategies (bearing in mind that blind advice on the web is potentially worth what we're paying for, this is intended as a representative exercise for you to go do your own homework and any negative consequences are on your own head. A suprise upturn of course we expect to get a cut :) ). In the process we'll point you to PoliticalCalculations SP500 return calculator which you ought to have handy. Now take a careful look at the inflation adjusted returns, either with or without dividend re-investments. The period '95-'07 was o.k. but when you break it down that was all pretty much in the boom years. Returns in the '99-'07 period only virtue was they were positive, barely. Of course if you'd gone in '04 you'd have done reasonably well. And there's our arguments in a nutshell.

• Is It REIT Time Yet ? - You've Got to Be Kidding Me

Find Bargains in Agriculture Agriculture is now the focus of the commodities boom, sending prices of items such as bread and beef higher. But bargains can be found among agriculture stocks, and they belong in every long-term investor's portfolio.

Markets

WRFest 24Feb08(Credit Markets): More Fear, Loathing & Writedowns The Readings section below starts off with a diagnosis of whey the rescue attempts for the credit market breakdowns are failing, coupled with several of our prior posts worth reviewing. Not least because they're turning out to be more right than we anticipated. Which naturall leads into another more recent post on the failures of securitization and the long-term outlook for the instruments and the industry. Coupled with several interesting stories not least of which is David Faber of CNBC arguing that the credit markets a) aren't recovering and b) are badly broken. THIS...on CNBC ???? Wow ! All of which ripples forward to pressures on corporate loans and related debt instruments which are facing rising risks of default and will likely also metastasize into big time down pressures on the many weak companies out there. Which is now spreading across the private equity markets and down to the mid-size deal. While that may not sound like much to you - who cares if they have to drink less expensive cigars after all ? - but is actually both a major symptom and diagnostic as well as indicator of accelerating future troubles. 

Fear and loathing, and a hint of hope Not all is lost for the structured-finance business. But it faces further discomfort before it can start to recover some of its past sheen. Securitisation has greatly enhanced the secondary market for loans, giving originators, mainly banks, more balance-sheet flexibility and investors of all sorts greater access to credit risk. Both have embraced it. By 2006 the volume of outstanding securitised loans had reached $28 trillion. Last year three-fifths of America's mortgages and one-quarter of consumer debt were bundled up and sold on. Though few bankers worked in structured finance, it was a huge earner, accounting for 20-30% of big investment banks' profits before the crisis … Alongside the banks, the “gatekeepers” who were supposed to lend stability and credibility to the new originate-and-distribute model of finance have also been found wanting. Rating agencies' models underplayed the risk that loans from different lenders and regions could turn sour at the same time. Bond insurers, too, misjudged the risks lurking in CDOs. That failing has undermined the worth of their guarantees and strained their own credit ratings—and hence financial markets.

A painful fix for the credit crisis Splitting the debt insurers in two -- an idea the banks hate -- would be drastic medicine. But for the financial markets, it's the only relatively fast-acting antidote available. It's the end of the beginning for the credit crisis: There are now plans to split up the companies that insure bonds and derivatives based on mortgages and buyout loans. What that means for you and me is that the credit crunch -- which has hobbled the stock and bond markets and is causing the U.S. economy to grind to a halt -- would be over in 2008 rather than producing a Japanese-style lost decade. The breakup plans also would lead to tens of billions more in write-downs from banks and other investment companies that have already written down tens of billions. And I'd expect the likely losers from these plans would fight them tooth and nail in the courts. It could be years before all the litigation was settled. But confirmation that a big insurer like Ambac Financial Group (ABK, news, msgs) is well along in talks to pursue this kind of breakup will provoke a rush to the exits by investors and institutions. They know prices for risky debt aren't going to get any better and could indeed get a whole lot worse. That giant whoosh you'll hear is the sound of somewhere between $50 billion and $125 billion in losses getting flushed down the toilet by the end of 2008. And that's a good thing. This drastic medicine is the only remedy that would put the financial markets on a relatively quick path to health. Anything else promises to stretch this crisis out for years and years and keep the U.S. economy grinding along in low gear.

Equity Trading Defies Bum Economy as Wall Street Transformers Proliferate The biggest surprise on Wall Street this year is proving to be the record $16.3 trillion of shares traded in the U.S. as stocks show no sign of rebounding from the first bear market since 2002 and the economy teeters on the brink of a recession. Daily trading in December and January averaged 7.44 billion shares, 13 percent more than the previous quarterly peak, New York Stock Exchange data show. The pace is a boon to Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos., whose equity- trading revenue will slip just 6.1 percent in 2008 from last year's record $36.7 billion, according to Sanford Bernstein & Co. The same income-stream shrank almost 40 percent in 2001 and 2002, after the Internet bubble burst. Hedge fund customers who thrive on market swings will buttress the results while the brokerages' increasing use of electronic systems rather than human traders will keep costs down, exchange officials and bank executives say. The growth in equity derivatives and the firms' international expansion may also sustain revenue in a way not seen in prior market declines. For the biggest U.S. securities firms, stock trading may cushion the blow of subprime writedowns and credit losses.

Posted by dblwyo at 12:22 AM | Permalink | Comments (0)

While we'll put this in our regular clipping files this is just an incredibly good summary of how the credit markets, over and above everything that's happened from Bear's spring surprises to last to to, let's say, Jan. of this. It traces the spread of rippling consequences in one of the few articles that even we understood. Here's the exceprt but if you haven't had too many scotches to digest the prior post go read this one while you're still clear-headed. It is superb.

A painful fix for the credit crisis Splitting the debt insurers in two -- an idea the banks hate -- would be drastic medicine. But for the financial markets, it's the only relatively fast-acting antidote available. It's the end of the beginning for the credit crisis: There are now plans to split up the companies that insure bonds and derivatives based on mortgages and buyout loans. What that means for you and me is that the credit crunch -- which has hobbled the stock and bond markets and is causing the U.S. economy to grind to a halt -- would be over in 2008 rather than producing a Japanese-style lost decade. The breakup plans also would lead to tens of billions more in write-downs from banks and other investment companies that have already written down tens of billions. And I'd expect the likely losers from these plans would fight them tooth and nail in the courts. It could be years before all the litigation was settled. But confirmation that a big insurer like Ambac Financial Group (ABK, news, msgs) is well along in talks to pursue this kind of breakup will provoke a rush to the exits by investors and institutions. They know prices for risky debt aren't going to get any better and could indeed get a whole lot worse. That giant whoosh you'll hear is the sound of somewhere between $50 billion and $125 billion in losses getting flushed down the toilet by the end of 2008. And that's a good thing. This drastic medicine is the only remedy that would put the financial markets on a relatively quick path to health. Anything else promises to stretch this crisis out for years and years and keep the U.S. economy grinding along in low gear.

Posted by dblwyo at 04:29 PM | Permalink | Comments (0)

No the headline isn't a mistake - this is indeed the news clippings intended for the weekend but the tsunamis of what we think are critical information just keep on coming. So we thought it best to get a jump ahead of what will be a large run of such postings. Just as a matter of fair disclosure not only may this suit your reading schedule but a good scotch would be appropriate as well.

First off walk, don't run, to watch this CNBC interview with Meredith Whitney who was the finance industry analyst who made the downgrade calls on the big banks and the mono-line bond insurers. Well unfortunately she's adding a bunch more bad news on earnings, write-downs, rising bad debt, the need for new capital & dilution and so forth. We'd suggest watching it at least twice and taking note the 2nd time. We'd provide them but haven't finished our scotches yet. 

The Readings section below starts off with a diagnosis of whey the rescue attempts for the credit market breakdowns are failing, coupled with several of our prior posts worth reviewing. Not least because they're turning out to be more right than we anticipated. Which naturall leads into another more recent post on the failures of securitization and the long-term outlook for the instruments and the industry. Coupled with several interesting stories not least of which is David Faber of CNBC arguing that the credit markets a) aren't recovering and b) are badly broken. THIS...on CNBC ???? Wow !

All of which ripples forward to pressures on corporate loans and related debt instruments which are facing rising risks of default and will likely also metastasize into big time down pressures on the many weak companies out there. Which is now spreading across the private equity markets and down to the mid-size deal. While that may not sound like much to you - who cares if they have to drink less expensive cigars after all ? - but is actually both a major symptom and diagnostic as well as indicator of accelerating future troubles. 

READINGS

Why Wall Street rescues are failing The financial system has become dependent on debt and the transfer of risk via convoluted debt instruments, creating a mess that will require hundreds of billions of dollars and global cooperation to fix. Yet each, including Federal Reserve Chairman Ben Bernanke and U.S. superinvestor Warren Buffett, has failed to lift investors' spirits for more than a couple of weeks, ultimately leaving stocks to tumble ever lower. Why? The fundamental problem in the world economy is that it grew over the past two decades to be incredibly reliant on optimistic risk takers' willingness to accept increasingly complex IOUs from companies, banks and government institutions as investments instead of real assets. Now we are seeing the same movie play back in reverse, as massive investor losses in debts once believed to be safe have led to falling confidence, rising pessimism and extreme risk avoidance. In a gentler era, debt was important but not as vital to world finance. In recent years, debt became the oxygen of the world financial system, along with a fanciful means of transferring its risks from borrowers and issuers to investors. To the extent that neither debt nor its conveyances are now trusted, even from organizations once considered rock-solid, the entire global banking system is asphyxiating before our eyes.

·        Credit Spreads .....Visiting the Proctologist ? Or Frankenfinance Monsters ?

·          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

Fear and Loathing on Wall Street: Credit Mess, Securitzation & More Here's a very recent set of stories on the widening of the credit mess, the impacts on the Finance industry and the whole strategic theory behind the Securitzation innovation. For example the metastasis of credit problems has reached the Student Loan market, is re-shaping the competitive landscape AND threatening a lot of loans, especially for poorer and/or dis-advantaged students. As Mohammad El-Arrian pointed out in a CNBC interview we posted a while back the whole process of securitization was a major new innovation with which the institutional and regulartory frameworks weren't prepared to cope. Worse the internal business practices and governence of the financial firms let short-term greed run ahead of themselves. In other words they screwed up big time by chasing quarterly returns that were badly, as in not at all, priced for the risks they were presuming. On the theory that they could always bail out. Belowis a set of readings that cover the Economist's take on the industry future. Also covered are the further massive writedowns the major banks, et.al. will be taking on mortgage related debt, the exposures to lose of credit insurance, and corporate/buyout writedowns. In other words you ain't seen nuthin yet ! Which pretty confirms what we've been saying for what now amounts to a couple of months.

• Credit Markets Are Broken The stock market has shown some resilience but not the credit markets, with CNBCs David Faber. Is Time Running Out for Bond Insurers?
• More Write-Downs Ahead?  The Citigroup research of Meredith Whitney, executive director of CIBC World Markets, triggered a staggering global selloff, and now shes warning that banks could face additional write-downs of up to $70B if bond insurers are downgraded.
• BofA: Monoline Split "Significant cost" to Financial Markets In the current Situation Room report (no link), BofA analysts suggest the monoline insurer breakup could lead to $30 Billion in write-downs for banks. BofA suggests further capital infusions, aimed at stabilizing the monolines at AA, would be a possible alternative. This is the first suggestion I've seen of trying to stabilize the ratings at AA. I'm not sure how that would impact the muni bond market

Junk Borrowers at Risk of Violating Covenants Rises  A record 41 companies with high- yield, high-risk credit ratings are in danger of breaching terms of their loan agreements within 12 months as the slowing economy cuts into corporate profits, Moody's Investors Service said. Junk-rated companies including Krispy Kreme Doughnuts Inc. and Blockbuster Inc. are becoming more at risk of violating loan covenants and defaulting as the slowing economy saps earnings and cash flow. Some companies including restaurant chain Buffets Holdings Inc. and homebuilder Tousa Inc. have already been forced into bankruptcy after bankers were unwilling to amend loan terms. The number of borrowers at risk at the end of January rose from 25 in June, Moody's analysts led by John Puchalla in New York said today in a report. Moody's used a four-step scale to rate how much a company is in compliance with its loan terms, which often include agreements to maintain a ratio of debt to earnings or cash flow. A weak cushion indicates a company may have trouble freeing up cash for spending and accessing revolving credit lines, according to the report. Violating covenants can lead to a default and the securities being called. Creditors are making borrowers 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. The percentage of speculative-grade bonds that are distressed, meaning their yields are at least 1,000 basis points higher than benchmark rates, rose to 20.9 percent as of Feb. 15, about the same ratio as in the months preceding the recession that began seven years ago, according to Merrill Lynch & Co. Debt is 20 times more likely to default within a year once it's crossed the distressed threshold, according to data by Martin Fridson, chief executive officer of high-yield research firm FridsonVision LLC in New York.

• Red Lights Flash in Credit Nooks The global financial squeeze is spreading to investments linked to the debt of major companies.
• Lending Squeeze Hits Ailing Firms Retailers Sharper Image and Lillian Vernon filed for Chapter 11 protection. Banks' mounting woes are adding to a rise in bankruptcies.

Mid-Market M&A Outlook: Spreading Downturn ? Being somewhat connected into the mid-market (that's smaller firms) M&A/Buyout market and community it's something I follow and every once in a while something really interesting comes across my desk. Now we've discussed before that the implosion in large deals might be spreading into the mid-market (circa Jan08) based on anecdotal evidence that the deal flow began drying up in late Dec07. Now some much harder data has crossed our desks from OEM Capital. OEM is a specialist in mid-market M&A for the technology space and has an enviable track record, and sterling reputation. They track activity in that space montly and from their data we can begin to see the downturn spreading. If you're interested check out their web site and see if you can subscribe to their monthly newsletter. An excellent if dry information source.

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

Being somewhat connected into the mid-market (that's smaller firms) M&A/Buyout market and community it's something I follow and every once in a while something really interesting comes across my desk. Now we've discussed before that the implosion in large deals might be spreading into the mid-market (circa Jan08) based on anecdotal evidence that the deal flow began drying up in late Dec07. Now some much harder data has crossed our desks from OEM Capital. OEM is a specialist in mid-market M&A for the technology space and has an enviable track record, and sterling reputation. They track activity in that space montly and from their data we can begin to see the downturn spreading. If you're interested check out their web site and see if you can subscribe to their monthly newsletter. An excellent if dry information source.

M&A Announcements (OEM Capital) For January 2008, merger and acquisition announcements targeting US information and communication companies totaled 99 compared to 145 for January 2007. In January, the Software sector accounted for 62% of all announced transactions followed by Hardware & Systems (15%), IT Services (14%) and Telecom Services (9%). Not only were the number of transactions down substantially from a year ago, there was only one transaction over US$100 million. The largest two transactions during the month were: NYSE Euronext Inc. announcement to acquire Wombat Financial Software Inc, a developer of data software for financial institution trading, for a total value of US$200 million; and, Universal Electronics Inc. planning to launch an unsolicited tender offer to acquire Zilog Inc, a manufacturer of semiconductors, in a transaction valued at US$77 million. US buyers accounted for 83% of the transactions. Foreign acquirers from countries with two or more announced transactions included Canada (6) and the Philippines and Japan (2).

Below the line though you'll find a bunch of other relevant information, either on technology or the M&A market in general (largely courtesy of the WSJ's Deal Journal which we also recommend following). The first item is an analysts' report which sees Tech spending turning negative ! Gee - wonder if these are correlated datum ? :) For regular readers this shouldn't be any sort of surprise given that we've been arguing for such for several months based on our macro-analysis of capex trends.

The rest of the Deal Journal readings will "read" you into the picture with growing tales of woe and consequences: declining business deal flows, likely downsizings, bring your own debt for deals and, most especially, an increasingly cloudy outlook for corporate debt defaults. Which'll just be another feedback loop to add to the general malaise until it turns into fullblown misery (thank you Pres. Peanut for creating a phrase). 

UPDATE 2/22 (this is from an e-brochure alerting/advertising for an upcoming seminar on Mid-Market Finance that, reading between the jargon, tells us a lot about the state of play):

What a difference just a few months can make!! Last summer, middle-market mezzanine finance was the subservient Cinderella to stepsisters like increased levels of senior debt and second lien loans. Now suddenly, mezzanine once again is the belle of the ball.It’s stunning to me how fast the whole landscape changed.

CLOs struggle with their ability to raise capital.  Second lien paper is nowhere to be seen.  Senior lenders have pulled back on their lending multiples.  Hedge funds are laying off their business development teams.  Covenant lite deals are a footnote in Wall Street history. In fact, when you look at all the participants in middle-market finance, mezzanine funds are the biggest beneficiary of the credit turmoil.

READINGS 

Corporate IT Spending Goes Negative Overview: ChangeWave’s latest corporate IT spending survey points to a negative growth rate for 2nd Quarter 2008 – and confirms U.S. business spending has already entered into a recession. A total of 2,013 respondents involved with IT spending in their organization participated in the survey, conducted February 11-15, 2008. 2Q 2008 IT Spending: Nearly one-in-four respondents (23%) say their company’s IT spending will decrease (or there will be no spending at all) in the 2nd Quarter – 3-pts worse than the previous ChangeWave survey in November 2007. Only 15% say spending will increase – an unprecedented 9-pt drop from previously. A Picture of Negative Growth: As seen below, the percentage projecting decreased IT spending for 2nd Quarter 2008 is far greater than the percentage projecting an increase. You have to go all the way back to August 2001 to find the last time a ChangeWave corporate IT spending survey projected negative spending growth.

How Bad Is It? The Hillary Clinton Edition Consider the dismal fortunes of the deal business. Leveraged finance is down 82% this year, while announced M&A is down 64% and fee income from private-equity firms is down 74%, according to data from Dealogic and Banc of America Securities analyst Michael Hecht. The M&A backlog of deals that were announced and not completed is a massive $1.5 trillion–which means that one-quarter of all the deals announced in 2007 haven’t closed yet. And the fees, the fees. Mr. Hecht provides some terrifying numbers. In 2007, investment banks missed out on $4.4 billion of revenue as a result of withdrawn M&A deals, up 56% from 2006. This year, the banks already have watched $126 million of fees escape their grasp because of withdrawn M&A deals that never paid their success fees. The investment banks didn’t do much better on equity offerings. Withdrawn equity offerings cost the banks $980 million of revenue in 2007. In the first six weeks of the year, banks already have forgone $200 million in revenue because of pulled deals. So this we know: lower revenue means fewer jobs and, if things don’t pick up, the stage could be set for layoffs on Wall Street. The Street already is staffed pretty fatly, with more than 211,000 working in the deal-making parts of investment banks in 2007, lumped together under “institutional securities.” In 2006, that head count was a little more than 189,000. And productivity at the investment banks already was down in 2007, a year that ended with layoffs. Average revenue per employee at the big investment banks fell 16% to $714,572 last year from 2006. In fact, the last year with lower productivity by headcount was all the way back in 2004, a year in which each investment-bank employee brought in $685,651. As Bette Davis said in “All About Eve”: “Fasten your seatbelts. It’s going to be a bumpy night.”

Gathering the Kindling for the Bankruptcy Pyres Is it time for the bankruptcy funeral rites to start? Here is evidence more companies may be nearing defaulting on their debt, particularly those with the lowest-rated, riskiest debt. Even though years of ever-weaker covenant agreements means such companies may not have officially defaulted on their debt, they still are burning through cash and that is cutting off their access to more funding. According to a Moody’s report today, companies with low-rated or junk debt have the weakest levels of liquidity since November 2004, with more than 90% of companies with C-rated debt having low or only “adequate” access to the cash and revolving credit lines needed to keep them functioning. Of course, many have foreseen an increase in the number of corporate defaults from the record lows of recent past. Still, the number of high-yield, or junk, bond issuers with the thinest of cushions before violating covenants on their debt is at a record, according to Moody’s. Forty-one companies have Moody’s lowest, speculative-grade rating of “4,” up from 25 only eight months ago.

For Private-Equity Buyers Now, the Party Is BYOD In a world of uncertain credit, private-equity deals are still getting done, but increasingly the prize isn’t going to firms with the highest offer. Rather fortune is favoring those who can get the deal to the finish line (or at least can show that they can). Often that means buyers who bring their own debt to the negotiating table, instead of turning to outside lenders. Executives at such firms as Carlyle Group, TPG Capital and Silver Lake Partners all say they have had to spend extra time recently lining up debt before heading to the bargaining table.

Leveraged Loans: The Hangover Wasn’t Worth the Buzz Investment banks now face around $197 billion in exposure to leveraged loans used to back big buyouts in 2007, adding inestimable stress to their efforts to extricate themselves from the credit crunch. Was it worth it? Not really, no.

Deals of the Day: Antitrust, Schmantitrust

Deals of the Day: ‘If You’re Up There, Save Me, Superman’

Posted by dblwyo at 02:10 PM | Permalink | Comments (0)

There have been three interesting (or more) stories on the rapid airline feeding/merger frenzy that's bubbling up before our eyes as the result of intractably higher fuel costs. Like every other strategic initiative since '00 this one too will NOT fix the underlying problems. Which won't stop the mergers nor prevent the financial community from providing the liquidity ammo necessary to bring it about on the theory that it will. Earlier we'd posted a first pass (Airline Merger Frenzies (I): Deep Cost Structure, Restructuring & Outlook) explaining how the hub-n-spoke network route structure was the deepest underlying factor in airline's lack of profitability and failures, since the end of WW2 btw, to earn their cost-of-capital. Excerpts from the three stories are below but here's an excerpt from a strategic assessment we wrote in '04 both predicting the consolidation and its' likely failure.

Consider the airline industry further - costs are much too high, labor relations are terrible and executive leadership has been extremely self-serving. But that's not the fundamental problem - that lies in the deep network structure, which is based on a hub-n-spoke network architecture, which has advantages over a total point-to-point network. But only when average load factor AND cost/prices are competitive. Bad network architecture combined with 'milk-the-last-cent' yield management tactics mindset that became strategy, and in the process sacrificed customer value and good will.

Any network solution is vulnerable when over-priced to pt-to-pt service cherry picking of major lane segments, one that offers lower prices and better service. Hence Southwestern - which is now BTW reaching it's own maturities, including higher than workable labor costs. The airline industry as we know it is dead. There will be room for 2-3 majors with viable international network connections plus a few mid-tiers in heavily traveled segments and maybe a few smaller regionals. The only thing keeping the industry alive is romance, nostalgia and misguided access to the capital markets.

As you read the excerpts below, or even click thru to read the entire original story, keep all this in mind. And then ask youself whether or not you believe the airlines will in fact improve their strategic position. We in fact believe these will continue to be abysmal failures and nothing much will change unless:

1. Airline management adopts new strategic network structures which so far it has proven unable to SEE as possiblities.
2. Based on that re-factoring major cost element re-structurings, e.g. labor, operating doctrine and (perhaps) fuel as well as fleet capital acquisition spending are likewise adapted to the new regime.
3. And, we also believe, a new value-focused emphasis on service and responsiveness is also adopted and adapted.

Within those overall observations that means that without these changes the mergers will fail and discount airlines won't be able to adjust their costs structures. Further their attempts to move upscale to capture more business travelers will have very limited success because their operating models won't support mulitple classes of passenger and service.

READINGS

A normal industry? Much is riding on the possible merger of America's third- and fifth-biggest airlines. ONE by one, the obstacles along the runway to what could be one of the most transforming deals in the world's air-transport industry are being cleared. If, within the next few days or weeks, executives at Delta and Northwest succeed in hammering out a common labour contract with their 11,000 pilots, the airlines will declare their intention to merge, subject to regulatory approval. Were the deal to go ahead, it would almost certainly trigger similar mergers between the rest of the “big six” American network carriers, with United and Continental likely to pair off on one side, and American and US Airways on the other. If, and it is still a big if, what emerged was a stronger, more stable American airline industry, that in turn would be an important step towards completing the stalled liberalisation of the global aviation industry.

Why Delta-Northwest won't work Industry consolidation is supposed to cure the airlines' most intractable problems, right? It won't. There was little doubt last summer when former Northwest Airlines executive Richard Anderson took the helm at Delta Air Lines that the carrier would gobble up a competitor. It was just a matter of which one and when. So Wednesday's board meeting to finalize a merger between Delta (DAL, Fortune 500) and its smaller rival, Northwest Airlines (NWA, Fortune 500), surprised no one. Shareholders clamored for it. Analysts gave their blessing. And the media breathlessly reported its inevitability. Consolidation, the thinking goes, will solve all of the industry's woes. Not so fast. An analysis of the likely deal terms suggests this merger won't overcome the many problems facing airlines. In the end, we might just have a bigger company plagued by the same problems, including sky-high oil prices and powerful labor unions. Ditto for United (UAUA, Fortune 500) and Continental (CAL, Fortune 500) if they too, as has been widely reported, tie the knot.

Posted by dblwyo at 08:58 AM | Permalink | Comments (0)

Yesterday we put up a post trying to summarize our sense of the congeries of problems (the problem portfolio as it were), what they are, what stage their in and likely to be and how they're likely to play out (Filterring the Non-Linearities: Sorting the Risk Factors). The key starting question was whether or not the Economy was at a slipping point. In an earlier post (Debating the Business Cycle: Alternatives, Risks & Catastrophes) on the alternate views of the Business Cycle we posted a graphic representation of the situation, what the different paths were/are and which are most likely. And discussed the policy challenges.

Now lo and behold we have two new stories that make it even clearer - one from our e-friend at BeYourOwnEconomist and the other from Martin Feldstein. If you don't get why Feldstein is as important and influential as he is click on thru to the bio. The man, along with Larry Summers, is worth listening to and has as much clout and reputation as anybody in the business. AS well as immense and practical real-world experience.

We've also updated that original graphic to reflect a little something we neglected to mention - namely where are we at. Which, along with these story excerpts goes a long way to making our key point here. Reasonable people can debate whether or not we're in a Recession and will be for some time. What is absolutely clear is that the Economy is slowing. AND that the rate of slowing is increasing. AND that the risk factors of tipping over into something more severe are high to very high. No pleasant reading for sure but necessary - and we've never considered it our purpose to deny reality (other than in our personal live of course where fantasy is the rule :) ).

Finally, when you've got 30 min. to spare and a good scotch at hand take advantage of technology and wisdom and watch this interview of Feldstein on Charlie Rose. That will be as soundly spent a 30 min. as you'll make in a long time IOHO. 

READINGS

Our Economic Dilemma Although it is too soon to tell whether the United States has entered a recession, there is mounting evidence that a recession has in fact begun. Key measures of economic activity stopped growing in December and January or actually began to decline. The collapse of house prices and the crisis in the credit markets continue to depress the real economy. The sharp reduction in the federal funds interest rate and the new fiscal stimulus package may, of course, be enough to avert a downturn. Many forecasters still predict that the economy will just slow in the first part of this year and then rebound after the summer. But the hope that monetary and fiscal policies would prevent continued weakness by boosting consumer confidence was derailed by the recent report that consumer confidence in January collapsed to the lowest level since 1992. If a recession does occur, it could last longer and be more painful than the past several downturns because of differences in its origin and character. The recessions that began in 1991 and 2001 lasted only eight months from the start of the downturn until the beginning of the recovery. Even the deeper recession of 1981 lasted only 16 months. But these past recessions were caused by deliberate Federal Reserve policy aimed at reversing a rise in inflation. In those cases, the Fed increased real interest rates until it saw the economic slowdown that it thought would move us back toward price stability. It then reversed course, reducing interest rates and bringing the recession to an end. In contrast, the real interest rate in 2006 and 2007 stayed at a relatively low level of less than 3%. A key cause of the present slowdown and potential recession was not a tightening of monetary policy but the bursting of the house-price bubble after six years of exceptionally rapid house-price increases. The Fed therefore will not be able to end the recession as it did previous ones by turning off a tight monetary policy. The unprecedented national fall in house prices is reducing household wealth and therefore consumer spending. House prices are down 10% from the 2006 high and are likely to fall at least another 10%. Each 10% decline cuts household wealth by about $2 trillion, and this eventually reduces annual consumer spending by about $100 billion. No one can predict the extent to which the coming fall in house prices will lead to defaults and foreclosures, driving house prices and wealth down even further. Falling house prices also discourage home building, with housing starts down 38% over the past 12 months. But the principle cause for concern today is the paralysis of the credit markets. Credit is always key to the expansion of the economy. The collapse of confidence in credit markets is now preventing that necessary extension of credit. The decline of credit creation includes not only the banks but also the bond markets, hedge funds, insurance companies and mutual funds. Securitization, leveraged buyouts and credit insurance have also atrophied. The dysfunctional character of the credit markets means that a Fed policy of reducing interest rates cannot be as effective in stimulating the economy as it has been in the past. Monetary policy may simply lack traction in the current credit environment. 

Our Economic Dilemma Although it is too soon to tell whether the United States has entered a recession, there is mounting evidence that a recession has in fact begun. Key measures of economic activity stopped growing in December and January or actually began to decline. The collapse of house prices and the crisis in the credit markets continue to depress the real economy. The sharp reduction in the federal funds interest rate and the new fiscal stimulus package may, of course, be enough to avert a downturn. Many forecasters still predict that the economy will just slow in the first part of this year and then rebound after the summer. But the hope that monetary and fiscal policies would prevent continued weakness by boosting consumer confidence was derailed by the recent report that consumer confidence in January collapsed to the lowest level since 1992. If a recession does occur, it could last longer and be more painful than the past several downturns because of differences in its origin and character.

The Sense Of An Ending  “The Sense of an Ending: Studies in the Theory of Fiction” is the title of Frank Kermode’s work of literary criticism. I’d like to borrow that title to frame today’s discussion of where the economy is now. There’s a tug of war going on between those who say we’re in recession and those who say we’re not. There are vested interests on both sides. People in positions of great authority say, “We’re not,” because they don’t wish to be blamed for recession or risk the chance of initiating a self-fulfilling prophecy. Critics of the higher-ups say, “We are,” because they routinely disagree with the higher-ups and believe the higher-ups rarely get it right. Three statistics that gauge the strength of output and production illustrate this point: Capacity Utilization, the Purchasing Managers’ Index and Job Growth. To Recap: None of these data by themselves point to recession, nor do all combined irrevocably confirm recession. But the gradual erosion is clear, so that a continuation of the trend points to a reduction in activity. Isn’t that what a turning point is all about? There seems to be a sense of an ending.

Understanding What Recessions Are One of the misunderstandings about recessions is what actually happens in the real world. A recession is where economic growth stops, and you are left with flat to contracting sales. Note that economic activity does not grind to a halt -- the year-over-year growth rate merely slips into the negative. This is often misstated, in some variation of "Gee, how it can it be a recession -- I was out shopping and the stores were pretty crowded." Whenever you see that, the speaker is either technically misunderstanding what a recession is -- or alternatively, is painfully long and hoping for the best. Of course, Growth may falter, not total economic activity. With the $13 trillion US economy, economic activity certainly won't fall to zero dollars.

Housing Cycle in Vicious Circle Housing is caught in a loop where one problem creates behaviors that make it worse. For example, falling home prices give borrowers incentive to walk away from mortgages. The trick for policy makers is to break the negative-feedback cycle. Economists have a term to describe what it means when things keep going from bad to worse: negative-feedback loop. One day's problems create a broad set of behaviors that only make the problems worse. Consider housing. As home prices fall, more families see the values of their homes decline to less than the amount of money they have to pay back on their mortgages. That gives them an incentive to walk away from their mortgages and leave their homes empty, which puts more downward pressure on home prices, drawing more households into the loop. Housing turmoil, in turn, causes consumers to pull back, hurting the broader economy, which puts more downward pressure on home prices. Banks, worried about mortgages going bad, tighten lending standards, shutting some new buyers out of the market and further depressing home prices. Negative-feedback loops can be pernicious when an economy depends heavily on borrowed money. Housing Starts in U.S. Near Lowest Since 1991 as Slump Enters Third Year

Posted by dblwyo at 12:00 PM | Permalink | Comments (0)

Here's a very recent set of stories on the widening of the credit mess, the impacts on the Finance industry and the whole strategic theory behind the Securitzation innovation. For example the metastasis of credit problems has reached the Student Loan market, is re-shaping the competitive landscape AND threatening a lot of loans, especially for poorer and/or dis-advantaged students. As Mohammad El-Arrian pointed out in a CNBC interview we posted a while back the whole process of securitization was a major new innovation with which the institutional and regulartory frameworks weren't prepared to cope. Worse the internal business practices and governence of the financial firms let short-term greed run ahead of themselves.

In other words they screwed up big time by chasing quarterly returns that were badly, as in not at all, priced for the risks they were presuming. On the theory that they could always bail out. Belowis a set of readings that cover the Economist's take on the industry future. Also covered are the further massive writedowns the major banks, et.al. will be taking on mortgage related debt, the exposures to lose of credit insurance, and corporate/buyout writedowns. In other words you ain't seen nuthin yet !

Which pretty confirms what we've been saying for what now amounts to a couple of months. But in particular we'll point out that yesterday's post (Filterring the Non-Linearities: Sorting the Risk Factors) trying to summarize the risk factors across the Economy, Markets, Consumers and Businesses argued a) we're early days, b) none of these risks is properly priced into valuations or accuately reflected in earnings estimates and c) business performance is going to be THE issue and very few firms are adquately prepared to cope.

So what does that mean for your investment planning ? Or your job, savings, etc. for that matter ? 

READINGS

Fear and loathing, and a hint of hope Not all is lost for the structured-finance business. But it faces further discomfort before it can start to recover some of its past sheen. Securitisation has greatly enhanced the secondary market for loans, giving originators, mainly banks, more balance-sheet flexibility and investors of all sorts greater access to credit risk. Both have embraced it. By 2006 the volume of outstanding securitised loans had reached $28 trillion. Last year three-fifths of America's mortgages and one-quarter of consumer debt were bundled up and sold on. Though few bankers worked in structured finance, it was a huge earner, accounting for 20-30% of big investment banks' profits before the crisis … Alongside the banks, the “gatekeepers” who were supposed to lend stability and credibility to the new originate-and-distribute model of finance have also been found wanting. Rating agencies' models underplayed the risk that loans from different lenders and regions could turn sour at the same time. Bond insurers, too, misjudged the risks lurking in CDOs. That failing has undermined the worth of their guarantees and strained their own credit ratings—and hence financial markets.

Wall St. Banks Confront a String of Write-Downs Wall Street banks are bracing for another wave of multibillion-dollar losses as the crisis that began with subprime mortgages spreads through the credit markets. In recent weeks one part of the debt market after another has buckled. High-risk loans used to finance corporate buyouts have plummeted in value. Securities backed by commercial real estate mortgages and student loans have fallen sharply. Even auction-rate securities, arcane investments usually considered as safe as cash, have stumbled. The breadth and scale of the declines mean more pain for major banks, which have already written off more than $120 billion of losses stemming from bad mortgage-related investments. The deepening losses might make banks even more reluctant to make the loans needed to prod the slowing American economy. They also could force some banks to raise more capital to bolster their weakened finances. The losses keep piling up. Leading brokerage firms are likely to write down the value of $200 billion of loans they have made to corporate clients by $10 billion to $14 billion during the first quarter of this year, Meredith Whitney, an analyst at Oppenheimer, wrote in a research report last week.  Those institutions and global banks could suffer an additional $20 billion in losses this year on commercial mortgage-backed securities and other debt instruments tied to commercial mortgages, according to Goldman Sachs, which predicts commercial property prices will decline by as much as 26 percent. Analysts at UBS go further, predicting the world’s largest banks could ultimately take $123 billion to $203 billion of additional write-downs on subprime-related securities, structured investment vehicles, leveraged loans and commercial mortgage lending. The higher estimate assumes that the troubled bond insurance companies fail, a possibility that, for now, is relatively remote.

 Student Loan Stress Reshapes Industry The supply of education loans is shrinking as credit tightens, creating an opportunity for Sallie Mae and some big banks to pick up market share as some lenders retrench. College-bound students are the ones who might get squeezed in the process. Smaller lenders such as College Loan Corp. and Nelnet Inc. are being forced to scale back as their ability to sell packages of student loans to Wall Street and other investors is crimped. Sallie Mae, the nation's largest student lender, and investment banks, on the other hand, are well-financed and have more flexibility to keep the lending spigot open. The entire student loan industry has been under pressure in recent months. Rising delinquencies last year applied the initial strain. The global credit crunch triggered by the collapse of high-risk mortgages aggravated the situation. And student-loan legislation that took effect in October cut about $20 billion in federal subsidies to lenders. The latest squeeze on student lending is tied to trouble in the $330 billion market for auction-rate securities, about $80 billion of which is made up of bundles of student loans. Since some of these investments are backed by troubled bond insurers, investors have been particularly reluctant to buy these securities, straining the student lenders that sell them to raise cash.

Posted by dblwyo at 07:31 AM | Permalink | Comments (0)

A friend of mine has suddenly paid some small measure of attention to the arguments we've been making about the problem portfolio we face and the likely outlook for the business cycle, as opposed to the headline reporting. And - thank goodness - started investigating his portfolio and investment strategies. Actually he's not quite the first - another friend called us a month ago on a business trip, and while talking to us, used his Blackberry to re-shuffle part of his. Boy, I sure hope I got that write. Now at the time we also suggested that the real time to pay attention was in Dec. but better late than never, we always say.

Obviously our view is that there's a long way to go to bring valuations into line with the business cycle and enterprise performance outlooks but we've been wrong, or at least badly timed, before; and surprised of course that the Universe didn't fit our "model" :). But all in all it seemed like a good time to translate the thrust of our arguments into some investing strategies (bearing in mind that blind advice on the web is potentially worth what we're paying for, this is intended as a representative exercise for you to go do your own homework and any negative consequences are on your own head. A suprise upturn of course we expect to get a cut :) ). In the process we'll point you to PoliticalCalculations SP500 return calculator which you ought to have handy.

What we're going to do is lay down a baseline courtesy of Davide Swensen, Yale's sui generii investing genius, who provides THE measuring rod here. But, given that he's smart, successful and wealthy, we're still going to argue at least a bit. Below is an excerpt from a recent NYT story and while you're reading it take a look at the accompanying table on returns for the SP500 based on Poltical Calculations tool.

Below the line we'll pick up some more arguments but our bottomline is that Swensen's right but doing it his way is going to be a very low return world for a long-time to come. Is there a way to take his basic approach and modify with some work and sweat ? We think/hope so. But before you start, and as you read, keep the table at right in mind (we'll discuss it later).

Keep It Simple, Says Yale’s Top Investor IT has been a time to worry even the savviest investors. The credit markets have been in a crisis, the domestic stock market has been shaky and overseas markets haven’t been much better. What should an individual investor do? Don’t try anything fancy. Stick to a simple diversified portfolio, keep your costs down and rebalance periodically to keep your asset allocations in line with your long-term goals. That is the advice of David F. Swensen, who has run the Yale endowment since 1988, relying on a complex strategy that includes investments in hedge funds and other esoteric vehicles. For most people, he recommends a very basic approach: use index funds, exchange-traded funds and other low-cost instruments, and stick to your long-term asset allocation — even when the markets are in tumult. For most individual investors, he said, copying the strategies of institutions like Yale is virtually impossible: big investors have access to fund managers and arcane strategies that are beyond the reach of most people. For most individual investors, he said, copying the strategies of institutions like Yale is virtually impossible: big investors have access to fund managers and arcane strategies that are beyond the reach of most people.

O.K. - sound advice from a great investor. Now take a careful look at the inflation adjusted returns, either with or without dividend re-investments. The period '95-'07 was o.k. but when you break it down that was all pretty much in the boom years. Returns in the '99-'07 period only virtue was they were positive, barely. Of course if you'd gone in '04 you'd have done reasonably well. And there's our arguments in a nutshell.

1. Long-term returns are likely to be flat for years to come; the old buy-n-hold strategy isn't going to work very well in an environment of low growth and poor earnings. In fact what the table shows is that they have been flat for the last nine years.
   
• Let's repeat that - stock market returns for nine years have been flat - worse than mediocre. Only by correctly assessting the trends and key themes has anyone made money.
  
2. But it is possible to understand the secular forces, business cycle trends and key themes, e.g. energy, developing world, etc. that are likely to get you off the baseline floor.
3. Getting off that floor will take some work. Perhaps not a lot but we're not talking a few hours and forget per year. We're talking a few hours per week in combination with on-going attention paid to economic, business and political news in general. You need to be doing that, IOHO, anyway just to improve your own security and well-being.
   

Now let's consider the chart at right, which please note, is from Mar04. We reproduce it here to illustrate the process, the approach AND to open ourselves up to some embarrassment if you think any of the observations in the table are questionable and/or wrong. Looking back on it it didn't strike us as too bad, but as incomplete and several things we didn't catch. On the other hand much of the longer-term trends are playing out pretty much as we indicated. Here's the real point though - it's hard to do a lot better so you need to work thru this little exercise in some detail periodically AND monitor it on a regular basis to see if it needs to be updated and/or refreshed. Think of this as a workbook not as the answer book.

If you take a look it's really a structured checklist. The columns are defined by timeframes and the major rows by asset classes. Notice that under "Economy" we have a multi-timeperiod outlook sketched out. What would be yours right now ? Feel free to cheat - in fact we encourage it - and go back to the blog. Now look at the comments for each of the asset classes - not to bad. Perhaps the most off was the Real Estate outlook. But was it off in the early Spring of '04 ? We'd argue not - and the Housing bubble really became a bubble in late '04 and definitely '05 but was also clearly topping in '06. Like Emerging Markets, Commodities and Energy those were all investment themes to play over that timeframe. Few of which are going to survive now - again in our opinion.

So how would you position your portfolio then or now ? And against what strategic evaluations ? Our attempts at answers are in the table at left where the first column is asset classes and the next our baseline. Not too different from Swensen's though perhaps a tad more aggressive. If however you're willing to be more active, that is work on this regularly and be disciplined, and take some more risk that will hopefully be mitigated by that work we have two other suggestions. And active allocation (Xbase) and a very active one (Xbase2).

A couple of things to note - under each Xbase we present allocations based on our notion of analyzing the trends so that Was is what was appropriate for, say '04-'06+ (in this scheme the jury is out on '07). And Is is the allocations for what we think is coming. BtW BOLD numbers indicate using leveraged funds or ETFs with Blue being long the market and Red short. 

Take a look and you'll see how we thought to play the big structural themes, e.g. Emerging Markets or Energy. And how we're suggesting both pulling back from those for now, emphasizing bonds and also shorting the markets more. All of which strikes us as consistent with our views of the outlooks for the economy and business performanc. One final note.

Another suggestion that floats around is the idea of splitting your investments into a Core and an Active portion, say 70/30. We think that's a very good idea - be conservative with the Core and more Aggressive with the Active portion. Only we'd suggest three categories: Base, Core & Active with the Active (perhaps we should say Aggressive investor) having a split of 15/35/50. But that's just an idea.

Anyway we hope that's a bunch of food for thought - hopefully it's useful and works with the prior posts on the economic outlook and the problems we see coming. And provides some useful things to think about and tools to start with. Good Luck ! 

Posted by dblwyo at 04:35 PM | Permalink | Comments (2)

We'd normally save this post and the embedded links for the weekend but then we try and be selective - that is pick not only interesting stories but ones that are accurate. Or at least make a good point. One of the better financial columnist (Tim Middleton from MSN Money - a goto guy on Mutual Funds and ETFs to be fair) has this column just up today on why REITs may be getting cheap. The last time he made this kind of bet looking backward was recommending the Japanese ETFs last Jan.

Just to be absolutely crystal clear we're not putting this up because we endorse the findings. Instead it perfectly illustrates two major themes we strike here, over and over again, which seem to be escaping most of the discussions about the market outlook.

1. You've got to understand the internal character of an industry and its' likely future path.
2. You've also got to understand how that industry works in the context of the overall macro-environment.

This column is, IOHO, a perfect example of just the opposite. The CRE dynamics are to follow residetial and the economy. In other words it's likely headed off the same cliff as a lot of different news would tell you.

It's also a perfect example of why the analyst community, with its' emphasis on bottom-up stock analysis ISOLATED from the macro-climate, is wildly over-optimistic about the earnings outlook.

Below you'll find Tim's column excerpted along with an excerpt from a WSJ article telling us how bad it's likely to get. And from Mr. GoTo himself, CalculatedRisk, taking his usual dive on CRE. His post in particular will lead you back to his on-going thread of detailed analysis where his charts make it clear that the CRE market is about to be in serious trouble.

Just to put another nail in the coffin this is a small example to set against our prior to posts on the outlook for the business cycle AND the portfolio of problems that are not being discounted in valuations. 

READINGS

Real-estate funds look cheap now The commercial sector is showing signs of strength. Is now the best time to buy in? That's hard to say for sure, but prices for real-estate investment trusts are down by a third. With equity markets foundering, the long-suffering commercial-real-estate sector lately has shown the barest glimmer of strength. That ETF tracks an index of real-estate investment trusts, or REITs, which allow one to invest in property without owning land. They've inspired some hope lately despite the real-estate slump, but is that hope well-founded? And real-estate investment trusts had rocketed ahead so much in recent years that even their current bear market may not have let out all the hot air. Since peaking one year ago and through Feb. 11, the MSCI U.S. REIT Index ($RMZ.X) -- the Vanguard fund's benchmark -- is down 33.8%. But at that peak, it was up 180% since the start of 2000. Now, I have no idea whether we've reached a bottom in real estate. But I do know that when securities are on sale for one-third off, they're a lot more attractive than they were at full price. I'm probably early, but I intend to start adding to my REIT holdings in coming weeks.

A Commercial Real-Estate Bust Investors are hoping the subprime-mortgage debacle will be a bad memory by the year's second half. Instead, they might have another mess to sort out in commercial real estate. If it were a movie, it might be called "Subprime II: Monster in Your Mall." Work on everything from new malls to office parks helped to carry the construction industry as housing crumbled. While residential construction spending was down 20% in December from a year earlier, nonresidential construction was up 20%, according to the Census Bureau. But clouds are forming over the sector. Commercial real estate probably didn't get as overheated as housing in this boom, but tight credit and a slowing economy are squeezing the sector. The Federal Reserve's latest survey of senior loan officers showed 80% of domestic banks tightened lending standards on commercial real-estate loans in the past three months -- the highest level since the question was first asked in 1990.

Posted by dblwyo at 02:08 PM | Permalink | Comments (0)

A few posts back we jokingly referred to the various reactive posts that went up last week because of the flood of important news stories. Those included real retail sales, Buffett's buyout offer for the bond insurers, GM's really terrible earnings and more. In trying to make sense of that swirl we referred to all the "non-linearities" where one thing was linked to another. We thought it might be helpful to have a single point-of-view where all that discombubulation was brought together in one place so here it is. The chart below looks at the major problem categories and then briefly summarizes their status thru several stages. First stage is the basic situation, second is the next level of concern and impact and so on. Each cell here probably deserves its' own post, and in fact has already gotten several. But then we'd back to multiple inter-twining issues and seeing the whole picture where everything's linked to everything else would be difficult. Maybe even impossible. Let's see if this helps. Click on the graphic for a larger picture of course.

Give some thought to each cell, what evidence you have to agree or dispute it but also take them all together. This is the information set, so-to-speak, that lies behind yesterday's post on what the cycle might really look like. In particularly start in the upper left-hand corner for the key initial question. And then look at the lower right-hand corner for the bookend question:

1. Is the economy at a slipping point, not immediately apparant in the data but visible by looking at trends and structural patterns, where consumer spending will "tip over" ? And rattle the rest of the house of cards. We don't think it's guaranteed but the risk factors are climbing exponentially.
2. Will the retreat of these tides expose deep fault lines in consumer, bank/finance industry and businesses that could crack and make things much worse, even ? We're pretty sure that all these faults exist in what many thought was bedrock but whether they can be prevented from cracking is the real question. We're not only going to find out who was swimming naked but who was swimming just above the sharp rocks and coral reefs. And there will be a lot of sharks (problems) that'll be attracted by blood in the water. 

Posted by dblwyo at 12:22 PM | Permalink | Comments (0)

Over the weekend a friend asked me what the result of the stimulus package was likely to be and how important it was. While we've asked and answered that question before we ginned up a little graphic to make things a little clearer. And also to make clear what the alternatives are likely to be, how it relates to history and why the "over-sanguinity", coining a word, of most market and economic commentators is likely to be severely mis-placed. Below the line you'll find an earlier chart that looks back to the investment bust and the consequences for the cycle. And, as it happens, three respected and respectable commentators just popped up this morning with dead on observations. All of which we suggest you skim. But let's start with this chart which lays out things the way we see them.

As the legend explains it the black line is the base case. Now we've deliberately left off the  vertical numbers because if base line growth is, say, 2.5% then the whole chart rotates left so the trend line points up. That gets back to the basic point that a growth recession where GDP growth is < 1% will be as painful as negative growth.

UPDATE:  Barry Ritholz over at TheBigPicture has a nice little riff on what is a recession, where we might be at and some real world stories. This kinda puts all this abstract chartsmanship in context.

Understanding What Recessions Are One of the misunderstandings about recessions is what actually happens in the real world. A recession is where economic growth stops, and you are left with flat to contracting sales. Note that economic activity does not grind to a halt -- the year-over-year growth rate merely slips into the negative. This is often misstated, in some variation of "Gee, how it can it be a recession -- I was out shopping and the stores were pretty crowded." Whenever you see that, the speaker is either technically misunderstanding what a recession is -- or alternatively, is painfully long and hoping for the best. Of course, Growth may falter, not total economic activity. With the $13 trillion US economy, economic activity certainly won't fall to zero dollars. 

The problem is that the base case - what one might expect if we were in normal circumstances isn't the one that scares the Fed nor people like Feldstein, Summers or Stiglitze, or Roubini for that matter (notice we're not citing Wall St's finest here as they tend to let the fact that there dog is in the hunt distort their commentaries. That said, Hartzius (G-S) Roach (Morgan-Stanley) and  Merrill's economist are pretty much in agreement and are "undistorted" voices here). The case everybody is scared to death about is the red line where the Housing and Credit bubbles cause years long malaise. Whatever we need to do to avoid that is, in our opinion entirely justified. But even if the Fed, the stimulus package and the next packages that the new president will need to put in work cycles are cycles. In other words the best outcome is the yellow line. Unfortunately none of this appears to have crossed the Chinese firewalls from one side of the investment community to the other. As we've ranted on about several time earnings and recession outlooks are very optimistic and are represented by the shallow drop and quick re-acceleration of the pink line (& no the color is not purely a mechanical choice).

While disingenousness is part of the problem the real breakdown is likely in people's views of the world. The green line shows a "normal" business-cycle pattern based on historical experience, that is what things might look like if the '90s and the century-to-date hadn't been so different from prior post-WW2 experiences. We go into that more below but the reason is that the Telecomm/Internet boom/bust was an investment-driven instead of consumer-led cycle. Now we've been flapping away at that notion for a while AND noticed that the meme is in much wider circulation. The problem is that the implications aren't factored into people's thinking - they're still, in their hindbrains, judging now by history, which is where they got imprinted like a baby duck.

So let's go back a little and understand how & why things were different and what those consequences are. The solid line shows a normal cycle while the dotted one shows a typical historical boom and bust (depression) cycle. The late '90s saw huge over-investment in capital, particularly technology, which also pushed up hiring. Normally when investment is that much in excess it's followed by a much longer and deeper downturn as the excesses are worked off, savings build back up, and new replacement investment begins to re-start the feedback loops. We've had several major downturns of that sort and Japan has yet to recover from its'. The consequences are severe and long-lasting - it took the largest and worst war in history to dig us out last time. What actually happened is shown by the dotted line. While GDP did fall it did't go as far though Investment went off a cliff. We held up Consumption thru a combination of low interest rates and fiscal stimulus which were the proximate causes of the Housing and Credit bubbles and our current strucural risks. But this "recovery" never reached a stage of organic growth where new, net job creation led to increased demand which in turn increases investment and tat generates more jobs. Instead we had the worse job creation recovery on record post-war; and net net we're still almost 3 million jobs in the hole by my estimates.

READINGS

It's too early to be bullish If you listen to some prominent market professionals, you might think the worst is over. But the credit/housing bubble is a far bigger mess than the tech-stock bust. The Sanguinity Chronicles. That's how I might title this week's column to capture the changing perspective of three once-wary market observers. I respect their views and include them here to update the bull/bear debate I began last week. To reiterate my view: Those who are really bullish, as opposed to being open to a potential bullish resolution, do not completely understand the ramifications of the credit/housing bubble and what the unwinding means. Someone who does grasp the ramifications and remains quite negative is GMO's Jeremy Grantham: "People think the Federal Reserve can stop a bear market because they can throw money at it and lower interest rates. It is even more certain we can collectively stop a bear market if some fiscal stimulus is thrown in. To which I say, 'Oh, you mean like 2000 and 2002?' -- when they threw what I call the greatest stimulus in American history, an unparalleled series of interest-rate cuts, cumulating in two, almost three, years of negative real returns, real interest rates coupled with a really substantial tax cut, which would never have happened without 9/11. "The combination would have gotten the dead to walk, and it stopped the bear market eventually. But the Standard & Poor's 500 ($INX) was down 50%, and the Nasdaq ($COMPX) -- which was all anyone talked about back then -- went down 78%. And a puny five to six years later, people are saying there is not going to be a bear market because the Fed is going to lower rates and because the government is going to have a stimulus package. But we have just been there, done that, and we had a nice bear market." (Click here to read the interview.) To which I would just add a point that I have made regularly regarding the difference between the two bubbles: We now have bad debts. The lender has a debt he can't quite collect on. The borrower has a debt he can't service. That is a much different proposition than what we dealt with in the wake of the stock bubble.

 America’s recession will be hard to shift Monetary policy affects the economy with long and variable lags. This much we know. How long depends on the state of the economy in question. In 2001, the US got away with an unusually short recession helped by aggressive interest rate cuts and an expansionary fiscal policy. But in Japan in the early 1990s, and in Germany in the early part of this decade, it took ages for low interest rates to help the real economy. One of the reasons was that those recessions were aggravated by crises in the financial sector itself. I fear that the US recession of 2008 will be similar in quality – though not necessarily in length and depth – to those in Japan and Germany, rather than to the US recession in 2001. Interest rate cuts work their way through to the real economy by a number of transmission channels. During the 2001 recession in the US, the most important was housing credit. The rate cuts came at a time when the housing market was already booming. They turned the boom into a super-boom. Inflationary expectations were low. People expected interest rates to remain low. It was a great moment to take on extra debt, and this was precisely what Americans did. The current US downturn could not be more different. House prices are falling, and have further to fall before reaching a more sustainable level (in terms of the price-to-rent ratios as well as several other measures). It would therefore be unwise, to say the least, for policymakers to rely on monetary policy alone. By far the best policy response – though clearly limited in scope – is a well-targeted fiscal policy stimulus, a point recently made by Lawrence Summers, the former US Treasury secretary, in his Financial Times column. The best stimulus package would be one that could be agreed today, enacted tomorrow, targeted specifically at subprime families, and was only temporary. Back in the real world, where politicians run fiscal policy, this is obviously not going to happen.

PRIOR POSTS

• Stage II Denial: Recession Downside Risks and Fracture Lines

• Cramer's Comeuppance vs Pump Priming Realities

• Weigh the World Works: Understanding the Business Cycle

• WtW Part Deux: Patterns, Cycles & Indicators

Posted by dblwyo at 09:32 AM | Permalink | Comments (0)

The airlines have managed to occupy a prominant place in the headlines for several years no, starting with the implosion of their traffic demand post-bust, going thru their painful re-structurings, downsizings and cost cutting and now, their merger frenzies. It's not musch discussed but all of these are surface phenomena based on the nature of their deep cost structures. In fact a discussion of that structure has never come to my attention. In the interests of aiding a broader understanding we're reproducing an e-memo we sent out in the Spring of '03, excerpted immediately below and reproduced on the continuation.

"As Warren Buffet pointed out years ago the airlines have never made their cost of capital and always disguised that fact with the next big recovery in a cyclical business (b.t.w. - I recommend Slywotsky's "Art of Profitability" and the chapter on cyclical businesses to understand how cost structures interact with cycles - there's a chapter on that very topic).

Simple reform of the surface of ticketing etc. won't do it. Also b.t.w. - AMR spent at least $150M I know of trying to get to the next level of the end-to-end travel experience but ran a terrible software project trying to clone Sabre in the early to mid-90s. Rumor has it that the real figure was closer to $300M.

Unless the airlines rethink their basic business model in terms of network design, route cost structure, including labor but exclusively, and their pricing and customer service strategies this nonsense will continue until there's major collapses."

 If you'd like to have a framework and toolkit for analyzing the mergers as a traveler, investor or employee this might be quite helpful. It also serves as decent example of a point we emphasize that investing in an industry is, at least to some extent, "Inside Baseball". That is it really helps to understand how it works and what it's capable of. A point the Sage of Omaha makes as well though you have to dig back into his history to see it. (Masterclass: Buffett on Investing and Business Analysis).

A second version of the memor, from a slightly later date, is available as a dloadable PDF. 

ORIGINAL E-MEMO

To: <scott.mccartney@wsj.com>
Subject: Airline Restructuring
Date: Wednesday, April 02, 2003 8:56 AM

Dear Scott:

Been meaning to write for sometime as I watch you discussion of airline conditions and strategy evolve. Having worked for nearly a decade in Fedex's corporate planning group I have some familiarities with some of the economics and drivers of flying planes, though not all of course.

As it happens you may recall that Fedex was the grandfather of the hub & spoke system which still forms the backbone of their network. However many years ago now we went to complementary point-to-point service where the volumes supported the infrastructure and ground-based capital investments. The model here is one of network connectivity - think of a matrix with all  the origins as rows and the destinations as columns. In a pure hubNspoke there's a single row of 1s for direct connect and a single column. You put in other connections and for us the associated large ground installations when the volumen pays the capital and operating costs.

This is a critically important model to understand and I don't see it being discussed.

All the low-cost airlines grew up by cherry-picking the point-to-point connections of the national network. It would be worth your while to wander over the some local university and talk to the OR department to have this discussion.

Now on top of that one has to look at the total cost and understand how each cost element is driven by the underlying route structure. One way to eliminate major cost disadvantages is to not fly a particular route. A reconceuptualization that doesn't appear in any of the airlines thinking.

The airlines have also made the mistake of assuming that they have a semi-captive audience rather than looking to deliver value. In the late 90s boom this was re-enforced. I was flying every week from NYC to ATL and generally choose Delta because it and AirTran were competitive until Delta got to feeling it's oats and I couldn't get a ticket under $600 while AirTran was continuing with the $300 tickets. The airlines have no sense of customer value and responsiveness but they're learning what the penalties for that are.

A deeper and more corrosive force is labor relations. I'm not sure what the history is but when Frank Borman was driven out of Eastern and later the mechnics, et.al. let the airline die rather than negotiate you got a measure of the level of dislike. That's happened several times. I had the opportunity to have lunch w/Borman in Las Cruces, me, him and my cousins at a little outdoor picnic table at a very cheap local Mexican place, if you can envision it. And Borman viewed his employees still the way a military man views expendable troops - as fungible commodites. I've seen that attitude at every airline I've been around.

As Warren Buffet pointed out years ago the airlines have never made their cost of capital and always disguised that fact with the next big recovery in a cyclical business (b.t.w. - I recommend Slywotsky's "Art of Profitability" and the chapter on cyclical businesses to understand how cost structures interact with cycles - there's a chapter on that very topic).

Simple reform of the surface of ticketing etc. won't do it. Also b.t.w. - AMR spent at least $150M I know of trying to get to the next level of the end-to-end travel experience but ran a terrible software project trying to clone Sabre in the early to mid-90s. Rumor has it that the real figure was closer to $300M.

Unless the airlines rethink their basic business model in terms of network design, route cost structure, including labor but exclusively, and their pricing and customer service strategies this nonsense will continue until there's major collapses.

Posted by dblwyo at 06:52 AM | Permalink | Comments (0)

Well let's try and finish off the week's collection of newsclippings by putting up the excerpts from the business side of the house. There was, as usual, a host of interesting and relvent info for you to skim ranging over a large sample from the Finance industry to some major stories regarding some of the traditional industries undergoing their own huge changes to equally large currents building up in the Tech industries. Before we try and summarzie and explain those a little bit let's set the stage with the following excerpt which puts a context around all of the news.

'Headwind' Blows as CEOs Navigate Trouble America's captains of industry are starting to talk like, well, sailors. As the U.S. economy slows, chief executives and chief financial officers have taken to slinging around a word more commonly heard on the decks of ships. To hear executives tell it, headwinds are to blame for the weak sales of cars, tires, paint and books. Just what are these headwinds? Everything from high fuel prices to slow foot traffic in handbag stores to rising newsprint costs. Weather terms appeal to economists and corporate executives because the market sometimes seems to behave like a force of nature. These days, Mr. Lakoff says, citing headwinds seems to be a way to duck blame for all kinds of business problems related to the subprime mortgage crisis, the credit crunch, even simple bad business decisions. Some economists say the metaphorical wind only blows in one direction. Although executives are quick to blame headwinds for their woes, they are less likely to cite tailwinds for their good fortunes.

If you re-phrase "Headwinds" to what they're really saying it's look about below the fecal matter is going to hit the rotary impeller. The stories start with a review of Buffett's bond insurere offer which points out what he really tried to do was cherry-pick the only part worth something; confirmed by Fri's announcement from Ambac that they're looking to breakup as well as parallet public comments from Spitzer and Dinello. What everybody may have missed is that Warren, true to his roots, also bought into Kraft and GlaxoSmithKline. Though even he conceeds that in general it's too early until more clarity is established on the markets.

Meanwhile the Finance industry's turmoil is widening and accelerating with Hedge funds shutting down, major Street firms having gone public experience losses with Other People's Money that they would never have risked as partnerships and PIMCO beginning to cherry pick certain bonds, e.g. Citi. Then we have both the railroad and the airline industries starting major re-structurings. The latter because they've never made their cost of capital (Warren btw is a charter member of Airlines Anonymous) and the former beginning to re-invest in expanding their trackage and capital investments for the first time in nearly a century, i.e. when they first crossed the threshold in terms of over-capacity that the airlines are at now. Then there's GM who's "surprise" positive earnings announcement was actually a major operating loss offset by tax manuvers; i.e. the Auto industry like the airlines is fighting a rearguard action to avoid the major downsizing, re-structuring and re-thinking they've been avoiding for two decades. On this time the bear is running faster than they are. There are also interesting stories on WMT and Cardinal Health; the latter in case you didn't know beginning to crawl away from some abysmal years after being one of the great service and value-innovators of the '90s.

And there's the Tech - wow, what a surprise (NOT if you've been reading along with us). In the last few weeks every major tech analyst shop (Gartner, Forrester, et.al.) has rapidly and significantly downgraded their outlook for tech spending. Which is of course entirely consistent with our analysis of the outlook for capex spending from the business cycle analysis we've been doing for several months. It's just taken a while for it to show up in the industry level analysis.

That's supplemented by more interesting tidbits on Yahoo as it continues to publically twist in the wind in a problem it created for itself thru a lack of innovation. On the other hand the Telecom industry has just discovered that the iPhone hath triggerred another revolution - paraphrased as "it's the user interface, dummy". In other words if you provide a lot of functionality that's both easy to use/understand and is integrated, reliable and appealing people will start making major use of it. Oddly while the iPhone is generating all sorts of new network traffic and forcing competitors to re-think their product and service strategies the industry still doesn't get it. What a surprise.

Bon Appetit'

Business

Buffett's an opportunist, not a hero The stock market seemed to hail the Oracle of Omaha as a savior for his offer to reinsure bonds, but the billionaire's proposal wasn't based on altruism. When Warren Buffett announced his solution for the beleaguered bond insurance industry earlier this week, you half-expected him to end his statement with a hearty "Yo, ho, ho!" and wave the Jolly Roger. His offer to reinsure the low-risk municipal bonds backed by Ambac Financial Group and MBIA but not their problematic, low-rated obligations in structured finance, was about as piratical as you can get and stay on this side of the law. You almost have to admire the old buzzard's devious but brilliant gambit, as it was the equivalent of a rich man walking into the parlor of a family about to lose its home to foreclosure and offering to buy all the good furniture, tapestries and china at pennies on the dollar. As much as I want to empathize with the monoline insurers in their season of humiliation, I can't help but wonder whether they are making the wrong move. After all, the bond insurers' executives have already made one boneheaded move after another in order to get to this point, deviating in the past decade from the business of guaranteeing supersafe municipal bonds to expand into the risk-mad world of guaranteeing securities larded with subprime mortgages. And now they are showing a sort of complacency about their weakened position that's reminiscent of a novice investor who just can't seem to sell a position that's down 80%.

Buffett's Berkshire Becomes Largest Shareholder in Kraft Foods Billionaire Warren Buffett's Berkshire Hathaway Inc. became the largest shareholder in Kraft Foods Inc., the world's second-biggest foodmaker. ``Kraft's a portfolio of iconic brands in a company that was undermanaged for quite a long time,'' said Tom Russo, who helps manage $3 billion, including shares of Berkshire and Kraft, at Gardner Russo & Gardner in Lancaster, Pennsylvania. ``The brands have the ability to carry the returns, once they're properly managed, which you're seeing under way now.'' Berkshire, based in Omaha, Nebraska, also disclosed a stake in drugmaker GlaxoSmithKline Plc, with 1.51 million American depositary receipts. The company increased holdings in Wells Fargo & Co., the nation's second-largest home lender, by 3.4 percent since Sept. 30 to 289.3 million shares. ``Warren Buffett is having a field day,'' said Frank Betz, who helps manage $800 million, including Berkshire shares, at Carret Zane Capital Management in Warren, New Jersey. ``He's always looking, but now he's seeing things that meet his standards'' at reduced prices. Kraft has declined about 15 percent during the past 12 months in New York Stock Exchange composite trading. The ADRs of London-based GlaxoSmithKline, the world's second-largest pharmaceutical company, have lost 26 percent in the past year, and San Francisco-based Wells Fargo dropped 18 percent.

Hedge funds put up shutters to weather storm Hedge funds are beginning to close their doors or lay off teams of traders in response to the unprecedented gridlock in the debt markets which has led to losses and significantly reduced the amount of money banks are willing to lend their hedge fund clients. Many players, both at hedge funds and the proprietary desks of Wall Street firms, have taken bets on the likelihood of buy-out deals getting done through private negotiations even if the public debt markets remain closed. Speculation in recent weeks has been particularly intense around whether two private equity firms would go through with their commitment to buy Clear Channel Communications. Market prices indicate the deal will not happen. But there is a new sense of caution among many market participants as a result of the volatility in the market, and acting on such expectations is more difficult. Credit hedge funds and so-called relative value funds are also having a hard time. To make profits from small discrepancies among prices, these funds use massive amounts of borrowed money. In the past they could borrow up to four times their own money. Now most are fortunate to get twice as much from banks.

Wall Street's Shareholders Suffer Losses Partnerships Could Never Envision -- Less than a decade after Wall Street's last major partnership went public, stockholders are paying the price for bankrolling the industry's expanding risk appetite. Four of the five biggest U.S. securities firms lost about $83 billion of market value last year, almost 90 percent of their net income since 1999, data compiled by Bloomberg show. That cut the annual average return for Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos. during those nine years to 9.7 percent from 16.8 percent. The private partnerships that once dominated Wall Street guarded their capital, used less leverage and limited their risk to trading blocks of stock for clients and shares of companies in mergers, said Roy Smith, a finance professor at New York University's Stern School of Business and a former partner at Goldman Sachs Group Inc. Since raising money from the public, many of the biggest firms have abandoned that caution. Shareholders, stung by the securities industry's losses last year on subprime mortgage-backed bonds and leveraged loans, may be in for more pain.

Pimco Proves Prince Alwaleed Isn't Only One in Love With Sullied Citigroup Citigroup Inc. has never been held in such low esteem by debt investors, and that's why Prince Alwaleed bin Talal isn't the only one in love with the bank whose looks are deceiving. Pacific Investment Management Co., manager of the world's largest fixed-income fund, and Calvert Asset Management Co. said Citigroup and Bank of America Corp. are attractive because yields on U.S. bank bonds are near record highs relative to Treasuries. Alwaleed, the biggest shareholder in New York-based Citigroup, bought more of the bank's stock even as the Standard & Poor's 500 Financials Index fell 9.1 percent this year. ``The fact that the banking sector has attracted fresh capital in the last couple of months is huge,'' said Mark Kiesel, an executive vice president at Pimco who oversees $158 billion of corporate bonds from Newport Beach, California. ``We've been playing defense for the better part of two years, and the question we've been asking ourselves is when to go on offense. In the banking sector, we've started to do that.'' Pimco has been buying new issues from financial firms because the market is ``too bearish,'' Kiesel said in an interview Feb. 5. Relative to benchmark indexes, bank bonds represent a bigger portion of Pimco's holdings, he said. On Jan. 22, Bill Gross, manager of the Pimco Total Return Fund, said Citigroup, Bank of America and Wachovia Corp. were appealing.

The need to shrink IT HAS been a long haul. In the past 18 months America's biggest airlines have shown signs of life after a near-death experience in the aftermath of the attacks on September 11th 2001. At one time or another, four out of the “big six” network carriers succumbed to Chapter 11 bankruptcy protection and as late as 2006 nearly half the seating capacity in America belonged to airlines in Chapter 11. But since then booming demand for travel, along with the painful cost and capacity reductions of the past few years, have given America's airlines surging profits and the fastest-improving yields in the industry. Now, led by merger talks between Delta and Northwest, the third- and fifth-largest airlines, it suddenly looks as if an often predicted, but never realised, wave of consolidation is about to hit American aviation—but only if competition regulators allow it.

New Era Dawns for Rail Building The upgrade is part of a railroad renaissance under way across much of the U.S. For the first time in nearly a century, railroads are making large investments in their networks -- adding sets of tracks, straightening curves that force engines to slow and expanding tunnels for bigger trains. Their campaign is altering the corridors of American commerce, more so than any other development since interstate highways spread to the interior. For decades, railroads spent little on expansion, even tore up surplus track and shrank routes. But since 2000 they've spent $10 billion to expand tracks, build freight yards and buy locomotives, and they have $12 billion more in upgrades planned. The buildout comes as the industry transitions away from its chief role in recent decades of hauling coal, timber and other raw materials in manufacturing regions. Now, increasingly, railroads are moving finished consumer goods, often made in Asia, from ports to major cities. Their new higher-volume routes, called corridors, often serve the South, where the rail system is less developed and the population is rising. Railroad operators are pressing for advantage over their main competitor, long-haul trucking, which has struggled with rising fuel prices, driver shortages and highway congestion. Railroads say a load can be moved by rail using about a third as much fuel as it takes to haul it by truck. And rail transport is becoming more efficient still, they say, as operators speed their lines and logistics companies build huge warehouse areas along routes. Demand for rail service increased sharply when the U.S. economy and Asian imports surged starting in 2003.

GM Has Loss of $722 Million, Will Offer Buyouts to All 74,000 UAW Workers General Motors Corp. posted a fourth- quarter loss on a mounting deficit in North America and will offer buyouts to all of its 74,000 United Auto Workers employees to further trim labor costs. GM, the world's largest automaker, lost $722 million after a year-earlier profit of $950 million. The deficit in its home market was more than double analysts' estimates and failed to make up for rising profit overseas. The shares rose as much as 2.6 percent because Detroit-based GM recorded a profit after excluding one-time costs.

Wal-Mart Revives Sales With Lower Prices on More Items, Challenging Target Wal-Mart Stores Inc.'s renewed focus on low prices amid a slowing U.S. economy may have revived sales at the world's largest retailer. Wal-Mart will probably say on Feb. 19 that fourth-quarter sales at stores open at least a year increased 1.5 percent, said Deborah Weinswig, a Citigroup Inc. analyst. For the first time in 3 1/2 years, the Bentonville, Arkansas-based company's sales growth may have outpaced that of Target Corp., the second- biggest U.S. discount chain. Chief Executive Officer H. Lee Scott discounted prices sooner and on more items than rivals to lure consumers coping with a depressed housing market as well as higher food and fuel costs. After a failed attempt to boost profit by attracting fashion-conscious shoppers with silk lingerie and velvet jackets in 2005 and 2006, Wal-Mart returned to emphasizing food and household merchandise at cut-rate prices at its more than 4,100 U.S. stores. The company marked down 20 percent more items going into the holiday season compared with 2006, and kept prices low into January. Target said last week that its fourth-quarter same-store sales rose 0.2 percent. That would mark the first time since August 2004 that Wal-Mart's growth outpaced Target's.

Cardinal Health Could Be Regaining Its Strength After three years of instability, Cardinal Health Inc. appears to be getting back on its feet -- and that could give a shot to its ailing share price. Investors have been ambivalent about the drug-wholesale and medical-supply company's stock, taking occasional nibbles but showing no sustained appetite since a 2004 inquiry by the Securities and Exchange Commission and subsequent financial restatements. The situation worsened in the past year with the exit of a key executive, a product recall and government action against some Cardinal distribution centers. Drug wholesaling is dominated by Cardinal, AmerisourceBergen Corp. and McKesson Corp. The trio distributes some 90% of drugs in the U.S., a volume game with razor-thin margins. Cardinal -- the most diversified of the three, with 45% of its profitability coming from nondistribution ventures -- had $87 billion of revenue last year and $1.9 billion of profit. The problem is that the Dublin, Ohio, company has never had solid equilibrium because of its three divisions.

IT spending forecasts cut on recession fears Forecasts for global IT spending in 2008 have been cut, as fears of a recession in the US puts the brakes on growth. Global spending on IT goods and services is expected to grow to just $1,695bn in 2008, a 6 per cent increase on last year, according to Forrester Research, the market research group. This represents a significant slowdown from 12 per cent growth last year. Only two months ago, Forrester predicted IT spending would grow 9 per cent to $1,7580bn this year, but the group has pared this forecast back after a series of poor reports on the US economy. These include news last month that the US economy grew at just 0.6 per cent in the fourth quarter, its slowest pace since 2002, and figures this month showing a fall in employment. The hardest-hit sectors will be computer and communications equipment, with software and services seeing stronger growth. Mr Bartels stressed that the technology slowdown would not be as severe as in 2001, when spending actually declined. “The tech sector will still grow marginally better than the overall economy. This is not a technology bust, it is a slowdown in growth,” he said.

·         Outlook for tech spending worsens The technology industry's outlook for 2008 looks worse than it did just two months ago, when fears of a U.S. recession already were leading analysts to predict a slowdown in purchases of computers, software and tech services. A report being released Monday by Forrester Research Inc. says U.S. companies and government agencies are expected to increase their spending on information technology by just 2.8% this year. That is a substantial downward revision from the 4.6% growth that Forrester was predicting in December.

·         Microsoft Record-Low P/E Pushes Technology Stocks to Market-Valuation Hell Microsoft Corp. shares haven't been as cheap since 1986, the year Bill Gates took what would become the world's largest software maker public. Nokia Oyj is trading at its least expensive level since surpassing Motorola Inc. as the biggest producer of mobile phones in 1998. Despite the fastest estimated earnings growth of any U.S. group except banks, technology stocks were hurt the most in the global stock market tumble that sent shares to their worst January in at least three decades. Computer and software-related companies in the MSCI World Index were valued at 20.8 times profit on Feb. 6, the lowest ever and down from 91.1 at the start of the decade. Earnings from more than two-thirds of technology stocks in the Standard & Poor's 500 Index that have reported fourth- quarter results exceeded projections. Analysts forecast profits at companies from Dell Inc. to Intel Corp. will grow 24 percent this year, even as the U.S. economic slowdown threatens to curb demand.

Was a Private Equity Bid for Yahoo Thwarted by Microsoft ? Last week, before the Microsoft (MSFT) deal was rejected by Yahoo's Board, some interesting chatter was bouncing around NYC. The latest rumor to make the rounds was that Yahoo (YHOO) was just about to announce a negotiated transaction for the sale of the company to an East Coast private equity firm. Then Microsoft stepped in the way. We first heard this story sometime between Mister Softee's $31/share, $44 billion hostile bid, and this weekend's rejection of that offer by Yahoo as an insufficient valuation for all of Yahoo's properties. The rumors of this now pre-empted private bid include the following:

·         Yahoo May Sidestep Microsoft Takeover by Forging Alliance With News Corp.

Nokia, Google Add Features to Compete With Apple's IPhone After only eight months on the market, the iPhone from Apple Inc. is prompting competitors including market leader Nokia Oyj to introduce mobile phones with competitive, and sometimes better, features. At the Mobile World Congress in Barcelona, Spain, Nokia, based in Espoo, Finland, unveiled the N96, a top-of-the-line model that comes with features the iPhone lacks, including faster third-generation mobile data connections, video recording, a slot for additional memory and the ability to watch live TV in parts of Europe and Asia. Chipmakers including ARM Holdings Plc, headquartered in Cambridge, England; Qualcomm Inc., based in San Diego; and Texas Instruments Inc., based in Dallas, showed off their prototypes running on Google Inc.'s Android mobile operating system. This is a free, open platform created by Mountain View, California- based Google and more than 30 partners, who have formed a group called the Open Handset Alliance. Based on prototypes shown in Barcelona this week, I can see Android competing with the iPhone's user interface and ease of use once phone makers and carriers decide to adopt it. While the iPhone has driven companies to innovate, no handset yet trumps its style, simplicity and integration of applications. The latest handsets are minor upgrades of existing phones, with a few interesting add-ons. Vendors need to do more.

• iPhones initiate 50 times more searches than other handsets, says Google
• iPhone: ‘It’s the user experience, stupid’

Posted by dblwyo at 04:39 PM | Permalink | Comments (0)

The title is a play on Gladwell's "Tipping Point" - which got a lot of attention that was puzzling since the concept and tools have been widespread in certain schools of analysis for decades but there it is. Stumbling Point because the economy has been visibly slowing since early '07, since consumer spending and jobs held up, proped up by MEW and borrowing and since - the threshold - it looks like consumer spending and employment are about to cross over the downturn line. At least when you look under the covers at real retail sales as we did earlier this week (HT - BigPicture).

On the continuation you'll find a lot of other interesting economic news which simply confirms what we've been excerpting and posting for a while. The domestic economy is slowing, sales and consumer spending are about to tip, the decoupling notion is being disproved in a rather ugly fashion with slowing apparant in Europe, Japan and Asis (China). And the fault lines in China continue to be exposed. Many of these problems have been exposed but are the result of structural problems that have accumulated over decades. Probably the key readings are on the accelerating problems in Housing where more and more homeowners are finding themselves under water along with Bernanke and Paulson's admission that we'ver really got a long way to go. We'd particuarly call attention though to the excerpts on Mexcio and Nigeria's accelerating breakdowns as oil suppliers. If that much supply continues to come off the market...well think about it.

Another very special prior post we'll draw attention to is the one on "Being Your Own Economist" because, for those of you who didn't read the whole thing, it carries a complete bibliography of five key books and discussions of business cycles and the economic policy wars that helped us into this mess. We'd say Bon Appetit' but it's not very appetizing - just something we have to consume. Sigh ! 

Key Readings

Self-Inflicted Wound But the dot.com boom and bust was the first classical business cycle in many years, i.e. centered in business investment. Household spending had driven earlier cycles. In a nutshell: The economy had boomed when households splurged on homes and autos, only to collapse as rising inflation and interest rates choked off spending. Then the Fed would ride to the rescue and rekindle the economy by reducing rates, permitting housing and autos to surge once more. Since the dot,com boom was a technological phenomenon rather than a response to reduced interest rates, falling rates would not rekindle it. But the Fed could not say “Reduced interest rates are not appropriate now because hi-tech will not respond to reduced rates. All that reduced rates will do is stimulate the residential-real-estate sector, which requires no assistance now. Since rate-cutting would be inappropriate and misplaced, better to do nothing and let things work themselves out.”

Social Notes: Be Your Own Economist and Related Readings Presumably if you're visiting this site you've got some concern with the direction of the world, particularly the direction of the economy, markets and buisness ? Mike's book is as good an introduction to the data sources (which are largely on-line now) and how they're reported in the WSJ as anything ever written IMHO. His old web site (I understand a new one is under construction is BeYourOwnEconomist.com ) as well as his blog carry pointers and guidelines to the data sources. More important is it'll provide you a guide to understanding the business cycle and how the data fits each part. And beneath that how it should look - or conversely what it means. His blog does a nice job of taking a macro-issue and working thru clearly, cleanly and directly using some nice, relatively simple charts.Certainly, despite a certain amount of background in the field (M.A. in Econ) Mike's book served me well to learn applied and jargon-free business cycle analysis, which has in turn, served me well in general over the years. In fact if it's a subject you'd care to pursue we have four sources to recommend to you, which are discussed below. Mike's book and blog, Joseph Ellis' "Ahead of the Curve", Paul Krugman's "Peddling Prosperity" and Greg Mankiw's "Macroeconomics" books. UPDATE: Actually five, the fifth being China's economic transformation and outlook referring to Greg Chow's excellent books on the subject.

Economy 

Housing as an Engine of Recovery I've written extensively about using housing as a leading indicator for recessions. Last year, at the Jackson Hole conference, Professor Leamer of the UCLA Anderson Forecast presented a very readable paper on this topic: Housing and the Business Cycle The following graph shows that housing usually leads the economy into recession. But here is a key point: not only does housing usually lead the economy into recession, but housing is usually an engine for recovery as the economy emerges from recession. Given the current fundamentals of housing – significant oversupply, falling demand – it is very unlikely that housing will act as an engine of growth any time soon. We need to see a significant reduction in supply before there will be any increase in residential investment. So, for those expecting a 2nd half recovery in the economy, I believe they need to look elsewhere for growth – and they need to argue this time is different, i.e. that the economy will recover before housing this time. More likely the economy will remain sluggish well into 2009 and the effects of the recession will linger. It is possible that fiscal and monetary stimulus will provide some 2nd half boost to GDP, but if that does take the economy out of an official recession, then I believe a double dip recession (or something that feels like one) is very probable. Housing is still the key to the economy. And the housing outlook remains grim.

• NAR: Housing Sales Bust is Everywhere The National Association of Realtors reports that year-over-year sales declined in Q4 in 46 states (including D.C.). Sales increased in 1 state (South Dakota from 36K to 39K) and sales in North Dakota were unchanged. Note: Data isn't available for Indiana, New Hampshire, and Idaho.
  Seven states saw sales declines greater than 30%: Nevada (44.2%), Wyoming, New Mexico, Oregon, Arizona, Utah and Maryland. Another seven saw sales declines greater than 20%: California, Florida, Georgia, Lousiana, Connecticut, Illinois, and Virginia. This shows the breadth of the housing sales bust. The bust isn't confined to the "bubble" states, the bust is everywhere.

Americans Selling Homes Find Prices So Low Mortgage Exceeds Current Values By the end of this year as many as 15 million U.S. households may owe more on their mortgages than their homes are worth, according to an estimate from Jan Hatzius, chief U.S. economist of New York-based Goldman Sachs Group Inc. That may fuel an increase in foreclosures, erode prices, and increase mortgage bond losses, he said in a Feb. 1 report. ``If borrowers who are underwater go into foreclosure, the properties are likely to be sold at discount prices and will further depress the price of housing,'' said Robert Engle, a Nobel laureate in economics who teaches at New York University's Stern School of Business in Manhattan. ``It becomes a spiral.'' Thirty-nine percent of people who purchased a home two years ago already owe more than they can sell it for, according to a Feb. 12 report from Zillow.com, a real estate data service. Only 3.2 percent who bought five years ago are in that situation, the report said. Almost half of the borrowers who took out subprime mortgages in the last two years won't have any equity left if home prices drop an additional 10 percent, New York-based UBS AG analysts led by Laurie Goodman wrote in a report yesterday.

Mortgage Crisis Spreads Past Subprime Loans The credit crisis is no longer just a subprime mortgage problem. As home prices fall and banks tighten lending standards, people with good, or prime, credit histories are falling behind on their payments for home loans, auto loans and credit cards at a quickening pace, according to industry data and economists. The rise in prime delinquencies, while less severe than the one in the subprime market, nonetheless poses a threat to the battered housing market and weakening economy, which some specialists say is in a recession or headed for one. Until recently, people with good credit, who tend to pay their bills on time and manage their finances well, were viewed as a bulwark against the economic strains posed by rising defaults among borrowers with blemished, or subprime, credit. Mortgage Crisis Spreads Past Subprime Loans, IndyMac: We Were Not Greedy and Stupid  It just looked like it to impartial observers. From IndyMac's shareholder letter:

Bernanke May Have to Lower Rate Again as Lenders Stymie Fed's January Cuts The Federal Reserve's interest-rate cuts last month have failed to lower borrowing costs for many companies and households, increasing the chance of further reductions from the central bank. Companies are paying more to borrow now than before the Fed reduced its benchmark rate by 1.25 percentage point over nine days in January, based on data compiled by Merrill Lynch & Co. Rates on so-called jumbo mortgages, those above $417,000, have increased in the past month, making it tougher to sell properties and risking further price declines. ``It's the clogging up of the credit markets that worries me most,'' Harvard University economist Martin Feldstein said in an interview in New York. ``The Fed has done a lot of cutting, the question is whether it's going to get the traction that it did in the past.''  Lenders and investors are demanding greater compensation for offering credit as losses mount on subprime-mortgage securities and concerns grow that ratings of bond insurers will be cut. Elevated borrowing costs mean Fed Chairman Ben S. Bernanke will have to reduce rates further to revive the economy, Fed watchers said. Banks have been forced to abandon loan sales or offer discounts of as much as 5 percent for companies including Harrah's Entertainment Inc., First Data Corp. and Alltel Corp. in the past six months because of investor reluctance to buy debt perceived to be too risky.

Tempted by China? 3 ways to cut risk China's runaway economic growth rate -- 11.4% in 2007 and a projected 9.6% in 2008 -- has meant huge gains for investors. The FTSE/Xinhua China 25 index is up 600% in five years. But with China you also get big risk. The market volatility is breathtaking on both the upside and the downside -- Hong Kong's Hang Seng stock index climbed 40% from July 9 through Oct. 30, 2007, and then fell 28% from Oct. 30 through Feb. 6, 2008. What do you do if you want the most China profit with the least China risk? You determine the sources of risk and devise strategies for limiting the risk of each source. In this column, I'll suggest three such strategies -- and seven stocks or exchange-traded funds (ETFs) for executing them. The first source of risk is simply that China's economy is growing too fast. An economy growing at 11% is speeding ahead so fast that when the train goes off the tracks, the result won't be a few derailed cars but a major train wreck. There's a second source of risk that's much less familiar to investors in other stock markets. I'd call this China-specific risk because it's a result of the unique characteristics of the Chinese financial and economic systems.  Most discussions of China-specific risk focus on accounting:

• Rushing on by road, rail and air 

The euro zone's economy The euro zone's economy shows signs of slowing sharply, and the limited flexibility of its labor markets, coupled with policy makers' reluctance to cut interest rates aggressively, could lead to a protracted slump. Weak consumption in Germany and a decline in business inventories in France helped halve the pace of the euro zone's expansion in the fourth quarter of last year to 0.4% from 0.8% in the third quarter, according to official data released yesterday. Many economists expect growth of around 1.5% this year in the 15 countries that share the euro, down from 2.7% in 2007. A closely watched service-sector survey hit a 4½-year low in January. Though an outright recession remains unlikely, the bloc's slowdown could be longer than the one in the U.S. The reasons include Europe's less-competitive labor and retail markets, the lack of a coordinated economic-stimulus effort and the European Central Bank's minimalist approach to interest-rate cuts.

Mexico's oil industry Mexico's oil industry is in decay and production is falling. But it doesn't appear the country is going to do anything about it anytime soon.President Felipe Calderón has made energy overhaul his top legislative priority for this year. But the evidence of the past few weeks suggests he faces long odds at a time when high oil prices mask the country's looming production crunch.

Nigeria is at risk of losing its credibility as a reliable supplier of crude oil, traders and analysts say, as worsening rebel attacks hold back exports.

Posted by dblwyo at 09:17 AM | Permalink | Comments (0)

An interesting weekand one, forgive us, that was tackled in a somewhat non-linear fashion with fairly large daily news posts that were married to narrative analysis intros; and which usually covered 3-4 topics. We've spent some time this weekend trying to step back and see what's going. If you look back over those prior posts they do share a common theme however - the gap between the underlying realities and the way the market/talking heades/MSM covered them.

Now our preferred approach is to summarize the week in linear fashion around the Readfest and spend time in the week focused on a particular topic. Blogs are an interesting medium in that lots of approaches are possible - most tend to be somewhat stream of consciousness but casting a fairly wide net we prefer to try and structure the information flow. You'll judge the merits of that approach for yourselves of course but it serves our purposes as a way to gather and analyze the flow, test out themes and analysis and pilot approaches to business analysis.

The preamble, and apparantly we do mean amble, is to set up the non-linar filter's this week - there was such a jumbled flow, the contradictions between interpretations and realities wide enough and enuff stuff happened that we're going to have to try for several different views. Think of it as a multiple dimension x-section. Confusing ? Well to us as well - that's partly the point. Below the line is some of the week's market news - who's major organizing theme is the accelerating metatasizing of credit market problems with whole new asset classes coming under pressure. But's take a look at the markets per se (as usual using the SP500 as our proxy). 

At right is a 3-month daily chart using a new charting tool we're experimenting with. The mid-chart shows the SP500 with 50- and 200-day MA's. The top sub-chart is the a MA momentum indicator (MACD) which is the difference between two short-term MA's which shows the momentum of the market while the bottom is a new indicator for us - Chaikin Money Flow which uses relative price movement measured against daily prices by volume (if we got it even 1/2-way right) to look for where the smart money is going. Notice that the two aren't necessairly consistent. Also notice that the 50-day MA is diving away from the 200-day MA, usually an indicator of continuing downpressure. Also notice that the vaunted Bear Bounce (1) got aborted badly with a huge drop in the first week of Feb. This week began with the market analysts calling for a new Bear Bounce (2) - which was actually presented as a bottom buying opportunity (!!!) - which aborted again. The bottom line here in our humble opinion is that Mr. Market badly wants to go up and thinks he's due the opportunity. A view best summarize as Denial II.

A view reinforced, we think, by the 3-year chart using the same indicators (hopefully at left but who knows how the blog tool will handle it ?). Since we've got same MA indicators (here 9- and 40-week MA's) you can see how the market kept running up over the long-term uptrend until '07, when fundamentals were deteriorating but ignored in the throes of the liquidity bubbles.

Now in this timeframe, no matter what the noisy daily news coverage says, you can see we've more than taken out the '07 bubble-lift. In fact we've busted the long-term uptrend fairly badly and now the 9-week MA is seriously diving down and away from the 40-week. But also the last month has basically looking for a bottom. Which in a return to la-la land is perhaps best exemplified by the fact that the Homebuilder's ETF was the best performer in the last month. Unbelievable. That and the equally hard to swallow second half outlook for earnings.

Both are credible if you think the economy will have a shallow recession. Our opinion is that the core economy is jus crossing the stumbling point but we'll pick that up nex pst.

Key Readings

Homebuilders catch fire The hard-charging homebuilding stocks are making believers of some investors. Shares of the S&P Homebuilders Sector Spider (XHB), the exchange-traded fund that tracks the biggest publicly traded companies in the residential construction business, have risen 7% this year. That gain is noteworthy on its own, given the 7% decline in the S&P 500. But what's even more dramatic is the huge rally that erupted in these stocks in the middle of last month, right before the Federal Reserve started cutting interest rates in a bid to stave off a possible recession. The homebuilders ETF is up 29% off its early January lows, while components Toll Brothers (TOL, Fortune 500), Lennar (LEN, Fortune 500) and Hovnanian (HOV, Fortune 500) are up 40%, 52% and 96%. So after two and a half years of steep drops, have the homebuilding stocks finally seen a bottom? Some investors believe they may have - and that the recent bounce foretells sunnier days for an economy that has been besieged in recent months by recession talk.

Earnings: Nowhere to go but up Poor results from the banking sector in the fourth quarter are likely to lead to the biggest drop in quarterly profits for large U.S. companies in six years. With 73% of the companies in the benchmark S&P 500 having reported results, overall fourth-quarter earnings are on track to fall 20.1% from a year ago, according to the latest figures from Thomson Financial. That's far worse than what had been expected as recently as Jan. 1, when analysts were predicting a drop of 9.4%. By the second half of 2008, year-over-year comparisons will get easier, since the third quarter and fourth quarter 2007 earnings were so miserable, said David Dropsey, senior research analyst at earnings tracker Thomson Financial. Dropsey said that if, as some analysts expect, banks are done writing off most of their exposure to bad mortgages by the middle of this year, earnings could rebound in the latter part of 2008. The S&P 500 should return to profit growth in the second quarter and that should usher in even higher levels of growth for the rest of the year as comparisons get easier and tech and energy sector earnings continue to show strong growth.

Markets & Investing

Three Questions: Jack Malvey The ongoing turmoil in the credit markets, where previously unheard-of asset classes and funding vehicles have fallen victim to the contagion that’s spread through subprime mortgages, monoline insurers and collateralized debt obligations, is hard to wade through at times. One person who has been following this through a number of credit meltdowns is Jack Malvey, chief global fixed income strategist at Lehman Brothers, where he has worked since 1992. Mr. Malvey says that “this is a credit recession” the market is experiencing now, one less volatile than some of the shorter downturns, such as the post 9/11 period, but certainly more wide-spread in terms of the affected assets. MarketBeat chatted with Mr. Malvey for a few minutes on Wednesday.

Muni Regulators Seek More Disclosure in Auction Market Beset by Failures Wall Street banks may be forced to disclose more information about bidding for auction-rate bonds after dealers stopped buying the securities, triggering a wave of failures that has squeezed local governments nationwide. The U.S. municipal bond market's main regulator, the Municipal Securities Rulemaking Board, plans to ask the public whether new rules should require disclosure of information about the securities, whose rates are set periodically at auctions, said Executive Director Lynnette Hotchkiss. The board may require that dealers reveal the number of bidders and how often auctions fail in the $330 billion market, she said. Banks including Goldman Sachs Group Inc. and Citigroup Inc. allowed hundreds of auctions to fail in recent weeks after they were unable to attract buyers at bidding they managed and decided not to use their own money to buy unwanted securities. The failures boosted borrowing costs for public borrowers, who often pay above-market rates when auctions fail.

Deal Journal Q&A: Defaults Will Rise, Recession or Not Martin Fridson, the CEO of credit analysis firm FridsonVision, spent 25 years analyzing credit for brokerage houses including Salomon Brothers, Morgan Stanley and Merrill Lynch. Just as things get interesting for debt sales ranging Harrah’s Entertainment to Clear Channel Communications to BCE, Deal Journal caught up with Fridson to get a sense of what the market is doing now. MF: The default rate is at a cyclical low. It has begun to rise off the bottom at around 1%. The risk premium in the high-yield market has uncharacteristically advanced well ahead of the rise in the default rate – around 700 basis points. The question in the rise is why there’s greater separation between the two. The spread is presumably always somewhat forward-looking but has not been this forward-looking in the past. It could be the case that Moody’s is simply wrong and expecting default rates to rise and that the market is irrationally anticipating a huge search in defaults that are not going to occur. Another possibility is that default rates are being delayed through financing engineering like covenant-lites. The actual money default occurs only if the company fails to meet its interest or principal payments. I along with many others in the market would say that the absence of financial tests in loan is simply delaying rather than avoiding defaults. The incidents of distress in the high-yield market has skyrocketed. Back in July, only 1% of issues in high-yield markets were quoted at over 1000 basis points over Treasurys. It has jumped to 17%. The probability of default for bonds in the distressed category is 22%. There’s more distressed paper at the high risk of default and the defaulted universe is likely to expand dramatically over the course of this year. That expectation is valid whether or not there is a recession. There’s a misconception that default rates rise only with a recession. Default rates are higher in recessions than expansions, but even optimists expect GDP growth in a relatively low 1% range, which indicates that default rates will rise even if we don’t go into a recession.

5 power plays for natural-gas stocks Potential regulatory changes have producers wary of building coal-fired electric plants. That makes gas the key to meeting demand -- and makes gas stocks a good investment. The renaissance in coal-fired electric plants has hit a snag, and some areas of the United States could be looking at electricity shortages and soaring utility bills at a time when family budgets are already stretched. The quick fix -- and the only one available because we don't have a national energy plan -- is to build more power plants that burn natural gas. And that's why I'm recommending North American natural-gas stocks, instead of the shares of oil companies, for purchase in 2008 (or as soon as you think the stock market has found some kind of stability). In this column, I'll explain why I think this is a year to get gas and give you the names of the five best stocks in that sector.

Grain Demand Boosts Heartland The agriculture industry is experiencing a boom as surging commodity prices are expected to result in record net farm income in 2008.

Posted by dblwyo at 07:21 AM | Permalink | Comments (0)

A friend has put up his own blog relatively recent on Be Your Own Economist:

 BE YOUR OWN ECONOMIST

 The friend is Dr. Michael Lehmann, retired econ prof at UC San Francisco (UCSF). I mention this for two reasons, one of which is that his name might be familiar. Mike's the authoer of, the Be Your Own Economist books, or more formally:The Irwin Guide to Using The Wall St.reet Journal, 6th Edition by Michael B. Lehmann . Which some of you may recognize. Back in the day I read an early edition (hmm...shall I mention which one ?). Actually the 1rst but over the years perhaps my favorite was the  4th. Highly reccomended. Let me explain.

Presumably if you're visiting this site you've got some concern with the direction of the world, particularly the direction of the economy, markets and buisness ? Mike's book is as good an introduction to the data sources (which are largely on-line now) and how they're reported in the WSJ as anything ever written IMHO. His old web site (I understand a new one is under construction is BeYourOwnEconomist.com ) as well as his blog carry pointers and guidelines to the data sources. More important is it'll provide you a guide to understanding the business cycle and how the data fits each part. And beneath that how it should look - or conversely what it means. His blog does a nice job of taking a macro-issue and working thru clearly, cleanly and directly using some nice, relatively simple charts.

Certainly, despite a certain amount of background in the field (M.A. in Econ) Mike's book served me well to learn applied and jargon-free business cycle analysis, which has in turn, served me well in general over the years. In fact if it's a subject you'd care to pursue we have four sources to recommend to you, which are discussed below. Mike's book and blog, Joseph Ellis' "Ahead of the Curve", Paul Krugman's "Peddling Prosperity" and Greg Mankiw's "Macroeconomics" books. UPDATE: Actually five, the fifth being China's economic transformation and outlook referring to Greg Chow's excellent books on the subject.

Business Cycles and Applied Macroeconomics Readings

Like we said there are (now) five and it's not entirely clear what order to suggest which should come first but we'll pick an order and explain the choices as well go.

Ahead-of-the-Curve (Ahead of the Curve: A Commonsense Guide to Forecasting Business and Market Cycles by Joseph H. Ellis):

Ellis is a retired Goldman retail analyst who a long and successful track record in his industries. Since he was tracking cyclical industries he needed to understand cycles and over the years evolved a simple graphical technique that's well-grounded in experience, accuracy AND theory. It also makes the underlying nature of cycles, structural patterns and relationships clear to the naked eye without a lot of econometrics. This is the source of the YOY% approach which we've used for several years and adopted/adapted (alright stole) from Ellis. We've also notice that in the last six months the YOY Meme has taken over the world from the WSJ to BreakingViews, to BigPicture to EconDay. Hmmph - we do our own charts. But if you want a more detailed explanation and dissection read the book.

Be Your Own Economist: covered that above but let me explain a bit of the dilemma. Ellis's book will certainly get you going, and in many ways, might be all you need to read. We say having come to with a pretty decent grounding in economics, business cycles and whapping away at the problem. Mike's book will ground you with an independent but complementary explanation of why cycles work, how to interpret the data in a cycle framework and to translate the headlines.

Peddling Prosperity (Peddling Prosperity: Economic Sense and Nonsense in an Age of Diminished Expectations by Paul Krugman)

 Krugman likely doesn't need much introduction but before you judge him entirely by his NYT columns he was and is a very good economist who won the John Bates Clark medal, made major innovations to int'l trade theory and wrote some very good popular economics books in the 90's explaining economic issues in as good a prose as anybody who's written (though you can see it evolve into clearer & simpler over time). We recemmend without qualification any and all of these books as essential reading and ground, and for the same reason we recommend PP here and now. While the dates would appear to make them dated in fact they are such good introductions to various topics that are not only still with his but are now orders of magnitude more important that we wish a) he's re-visit, refresh & update everyone of them while b) keeping his personal political proclivities out of the analysis as he did then. Sadly much of his recent popular work is disingenous in the extreme where very good economics is inter-mixed with biased policy and not so disguised polemics. There's a reason why Paul wasn't made Chairman of the CEA; and unfortunately will have difficulty getting the Nobel that his earlier work put on the path toward. All that said let me piggyback a couple of more comments as long as the rant toggle is ON.

1. "Madmen who hear voices in the air distill the frenzy from some academic scribbler of generations past" - Lord Keynes. We can actually show where that's true with regard to Hitler and unfortunately, as the Supply Side voodoo magic meme shows, it's still true today (Krugman does a nice job of walking you thru all the ins & outs). Yet macroecon matters, at the bedrock basis, as much as any other social policy - and mistaken ideas in that regard are devasting to the health and welfare of society. Yes, we're talking about you and your children - pay attention. Churchill's decision in the 20's to return to a "sound money standard (gold)" was driven by nostalgia for a dead age rather than sound reasoning and led Britain into a major depression in the '20s which almost collaped their society and was so bad the Great Depression hardly added to the pain. Our own troubles with Guns-n-Butter in the '60s, Nixonian price controls and Carter's ineptitude created problems which a) we just began to recover from in the mid-90s, laid the foundations for the income disparities that are so troubling to us all now and set the table for problems that will be-devil us for the next two decades. At the same time Volcker (& Reagan's) breaking the back of inflation, some growing sense in macro-policy and a competent non-political Fed laid the foundations for the Great Moderation which gave us two decades of increasing general prosperity. Aside from a major war perhaps the most momentus policy decision the next President will make will be the next Fed chair. If a more complacent political appointee is put in we could end up where we were in the '60s and '70s; or heaven forbid where the French, et. al. got themselves in the 1890's for example. The most dangerous current beginning to run right now is the notion that Bernanke has done a bad job when he's done superbly.
2. Peddling Prosperity takes you thru the various macroeconomic currents and events of the '80s and '90s, the growth of policy entrapaneurs who distilled their frenzies from extractions and distortions from the sound work of Feldstein, Mundell and others on taxes and money and trade. It also weaves in the internecine food fights in the profession where, because it was intellectual difficult to link clean, clear and well-established micro-principles to the extremely messy and complicated aggregate economy the entire profession went nuts in pursuit of mathematical abstractions. This 20 year journey in the wilderness bubbled out in the public consciousness and opened a wide window for a lot of kuku moi (that's bat quano for the rest of you) to ooze into policy-making.
   
• If you'd like another take Greg Mankiw has as a great paper (Economist as Scientist and Engineer [ web, dloadbable from us] ) paper that we highly recommend that is as nice a survey as there is.
• Charlie Munger (yes that Munger - Warren's partner in profit) gave a wonderful lecture at UCSB several years ago giving you a very hard-nosed look at key ideas and real-world relevances. It's on the strenghts and weaknesses of academic economics and should be required reading for any academic or policy-maker [UCSB speech PDF, blog dloadable].

Back in the day when I moved on (escaped) to the real world there were a set of issues on disequlibrium, dynamics and micro-foundations that were the next frontier. Imagine my utter disappointment and dismay on discovering that 20 years later the entire profession lost itself in navel gazing and abstract debates. Take a look at both books. If you're interested in understanding the theory, applications, data and so forth that backup Mike's work these are the books and not just as good as it gets but the best we know of. If you look them over and are more comfortable start with the Principles book (get the whole principles book instead of just the macro one). But we wholeheartedly recommend the Intermediate textbook because it carefully lays out, reconciles and integrates all the previously conflicting currents. And does it in a very good style. If you can spare the time, energy and attention you'll be well repaid. If you have younger friends and relatives at college insist that they get to and thru an Intermediate macro-course (though share this blog with them of couse !).

China's Economic Transformation (China's Economic Transformation, Knowing China by Gregory C. Chow): Greg Chow has written a wonderful applied macro textbook on the transformation of the Chinese economy. Where this one bites in particularly is on several levels.

First off Chow is one of the preeminant econometricians and applied macro-economists of the last 50 years. Next he is native Chinese and grew up with the language and culture. And third he's been a very senior advisor over decades to both the Taiwainese and mainland governments and been as influential as any single person could be in influencing their choices (btw - how many most sr. gov't officials could interview Larry Summers and get into a discussion of Black-Scholes option pricing and real-world applications. Well the Chinese can and did when he was over there. Can't imagine that happening anywhere in the West. Can you imagine ?!!).

On the next level Greg's discussion of history & culture, analysis of major sectors and policy challenges and overall macro-analysis as well as inclusion of institutional factors is wonderful. Where the latter is important is that none of the classic models work here so he had to create his own - as good an example of applied macroecon as there is. Some of the chapters are a bit technical much of the book is not so just skip the parts that make your head hurt if you like. The chapters on education, banking & finance, education, pollution, the trade-offs between Agriculture and modernization, the history of policy-making, the choice to emphasis coastal provinces first over interior zones are each worthy of books in their own right. This book should be reqiured reading for any journalist, businessman or policy-maker involved with China. In fact if it were up to me I'd require a couse in it for any of my folks heading there on on assignment. As a side note if the textbook is heavy going Greg's book on Knowing China includes much of the simple prose analysis as well as good introductions to Chinese culture and history. That should be essential reading for anyone interested in China (a complementary historical work contrasting Chinese socio-economic history with Western is China Transformed: Historical Change and the Limits of European Experience by R. Bin Wong).

Archives

And of course we've put up a few things from time-to-time which are contained in the archives: Economy. In particlar we'd point you to two major posts that tried to explain our synthesis of all these sources into a "concise" explanation and toolkit intro for business cycle analysis.

Weigh the World Works: Understanding the Business Cycle

WtW Part Deux: Patterns, Cycles & Indicators

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

Love some of the headlines today. Especially the ones on Prof Ben's testimony from Marketwatch and Fortune. You've really got to be kidding - the Oct. Fed notes, which we excerpted here pretty well laid it out almost four months ago. And there have plenty of folks doing first rate truth telling since, e.g. Paul Kasriel. We'll even include ourselves in that a bit (check the Economy archives, to much to re-link). But really - not just in the spirit of "told ya so" but also in trying to measure the gap between realities and what the pundits, MSM and the Street would like to believe, which is huge - will point everyone back at the last two day's posts that focus on the contrast. The one between what's going on and what's being said - you know that one.

In the midst of all the drop in the market as they're told that not only has the punch bowl been taken but it was taken months ago you likely missed some other news which should be much more scary. Which is a whole slew of stuff on the metastisizing of the credit cancers to whole other markets. And with NY's testimony on breaking up the bond insurers bet they're sorry to have turned down Warren; but not as sorry as their stockholders. Does the phrase "gun to their heads" mean anything to you ? That's not where it's really at but let's pretend to politeness.

Below the line, continuing the spirit and letter of schadenfreude, you'll find a few stories on the economy, especially real retails sales (HT - TheBigPicture) and a whole slew on the credit problems. Did you ever see the movie Outbreak with Dusin Hoffman and Morgan Freeman - about the spread of Ebola ? Remember the maps that showed how quickly it could spread ? Well, guess what...

We'll put up two of the top stories (& hope you find the Fortune/Marketwatch headlines as hysterical as we do; note that's hysterical not hysterically funny) and let the rest speak for itself:

Bernanke Signals Fed May Reduce Rates Again as Economy Continues to Weaken Federal Reserve Chairman Ben S. Bernanke indicated that policy makers are prepared to lower interest rates further as the economy continues to deteriorate. The Fed ``will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke told the Senate Banking Committee in Washington today. ``A significant worsening in financial conditions or in credit availability would certainly be a warning bell that we need to take further action.'' Fed officials have lowered their forecasts for economic growth after the U.S. lost jobs in January and consumer spending was threatened by falling home and stock values and rising energy costs, Bernanke said. Traders anticipate the central bank will cut rates a further half-point by March 18 after 2.25 percentage points of reductions since September. Bernanke appeared at the hearing with Treasury Secretary Henry Paulson and Securities and Exchange Commission Chairman Christopher Cox, the first time the heads of the three agencies testified together on the economy at the panel since the aftermath of the Sept. 11, 2001, terrorist attacks.

·         Heartbroken over economic woes (Fortune/CNN)

·         Now Bernanke's telling us (Marketwatch)

Bond insurers have days to re-capitalize, Spitzer says Bond insurers have four to five business days to re-capitalize themselves enough to keep their crucial AAA credit ratings, New York Governor Eliot Spitzer said during a Congressional hearing on the $2.4 trillion industry on Thursday. If that doesn't happen, regulators will have to step in and separate bond insurers' municipal businesses from their more troubled structured finance units. "We will need to move in that direction. It is not our first choice but time is short," Spitzer said. "In the next for or five bus days we would like to see a resolution," Spitzer added. "It's time for deals to get done."

Credit Markets & Investing

Credit Woes May Widen A widening array of financial-market problems threatens to trigger a new phase in the global credit crunch, extending it beyond the risky mortgages that have cost banks and investors more than $100 billion in losses and helped push the U.S. economy toward recession. In the past few days, low-rated corporate loans -- the kind that fueled the buyout boom of recent years -- have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices. Nervous buyers also have retreated in recent days from the market for securities backed by student loans and municipal bonds, roiling some corners of the short-term money markets. Similarly, investors have recoiled from debt backed by commercial real estate, such as office buildings.

• Back to Business: Pimcos co-chief investment officer Mohamed El-Erian is back to business, reports CNBCs Michelle Caruso-Cabrera

Solvency Worries Stalk Credit-Derivatives Market Counterparty risk isn't a new concept, and there are mechanisms in place to mitigate the hazards of a trade failing because one side is unable to meet its obligation. In the interest-rate futures market, in particular, collateral agreements mean you don't let the other guy owe you too much without booking some of the profit ahead of time. The issue gains added urgency, though, as liquidity concerns mature into deeper worries about solvency. This isn't scaremongering. The damage now inflicted by U.S. bond insurers, known as monolines, shows the increased danger of owning a security that relies for its well-being on a single firm, however well-capitalized it may seem and however high its credit rating. The correct number of banks to go bust in the current environment isn't zero. Which means you might think twice before buying a credit-default swap from, say, a small Spanish bank with a ton of real-estate loans, or a minor Japanese securities firm with a shrinking capital base. Who you trade with is becoming as important as which instruments you buy and sell.

Crisis Moves Into 'Auction' Bonds Auction-rate securities -- an unusual type of long-term bond that behaves like a short-term bond -- have become a keystone of modern finance. They are routinely used to fund everything from college student-loan programs to municipal road-and-bridge projects. These bonds became popular with investors looking for cashlike investments, because they offered better returns than traditional money-market investments but were just as easy to buy and sell. Recently, however, that advantage has disappeared. The market for auction-rate securities has dried up amid fears about fallout from the subprime-mortgage crisis. This week, New York's Port Authority saw the interest rate on some of its debt jump to 20% from 4.2% amid disruptions in this market.

Ahead of Tape: Frozen Corners Thaw Last year, the problems centered on structured investment vehicles and conduits, off-the-books vending machines that spat out short-term commercial paper backed by mortgages and other longer-term debts. When investors got jittery about the value of mortgages, they stopped wanting to buy the short-term paper, no matter what kind of debts were backing them. Suddenly, the vending machines became dead weights around the necks of their backers. Some guy can't pay his mortgage, and the next thing you know Citigroup needs to raise cash. Who knew? Now, problems are bubbling in two other backwaters of the credit markets, auction-rate securities and tender-option bonds. Like SIVs and conduits, these financing vehicles issue supposedly safe short-term securities that are meant to appeal to the most conservative investors. But the credit-risk panic has shaken faith in those assets, as well, and suddenly your daughter can't get a student loan in Michigan. Once again, who knew? If this is truly a repeat of the credit-market dislocations in August and November of last year, then there's a risk these troubles will flare and spread again, once more seizing up the broader credit market. That would mean the credit calm that settled in around the turn of the year, thanks to huge injections of cash into markets by the Federal Reserve and other central bankers, was a massive head fake.

Heard on the Street: Woes Hit Tender Spot When the credit crisis began in August, shareholders were surprised to learn that some banks were potentially on the hook to provide billions of dollars in assistance to little-known entities called structured investment vehicles and conduits. Now, vehicles that issue short-term debt to fund purchases of municipal bonds and student loans are coming under pressure. If things get really bad, that could cause banks to shift more assets onto their books at a time when balance sheets are already under considerable stress because of the mortgage mess and sluggish economy. It is hard to tell how much the gridlock in the market for municipal and student-loan-backed instruments might affect banks, partly because the problems have emerged only in the past several days. It is unlikely that banks would face as much peril as they did from SIVs, which invested in far riskier assets such as subprime mortgages. Still, the mere possibility banks could be forced to absorb additional assets shows that off-balance-sheet activities continue to pose substantial risks for bank investors.

Buffett Bids to Assume Municipal Liabilities of Insurers MBIA, Ambac, FGIC Billionaire investor Warren Buffett said he offered to assume responsibility for $800 billion of municipal bonds guaranteed by MBIA Inc., Ambac Financial Group Inc. and FGIC Corp. Buffett's Omaha, Nebraska-based Berkshire Hathaway Inc. would provide so-called reinsurance for the debt, he said in an interview with CNBC television. The offer excludes the bond insurers' subprime-related obligations. One company has already rebuffed the proposal and the two others haven't responded, Buffett said in the interview. Berkshire Hathaway, which gets about half its earnings from insurance, is looking to make money in the municipal guaranty business that provided MBIA, Ambac and FGIC with 14 years of uninterrupted profit until last year. The three companies are on the verge of losing their AAA credit ratings that would cripple their sales to municipalities after losing $5 billion from insuring mortgage-related securities. ``The Buffett plan basically cherry picks out the only worthwhile parts of the portfolio,'' said David Havens, a credit analyst at UBS AG in Stamford, Connecticut. ``It leaves them with a terrible mix of business.''

Buffett Plan Saves Muni Market, Dooms Ambac, MBIA Yesterday, Buffett, whose Berkshire Hathaway Inc. entered the field late last year, told CNBC that he had offered to take all the municipal-bond business, some $800 billion worth, off the three major, imperiled financial guarantors' hands. The firms -- MBIA Inc., Ambac Financial Group Inc. and FGIC Corp. -- would have to pay Berkshire Hathaway billions of dollars to take over their municipal bond risk. They would be left with the stuff that got them into trouble in the first place: mortgage-backed securities, collateralized debt obligations, credit default swaps and all the rest of it. In other words, the insurers would give up all their future, in the form of the unearned premiums they have yet to draw down on the municipal bonds they have insured, and be left with all their bad, recent past. And, of course, they would have to pay for the privilege. What you think of this proposal depends upon where you sit. If you participate in the municipal bond market as an issuer, an investor, or an underwriter, Buffett is a savior. If you are one of the bond insurers or their stockholders -- and Buffett said one of the companies had already rejected his offer -- the deal is beneath contempt. The Buffett plan saves the municipal bond market, in general and in particular. And when the waters get too high, as they might (Buffett basically called the insurers' subprime liabilities unquantifiable), and if the insurers are downgraded, then their problem becomes the banks' problem. Here comes another round of losses and writedowns.

New York's Dinallo Says He Is Considering Splitting Bond Insurers in Two Bond insurers may be split into two businesses in what would be the biggest overhaul of the industry since it was created almost four decades ago. New York Insurance Department Superintendent Eric Dinallo said such a separation is one of the proposals regulators have been discussing with bond insurers, including MBIA Inc. and Ambac Financial Group Inc. Spitzer told the committee that the economy may face a ``financial tsunami'' as a result of potential downgrades to bond insurers and a tightening of credit markets that resulted from bad loans to homebuyers. Federal regulators blocked earlier efforts to tighten rules, and the Office of the Comptroller of the Currency allowed ``the problem to grow and the bubble to inflate,'' Spitzer said. Spitzer and Dinallo both said their focus is on the municipal market rather than banks and financial institutions that sought insurance on structured-finance securities.

Economy: Retail Sales

Retail Sales in U.S. Unexpectedly Climb 0.3% on Spending for Autos, Fuel Retail sales in the U.S. unexpectedly rose in January, easing concern that the world's largest economy has already slipped into a recession. The 0.3 percent increase was led by spending on autos, clothes and gasoline, the Commerce Department said today in Washington. The figure followed a 0.4 percent decrease the previous month. Purchases excluding automobiles and gasoline were unchanged. Excluding autos, gasoline and building materials, the retail group the government uses to calculate gross domestic product figures for consumer spending, sales rose 0.2 percent, after a 0.1 percent decrease the prior month. The government uses data from other sources to calculate the contribution from the three categories excluded.

Retail Sales Show Inflation, Not Growth Not for price changes means that these are nominal -- not inflation adjusted -- numbers. Hence, with Gasoline station sales up 23%, and non-store retailers (home oil delivery) up 10.6%, the surprise gains were all energy/inflation related. I have to  wonder about the boost in demand for cars, considering what we have heard from all the auto makers -- they almost across the board announced weaker sales. I don't know what the Commerce department is looking at, but I cannot figure how its a positive sign for the economy. Take the Retail Sales EX Inflation (gasoline, food & beverage) and retail sales were DOWN. Excluding inflation, demand at all other retailers last month were unchanged to negative. Economically, speaking, how bullish is that?

Real Retail Sales Fall to 2003 Levels If we want to see Real Retail Sales, we need to fully adjust for the pernicious effects of inflation. Haver Analytics has done the heavy lifting for us, and as the chart below shows, Real Retail Sales fell to levels not seen in 5 years: This is the first negative Real number this cycle. This, strongly suggests a US recession is either underway or due any month now. And that's using CPI as the inflation adjustment factor. Its well understood amongst

Posted by dblwyo at 05:57 PM | Permalink | Comments (0)

Following two of our long traditions we're going to a) post several links together rather than sepertately, unlike typical blog practice (a several months tradition now with our Readfests :) ) because these stories are valuable individually but more so IMHO taken all together, as William James puts it. And b) post them en passant during the week (a many (3 ?) weeks old tradition).

As you may have noticed the markets roared ahead today and it was all because of the outstanding Retail Sales numbers, not to mention momentum from yesterday when Buffett's offer to the bond insurers plus GM's earnings surprise got this 2nd Bear Bounce kicked off (and oh yeah, leave us not forget yesterday's look at earnings and the talking heads also: Grading the Takehome: Bottoms, Earnings & Outlooks).Setting the table here was Marketwatch's take on things:U.S. STOCKS RIDE HIGHER ON RETAIL SALES AND STIMULUS; NASDAQ CLOSES UP MORE THAN 2%

Tim Walker over at Hoover's Business started an interesting line of discussion with a post on asking simple questions about apparantly complex problems - btw, the comments are worthwhile, ahem.

The power of naive questions. One of the basic beliefs behind this blog is that the same basic psychological issues confront us both as individuals and in our organizational lives. In other words, the same hangups that drag down one person can drag down an organization. We see this all the time in the way, for example, that fear undermines the confidence of both individuals and companies. For a person, we call it a “mindset”; for a company, it’s a “culture”; but the outcome is the same — paralysis. With that in mind, I’d like to kick off a discussion of one of my favorite hangup-busting tools: the naive question.

Now Tim's bottomline is that you can dig beneath the surface so let's do that by asking what's beneath the surface. Well:

1. Buffett's offer was actually to gurantee the municipal bonds covered by the insurers leaving them with the screwball stuff and taking away their only income source. Which would mean their deaths as viable companies.
2. It turns out that GM's earnings surprise of +$.08/share was closer to -$.58/share when you take away the $1.5B North American loss that was offset by claiming a $1.6B tax credit. BTW it was Phil Le Beau of CNBC who reported this (vidclips below) and it wasn't picked up by any other news source we can find ! Earned his pay on this one, he did.
   
3. Retail sales rise was in autos and energy related stuff - in other words when you take out the inflation factor real sales are, again, likely to have gone down. But, also again, everybody looked at the headline even though it was clearly based on nominal numbers.

READINGS

Buffett Plan Saves Muni Market, Dooms Ambac, MBIA Yesterday, Buffett, whose Berkshire Hathaway Inc. entered the field late last year, told CNBC that he had offered to take all the municipal-bond business, some $800 billion worth, off the three major, imperiled financial guarantors' hands. The firms -- MBIA Inc., Ambac Financial Group Inc. and FGIC Corp. -- would have to pay Berkshire Hathaway billions of dollars to take over their municipal bond risk. They would be left with the stuff that got them into trouble in the first place: mortgage-backed securities, collateralized debt obligations, credit default swaps and all the rest of it. In other words, the insurers would give up all their future, in the form of the unearned premiums they have yet to draw down on the municipal bonds they have insured, and be left with all their bad, recent past.

GM Earnings: When The Good News Is NOT So Good When is a positive earnings surprise actually a a doozy of a loss? When it's General Motors fourth quarter earnings. Confused? You aren't alone. Let me explain. GM reported adjusted fourth quarter earnings of $46 million dollars or 8 cents a share. On the surface that's a huge upside surprise over the street estimate of GM losing 54 cents a share. But GM's upside surprise includes a tax benefit of $1.6 billion dollars. It's the kind of surprise almost no one outside of the company could have predicted. By my calculations, if you strip out that tax benefit GM posts an adjusted loss of $2.77 a share. Want more confusion? GM says it's not accurate to look at the benefit as a straight earnings per share benefit, so it would be incorrect to say the company lost more than $1.5 billion in the 4th quarter. So what do you make of all this? Clearly the 4th quarter was a rough one for GM, with the company losing $1.1 billion in North America--largely because of weaker sales in the U.S. GM Chairman and CEO told me this morning that he believes GM is on track to eventually get back to profitability in North America. When? He can't say. After the 4th quarter, GM is still spinning its wheels trying to get its business here in the U.S. back on track.

• GMs Record-Breaking Loss General Motors is reporting a nearly $39 billion loss for 2007 -- the largest loss ever for an automaker. GMs Road to Recovery

Retail Sales Show Inflation, Not Growth Not for price changes means that these are nominal -- not inflation adjusted -- numbers. Hence, with Gasoline station sales up 23%, and non-store retailers (home oil delivery) up 10.6%, the surprise gains were all energy/inflation related.

Where the lows are  Investors need to practice discipline over conviction in this tricky market. And, watch out for the January lows. Four primary metrics shape the tape. When viewed in isolation, they're inherently flawed. When assimilated properly, they serve as legs under the trading table that balance an approach. Last week we discussed whether or current juncture was akin to 1998 or 2001. That destination remains to be seen but the journey is where the path to profitability resides. It is in that vein that we scribe today's vibe. News is always best at the top and worst at the bottom. Given the decline in the market from the October highs, we must now ascertain how much bad news is reflected at current levels. I would offer that a shallow, transitory recession is priced into the market but further credit comeuppance is not. As of Friday's close, with 73% of the S&P 500 having reported, Bloomberg projects that overall earnings will be down almost 19% from the year-ago period. Some will argue that a litany of write-downs in the financial sector skewed the data, but it's a flawed argument. Every investment professional I know is watching the January lows for signs of a double bottom. As with any charts, it'll work until it doesn't. Hence the fatal flaw. If the retest scenario plays out, it could pave the way for a trading rally. The broader picture continues to warrant caution, however, as lower highs remains in place. In short, we've got room to run in the context of a bear market bounce but until proven otherwise, that's all it will be. There is a massive disconnect between what the credit markets are saying and what the stock market is hearing. Either the former will stabilize or the latter will follow the debt unwind lower. While spates of near-term capitulation have littered the landscape over the course of this slippery slope, conventional wisdom is clinging to the notion that the credit crunch and, by extension, the equity malaise is transitory.

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

Earlier today we put up two contrasting views on the outlook for the markets between what appears to be a building Street consensus vs. one more grounded in a realistic view of the Economy and earnings. What we'd like to do here is take a look at the market charts and then go back to look at the long-term relationship between the Economy, Profits, Earnings and the Markets.

The chart at the right shows a short-term and longer-term view of the market (if you'll allow as that the SP500 is a decent proxy for all the markets). The first sub-chart shows the SP500 for the last six months and the bottom one for the last four years. In the top one you'll notice that the bear-market bounce peterred out pretty quickly, on the one hand. On the other it "looks" to be bottoming and getting set if you believe the pundits for another run up.

The bottom chart is more interesting in several ways. First, for the the first time, the markets breached the lower bound on the long-term uptrend. Interesting, is it not ? But it came right back into the range. Which would tend to support the pundit's thesis, at least in their not so 'umble opinions.

But take a closer look. With all the sturm und drang since Jan. (or Oct for that matter, or since Jan07 even :) ) all we really did was take the bubblicious hot air out of the uptrend but stay in the range. In fact we find it both curious and amusing that after several years of moving up nicely in a channel, in some accordence with the performance of the economy, that last yar saw such a puff over the upper bound. Think about - when all the problems with the core economy were already visible and when, for those paying attention, Housing and Credit Market problems were clearly visible and paying attention (shall we mention Wilbur Ross, Julian Robertson, Goldman-Sachs, et. al. ?) the markets still bubbled.

So what about the economy vs. markets ?

Well let's look at the SP500 vs GDP, on the fairly well-established theory that the business cycle drives profits which drive earnings which drive market valuations (P/E's) and the market indices. Now recall however that this relationship has been more than a bit broken because of buyouts and buybacks driven by liquidity (for prior posts try here and here). Nonetheless there appears to be a clear cyclic relationship just as the textbooks would have it.

Both charts show YOY% change in economic indicators (GDP, Industrial Production) on the left and the SP500 on the right. Notice how as IndProd dipped in the long-term chart that the markets went right along. In the short-term chart we'd argue that nobody has been doing particularly well in the last several years. But again the reason for the charts is to let you do your own inspections and reach you own conclusions. But based on these charts it seems to us that if the economy continues to slow then so will profits and earnings and, eventually, the markets. BtW - another really key point on the first chart that ties in here.Notice the enormous compression of P/E ratios; in other words the fundamental weaknesses in earnings quality, i.e. not being based on organic growth in revenue and profits is reflected there. Even if it's been one of those Dirty Little Secrets that nobody mentions. Now one has to wonder what those valuations might turn out to be if all the structural problems we've been beating our gums about turn out to be valid. Not a pretty mental image, eh ?

The next chart pair shows GDP, Consumption (PCE), After-tax Profits (CPAT) from the national accounts, quarterly earnings (from S&P) and the SP500 in two views. The scales btw are cumulative growth using the '88 start point as the basis for normalizing them to a common scale. So everything has been converted to a common metric. Also the charts only run out to the end of '06. Someday we'll update them to current but...the point about relationshps still hold.

The bottom one uses the same scale so you can see how the economy went thru a long period of steady growth while the other indicators "inflated" up and over that trend. Also note btw that from '88-'94 they moved pretty sychronously. The top chart shows them on seperate scales to get the structural relationship more visible.

In both charts you can see the markets "bubbling" weigh, weigh up over the l.t. trend but reverting to the same growth trend as earnings and profits. You can see, again in our opinion, a lot of other potential chickens returning to the roost as well. Consumption > GDP growth for reasons we know (MEW), Earnings were held up by financial engineering and the market responded accordingly. Yet now Profits, Earnings and the Market are re-converging. And that was before the last 14+ months of data.

We think the case for economic cycles driving markets is pretty well made, including all the bubble-based exceptions that turn out to fit into the model on consideration. Which means that if you think the economy has a lot of trouble ahead of so do the markets.

Now the real questions are how much and when ? 

Posted by dblwyo at 05:23 PM | Permalink | Comments (0)

We left a takehome test with y'all in yesterday's post on Bigg's Bottom vs the News. The key question being was his argument (and all the fairly sensible folk on CNBC) aligned with a whole slew of major scary news - that picked up four of our major themes btw. So what was your answer ?

We're going to sneak up on ours though our direction is pretty clear but before taking a look at some charts and graphs (follow-on post) we'd like to ask what's driving the Street's optimisms. The answer turns out to be very clear - the Street and the analyst community is expecting a major uptick in earnings growth (something else we've been ranting on about as well) but we thought we'd do a compare & contrast between Fortune (who's reporting what it's been told) and Jim Jubak (who's analyzing what he sees).The differences are large, understandable in view of their different responsiblities and the gap tells us what's driving the market sentiment right now. If you check out Fortune's chart from Thompson the rationale is pretty clear. In fact if we thought those were the numbers then now would be a good time to reverse direction from our current position. Here's what Fortune had to say:

EXCERPTS

Earnings: Nowhere to go but up Poor results from the banking sector in the fourth quarter are likely to lead to the biggest drop in quarterly profits for large U.S. companies in six years. With 73% of the companies in the benchmark S&P 500 having reported results, overall fourth-quarter earnings are on track to fall 20.1% from a year ago, according to the latest figures from Thomson Financial. That's far worse than what had been expected as recently as Jan. 1, when analysts were predicting a drop of 9.4%. By the second half of 2008, year-over-year comparisons will get easier, since the third quarter and fourth quarter 2007 earnings were so miserable, said David Dropsey, senior research analyst at earnings tracker Thomson Financial. Dropsey said that if, as some analysts expect, banks are done writing off most of their exposure to bad mortgages by the middle of this year, earnings could rebound in the latter part of 2008. The S&P 500 should return to profit growth in the second quarter and that should usher in even higher levels of growth for the rest of the year as comparisons get easier and tech and energy sector earnings continue to show strong growth.

Which we'd like to contrast with Prof. Jubak's comments, which are more in line with our thinking:

Tempted by China? 3 ways to cut risk The biggest risk to the stock market right now is the continued optimism of Wall Street analysts about corporate earnings. Wall Street still expects a quick end to the U.S. economic slowdown, recession, whatever. As of Jan. 31, Wall Street analysts were projecting a decline in first-quarter 2008 earnings and then a quick pickup in the second quarter, even for the embattled financial and consumer-discretionary sectors. (Consumer discretionary, as opposed to consumer staples, is the stuff that people can put off buying when they don't have the cash -- unlike, say, food.) For example, Wall Street is looking for a drop of about 15% in earnings for the consumer-discretionary stocks in the Standard & Poor's 500 Stock Index ($INX, news, msgs) from the fourth quarter of 2007 to the first quarter of 2008. But then, Wall Street is projecting a 35% jump in earnings in the second quarter (and a 2% drop in earnings in the third quarter). Financials are projected to show a 4% increase in the second quarter and a 3% increase in the third. The telecommunications sector is projected to show a 23% jump in the second quarter. Looking at those projections, it's easy to understand why consumer stocks, such as retailers, and financials have led the market in recent rallies. And it's also easy to see, unfortunately, how the market could drop again if those expectations for second-quarter earnings are dashed by a slowdown that doesn't turn around as quickly as Wall Street hopes.

The charts are built from S&P's earnings estimates which are available online on their site - though if you want to do historical comparisons you have to dload 'em and build up your own archives. The first chart shows '07 and '08 earnings and estimates along with growth rates from Dec31 and Feb5. Lots of little things to notice but two really worth contemplating. The annual growth rate in the revised seems to be because earnings dropped. And 2nd do the sector estimates hang together - especially when you have in mind our prior dissections of GDP components plus the various sector/industry news stores, e.g. the sudden rapid downward revision in tehcnology spending outlooks (as of yesterday morning).

 The 2nd chart is the quarterly breakdown of actuals and estimates for '07 and '08 on the two dates. Again the same questions apply - given the state of the economy, the sector outlooks ofthe GDP components plus independent industry estimates do they make sense ? For example EPS for Consumer Discretionary is supposed to increase in absolute terms. Yet all of the last week's news tells us that consumer spending is about to slowdown sharply.

 The final chart is QtQ% growth rates being forecast (Note: this is not our normal YoY% rates). Again take a close look and run a reality check on these numbers. The first chart, above the break, from Thompson was probably a YOY estimate which is consistent with these S&P numbers on that basis btw. Q407 to Q408 is 59% YOY for example if you run the calculations. Pretty good - astounding even. However, even on this QtQ basis the numbers look pretty good. One observation - notice the differences between the two Q1 estimates and the lack of difference in the 2nd half.What does that tell us ?

Posted by dblwyo at 08:43 AM | Permalink | Comments (0)

Normally some of this would be saved for the weekend readfests but there were several breaking pieces of news today that were dead on recent major posts/readings and issues that we thought we'd collect up the morning's news and match them to the prior posts. But before diving into that we'd like to point you to the "inside-market" sentiment which is arguing that the last week put in a bottom. From Barton Biggs on Bloomberg to some "talking heads" on CNBC. The catch is that some of these talking heads are pretty good ones.

 Biggs Says U.S. Stocks Near `Important Bottom,' Sees Banks Leading Rebound Biggs, the former global investment strategist for Morgan Stanley, said in a Bloomberg Television interview that the market is ``at or very close to an important bottom'' and may be led higher by banks and brokerages when a rally occurs. Some financial companies may advance 20 percent to 25 percent over periods of two to three weeks, said Biggs, who helps manage $1.5 billion in Greenwich, Connecticut. Biggs correctly forecast U.S. equities would rebound from declines in March and August last year. On March 16, following a 5 percent decline by the S&P 500 from its Feb. 20 peak, he said stocks were approaching a bottom and predicted a gain of as much as 15 percent for the index in 2007.

 You might also want to look at the two CNBCvidclips, either by clicking on the picture or here:

Todays Market Outlook:Discussing the trading week ahead, with Jeffrey Saut, Raymond James; John Silvia, Wachovia and CNBCs Joe Kernen and CNBCs Joe Kernen

After you take whatever look at these vidclips and stories you care to, though the basic point is pretty clear - the liklihood of a recession is not too high, it won't be severe and it's already discounted into the valuations - consider the news below. Which covers the economic outlook (CalculatedRisk and Paul Krugman got into a near real-time x-riff on just how bad it might be - does 2010 mean anything to you ?). And the credit markets - oops rather like our Rocks in the Pond model it appears to be spreading widely and rapidly, at least if you give any credence to the front-page of the WSJ which are commentators above poo-poohed. Then all of a sudden Tech Spending outlooks in general have abruptly worsened - wow, deja vu' and as for the Yahoo/MS war we're just debating price, not good sense. We repeat- D.I.S.A.S.T.3.R. And just to wrap it up it turns out that all these headwinds are to blame for poor business performance and outlooks instead of corporate management learning how to build a good ship, hire a good crew and read the charts (we sail but the analogy is their's BTW :) ).

Bon Appetit' ! (afterwards it'll make good sense why we waited until after breakfast though we're probably catching a bunch of folks around lunch).

Economy

Housing as an Engine of Recovery I've written extensively about using housing as a leading indicator for recessions. Last year, at the Jackson Hole conference, Professor Leamer of the UCLA Anderson Forecast presented a very readable paper on this topic: Housing and the Business Cycle The following graph shows that housing usually leads the economy into recession. But here is a key point: not only does housing usually lead the economy into recession, but housing is usually an engine for recovery as the economy emerges from recession. Given the current fundamentals of housing – significant oversupply, falling demand – it is very unlikely that housing will act as an engine of growth any time soon. We need to see a significant reduction in supply before there will be any increase in residential investment. So, for those expecting a 2nd half recovery in the economy, I believe they need to look elsewhere for growth – and they need to argue this time is different, i.e. that the economy will recover before housing this time. More likely the economy will remain sluggish well into 2009 and the effects of the recession will linger. It is possible that fiscal and monetary stimulus will provide some 2nd half boost to GDP, but if that does take the economy out of an official recession, then I believe a double dip recession (or something that feels like one) is very probable. Housing is still the key to the economy. And the housing outlook remains grim. Update:Housing as an Engine of Recovery

• WRFest 9Feb08(Econ/Mkt): the Adventure Continues
  

 Credit Markets

Credit Woes May Widen A widening array of financial-market problems threatens to trigger a new phase in the global credit crunch, extending it beyond the risky mortgages that have cost banks and investors more than $100 billion in losses and helped push the U.S. economy toward recession. In the past few days, low-rated corporate loans -- the kind that fueled the buyout boom of recent years -- have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices. Nervous buyers also have retreated in recent days from the market for securities backed by student loans and municipal bonds, roiling some corners of the short-term money markets. Similarly, investors have recoiled from debt backed by commercial real estate, such as office buildings.Back to Business : Pimcos co-chief investment officer Mohamed El-Erian is back to business, reports CNBCs Michelle Caruso-Cabrera

This is the 2nd half our Readfest on Business news. Rather like the B2C/Tech news what we're seeing is major changes on both the secular fronts and deep structural changes. A friend commented on our little exposition of our framework and its' comparison to Buffett's approach by saying you also needed to look at the bigger picture. Exactly - the point our our mantra on Economy-Industry-Business is to combine those factors into an understanding of the context, the particulars and the consequences. Of which there are an enormous lot.

Retail is showing severe signs of distress which is bringing out the buyout guys - but IMHO this is just getting going. As the Sears Saga shows you have to really understand the business to fix it; and you can't just fix it these days but need to re-invent it. Similarly the CPG manufacturers who supply the retailers, as shown by a story Electrolux, are having parallel problems.

Meanwhile the Auto and Airline industries are beginning to fundamentally re-think themselves with the latter beginning major merger talks across the board. And Chrysler doing the unthinkable - beginning to re-think and downsize itself to where it can make a profit at the levels of production it can sell. You'd think this'd be common sense and standard practice. But, as a strategy that's been visibly necessary for two decades it's only been put on the table in the last 18 months by F, GM and now Chyrsler. As Carlos Ghosn pointed out (in our last readfest) it's not clear how much of the US auto industry can survive.

Another really interesting change is that not only are the auto companies begining to get more and more of their business offshore but they are putting more engineering and R&D offshore as well. In other words the high end of the value-stack is moving into the developing markets in THE manufacturing industry. Which in the long run will be all to the good for everyone in a non-zero sum world. And in the short- and intermediate-runs means large-scale painful adjustments.

Speaking of which despite last week's headlines on the Pharma industry about how '08 would be better because the comps in '07 were so terrible they are starting major downsizings, layoffs, and consolidations and shutdowns. That's what happens when your basic business model is badly broken and you leave finding a substitute for when it's clear you have no choice.

An interesting counter-point story is Merck's which has begun a serious recovery from its' troubles by completely re-thinking and re-factoring itself. It's down-sized, re-structured to become more internally well-organized and less a series of disconnected fiefdoms and changed it's research model. Maybe it'll turn out that all its' earlier troubles were good news in terrible disguise because it was forced to do what was, again, visibly necessary earlier than its' competitors.

Just to put a final point on it notice the similarities between the Merck re-think, re-factor and re-balance story and what HPQ has done (the last story in the tech news Readfest). And the alignment between what both are doing and what our business analysis framework would suggest they do.

READINGS 

Earnings, Valuations & Business Analysis(I): Readings Yet, judging by the market action so far this week, the increasing liklihood of a recession and the associated impacts on earnings are NOT priced into the market. A critical part of this is the very optimistic outlook for second half earnings on the part of sell-side analysts, who are looking for amazing up-bumps in Q3/Q4 earnings. None of which is consistent with a slowing economy. When you factor in the liklihoods of increased pressure due to decelerating consumer spending as Housing worsens and a generally tight credit market wil be worsened. When you factor in the fragilities of excess leverage & buybacks/buyouts, margin and revenue pressures, etc. etc. indicate, at least in our 'humble opinions, that the Street's analysts are too focused on bottom-up views of their indiviudal companies. And not enough on their ability to survive in this rapidly evolving environment. Put another way - what are they thinking ? Or smoking as the case may be !

• Earnings, Valuations & Business Analysis (II): Resources and Approaches

Business

Rescuing stores in distress With retail stocks getting clobbered and sales growth expected to hit the skids in 2008, buyout firms say the retail landscape is a veritable goldmine of hot prospects. "We have half a dozen active deals we're involved in right now," said Love Goel, CEO of Growth Ventures Group, a global private equity firm that's focused on retail investment. From a valuation perspective, Goel said the fact that retail stocks are down significantly over the past 12 months makes the entire sector very attractive for private equity firms looking for bargains. But unlike the multi-billion dollar mega deals of the past two years, industry insiders, citing a more cautionary investment environment, say private equity money this year will target midsized merchants in deals priced between $100 to $500 million. Besides low valuations, Goel said the other driver for retail buyouts is the opportunity to acquire distressed chains - such as Pier 1 Imports - whose brands still resonates with today's consumers but are in desperate need of a wholesale makeover in terms of merchandise, store design and marketing.

·         At Sears, there are signs that cash flows -- which had remained healthy -- are dwindling. Now, some analysts wonder whether falling sales, slimmer margins and other woes are causing cash flows to decline to a level that could hinder a turnaround.

Electrolux Profit Proves Future Is Dim for Europe's No. 1 Appliance Maker While Straaberg has pledged to move more than half the 89- year-old company's production to low-wage countries such as Poland by the end of next year, so far he's only closed 13 out of 35 high-cost plants. Amid a flood of Slovenian, Turkish and Chinese refrigerators, dishwashers and vacuums, the CEO failed to improve operating profit margins enough to satisfy investors. Today he announced a 22 percent drop in fourth-quarter profit. If Straaberg's five-year restructuring program can't assure investors within 18 months that margins will widen to 6 percent from the current 4.3 percent, ``there will be questions about the longevity of management,'' said Ben Uglow, a London- based analyst at Morgan Stanley. The restructuring plan is set to end in 2009. ``When they started this program to move the plants, they had margins below the industry average, and they still have margins below the industry average,'' said Olof Cederholm, a Stockholm-based analyst with UBS. Cederholm has a ``sell'' rating on Electrolux and predicts the shares will lose about a quarter of their value in the next 12 months. Electrolux lost almost half its value since the shares reached a 52-week high of 190 kronor on April 23. Only two of 17 analysts surveyed by Bloomberg say ``buy.'' Ten say to hold and five advise selling.

GM Is Still Facing Tricky Curves GM still has serious kinks in its core automotive business in North America, and, despite some big cost cuts, it may be challenged to come close to breaking even this year. The rise in January sales in the U.S. came in part as a result of a surge in rebates and incentives, which erode profit margins. GM may have to keep incentive levels high through the year to lure buyers into showrooms amid the slowing U.S. economy. Sales of its most-profitable products -- trucks and sport-utility vehicles -- are declining, while sales of cars, which generate less profit, are increasing. GM has a more attractive lineup of cars, led by the redesigned and heavily promoted Chevrolet Malibu sedan. The improvements that GM has made -- like more-luxurious interiors -- come with a price, and the higher cost of materials on…

Car Makers Export Engineering Jobs Car makers are starting to move high-skill design and engineering operations to low-cost countries like Vietnam, Russia and Mexico in an effort to compete with rising auto makers from such countries as China and India. For years, car makers have been slashing expenses by building assembly plants in low-cost countries such as Russia, Turkey and Mexico. Now, high-skill design and engineering operations, which have long remained in industrialized countries like the U.S., Germany and Japan, are starting to follow. Honda Motor Co. last year announced plans to create a development center in Guangzhou with one of its partners in China. Last month, Chrysler LLC said it will begin shifting development work to low-cost countries. General Motors Corp. has begun designing interiors in China for Buicks it will sell in the U.S. Alan Taub, GM's executive director of research and development, said both cost savings and the desire to cater to the local market drove the effort to shift product development work to China. GM has discovered, for instance, that Chinese drivers want their rear seats to be "more spacious" and "comfortable" than their American counterparts, because many Chinese car buyers have chauffeurs. "If you are trying to engineer product out of one location, such as Detroit, you just miss those nuances," Mr. Taub said. Nissan has been aggressive among big car makers in moving engineering operations to the developing world. In downtown Hanoi, Nissan has assembled a team of 700 Vietnamese engineers who are designing basic auto parts such as fuel pipes and nozzles -- at a fraction of the cost of doing the work in the auto maker's main engineering center in Japan. The Vietnamese engineers, many of whom have never driven a car before, earn about $200 a month -- a 10th of what their counterparts bring home in Japan, according to Nissan.

Chrysler Plans to Cut Models, Dealers Chrysler LLC is laying out plans to cut by a third the number of models in its product line and significantly reduce the number of dealers selling its cars, company officials told dealers in meetings recently.The moves are part of a strategy to shrink the company to a level where it can generate healthy profits, people familiar with the matter said. It is a reversal from the strategy when the auto maker was part of DaimlerChrysler AG and it aimed to nearly double sales to about four million vehicles a year by the end of the decade. In December, Chief Executive Robert Nardelli told employees Chrysler was on track to lose about $1.6 billion last year, people familiar with the matter said. In meetings with dealers last week and this week, Chrysler executives said they have accepted the "reality" that Chrysler can't expect to increase its sales volume substantially. To trim costs, Chrysler will prune its product line further, Chrysler Vice Chairman Jim Press and other officials said, people familiar with the matter recalled. Last year Chrysler dropped three models, leaving it with about 30 vehicles in total in the lines sold by its Chrysler, Jeep and Dodge brands. In a few years, the three brands together will probably offer a total of 15 or 20 -- roughly six cars, six trucks and six sport-utility vehicles, people who attended the meetings said. At the same time, Chrysler, which is now a closely held company controlled by Cerberus Capital Management LP, is looking at ways to shrink its network of about 3,600 dealers in the U.S.

Northwest and Delta Talk Merger In events that could reshape the airline industry, merger talks have picked up pace between Delta Air Lines and Northwest Airlines, a combination that could force other carriers to seek partners, people with knowledge of the talks said Wednesday. In particular, these people said, a Delta-Northwest combination could spur Continental Airlines — albeit reluctantly — and United Airlines into negotiations of their own. In their discussions, Delta and Northwest have reached the point of settling on leadership, and it appears that Delta’s chief executive, Richard H. Anderson, would retain that role in a combined carrier, these people said. Participants would like to announce a deal as early as next week. But these people warned that the talks could still be derailed over any of several issues. A softening economy and high fuel prices have convinced many in the industry that mergers — and the sweeping cost cuts that can accompany them — are needed to prevent carriers from facing a reoccurrence of the financial problems from which they are still recovering. Most major domestic airlines reported losses in the fourth quarter. Northwest lost $8 million and Delta $70 million.Analysts said the mergers could also lead to higher fares in some markets, at least in the short term, as combined carriers reduced flights and the number of seats, and used their increased market power to raise prices.

• Airlines Face a Wary Audience Merger talks between several U.S. airlines could shake up routes, hubs and fares. But industry observers say deals resulting from current discussions aren't likely to be disastrous for airline customers.

Big Pharma's tough medicine It's been a rough 2007 for Big Pharma workers. Crippled by mounting competition and slowing pipelines, the country's largest drugmakers have announced plans to shed a record number of jobs this year - more than 30,000 at last count - that are unlikely to ever return. The latest sign of the downsizing frenzy: On Thursday, Novartis (NVS) announced plans to lay off 2,500 workers, or about 2.5 percent of its global workforce, by 2010. The Swiss drug maker hinted that deep cuts were coming when it said earlier this year that it would cut about 1,260 sales positions in the United States. Announcements such as Novartis' seem to be a weekly event. "It's a difficult time for drugmakers," said John Challenger, the CEO of outplacement firm Challenger, Gray & Christmas, whose employment tracking service shows that 2007 has been a peak year for Big Pharma hemorrhaging. Drug companies are getting clobbered by cheaper generic medicines, less-productive research, and expiring patents on their most lucrative drugs. "The business," continued Challenger, "is very different and they're forced to undergo some very painful changes." In response, the American and European drug giants that have historically dominated the industry are overhauling their businesses. From sales and marketing to research and manufacturing, these companies are finding more cost-effective ways to conjure up and sell new medical treatments. Among other steps, they're redesigning their sales teams and turning to India and China for less expensive manufacturing and research. Developing countries offer not only the opportunity to create new drugs cheaply, but also their own potentially lucrative market, ... He noted that developing countries tend to have less-onerous regulatory processes and sufficient intellectual property laws to lure Big Pharma.

How Merck healed itself Over the past two years Merck has exceeded expectations on all fronts - scientific, financial, and legal. Since the beginning of 2006 it has gained FDA approval for seven new drugs, more than any of its peers. At the same time, the company has won the majority of the jury trials in its defense of Vioxx, the painkiller it was forced to withdraw from the market in October 2005 after studies linked it to heart attacks and strokes. Those victories enabled the company to settle the bulk of its lawsuits last November for $4.85 billion - considerably lower than the initial estimates of $20 billion. Investors have noticed, sending Merck's stock price up 75% since the beginning of 2006, far outpacing its peers. The lion's share of credit for Merck's recovery goes to three men: CEO Richard Clark, chief scientist Peter Kim, and former legal counsel Ken Frazier. "Over time Merck had developed into several fiefdoms, each doing their own thing," says one insider. Clark, 61, insisted on "One Merck," a catch phrase he repeated often. Beyond the words, he sought to unite Merck operationally. "We needed a more integrated approach," says Clark. "From the moment we begin talking about a particular drug franchise, I want researchers, marketers, and manufacturing people sitting in the same room."As Clark kept his eye on the big picture, Kim focused on the labs. Merck's scientific excellence had long inspired admiration and envy; corporate leaders voted it America's Most Admired Company in Fortune from 1987 to 1993. By the early part of this decade, however, Merck was finding it difficult to turn its science into new, profitable medicines. In Merck's case, there was a unique element added to what was an industrywide drought. Merck was so pleased and proud to be Merck that its research culture had become haughty and insular. The company refused to consider medicines discovered outside its own labs and spurned the mergers and research alliances that were reshaping the industry.

Merck's risky research bets Merck has pulled off a remarkable comeback in the last two years. Now the pharma giant is conjuring medicines with a new scientific swagger, making two particularly risky bets. Each of these controversial development projects - an experimental weight-loss pill and a cholesterol-lowering treatment - resemble a drug that Merck's peers, Sanofi-Aventis (SNY) and Pfizer (PFE, Fortune 500), spent nearly $1 billion to develop and yet failed to bring to the U.S. market. Merck's progress is being closely watched. It wasn't long ago that Merck Research Labs was in the doldrums. In 2003, the company was forced to discontinue development of four potential blockbuster drugs - including a potentially lucrative antidepressant and a diabetes treatment - because its research didn't pan out.

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

This has been a rich week for news and stories in the general business sector but particularly in the technology and related industries. On the continuation you'll find several interesting excerpts and links but we want to set the stage with our own post on the B2C Wars:

B2C Wars:Yhoo/MS Merger - Disaster in the Making ? Among the other big news, and there was sure a lot of it last week, was Fri's announcement of MSFT's semi-hostile offer for Yahoo. An offer which apparantly is the last item in almost two years of on-going discussions and failure to reach agreement. In our humble opinions this is a disaster in the making and they only possible beneficiary is Google. That conclusion is reached by a combination of familiarity with the Industry, with companies and technologies involved and applying our model of enterprise assessment (Masterclass: Buffett on Investing and Business Analysis). It's also a lesson in business history among other things. In any case how this plays out is important for Internet users, for investors and for employees as well as customers and suppliers of the companies involved. As a start on pulling the pieces together we used our framework to put together a preliminary analysis skeleton of the merger and wrapped it in a bit of industry analysis as well.

Not only for it's own sake, that is specific to the Yahoo/MS merger talks but also for the portrait of the B2C Industry, the illustration of the business analysis approach and also for a bit on the broader telecom industry. As you read 'em put the exceprts into the context - Google's continuing it's charge on network hosted apps - how much influence does that have on MS's thinking ? Meanwhile after all the $ they haven't figured out how to monetize social sites (maybe Murdock was lucky to miss out). What does that say about Google's strategic outlook (which is dissected in the B2C Wars post a bit). Meanwhile Time-Warner is about to spinoff part of AOL but has yet to come to grips with what the rest should be. Has the industry evolved beyond their ability to morph with it ?

In complement the Telecom industry is facing some mounting challenges with growth in wireless and broadband slowing rapidly; largely due to saturation and lack of compelling new value. And the Tech sector as a whole, as proxied by the Nasdaq/NDX, continues to head down. This week triggerred by Cisco's quarterly report which found weakness more widespread than anticipated. We'll refer you back to an earlier post on innovation-based industries for a broader discussion of trends which you might want to review, especially as the earlier posts it points to take you back to when it was time to get out of tech for fundamental reasons which are further explained and still relevant.

Finally there was an interesting Bloomberg story on HPW and Mark Hurd. Now the book on Hurd is that he's an ops guy but in actual fact he's an everything guy. That is he focuses on getting the strategy right, making the ops will in fact do what they need to do, cutting costs where necessary and investing where advantageous. And especially getting the people and accountability issues right. He's not only managed to grow HP's revenue but it's profit and margins significantly. All in all we'd take Hurd's work as a perfect example of how performance results from a balance of strategy, execution and leadership.

And for which we'll point you to two posts on business analysis:

• Earnings, Valuations & Business Analysis(I): Readings
• Earnings, Valuations & Business Analysis (II): Resources and Approaches

We'd like to suggest that the HPQ story is the perfect opportunity to read the latest 10-Q/K and go to the web site. We won't post the links because they're relatively easy to find. But the PDF files on the HP site with the quarterly dissection are pretty good, the introduction of the Annual Report provides some strategic perspective and the SEC filings flesh it out (though amusingly the annual report's main body is almost the filing ! Talkg about cheap - we love it !). For an investment of 90 mins to 3-4 hours you'll get a good idea of how HP sees the world, what their strategies are and whether or not you want to consider them an investment.

Now given they are the world's dominant PC and printer manufacturer and what they have to say about the industry is educational and worth your time. But also consider - it wasn't that long ago that the Street's finest were talking about splitting up the Company. Take a look at the revenue and profit numbers by segment and tell me how much sense that now makes. In other words to put the point on it - the Street's simple financial engineering fix would have not fixed anything. By failing to look at the underlying business capabilities they missed a key opportunity. Which Hurd has developed.

Here's another point to think about - after reading the materials. If the strategy and business model makes sense, if HP can keep executing so well against it, aren't they going to be a great buying opportunity once things settle out here ? We sure think so. Though in the broader context we also think the "settling" process has a long way to go.

READINGS 

Google Chases Business Technology Dollars  While Microsoft is telling anyone who will listen that it’s challenging Google for online search dollars – see the proposed acquisition of Yahoo – Google is challenging Microsoft for corporate customers. The latest example: Google today released a set of security products aimed at businesses. The new products are online email management tools that come from Google’s acquisition of Postini last year. For $3 per person per year, a business can get tech that filters out spam emails and messages containing computer viruses from their inboxes; for $12 per person per year, a business can add monitoring that prevents employees from sending messages they shouldn’t, like top-secret takeover plans; for $25 per user per year, a business can add discovery tools that help it find emails that it may need for legal or other reasons. In each case the Google tools are available over the Internet, meaning there’s no software to install. The products are being sold by Google’s business division, a small but growing part of the company best known for its online Apps package, which includes word processing and spreadsheets that multiple people can use. Google’s business strategy is essentially to get people hooked on its online software in their personal lives, and then develop business-friendly versions of the same software that information-technology departments feel comfortable running in the office — once they realize that workers are going to use the software whether IT supports it or not. Microsoft, on the other hand, is counting on the relationships it has with IT departments to get its collaboration products into businesses. This is one fascinating aspect of the Yahoo deal: It gives Microsoft the chance to combine Yahoo’s user-friendly online software with Microsoft’s business credibility. Google Marginalizes Tech Departments Even More

Social Sites Don't Deliver Big Ad Gains Social networking and video-sharing sites are yielding ad revenue slower than some Internet companies hoped. As Microsoft Corp. makes a $44.6 billion bet on Internet advertising with its unsolicited offer for Yahoo Inc., there are signs that some of the biggest new places where consumers are flocking on the Web -- social networking and video-sharing sites -- are yielding advertising revenue slower than some Internet companies had hoped. The latest warning that the hottest Web properties are proving difficult to make money from came from Internet giant Google Inc. While announcing disappointing fourth-quarter earnings Thursday, Google executives said the company was having a harder time than it expected generating ad revenue on social-networking sites and figuring out the best ad formats for its YouTube video-sharing service. Social-networking phenomenon Facebook Inc. also has been publicly grappling with how to make money amid its massive spurt in usage. One key will be the speed at which advertisers ramp up their spending in these areas. Another issue is advertiser comfort with having their ads displayed alongside less-predictable content. Some advertisers say sites such as YouTube, where most clips are uploaded by users and can run the gamut from raunchy to poor video quality, still lack enough videos where mainstream advertisers are comfortable running their ads.

Change Coming at Time Warner Taking a hard-charging tone in his first address to investors, Time Warner Inc. Chief Executive Jeff Bewkes laid out his blueprint for shaking up the sleepy company, confirming for the first time his intention to cut costs and explore changes in the company's ownership of Time Warner Cable Inc.Mr. Bewkes, who succeeded Richard Parsons in the top job at the start of the year, also confirmed he is separating AOL's shrinking Internet-access operation from its Web-portal and advertising business. Such a move could pave the way for the divestiture of both businesses.Investors are looking to Mr. Bewkes to revive Time Warner's ailing stock by taking a more aggressive approach than his predecessor. Kicking off his debut conference call by saying he intended to have a "straightforward" dialogue with shareholders, Mr. Bewkes said he would focus on improving profitability and striking the right mix of businesses. Eight-Year Time Warner/AOL Marriage On the Rocks

Why U.S. Telecom Is Losing Juice For the U.S. telecom industry, January has been bloodier than a Quentin Tarantino movie. After leading the market for most of 2007, telecom stocks have been beaten to a pulp this month, with the Standard & Poor's Telecom Services index off 10%. That's more than the Dow, the S&P 500, even the much- pilloried investment banking index. What's going on? In a nutshell, the industry's two growth engines for the last decade—wireless and broadband—are sputtering. Fact is, more than 80% of Americans now have a cell phone, and 79% of homes with a PC have broadband service. This year, according to Banc of America Securities (BAC) analyst David Barden, wireless subscriber growth is expected to drop to 7%, the first year ever in single digits. Broadband subscriber growth is expected to hit 12%, down from 18% in 2007. To be sure, AT&T (T) and Verizon Communications (VZ), the industry's two giants, reported solid fourth-quarter earnings and respectable outlooks for 2008. They may be more insulated than rivals such as Sprint Nextel (S) and Qwest Communications (Q). Still, with the economy expected to slow in the months ahead, the challenges with wireless and broadband will have a significant impact on the way communications companies operate and compete.

Hold the iPhone: AT&T expanding network speed AT&T Inc. on Wednesday announced it will expand its high-speed wireless network, a move that would especially benefit future iPhone buyers. One of the few major complaints about Apple Inc.'s wireless phone is its reliance on AT&T's slower wireless network, known as Edge. Download speeds on Edge rarely exceed 200 kilobits, far less than what's offered by rivals Verizon Wireless and Sprint Nextel Corp.. Sending data over the Edge network is even slower. AT&T's newer "3G," or third generation, network is based on a different technology known as HSPA. That network enables AT&T customers to download music or video at much faster speeds -- up to 1.4 megabits per second. It's as fast as basic DSL Internet service. What's more, the HSPA network is also being upgraded to allow customers to send or "upload" data at significantly faster speeds, peaking at 800 kilobits per second. (That version is known as HSUPA, with the "U" standing for uplink.) With faster access to the Internet, the popular iPhone would become even more attractive and potentially drive Apple's sales higher in the second year of the product's life cycle. Future buyers could take better advantage of the device's multimedia capabilities such as surfing the Web or directly downloading music and videos. Downloads on the iPhone can sometimes be painfully slow. Although Apple and AT&T have not specified a date, the companies have indicated that new iPhones compatible with its faster mobile network would be available in 2008.

Cisco Declines as Sales Forecast Misses Estimates, Eclipsing Profit Gain Cisco Systems Inc., the biggest maker of computer-networking equipment, fell as much as 8.6 percent in European trading after Chief Executive Officer John Chambers said a sales slump may last months. Third-quarter revenue will grow 10 percent, Chambers said yesterday on a conference call, falling short of the 15 percent predicted by analysts in a Bloomberg survey. It was the second straight quarter that his sales forecast disappointed investors. The outlook fueled concern that a slowdown in U.S. technology spending is spreading overseas. Sales in both the U.S. and Europe grew less than predicted in January, Chambers said. Customers are ``cautious,'' he said, and that may continue for the next several months. U.S. orders grew 12 percent, compared with 13 percent in the previous period, Chambers said. European orders slowed to 8 percent from 20 percent as telephone companies cut spending. ``That's good, but that's not great,'' Chambers said in an interview. ``If you add the U.S. and Europe together, that's 70 percent of my business.'' 

• Cisco Anticipates Sector Weakness Cisco posted a 7.2% rise in net and a 17% jump in sales, driven by growth across its portfolio of products. Cisco's earnings come amid an uncertain environment for the tech sector. In recent weeks, tech giants Microsoft Corp. and Google Inc. have reported a mixed bag of earnings and sent cloudy signals over projected tech spending growth. Mr. Chambers helped trigger the concerns over tech in November when he cautioned that U.S. spending on networking might be "lumpy" over the next few months. Overall, Cisco posted diversified growth for the quarter. Its two main businesses -- switches and routers -- posted 11% growth and 18% growth, respectively. Sales of newer products, including wireless products and home-oriented networking equipment, which are part of Cisco's Advanced Technologies Group, rose 25% over the quarter, while services revenue increased 18%. Emerging markets revenue soared 53%, outstripping 14% growth in the North American market. Cisco has been working to diversify away from its core computer-networking business by pushing into new technology areas, such as videoconferencing and set-top TV boxes, as well as into developing regions like China, India and the Middle East.

Alcatel-Lucent Deal, Revisited At Alcatel-Lucent, some investors are betting that there is no where to go but up.The merger in late 2006 that united Paris's Alcatel SA with Lucent Technologies Corp. of Murray Hill, N.J., was supposed to form a sleek company with the scale to weather bruising industry competition and consolidation among telecommunications operators. But nothing seemed to go right, and the company soon became a punching bag of the telecom-equipment industry. "We've made a bet that the demand for telecom equipment is decent, that the consolidation the sector has undergone will help and that Alcatel is a relevant global player with good assets…However, Mr. Eiswert acknowledges a big unknown: "The key to our investment being successful over the next year or two is the management team's ability to unlock the value of the company," he said.Last year's poor performance has put pressure on Ms. Russo and Mr. Tchuruk, but the company's board has stood by them so far. The board has a regularly scheduled meeting today before fourth-quarter earnings are reported tomorrow. An Alcatel-Lucent representative declined to comment.The telecom-equipment market has yet to recover from the wave of consolidation among both manufacturers and buyers, making more turbulence possible in the short term.

Hewlett-Packard's Hurd Restores PC Profit by Debating `Every Single Dime' Mark Hurd asked managers how they would build the perfect company in five years when he took over the top job at Hewlett-Packard Co. in 2005. He also said he would scrutinize every cent they spent to get there. His cuts at the world's largest personal computer and printer maker include spending on jobs, data centers, real estate and even file cabinets. Hurd, 51, reshuffled the management team, merged data centers and added 2,000 sales people last year. Hurd has reclaimed the PC lead from Dell Inc., topped each of his profit forecasts and driven sales beyond $100 billion. That has led analysts and investors to declare Hewlett- Packard a turnaround just three years after Hurd succeeded former Chief Executive Officer Carly Fiorina, a strategic thinker who courted media attention. Under her, Hewlett-Packard failed to deliver on profit forecasts and lost the lead to Dell, prompting analysts to call for a spinoff of the PC division. PC profit margins are now the best in five years. That doesn't mean Hewlett-Packard isn't investing in the business, Hurd said. It spent about $7 billion last year on acquisitions, mostly software companies, and made $3 billion in capital expenditures. ``You get the strategy right, get the operating model right, get the people right, I mean generally, good things happen to you,'' he said.

Posted by dblwyo at 07:34 AM | Permalink | Comments (0)

As is getting to be, at least not unusual, we ended up splitting up the Weekly Reader Readfest as well as putting up some more specific posts on particular topics. But talking about how much is going on if you try to pay attention is not news anymore. There's a lot of events but not a lot of startling ones, changes in direction, structural shifts or what have you. The Bear Bounce seems to have run out of steam a little quickly but we'll see how things go. Meanwhile the economic news continues not good. We want to make a couple of key points but by and large this week's readings and links are consistent with last week's and some earlier posts of ours. So in the links and excerpts we're a bit self-referential. In particular the economic links tend to confirm some arguments we've made for some time and we post the links back to last week's analysis of GDP and Employment which puts them in context. Similarly for some of the information on the markets, credit, etc. etc.

Here are the two important points we think stand out after you step back and think about it for a while:

1. The markets in general and the analysts in particular haven't factored a recession into their outlooks. A point supported by the surprise of the ISM numbers and the market's reactions as well as the EPS outlook for the second half.
2. That we're in a slowdown and likely recession now is not being debated as much. That Housing problems will continue into 2010 is just now being acknolwedged and the spreading "ripples in the pond" of credit and derivatives are still not fully reflected. Yet those ripples are becoming widely apparant. 

General & Special

• More on GDP and Economic Outlook

• More on Payroll Data: the Employment Outlook

Economy

The Great American Jobs Machine Is Conking Out Like lava flowing from a volcano, creative destruction—the economic notion that old companies and industries have to be wiped out before new ones can be born, first popularized by economist Joseph Schumpeter—is scary but beautiful. In the New Economy of the late 1990s, this phenomenon turned the U.S. into an amazing job-generating machine, because the rapid destruction of companies and jobs in flagging industries was outpaced by even more rapid creation of new jobs in growing sectors. From the bottom of the 1991 recession through the economy's peak in early 2001, the U.S. created 24 million jobs. That creative/destructive energy, triggered by rapid technological change and globalization, is long gone. From the end of the 2001 recession through December, 2007, the U.S. economy added just 7 million jobs. Even taking into account that this expansion has been shorter than the 1990s one, the growth rate of jobs was about half as fast this decade. Now, what little energy the jobs machine had left may finally have run out. On Feb. 1 the government reported that U.S. employment shrank by 17,000 jobs in January, the first time employment declined for a month since August, 2003. The weak report helped convince some wavering economists that the U.S. is entering a recession, which would mean further job losses in the months ahead. On its face, the January jobs report isn't dire. The net loss, while it made headlines, was just 17,000, which is so close to zero that it's statistically indistinguishable from no change. What's more of a concern, though, is evidence in the report that 2000's pattern of pokiness is continuing. Jobless Claims Show Labor Market Strain

Debt & Borrowing The binge may be done, but get ready for the hangover. The economy has become dependent upon rising borrowing (and therefore indebtedness) to support the increased demand that is key to production’s and employment’s healthy growth. When borrowing slows, however, so does spending. (Note the residential-construction collapse.) And that has always brought recession. This time is no exception. Until recently a portion of American households saved enough to supply all the funds required by private and federal borrowers. Lately our domestic borrowing became so large and our domestic saving so small, that we had to “import” funds from overseas. That puts the quotation in the New York Times article in a different light. Our lack of saving never constrained our borrowing. We merely obtained more of the funds from abroad. The stock market and residential real estate gained value, buoyed – increasingly – by funds flowing in from elsewhere. There’s another point that bears mention. Contrary to what the quotation implies, capital gains (increasing stock-market and home values) are not the same as accumulated saving. Both increase wealth or net worth. But the person who continues to save during the upcoming recession will continue to see his or her assets grow. Those who relied upon capital gains, and hoped for more of the same, will continue to see the value of their portfolios and homes melt away.

What slump? Homeowners in denial Despite numerous reports showing home values in historic decline, more than three out of four homeowners believe their own home has not lost value in the past year, according to an online survey. The survey was conducted by Harris Interactive for Zillow.com, a Web site that gives estimated home values. The survey of 1,619 homeowners found 36% believe their home has increased in value, and another 41% believe their value has stayed the same. Only 23% believe their home has lost value. "This survey reveals that despite the data to the contrary, people either aren't paying attention to their housing market or are in denial about their own home's value," said Stan Humphries, Zillow.com vice president of data & analytics. Zillow's own estimates are that home values declined 5% on average last year, with many markets posting much steeper declines.

·         Home prices set to slide in '08 National Association of Realtors pulls back on outlook, forecasting second consecutive annual decline. Pending Home Sales