bizzXceleration: Performance, Value and Profit

Since Dell not only announced it's results this morning and surprised everybody, perhaps itself also, with pretty good numbers we thought a deeper dive on what's going on might be appropriate. And a test of our various toolkits for enterprise and industry analysis. Here we're going to dive into Dell's strategy, commenting along the way, as they see it themselves. And base it on their most recently available analyst presentations. We've argued before that Dell's downturn was visible at least three years before the fecal matter hit the impeller for two reasons. First off their core business - selling cheap beige boxes to large enterprises - was maturing and headed down. Now we also admit that we though their basic business model of low-cycle-time, customized order fulfillment would adapt nicely to a lot of other opportunities. Second we argued that they were cutting way too many corners since their whole business model was based on trust, reliability and outstanding, responsive customer service. When they started off-shoring and that service became non-responsive what had been a competitive weapon devolved into a cost to be shrunk. We won't mention the disingenuous accounting that went along with all this. Well let's not get to excited but things may in fact be turning around...and not because of the numbers. We still have to see how sustainable those are and how the economies hold up. Nonetheless DELL goes on our watch list as a strategic buying potential. Let's talk about why.

The two major challenges Dell had was they needed to re-think their business model for a new world. AND they needed to completely re-think, transform and re-build their operational capabilities to support whatever they finally came up with. Dell had three key initial challenges: 1) face reality, 2) re-think, re-craft and adapt their historic business model and 3) translate that re-thinking into new execution capabilities. We'll take a deeper dive on major aspects of these after the break but here's a composite picture of two key charts from their Apr08 analyst meeting.

The top half lists out the key challenges, where they want to go and where, according to their dashboard they think they're at. Refreshing and honest on many levels take a careful look. The bottom chart focuses on the two key strategic elements of profits and costs. Re-thinking product design and development, both as a cost control and a strategic marketing initiative. And reducing on-going operating expenses. Again both appear well-thought thru and accurate. The proof of course will be in the pudding. 

That is are the new ideas and business models being translated into the key strategic initiatives required to implement them. Well take a look at another composite chart which certainly indicates somebody has done some serious thinking indeed. The top sub-chart shows key strategies combined with the major, DIFFERENT, markets they are going after. Each of which requires different capabilities, business model adaptations and NEW operational capabilities. From marketing to customer service to go-to-market channels, logistics, manufacturing and product design and development.

So the next critical questions are they being put in place - which is preceded of course by recognition, acknolwedgment and commitment. And are they working as planned - likely in the face of economic turbulence and worldwide competition as well as the inherent challenges of doing business in unfamiliar markets. But it is the right, componentized, modular and adaptive Chinese menu of re-structurings that suits the markets they propose to tackle. 

Consumer Markets (US,  RoW, Emerging)

One key area they intend to tackle, looking at the preceding charts, is consumers. In both the US and worldwide. Now bear in mind while Dell has sold to consumers they made their bones selling cheap to big corporations and government organizations. Now they're trying to "re-vitalize" their US consumer image, increase their share in the developed world and go after the emerging world big time. Part of this is operational capabilities because this requires new channels, i.e. the direct order model doesn't work well. Which in turns means a complete re-think of of manufacturing and logistics since their old system was rigidly designed and built for their old strategy. It also means re-branding themselves. Well from the chart at right at least they get the point...we'll have to see but you'll be able to tell for yourselves to some extnet by watching their advertising, web site and the trade press. In any case just starting these sorts of strategic marketing efforts breaks new ground for Dell. They are clearly adapting.

 Business (Large and SMB)

Again across geographies Dell is trying to re-vitalize it's enterprise business but this time it's looking to go after not just desktop PC's for large enterprises. It's also looking to go both worldwide and after the Small/Medium business. Now several years back it was my opinion that Dell's existing business model would readily extend beyond PC's to go after servers, networking gear, printers, etc. in the market segments it was already well-established in. And that it's responsive logistics and order fulfillment ought to give it a leg up on the SMB space. Unfortunately they lost ground in those spaces for the same reasons they lost ground overall...which was really dangerous because it was home turf and the cash cow. 

Now it looks like they've come up with the right strategies and value propositions along with a pretty good notion of the necessary operating  capabilities needed to go after the large enterprise and SMB spaces. The latter is particularly important if you'll recall some of our earlier work on the structure of the IT marketspace. 

Go-to-Market Channel Strategies

Whether it's large or SMB, whether it's developed or emerging world the old direct model isn't appropriate for all the target customer sets. In fact for consumers they really do need to go after retailers - this is especially true in the developing world. Which means they need to build a robust channel management capability built around partners that they've never had to have before. And, the good news is that they not only realize that but it appears to be coming into place. Again if these two charts are a fair representation of the thinking and capabilities Dell is well on its' way to building the kind of channel management capacity required. Again of course we'll have to see but this is NOT just a proof of the pudding sort of thing - if you stick with it after getting the initial idea right it becomes a major new competitive weapon.

Services

For Consumers, SMB and Large enterprises the "undiscovered country" for almost everybody is services (recall HPQ's recent acquisition of EDS). Computers are still no easier to use than they were. The catch is that services are hard to do, require lots of bodies and capabilities and can be low margin businesses if you screw up any of these requirements. 

Dell appears to be addressing this in several ways (& being more than a bit disingenuous along the way). They've id'd addon services as a huge marketspace but their counting includes all services, e.g. hugh server install and applications support. Which they are not proposing to do. So the addressable marketspace is much smaller than they told the analysts. Nonetheless by focusing on the picky little stuff they're focusing on stuff that costs their customers, that fixing adds value, are common and repetitive and therefore modularizable. So even if they leave most of the total market on the table the parts they're going after suit them, are amenable to cost efficient management, synergize with their core offerings well and could double the revenue over time. Albeit at lower long-term margins.

Bottomline

At long-last Dell is saying and, apparently, doing a lot of the right things. There's a long way to go before all this stuff is in place and begins to fire on all cylinders. But it wasn't that long ago that they stood up at major national conferences and could NOT present a clear, simple picture of who they were going to become and how they were going to do it.. Now they can. If they can turn these good ideas into new parts of their enterprise DNA they will build a new set of moats behind them and create major new value propositions. I don't know yet whether this can result in returning them to their glory days. Frankly I doubt it. But it will turn them into a large, growing, profitable and well-run company with great, sustainable strategic opportunities in the developed and developing worlds.

All of which doesn't mean they're yet an immediate buying opportunity. Depending on how you think the economy is going, and will go, and how that impacts Dell's business a downturn is likely to take down earnings and therefore the stock price. You'd also want to start testing at least the obvious signs of whether or not they're delivering on these initiatives - from the web site to word of mouth to quarterly analysts reports and annual updates. But right now Dell looks like it goes on your long-term watch list in our humble opinion ! 

And a final caveat, and a major one. Each of these new structural changes/strategic initiatives has a major weakness to be overcome. In the consumer space it'll be re-thinking the product design for appeal as well as function and then marketing it. In the enterprise space it'll require a commitment to on-going innovation in larger servers and networking. As well as the appropriate sales, marketing and channel operations. ALL of which are new capabilities. And future growth is critically dependent on services yet Dell's not equipped to go after the more complex services and isn't. And so on and so on thru each line-of-business, initiative, target market and geography. YET...this is a SEE change. 

Posted by dblwyo at 10:49 AM | Permalink | Comments (0)

It's time to pick up the thread of our readings on the future of the Oil Industry and extend it to a structural picture of the future. Within our limits of course. The prior post provided a sampling of readings as well as a strategic summary (). Here we'd like to tunnel into the big picture and little bit and take a look at price trends, energy demand patterns and long-term supply-demand balances. Or as the case is...supply-demand imbalances. Let's start with the following chart on long-term prices and S/D trends.

In some ways no big surprises, at least until you look fairly closely. The top sub-chart shows annual growth rates in world supply, demand and the balance along with trends for the former. The bottom sub-chart shows oil prices, real oil prices and YoY% changes in real prices since '64. A couple of "small" surprises. While we did our own calculations of real prices, so they're at odds with the official ones, our guesstimate is that they are as high as they've ever been and climbing. The surplus of S>D has shrunk abruptly but the rate of growth in Demand has now shrunk below that of Supply ! If that were the long-term trend we'd be pretty happy. That reinforces many of the arguments we made.

After the break we look at the bigger picture strategic issues but here's the bottomline, again. Oil is economically and affordably available but is increasingly controlled by non-market decision-making. And we are increasingly hostage to that decision-making almost entirely thru our own choices. Until we have a major national commitment to a national energy policy that is pragmatic, workable and realistic these trends will continue. And will likely accelerate. And you should note that this is NOT something foisted off on us. Who owns an SUV ? What's the H.P. in your car ? We choose to pay bottom-dollar for gas in the last several decades instead of pursuing alternatives. No the vultures are coming home to roost. 

Energy Consumption vs Supply

Consider the chart from the most recent National Energy Plan (NEP) which dates from circa '01. It tells us something we've known for a long-time. That is, demand >> supply. The problem is that while we've known we haven't done much about it. And since this work was done the entire structure of world energy supply and demand has undergone a major structural shift. Which means these estimates are likely conservative in the extreme. Not in terms of our D>S but it terms of supply availabilities.

Long-term World Oil Prices

Nor is this problem likely to go away anytime soon. Here are DOE's assessments of long-term oil prices under high, base, and low oil-price cases from now until 2030. A couple of key points to notice. These were done long enough ago that we've already blown thru the high price. Even under the high price scenario total demand keeps growing steadily. And the underlying realities that oil could be available are reflected. So we're back to geo-political and offshore-control premia being built into the current prices. Which suggests in the short- and intermediate-terms that prices could come down. 

World Reserves Sourcing

Remember we keep talking about the huge structural changes. Well here's one way to look at it. BigOil no longer controls its' fate nor ours. More and more of the world's oil reserves are somewhere else. In fact if the WSJ's take is correct approx. 7% of the world's oil reserves are open to free, market-based competition, with another 12% under limited access. Which leaves 65% + 16% = 81% of the world's oil under restricted, controlled access.

Which would actually be o.k. if we were sure it'd come onto the market according to economic and not political forces. Reinforcing our point out oil being available. But also reinforcing the two critical points. Decision making is political and they're enforceable. And second, most/many/all of the political entities are not investing in existing production as required to maintain flow. Nor in exploration and development to replace declining production from old fields. Oops...or better yet damm.

US Political Choices

While Peak Oil Theory would argue that much of the US's continental reserves have been discovered, developed and used up we don't know about our own offshore reserves. Which judging from prior geological work as well as recent discoveries, e.g. Brazil, may in fact offer extensive resources for development. Unfortunately, like almost every other energy policy switch we could throw, this one is also in the OFF position.

We need a sustained, multi-decade effort to develop new sources of energy, new technologies for using what we have, promoting conservation and demand reduction and we need to commit to it. This is our choice. How do you vote ? Meanwhile just remember when you buy an OECD oil major you're buying the cash flow of a depreciating asset. And you can't invest in that other 80%+ of the world's oil. 

Posted by dblwyo at 10:49 AM | Permalink | Comments (0)

Needless to say oil prices are occupying everybody's mind right now - particularly since you can't go down the street without seeing $4/gal gasoline prices. Congress is holding hearings to chastise the speculative excesses with "inside baseball" players using the correlation is causation argument to prove widespread evil-doing. My favorite bloggers (BigPicture, CalculatedRisk) and financial writers (Jubak, Mauldin) have all put together excellent summaries recently that are worth reviewing. And of course the MSM (WSJ, NYT, et.al.) is covering the issue extensively. So here's our collection which we've been putting together for a couple of weeks now, and for which the time seems ripe.

The basic argument, which we plan in expanding into an analysis in a follow-on Part II, is the fight between fundamentals and speculators. As you skim over the readings below you'll find a wide sampling of sources and informed opinions but here's our take. Of the ~ $150 price/barrel target price the long-term fundamental price is in the $80-100 range. Another big chunk of that target is caught up with geo-political risk factors. And a third with speculative feedback on short-turn prices. Let's say that the proportions are roughly 60% fundamental, 20% risk and 20% speculation.

Except for one thing. The basic structure of the oil industry is that the major cost drivers are exploration and production; then distribution and processing (refining). As oil has gotten more scarce in inexpensive and readily (politically) accessible areas of the world there are non-linear rising costs to the two fundamental drivers. That's lead to a fundamental and long-term supply-demand imbalance as new oil production hasn't been keeping up with new oil demand and consumption. A partial result of that long-term dynamic of skating on the margin is that the system has been and is increasingly vulnerable to shocks as its' fragilities grow.

That's been the basic dynamic for at least three decades only it's gotten much more pronounced in this century. HOWEVER....there is another fundamental shift well underway that is greatly exacerbating all these innate structural characteristics.

Not only are new oil sources in increasingly hard to get to areas but the bulk of the world's known and potential reserves are no longer market priced nor controlled by private companies. Rather they are controlled by national oil companies or other political entities. Who's priorities are NOT long-run profit maximization.

Worse yet for those reserves controlled by political entities they are milking existing reserves to fund socio-political priorities and significantly under-investing in maintaining current flows while not developing new ones.

There are two bottomlines here:

1) oil is likely available but is getting increasingly scarce at prices we're comfortable with; i.e. the $80-100 baseline structural price, which shifted up from $40-50 in the last ten years, is likely go toward $150+. 20% X $150 = $60. 2 X $60 = $120. $150 + $120 ==> ~ $300 oil !

2) because oil is depletable and demand is growing there is a long-term scarcity premium that's being increasingly reflected in the base (cf. Prof. Hamilton's discussions below). In other words there is a rising scarcity rent being built into l.t. prices that's feeding speculation.

So below you'll find readings on the short-term and long-term pricing factors as well as the impacts on gas prices and the survivabilities of the refiners, or refining operations. You'll also find some fundamental re-thinking about the future prospects of Big Oil as we know. Which is pretty good though it generally doesn't reflect these deep structural changes evolving in the fundamentals of the industry....yet....other than by symptom.

The next steps of course are diagnosis and treatment....otherwise known as a National Energy Plan. Yeah, right. 

Short-term Pricing Factors

Oil: Key players and movements The rising oil price, which topped $130 a barrel this week, risks pushing the global economy into a deep and prolonged slowdown. As long as demand from leading developing countries such as China and India remains strong, the price is likely to stay high. A combination of other forces, including the weakening US dollar and geopolitical tensions, is driving prices higher. Our map examines the world’s largest oil producers, consumers, and how oil flows around the world.

• ·         Whither the Price of Oil? Why has the price of oil risen so much in the past few months? Is it a supply and demand issue as some believe; or is it because of an out-of-control futures market driven by the proliferation of commodity index funds and rampant speculation, as everyone tries to get in on the rise in commodity prices? This is a very complex issue, with a lot of emotion attached to it. This week I try to give you an understanding of why oil prices have risen and whether they are likely to stay at such lofty heights or maybe even fall! And we look at a very odd statistic: where are all the tankers? There are some very unusual things happening in the oil patch. If you are currently exposed to the energy or commodity markets, or are thinking about it, I believe you will find this letter of interest.

Blame Wall Street for Oil at $135 a Barrel as Traders Cover Wrong-Way Bets Oil's rally to a record above $135 a barrel came as traders bought crude to cover wrong-way bets that prices would decline, according to data from the New York Mercantile Exchange. The number of outstanding futures contracts, known as open interest, fell 8.1 percent in a week to 1.36 million at the same time that prices rose 2.6 percent, the data show. Falling open interest and rising prices are signs that traders are buying to exit so-called short positions that would profit if oil fell, and lose money as they rose. Oil prices have closed at record highs on 27 days so far this year, prompting OPEC oil ministers including Saudi Arabia's Ali al-Naimi to declare that the rally is led by investors, rather than a shortage of supply. U.S. oil executives told Congress yesterday that prices should be between $35 and $90 a barrel. John Hofmeister, president of Shell Oil Co., the Houston-based subsidiary of Royal Dutch Shell Plc, pegged the proper range ``somewhere between $35 and $65 a barrel.'' Saudi minister al-Naimi said in March when oil was trading near $100 that prices were unlikely to fall below $60 or $70, representing the cost of producing alternatives such as biofuels or tar sands.

Soros, Ghanem, Tanaka, Chalabi's Own Words on $135 Oil May 22 (Bloomberg) -- Crude oil rose to a record $135.09 a barrel, an increase of 19 percent in the month of May, on supply concerns. This report compiles comments on the outlook for oil prices and factors affecting demand from International Energy Agency head Nobuo Tanaka, Chairman of Libya's National Oil Corp. Shokri Ghanem, billionaire investor George Soros, Fadhil Chalabi of the Centre for Global Energy Studies in London, Ashley Heppenstall, chief executive officer of Lundin Petroleum AB, Manoj Ladwa, a derivatives broker at TradIndex, Rachel Ziemba, an analyst at RGE Monitor, and Kevin Daly, a portfolio manager at Aberdeen Asset Management.

Long View: Classic films shed light on commodities boom Instead, the debate is narrowing around two explanations. The Jean de Florette thesis is that supply is being tightly constrained. The Trading Places thesis is that the new speculative money moving into commodity futures has distorted the market. The former leads to tragedy – a return to the 1970s, with commodities fuelling inflation while imposing a brake on growth. But the latter does not have ahappy ending. Instead, commodities’ new investors could lose their shirts as the bubble bursts. How does the evidence for the two hypotheses stack up? UBS details the constraints that are stoppering up the supply of oil. The big oil companies have made their plans on the assumption of $60 per barrel oil, it takes time to develop new supply, and so there is little relief in sight. According to UBS, 72 per cent of new global supply in the foreseeable future will come from just eight companies. Neither story explains everything. Tim Bond of Barclays Capital says many commodities that cannot be traded via futures and are closely held, such as tungsten and cobalt, have risen as much as mainstream commodities. Speculators have nothing to do with this.

• The Oil Speculation Debate , Speculators & Oil Price Spikes, Part II, The Short View: Commodity speculation

Long-term Structural Factors

IEA May Slash Oil-Supply Estimate The world's premier energy monitor is preparing a sharp downward revision of its oil-supply forecast, a shift that reflects deepening pessimism over whether oil companies can keep abreast of booming demand. The Paris-based International Energy Agency is in the middle of its first attempt to comprehensively assess the condition of the world's top 400 oil fields. Its findings won't be released until November, but the bottom line is already clear: Future crude supplies could be far tighter than previously thought. A pessimistic supply outlook from the IEA could further rattle an oil market that already has seen crude prices rocket over $130 a barrel, double what they were a year ago. For several years, the IEA has predicted that supplies of crude and other liquid fuels will arc gently upward to keep pace with rising demand, topping 116 million barrels a day by 2030, up from around 87 million barrels a day currently. Now, the agency is worried that aging oil fields and diminished investment mean that companies could struggle to surpass 100 million barrels a day over the next two decades. The decision to rigorously survey supply -- instead of just demand, as in the past -- reflects an increasing fear within the agency and elsewhere that oil-producing regions aren't on track to meet future needs.

What the Export Land Model Means for Energy Prices To understand the importance of exports when discussing peak oil, ask yourself the question, "What's more important: the fact that global oil production is falling ... or that the oil-exporting nations are cutting off their exports?"  The basic thesis is that, to fully appreciate the impact of peak oil, you cannot look only at the production declines so presciently anticipated by MK Hubbard in 1956. You also have to look at the rate of local consumption and the effect of that consumption on the ability of a country to export its oil. Mexico provides about 14% of the oil the US imports. On any given day that makes it either the #2 or #3 leading source for US oil imports after Canada and Saudi Arabia. Given that the US currently imports close to 70% of its oil needs, the Mexican oil is critical. But here's the thing. Using straightforward ELM calculations, Jeffrey Brown is confident that Mexico will ship its last barrel of oil to the United States -- or anywhere else, for that matter -- about 6 years from now, in 2014. In my interview, I also asked Jeffrey to share his thoughts on the situation globally. Here's his response. "Global production peaked in 2005, and we're now into the third year of decline. And the critical point to keep in mind is, our model and case histories show that the decline rate accelerates, year by year. Using the Lower 48 in the United States as an example, you can see the annual declines going 2%, 3%, 5%, 7%, 10%, 15%, 20, on and on. So it's an accelerating decline rate." Underscoring Brown's concerns: On April 15, 2008 the Russians, the world's second largest oil exporter, announced that their oil production appeared to have peaked, with production in the first quarter of this year declining for the first time in a decade. If they have indeed peaked then, based on the ELM, the world could lose Russia's current ~7 million barrels a day in exports within 6 to 9 years. Echoing the baseline premise of the ELM, Herman Franssen, president of International Energy Associates, projects that Iran, the world's fifth largest exporter, may consume an amount equal to their exports by 2015. Most concerning, this April Saudi Arabia's King Abdullah announced they were not going to raise oil production above 12.5 million barrels a day.

Understanding crude oil prices How would one go about explaining what oil prices have been doing and predicting where they might be headed next? This paper explores three broad ways one might approach this. The first is a statistical investigation of the basic correlations in the historical data. The second is to look at the predictions of economic theory as to how oil prices should behave over time. The third is to examine in detail the fundamental determinants and prospects for demand and supply. Reconciling the conclusions drawn from these different perspectives is an interesting intellectual challenge, and necessary if we are to claim to understand what is going on. In terms of statistical regularities, the paper notes that changes in the real price of oil have historically tended to be (1) permanent, (2) difficult to predict, and (3) governed by very different regimes at different points in time. From the perspective of economic theory, we review three separate restrictions on the time path of crude oil prices that should all hold in equilibrium. The first of these arises from storage arbitrage, the second from financial futures contracts, and the third from the fact that oil is a depletable resource. We also discuss whether commodity futures speculation by investors with no direct role in the supply or demand for oil itself could be regarded as a separate force influencing oil prices. In terms of the determinants of demand, we note that the price elasticity of demand is challenging to measure but appears to be quite low and to have decreased in the most recent data. Income elasticity is easier to estimate, and is near unity for countries in an early stage of development but substantially less than one in recent U.S. data. On the supply side, we note problems with interpreting OPEC as a traditional cartel and with cataloging intermediate-term supply prospects despite the very long development lead times in the industry. We also relate the challenge of depletion to the past and possible future geographic distribution of production. Our overall conclusion is that the low price-elasticity of short-run demand and supply, the vulnerability of supplies to disruptions, and the peak in U.S. oil production account for the broad behavior of oil prices over 1970-1997. Although the traditional economic theory of exhaustible resources does not fit in an obvious way into this historical account, the profound change in demand coming from the newly industrialized countries and recognition of the finiteness of this resource offers a plausible explanation for more recent developments. In other words, the scarcity rent may have been negligible for previous generations but is now becoming significant.

Brazil Oil Trapped by 500-Degree Heat, Salt Barrier Brazil's plan to become one of the world's biggest oil exporters hinges on exploiting crude six miles below the ocean surface in deposits so hot they can melt the metal used to carry uranium to nuclear plants. Tapping what may be the biggest oil finds in the Western Hemisphere in three decades will require equipment that can withstand 18,000 pounds per square inch of pressure, enough to crush a pickup truck, pipes that can carry oil at temperatures above 500 degrees Fahrenheit (260 Celsius) and drill bits that can penetrate layers of salt more than one mile thick. Petroleo Brasileiro SA, the state-controlled oil company, is betting on the Tupi and Carioca fields to become one of the world's seven biggest crude exporters. Until the tools needed to exploit the reservoirs are invented, the crude will remain locked under the sea, said Matt Cline, a U.S. Energy Department economist.

• Powering Brazils Economy Petrobras, Brazils state-controlled oil producer, is rapidly emergin as a major player in the global energy empire, with Jose Sergio Gabrielli de Azevedo, Petrobras CEO and CNBCs Maria Bartiromo.

Gas Prices and the Refining Industry

AP IMPACT: What makes up the price of gas? So how exactly are gas prices set? What determines the hair-pulling figure you see displayed in large electronic or plastic numbers? Why is a gallon of gas, say, $4.11 -- not $4.10 or $4.12? Why is the price different across the street? It all starts with oil. The biggest factor in the skyrocketing price of gasoline is the historic ascent of crude oil, which has surged from $45 per barrel in 2004 to more than $135 this past week, setting new record highs all the while. In the first quarter of this year, based on a retail price of gas that now seems like a steal -- $3.11 a gallon -- crude oil accounted for all but about a dollar, or 70 percent, of the cost, according to the federal government. The rest is a complex mix of factors, from the cost of turning oil into gas to taxes to marketing costs to, sometimes, nothing more than the competitive whims of your local gas station owner.

• ·         If $4 Gas Is Bad, Just Wait

Brough Expects `Huge Demand' for Oil Exploration Stocks May 23 (Bloomberg) -- Andy Brough, who helps oversee about $6.5 billion at Schroder Investment Management Ltd., talks with Bloomberg's Sara Walker in London about the impact of higher oil prices on his strategy for stocks and billionaire Warren Buffett's plans for acquisitions in Europe. Halliburton Co., the world's second-largest oilfield contractor, offered to buy Expro International Group Plc for 1.71 billion pounds ($3.4 billion), topping a 1.61 billion-pound offer by Candover Partners Ltd.

Oil Refiners See Profits Sink as Consumption Falls While drivers are facing sticker shock at the pump these days, here is a bigger shock: high prices are putting a strain on oil refiners. After last year’s stellar profits, American refiners are going through a traumatic period. In a time of record gasoline prices, some of them actually lost money in the first quarter, and for virtually all refiners, profits are down sharply. Experts say the refiners are caught in a double bind. The price of their raw material, oil, is rising because of strong global demand. At the same time, consumption of gasoline in the United States is falling as a result of slower economic growth and consumer efforts to conserve. However much the companies would like to raise gasoline prices enough to pass along the full increases in oil, analysts say they have been unable to do it. Oil prices doubled in the past year, while wholesale gasoline prices rose a mere 39 percent.

Chevron Plans to Fire Up to 1,000 Refining Workers After Profit Drops 84% Chevron Corp., the U.S. oil company that reported an 84 percent drop in quarterly refining profit, said it plans to fire as many as 1,000 employees in its refining, marketing and transportation divisions. About 300 workers, mostly located outside the U.S., received termination payments in the first quarter, according to a regulatory filing today by the San Ramon, California-based company. Most of the firings will occur this year, and the restructuring program is forecast to be completed in 2009, the filing said. A call to the company wasn't returned. Chevron, the second-biggest U.S. oil company after Exxon Mobil Corp., said on May 2 first-quarter net income rose to $5.17 billion, or $2.48 a share. Per-share profit was 8 cents higher than the average of 18 analyst estimates compiled by Bloomberg. Record crude prices in the quarter pared refining earnings because gasoline failed to rise as fast, narrowing profit margins. Chevron's refining earnings dropped 84 percent from a year earlier to $252 million.

Big-Oil Futures

Time for big oil to explore places it would rather avoid In fact the best-performing oil companies globally have been the ones that have had exploration success, such as Petrobras in Brazil. Rising costs and taxes, and limited access to new supplies help explain why BP and Shell have performed so badly and underperformed US peers ExxonMobil and Chevron. But other factors have been at work, such as the fatal accident at BP's Texas City oil refinery and the reserve misreporting scandal at Shell. Analysts estimate that underlying operating costs and capital expenditure across the oil industry are increasing 10 to 20 per cent a year. Taxes have also been rising. The Labour government has increased corporation tax on North Sea oil profits from 30 to 50 per cent in the past few years. Another way to look at rising costs and taxes is the impact on returns. Return on average capital employed at Shell was 24.5 per cent in the first quarter of 2008. That is only 10 percentage points higher than a decade ago. Yet in that time oil rose by $80 a barrel. Finding oil is also more difficult, and big western oil companies are forced to explore in places they would rather avoid. One of Shell's big projects is extracting oil from tar sands in Canada, and BP is drilling in ultra-deep waters in the Gulf of Mexico. In these large, complicated projects costs per barrel are high. Production at Shell has almost stood still in the past 15 years and BP's first-quarter figures showed production flat at 3.9m barrels of oil equivalent per day. A step change in output at both companies is not expected until 2011 when new but risky projects come on stream. Big oil is also facing lower returns in projects that are already running. Oil-rich nations no longer feel they have to call in one of the large integrated oil companies to exploit natural resources. They can buy expertise in large project management direct from oil-field services companies such as Schlumberger. This puts host governments in a very strong position to demand better terms from production-sharing contracts.

Is ExxonMobil's future running dry? Are we witnessing the death of ExxonMobil ? Strange question to ask with oil above $120 a barrel and ExxonMobil reporting $11 billion in first-quarter profits? Not if you understand that ExxonMobil's management has bet the company. If that bet is wrong, over the next 15 years or so, investors will get to watch the gradual disappearance of ExxonMobil.  In one scenario, the company disappears as a public company, going private by 2018 after buying up all its public stock. In another, the company simply liquidates as it distributes its cash to shareholders until there's nothing left. Far-fetched? Not at all. The warning signs were pasted all over the company's May 1 earnings report. Yes, revenue for the quarter was up 34%, to $117 billion, from the first quarter of 2007. And, yes, net income climbed 17%, to $10.9 billion. But production of oil and natural gas was down almost 6%. All the evidence argues that the company will report lower oil and natural-gas production for all of 2008, even though new projects are scheduled to come on line in the second half of the year. Looking just at oil, the company's production will not grow at all through 2012. But falling production is only part of the problem, the consequence today of a longer-term problem that seems to worsen each year. You see, not only is production likely to stay flat or fall through 2012, but proven oil and gas reserves are declining. Proven oil and gas reserves fell by 3.1% at year-end 2007 from the end of 2006, according to Standard & Poor's. What's going on here? If any oil company in the world should be able to find more oil and natural gas, it's ExxonMobil, with its immense reserves of both engineering skills and cash resources. Today, though, the positions of the Western and national oil companies are reversed. Now the national oil companies control about 80% of the world's proven and probable reserves, and they're keeping the most promising geologies for themselves. As a result, Western oil companies with the cash reserves of an ExxonMobil, a Chevron or a Royal Dutch Shell simply don't have enough places to put their cash to work. Further, that money doesn't go as far as it used to when it comes to finding new reserves. The places Western oil companies can put their money to work are among the world's most hostile environments and most challenging geologies: in Siberia or beneath a mile of water and a mile of salt, for example.

Big Oil's big 'problem' While many Americans struggle to fill their gas tanks, big U.S. oil companies are making so much money that they literally don't know what to do with it. Instead of reinvesting more of their newfound wealth to increase supplies or develop emerging technologies that might one day reduce energy costs, they are giving much of the loot to shareholders already enjoying outsized gains. In a capital-intensive business, giving cash back to shareholders is often the equivalent of throwing in the towel. It's saying "we can't do anything with this money to improve our business." And it certainly doesn't address the oil crunch that consumers pay for every day at the pump.

A family affair The Rockefeller family confronts the board of Exxon Mobil. THE involvement of the Rockefeller family gives added piquancy to one of the two most significant shareholders- versus- board battles of this year's proxy season. Exxon strongly opposes the resolution and has tried to stem growing enthusiasm for it ahead of its annual meeting on May 28th by writing for a second time to shareholders urging them to vote no. Exxon says that its board is better placed than shareholders to determine its leadership structure, and that it wants Rex Tillerson to continue as both chairman and chief executive. The Rockefellers worry that Exxon does not spend enough time analysing risks to the business, such as climate change and the need to replace reserves as countries are becoming more nationalistic about their natural resources.

Posted by dblwyo at 10:47 AM | Permalink | Comments (0)

A major and critical part of the financial frenzies of the last several years have been the LBO buyout and somewhat related buyback booms. As most of us know by now there's been a relative freeze on LBO activity since last summer, at least among the very large/large PE funds. Talking to my friends in the mid-size business that began to show up abruptly around the holidays and, judging from various statistics on mid-size deals, has spread there as well, if not as seriously. Yet at the same time the various PE firms have continued, successfully, to raise enormous amounts of investment dollars. Despite the fact that, if anything, the freeze continues and, if you believe our analysis, is likely to face much worse.

Part of it of course is that buyout funds have, over the years provided unusually good returns and part of it is that there have been few alternatives in this era of low returns...so why not ? And another part, how much we don't know, is that LBO activity, or more correctly Private Equity investing is actually facing several interesting opportunities. Thought not as business as usual. But let's backtrack a bit and start with this chart, slightly dated, of the cycle in buyout fund investments.

You'll have to update it a bit in your minds eye with the '06 and '07 data which was even larger than the illustrated '05. The catch is that buyout investment kept on during YTD for this year as well. As you can see historically there were pronounced cycles in the business accompanied by a general upward trend in the amount of funds raised. A trend that was non-linear. It'll be interesting to see what updated versions of this chart look like when they become available because if the news headlines are right fund raising hasn't busted so far even if investing has.

There's another interesting aspect of this, which is what do you do with the money. With so much of it floating around there was not only an enormous increase in total funds but a lot of new firms and funds got started. Like the Hedge Fund industry though there are also enormous differences in performance. My suspicion is that these historical differences in fund performance and in performance over the years are about to get greatly exaggerated as we find out who's been swimming naked indeed. In the first sub-chart notice that the top firms enormously outperform the rest of the pack. And then bear in mind that all the newbies performance is not yet, and won't be for some time, reflected in those numbers. The second sub-chart suggests that there's also a big difference in performance over time that's worth looking at as well.

 Take a careful look at this chart and notice that the years of great performance are years of significant downturn - that is investments made during '91 and '01 did exceptionally well. Why ? Well largely because they weren't made at extraordinarily high multiples with unusual leverage built into them. All of which is not true this last few years. This time around there were three things that were generally true. 1) Prices (EBITDA multiples) were exceptionally high - most likely as a friend of mine has pointed out historically unique and never to be repeated. 2) Funding was easy and cheap so the levels of leverage in deals was also unusually large - which is about to come back and haunt folks a great deal. And 3) the terms of that borrowing were extraordinarily lenient - what're called "covenant lite" in terms of re-payment, default and other loan terms. Which means a lot of deals got done at too high a price, with too much leverage and assuming that prices would keep going up. Stop me when this all sounds familiar.

Yet in these potential disasters lurks at least a couple of key alternatives. Actually several. First off all that debt is going to generate a lot more distressed debt than in previous cycles and the PE firms are going to be able to pick it up for half price, or perhaps better. Though they'll then face some serious workout problems. Which leads to the second major opportunity for those who kept some dry powder and their heads - as Wilbur Ross has shown in his beginning to buy up mortgage servicing firms. There'll be a lot of companies across many industries who used capital to buyback their own stock, are now leveraged at the beginning of a major downturn AND didn't make the operational improvements they should have with those funds. Judging from the historical cycles illustrated above that suggests that as we move into and thru the downturn, whatever it's length and depth, PE companies who focus on returning to their roots and have the skills and acumen to do so will be doing well in the years ahead.

By return to their roots we mean moving away from financial engineering, though not ignoring or neglecting the benefits of capital re-structuring. And moving toward what's been claimed as the major benefit, capability and strategy of PE firms. Putting in money, re-vamping operations, instilling good management and management practices and in general returing enterprises to high performance status. The firms that can do that in the next few years stand to do very well indeed and ought to be entering a new era. Not a golden one that turned out to be gilt. Rather an "Age of Iron". Look back at the second chart and the huge jump in performance between the top and restof the pack, especially during tough times.

As you go over the readings below you'll find a lot of these various aspects reflected from the section on the Strategic Outlook to indicators of current deals slowing and/or going bad. To my favorite section on the Mid-Markets. Now there's not a lot ever covered in the MSM on the mid-markets. So what you'll read there are the excerpts from various newsletters and seminar announcements which have come to my attention. Which aside from their intrinsic merits also are great indicators of the outlook - and they all are focused, one way or another, on the situation as we've sketched it. Life is about to get interesting indeed for the Private Equity industry. 

Strategic Outlook

Private equity: Year of the vulture While the days of the brainless megabuyout are over (at least for now), private equity has not gone away. It has just retreated. Veteran dealsters say they welcome the current separation of the men from the boys, of the serious players from those who merely surfed on waves of cheap debt but have now wiped out. What's different in private equity now from its last meltdown, in the late 1980s? Answer: It's become part of the landscape in a way that it wasn't 20 years ago. If you get coffee at Dunkin' Donuts, stay at a Hilton, or drive a Chrysler, private equity is part of your life. If your pension fund has money invested in buyouts, these guys' performance will have a say on whether your golden years are spent eating caviar or cat food. Many public-employee pension funds have a piece of buyout action (or soon will), and if they don't make their projected returns, governments will turn to taxpayers to make up the shortfall. So what do smart people do when they're confronted with violent change in the markets? For starters, they're engaging in what we'll call "double cropping," which we'll explain in a minute. Second, they're making grand plans to profit off the next boom by becoming publicly traded companies. That's the same transformation that a previous generation witnessed when a handful of brokerage houses began going public in the 1970s.

Following the Era of Large Buyouts, Private Equity Funds Find New Ways to Compete Now that credit has dried up, the future of large private equity buyouts has become uncertain. Today, buyout firms are looking to compete in middle-market and foreign deals and, in many cases, are teaming up with strategic buyers and corporations in new types of transactions. According to PE firm partners and other industry experts, the economic downturn has also paved the way for a resurgence in distressed investing, as lenders and investors alike begin to adjust to new pricing realities.

• Carlyle Group's David Rubenstein: 'The Greatest Period for Private Equity Is Probably Ahead of Us'

Carlyle Says Game Is Set to Restart Carlyle's David Rubenstein expects more $2 billion to $4 billion deals in coming months as companies begin to adapt to life beyond the era of megabuyouts. Early last year, private-equity firms struck deals that were as large as $45 billion, fueled by easy credit. Later in the year, as credit markets seized up, deal making ground to a halt and some of those buyouts collapsed. Now, as credit markets show signs of thawing, Mr. Rubenstein says, private-equity firms will cast their nets wider and close more deals ranging in value from $2 billion to $4 billion and that require less debt. One example is Carlyle's recent purchase of a majority stake in the U.S. government-consulting business of Booz Allen Hamilton Inc. for $2.54 billion

French Boardrooms Are All Shook Up as Private-Equity Funds End `Beffa Era' Investor activism is shaking up French boardrooms as funds buy stakes in listed companies following a credit shortage that dried up financing for leveraged buyouts. The confrontations are breaking down links between executives and directors who attended the same schools and sat on each other's boards, making managers more accountable. The cozy relationship between companies and the state left France behind the U.S. and the U.K. in adopting shareholder- friendly policies, he said. In the 1980s, 12 of France's top 20 industrial groups and most banks were state-owned. Even after the government sold companies from Saint-Gobain to Renault SA, shareholder protests were rare. A new generation of executives is more receptive to investors, he said. Half the CEOs of companies in the CAC 40 Index, including Lafarge SA's Bruno Lafont, were appointed less than five years ago. Many, such as Schneider Electric SA's Jean- Pascal Tricoire, never held government jobs. Funds such as Los Angeles-based Colony Capital LLC and private-equity firm Eurazeo in Paris have built stakes in four CAC 40 companies, including hotelier Accor SA and retailer Carrefour SA, and are demanding better returns.

Deal Problems

M&A Deals in the Industrial Manufacturing Sector Drop A total of 39 deals (disclosed value at or above $50 million) were announced in the first quarter of 2008, a 17% decline from the 47 deals announced in the first quarter of 2007, according to PricewaterhouseCoopers. Total deal value for industrial manufacturing transactions totaled $7 billion, a 46% decline from the $13 billion announced in the first quarter of 2007 and a 78% decline from the $31 billion announced in the first quarter of 2006. At this rate, projected total deal value for 2008 is set to fall far short of the levels set in 2007 ($88 billion) and 2006 ($92 billion). "A shortage of large industrial manufacturing deals took a toll on deal values during the first quarter of 2008 and will likely impact deal values for the remainder of the year," said Barry Misthal, U.S. industrial manufacturing leader at PricewaterhouseCoopers. "Financial investors are playing a lesser role due to higher risk premiums and a decline in debt market liquidity, and it is unlikely that total and average deal values will rise to previous levels until the financing environment improves."

Bell Canada buyout in trouble Closing the biggest deal ever just got a little more complicated. According to Monday's The New York Times, the banks providing financing in the takeover of Bell Canada parent BCE, are seeking to renegotiate terms of that deal. Providence Equity Partners, Ontario Teachers' Pension Plan and Madison Dearborn are seeking to take BCE private for nearly $52 billion. The reason for the financing snafu? Banks are feeling squeezed because of losses from the subprime crisis, and their stomach for financing leveraged buyouts has diminished from even a year ago, when the Bell Canada sale was brokered. In interviews earlier this month, Providence Equity Partners CEO Jonathan Nelson told Fortune that he expects the banks and other partners to honor their commitments to the deal.Still, Providence has shown a willingness to sue its lenders: Earlier this year it countersued lender Wachovia (WB, Fortune 500) when that bank tried to extract itself from providing financing for a $1 billion buyout of Clear Channel's television group. That deal was separate from the acquisition of Clear Channel's radio stations, a deal that also found itself in litigation as lenders sought to renegotiate terms of the deal. In both Clear Channel (CCU, Fortune 500) cases, the deals ultimately got done. In March Clear Channel's television group and Providence agreed to a reduced price and announced the closing of the deal, and last week Clear Channel lowered its takeover price of its radio assets in order to get the $18 billion transaction financed. Indeed, three of the four lenders involved in the Clear Channel radio buyout are also involved in the BCE buyout, and the street had been speculating for months that those banks would "pull a Clear Channel" on BCE. BCE's buyers, though, seem eager to close on the transaction. It is a deal that is very much in Providence's wheelhouse: A big, national telephone company with strong cash flow. Providence likes these kinds of companies, adding to the likelihood that it is unlikely to let this one get away. ·  Inside a record-breaking $51 billion... More

Owner of Bill Blass Faces Cash Shortage After Acquisition The fast-growing buyout firm that owns the fashion house Bill Blass, the retailer Athlete’s Foot and the ice cream chain MaggieMoo’s appears to be on the verge of collapse.NexCen Brands, a little known firm that owns many high-profile brands, said on Monday that it faced a severe cash squeeze and warned that there is “substantial doubt” that it will remain in business. The company, which dismissed its chief financial officer two months ago, said that its 2007 financial statements could no longer be relied upon and that it was investigating its financial reporting practices. NexCen, which earns revenue from 1,900 franchised stores, said it might try to sell off some, if not all, of its brands. That could put eight chains — including Marble Slab Creamery, Pretzel Time, Pretzelmaker, Great American Cookies, Shoebox New York and Waverly home furnishings — up for grabs. And it could put the future of Bill Blass, an influential clothing label sold at high-end stores like Saks Fifth Avenue, in doubt.

Mid-Market Situation

The Big Picture: the Fate of Leveraged Deals (Capital Roundtable Seminar) Last summer, the credit market drama dealt private-equity mega-deals a losing hand.  But what the credit meltdown has in store for middle-market (LBOs) deals is still something of a mystery.  Even though leveraged deals in the middle-market seem to be holding off the downstream spread of credit upheaval for now, everybody, it seems, is watching for tell-tale cracks in the dam and asking:Is the credit infection spreading? If so, who’s more at risk – equity or debt investors? What new funding opportunities are emerging? Is there another shoe still left to drop? To answer these questions and learn what underlying factors will shape the murky credit markets and deal-making in all parts of the middle market for the remainder of the year and beyond, we invite you to an important new MasterForum -- and cocktail reception -- on Wednesday, July 16, called “the fate of leveraged deal financing,” featuring Ed Altman, Peter DeMaria, and James H.M. SprayregenTheir high-level discussion and lively Q&A session will be moderated by leveraged-finance investment banker John Miscione, himself a former commercial lender and current Managing Director at Duff & Phelps LLC. Come hear how these top minds view the erosion of confidence in the credit markets -- and what they predict will happen next for middle-market buyouts and the larger economy. They’ve given leveraged investing a lot of study -- and their well-considered recommendations for how best to proceed amid hemorrhaging valuations and liquidity demand our attention. And if you’re active in middle-market deals during these volatile times, then you need to hear what these three wise men are saying.

Checks and Balances (Merger Mogul Newsletter)This year, as the credit markets struggle to regain their feet, I imagine it can be pretty difficult for some to smile through the adversity. Nevertheless, I’m still a believer that a good soak can wash the toxins out. In our latest issue of Mergers & Acquisitions Journal, due out in June, Danielle Fugazy wrote the cover story on due diligence. The central theme of the article was that during the hysteria that engulfed the deal market from 2005 to the first half of 2007, buyers were giving short shrift to their homework. It’s not that they didn’t want to perform due diligence, it’s just that the pace of the market didn’t allow for it. The sell-side advisers pushed the PE firms, who pushed the lenders, who pushed someone else, until nobody knew even who was pushing whom. If anyone even thought to push back, someone else would step in to take their place in the daisy chain of “investors” unwilling to say no. Today, however, everyone seems to be pushing back – buyers, sellers, lenders, advisers, consultants, you name it. I’d argue that even us reporters are asking more of the right questions lately. On one hand, the collective pushback probably makes dealmakers feel even more squeezed in an already tight market. But these are the checks and balances that are necessary to truly thrive. Experienced buyers often tell me that their best deals were made during the last economic downturn at the beginning of the decade. While some of that success had to do with buying low and selling at the high end of a cycle, one has to believe that the increased focus on due diligence, and perhaps the fear of doing a bad transaction, played just as important a role.

Post-Crunch M&A (Merger Mogul Newsletter) No matter how challenging the deal market becomes, it’s a sure bet there will be folks, funds and firms who find ways to benefit from the down cycle. (In fact, you can hear from some of them at our June event on Post-Crunch M&A.) Restructuring firms are chief on the list of beneficiaries, since economic slowdowns tend to expand their pool of potential clients. Talk to firms like Alvarez & Marsal and FTI Consulting, and they’ll tell you they have more clients than they can handle these days, which is a problem most of us would love to have. Among the list of not-so obvious beneficiaries—at least within the mid-market—are private equity firms willing to increase their equity contributions. History has shown, and conventional wisdom would support that firms who are willing to invest in down cycles generally come out of those cycles in better shape than counterparts who sit on the sidelines. Of course, it’s tough to know how long the current downturn will last, but a financial buyer who buys now and can afford to be patient has a good shot at turning a big profit a few years down the road. Small companies who price their assets to sell should also do well in the current market. My numerous talks with small market participants at the recent ACG InterGrowth conference only confirmed what most people had been telling me leading up to the event: The smaller the deal, the less impacted it is by Scrooge-like lenders. Another thing helping small deals is the creep down market by mid-market buyers who can’t get bigger deals done as easily anymore but still need to put money to work.But without question, getting deals done post-credit crunch is no easy task. Due diligence is going the way of the tortoise, limited partners are asking more questions of their GPs, and even some strategic buyers are more gun-shy, wondering how long the current downturn with last. Meanwhile, anyone who bought a company before Fall 2007 is now dealing with a new set of rules, forecasts and expectations. PE buyers have to determine whether to invest in their companies, stay ultra-lean until the downturn is over or, despite the blow to ego, cut their losses. More than deal sourcing, portfolio management is arguably the most important skill of any M&A buyer. Only those who can manage effectively through the current storm will circumvent the crunch.

Creating Value in PE Portfolio Companies – Strategies for Catalyzing Operational Success (Capital Roundtable) Facing greater competition and limited financing, private equity investors recognize that gone are the days when they could achieve good returns just by buying low, leveraging up, and selling high. Busy GPs who used to “pinch hit” between deals by helping improve portfolio company performance are seeing that this work takes a specialized skill set, quite different from what it takes to source and finance a deal. So today, some GPs are themselves becoming deeply enmeshed in portfolio company operations, while others are relying  on the services of “hired gun” consultants – or increasingly are developing in-house operations teams.  As a result, to differentiate their firms in today’s competitive and recessionary markets, many GPs have entered an operational “arms race,” struggling to develop or access capabilities to enhance the performance of their investments.  If you’re interested in comparing notes on these trends with 20 of your peers who are testing out different operational strategies, then please join us for The Capital Roundtable’s first MasterClass on “Creating Value in P.E. Portfolio Companies,” being held Wednesday, May 21, in midtown Manhattan. Come see how some of the best-managed private equity firms are -- …conducting rigorous pre-investment operational assessment and planning… achieving 360° company and sector awareness…analyzing executive talents needed to manage and coach portfolio companies …pushing their companies’ management outside of their comfort zones to boost returns

Posted by dblwyo at 01:06 PM | Permalink | Comments (0)

Let's keep cranking on trying to take apart the current situation and strategic outlook for the Finance Industry. But first we should note that BM stands for "Business Model". Not what you thought it stood for but, nontheless, the pun was intended. And gets to the heart of our argument - which is that the business models of key sectors of the Finance Industry are flawed to badly broken, and we believe that many of the readings support that. The extent of the breakage depends on the sector but those which depended on leveraged trading and investment are most exposed for multiple reasons which are discussed below. Those closer to traditional banking and finance practices have lots of room to improve but equally a good dose of sound business practice, a little innovation and an increased focus on marketing and customer service would go a long way. If you are a stakeholder in any of these you need to walk thru the blueprint and use it as a checklist for assessing their statii and outlook.

The chart at right will be no surprise of course. It shows the Industry as a whole (XLF), the Broker-Dealers (IAI), the Insurance sub-industry (IAK) and Regional Banks (IAT). If you buy the arguments of the last three posts (Market, Economy, Finance I) we've had a bull rally with terrible misjudgments on valuations and earnings outlooks with a weakening economy which has yet to tip over into a real downturn. Consumer demand has been weakening in any case, and that was before factoring in the implicit tax of energy and food costs surges, which would feedback destructively to hiring and investment spending (per the normal causal linkages). And as a result we were about to see many more boulders topple into the credit pond with a series of feedback loops between deteriorating economics and worsening delinquencies. Net net the question would therefore be how much farther on that chart - over and above where we think the markets are going ?

Well we could let you just skim the readings excerpts and reach your own interpretations. Which we urge you to do. BUT...we'd also like to testfly the framework we deployed against our strategic evaluation of Citi as a way of thinking about the industry as a whole. Both because we think the general enterprise framework works and because the work that Pandit and his team have done strikes us as capturing 80-90% of the total industry situation (excluding the Insurance industry of course). (Poster-child II: Citi's Potential Turn-around as Performance Examplar) You'll find the readings below collected in various takes on the Strategic Outlook, specific companies (including one that shows AIG's writeoffs and capital raising changing radically in a week as well as UBS's huge discounted rights offering...shocking though nobody appeared shocked...numbness setting in all over ?). The final section gets to the heart of the matter by providing various readings on thinking about the futures of the industry...that is does their business model and strategies still work, if they ever did ? 

Based on those readings, all the prior posts which basically dealth with the same question and the strategic assessments in Citi's presentation we end up with the graphic at right. After two decades of innovation in the '70s and '80s which provided tremendous value-add and new services for consumers and business the industry shifted its' emphasis to leverage, complex products and trading on its' own account. That worked, apparently, since the mid-90s til last year. And then broke badly despite bringing us an unprecedented series of booms and busts for the same underlying structural reasons.

Now we're in a regime where de-leveraging will be the dominant macro-environmental theme and as a result capital requirements will be raised, explicitly by regulation or implicitly by investment returns. So instead of being able to reap the profits from being leveraged 30x, or 40x or 70x the banks, brokers/dealers are entering an era where they'll have to return to fundamentals. Hence our judgements in the various shade of warning indicators as to whether the business models of the last decade are sustainable going forward.

We could argue thru each sector individually and then discuss each of the major players but won't - though we do think this is the kind of evaluation any employee, investor or stakeholder needs to do for each and every one of them. What we will assert though is that these fundamental re-thinkings aren't widely recognized, acknowledged or accepted though several key commentators have made similar observations. And this kind of re-thinking is clearly implicit in Citi's new strategic framework. So apply the Buffett test - which of these are businesses you'd want to own a piece of as businessess ? Our answer - not many until these re-structurings are begun. On the other hand as Rubenstein, Buffett, Jubak, et.al. are pointing out there will be lots of gems to be sorted from the rubble. Once the rubble all falls down...which point we are IOHO a long way from. 

Strategic Outlook

De-leveraging dilemma Investment banks like Goldman, Lehman Brothers and Morgan borrowed more and more money in recent years and used that to accumulate assets. That left the firms leveraged more than 30 times at the end of 2007, a record, analyst Michael Hecht noted. But the mortgage-fueled credit crunch is now forcing investment banks to sell assets and cut borrowing, in a de-leveraging process that Hecht thinks has only just begun. If investment banks cut leverage to 20 times, down from 30, that would slash return on equity in the industry by 24%. Return on equity, or ROE, is a closely watched measure of how efficiently companies use the money they get from shareholders. Lehman could be the worst hit, suffering a 55% slump in ROE in Hecht's de-leveraging scenario. Goldman and Merrill would see the smallest declines in ROE, the analyst added. Reducing leveraged to 20 times from 30 may also slash net income in the industry by 27% and imply an 11% reduction in total assets. That's a reduction of more than $370 billion in assets across Wall Street, something that "would undoubtedly put some pressure on asset prices," Hecht warned.

• Wall St. Compensation Disaster? All of Wall Street has to prepare for a compensation disaster that will make Citis layoffs and pay cuts look like small change, according to CNBCs Charlie Gasparino.
• Brokerages Under Fire  Cutting rates on a few financials, with Dick Bove, Ladenburg Thalmann and Co analyst and CNBCs Carl Quintanilla

 Plastic's Uncertain Future A growing feeling that stand-alone credit-card lenders will weather the economic slowdown has started to lift shares in firms like American Express Co., Discover Financial Services and Capital One Financial Corp. But recent credit-card data indicate that none of the big card companies -- including the large card units at banks like Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co. -- are in the clear. Rising defaults could weigh on earnings for longer than expected. But two key data points indicate defaults climbing higher, not falling fast. First, card borrowers are starting to pay back less of their outstanding balances each month. Analysts at Oppenheimer & Co. say that a sustained decline in the amount borrowers repay each month, compared with a year-earlier, can be a leading indicator that borrowers will start to fall behind on payments. Also worrisome are data from Moody's suggesting that borrowers are finding it harder to become current on credit-card loans once they fall behind. The ratings firm notes that the amount of loans on which borrowers have skipped three or more payments has started to rise more quickly than loans that have missed one or two. Once borrowers are three payments behind, fewer of them ever catch up.

Investors see one Wall St., while bankers and brokers see another Investors see sunshine; bankers, rain. No one seems to be on the same page. Or are they? In this case, the diverging opinions of the industry and the investors who stake their fortunes on it aren't mutually exclusive. The idea that Wall Street -- or any industry, for that matter -- can get leaner and meaner when business slows isn't radical thinking. Banks and brokerages operate in a cyclical business. Things will turn around. Investors may be wise to buy when prices are relatively low. The issue, then, isn't if profits will return to the industry, but when. And here's where the two sides diverge. Wall Street is bracing for a long slumber, and investors think a rebound is already here. Unfortunately, there's ample evidence that the Street has this one right. Since first-quarter earnings hit in March, there's been little to suggest a turnaround is imminent. Jamie Dimon, J.P. Morgan's chief executive and the last banker standing without foreign ownership or diluted shareholders, has been among the most pessimistic when it comes to forecasts.

UBS's Magnus Sees `Long Way to Go' for Recovery of Banks May 23 (Bloomberg) -- George Magnus, senior economic advisor at UBS, talks with Bloomberg's Naga Munchetty in London about inflation risks in the global economy, interest rates in the U.S., U.K. and Europe and the outlook for banks recovering from the credit crisis. The world's biggest financial companies have posted at least $383 billion in writedowns and credit losses since the start of last year after the subprime mortgage market collapsed. The resulting economic slowdown has prompted the Fed to lower its benchmark rate 3.25 percentage points since September to 2 percent.

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

The prior two posts were our weekly surveys of Market and Economic information. We'll grant that typical blog practice is one/two clip(s) per post but we think something is served by collecting and categorizing them so that the patterns and implications are clearer. At least it works for us. We mention that by way of pro forma apologia for the infodensity, there and now. Because that econ/mkt information is only mildly interesting to us for its' own sake. What we think is even more important is the implications for business performance...industries...companies and you. Which is also by way of suggesting that with those two in mind it's really time to roll it forward and look at the consequences....which are, IOHO, pretty dire. Before rolling on we'd like to suggest a few minutes spent listening to Dave Wessel on CNBC will help set the table:Econ-Recon Mission  Perspectives on the economy, with David Wessel, The Wall Street Journal economics editor.

Here we'll focus on the implications for the Finance Industry...at least in part. Consider the graphic at right where we've down our best to capture what we think is going on. Though admittedly I'm not a finance industry expert we've all had to learn more about that arcane and mysterious industry in the last year than we ever wanted (btw do you realize we're over a year on the first small canary the Shanghai Surprise and the big one - the first BSC disasters ? Think about those as warning sigils in light of this arm-waving).

What we've tried to capture is the impact of the credit crisis so-called and how it's rippled thru the system and what's likely to still happen. So what we've seen so far is bad loans (1) moving up the chain of leveraged links to create ripples (2) and breakdowns across many different credit markets. That almost brought the whole house of cards down. Those losses led to massive writedowns and P&L losses (3) which severely damaged almost all the players in the Finance Industry. The catch on that set of loops is that sub-prime problems aren't thru and we have a whole host of other sources, e.g. ARM resets, HELOCs, etc. which are also turning bad; which'll keep that loop going. It's that metastasis of the credit contagion that folks like Whitney are warning about. Consider this the revenge of the "Rocks-in-the-Ponds" model.

The real on-going problem likes in the deteriorating general economic conditions which will lead to to additional credit tightening (4) and asset deteroriorations (5). In fact as we enter a "normal" cyclic downturn all the host of standard consumer and business loans (6) are now qued up to go thru a similar decline. And there impacts on things are not even factored in because everybody knows "the worst is over", right ? So as you skim the readings below please keep in mind that the real reason to make you wade thru the Market and Economy readings was to frame the context of what's going to happen to the Finance Industry as these cycles kick into high-gear. 

UPDATES (5/22): Two other major data points on rising delinquencies and on leveraged loans have been added to the readings. 

Barbarians at the vault BANKS have endured a brutal nine months since credit markets froze in August. Losses and write-downs already total $335 billion; many of their best businesses have disappeared. In developed economies, almost all banks are facing economic and regulatory headwinds that will cut revenues and jobs. Yet the biggest danger facing Western finance is not a fall in its earning power but a loss of faith in how it works. Two criticisms assail the industry, one based on fairness and the other on efficiency. The first argues that finance is rigged to enrich bankers, rather than their customers, shareholders or the economy at large. Some worry about the way bonuses are calculated; others about moral hazard. Bankers will take wild bets because they know they will be bailed out by the taxpayer. Look at Bear Stearns or Northern Rock. The second, deeper question is whether a market-based approach to finance is efficient. Some Chinese officials claim the Western system has been shown up by the crisis (see article). This week Germany's president demanded that the “monster” of financial markets “be put back in its place”: bankers had caused a “massive destruction of assets”. The critics do not lack ammunition. The lapses in credit-underwriting in the subprime-mortgage market hardly reflect a wise allocation of capital. The opacity of the shadow banking system and the mind-boggling complexity of those toxic asset-backed products have raised doubts about the discipline of the market. Economist Special Report on International Banking…breakdowns, problems, regulation and futures. (***)

Ken Griffin, and Thoughts on Fixing Wall Street Kenneth C. Griffin, who runs one of the biggest and most successful hedge fund firms, has a blunt assessment: “We, as an industry, dropped the ball.” The breakdown happened, Mr. Griffin contends, when big investment banks gambled away money and jobs during the late great credit boom. The bosses let all those young gung-ho traders take far too many risks and now everyone is paying the price. But the answer is simple, in his view. The entire industry needs to overhaul its thinking and, believe it or not, perhaps even accept greater regulation. He is upset that the investment bank Bear Stearns ran aground. He is annoyed at the big-name chief executives who took too much risk and then watched as billions of dollars of value vanished from balance sheets. He is anxious about high-priced finance jobs moving abroad. And he is particularly galled with regulators in Washington who have overseen what he calls “the great depression on Wall Street.” But Mr. Griffin isn’t just a serial complainer. He has thought about solutions. First, “the investment banks should either choose to be regulated as banks or should arrange to conduct their affairs to not require the stop-gap support of the Federal Reserve,” he says.But that’s not all. He also wants new government oversight of the arcane world of credit default swaps, a business with a notional value and risk of $50 trillion. “Everyone is missing the elephant in the room,” he said. It was the interlocking relationships between thousands of investors and banks over credit default swaps that pushed the Fed to help rescue Bear Stearns. In particular, Mr. Griffin wants the government to require the use of exchanges and clearing houses for credit default swaps and derivatives.That way, instead of investment banks playing matchmaker between parties, an exchange will do it with strict rules in place, eliminating billions of dollars in exposure and creating more transparency.

• Hedge Fund Headwinds Hedge funds are hurt by the credit crunch and under pressure in Washington, with Richard Baker, Managed Funds Association president/CEO and CNBCs Carl Quintanilla

Rubenstein Says `Enormous' Bank Losses Unrecognized U.S. and European banks and financial institutions have ``enormous losses'' from bad loans they haven't yet recognized and may have a harder time wooing sovereign-fund rescuers, Carlyle Group Chairman David Rubenstein said. ``Based on information I see,'' it will take at least a year before all losses are realized, and some financial institutions may fail, Rubenstein said at a breakfast meeting of the Institute for Education Public Policy Roundtable in Washington. He didn't name any companies. Rubenstein said sovereign wealth funds are becoming wary after losing $25 billion on their investments in struggling banks and securities firms worldwide. Financial institutions worldwide have recorded $329.2 billion in credit losses and writedowns and raised $246.6 billion in capital since the beginning of 2007. Rubenstein said about $60 billion of that capital was provided by sovereign funds last fall, and their investments today are worth about $35 billion. On April 28 at a conference in Baltimore, Rubenstein said financial institutions and financial assets are ``the single greatest investment opportunities'' in the U.S. and ``a lot of private-equity firms like ours are going to try to make investments in these firms.'' Sovereign wealth funds and private-equity firms typically have different investment goals. Sovereign funds usually buy a minority stake in a quest for share-price appreciation, while private-equity firms often assume an ownership role and try to rebuild distressed companies. Rubenstein said today that the industry and broader economy aren't likely to turn around until early next year. The economy's troubles, compounded with tighter lending standards, have brought the leveraged-buyout industry to a standstill, he said. There are fewer buying opportunities because many owners of companies have an inflated and irrational sense of their property's value, he said.

CalculatedRisk on Delinquency Contagion:

• S&P: Subprime and Alt-A Delinquencies Rising
  

• S&P Cuts Ratings of Prime-Jumbo Mortgage Bonds

• Comptroller Dugan on "Unprecedented Home Equity Loan Losses"

Allianz's Dwane Says Some Banks `In Denial' on Debt Risk May 9 (Bloomberg vidclip) -- Neil Dwane, who oversees $65 billion of equities as chief investment officer at Allianz Global Investors, talks with Bloomberg's Jeremy Naylor in London about corporate earnings, the outlook for commodity and financial stocks and his investment strategy. Analysts predict earnings for companies in the S&P 500 will shrink in the first and second quarters, based on data compiled by Bloomberg.

AIG to Raise $12.5 Billion of Capital After Reporting Second Straight Loss American International Group Inc., the world's largest insurer by assets, said it will raise $12.5 billion after posting its second straight quarterly loss, sending the shares down 7 percent. AIG had a record first-quarter net loss of $7.81 billion, or $3.09 a share, compared with earnings of $4.13 billion, or $1.58, a year earlier, the New York-based company said today in a statement. The insurer wrote down the value of contracts to protect fixed-income investors by $9.11 billion. Chief Executive Officer Martin Sullivan's job may be on the line unless he stems losses from the subprime mortgage collapse and reverses a 12-month stock decline of 38 percent. Financial products head Joseph Cassano stepped down after AIG reported a then-record $5.29 billion loss in the fourth quarter. AIG's Need to Raise $12.5 Billion After Loss Renews Doubts About Sullivan

• Bad Investments and a $7.8 Billion Loss at A.I.G. In the worst three months of the company’s 89-year history, American International Group lost $7.81 billion, primarily from bad investments in complex financial instruments.

Posted by dblwyo at 02:59 PM | Permalink | Comments (0)

Again we're jumping the gun to free up the bandwidth for more interesting stuff and because there's so much which appears to be a cusp point indicator. BtW - if the terrible adolescent schoolyard joke punned on in the title means nothing we're not going to explain it either. But the real surprise is in the latest Fed minutes, encapsulated in the charts at right. Which are really worth contemplating. Particularly since they apparantly cratered the markets today by telling the truth about the economic outlook.

Let's start with the graphic showing the ranges and trends of estimates. While the Fed isn't expecting an outright recession in '08 it is projecting very low growth and, at best, a U-shaped, slow recovery with sub-par growth in '09 and middlin fair in '10. Accompanied by relatively high inflation and increased unemployment until the the latter and a slowing economy bring down the former. There are however some problems with and exposures with those expectations that we'll get into and are reinforced in the excerpts.

But let's take a look at the specific numbers in the outlook tables - which are really interesting for the downward revisions, or should we say much more pessimistic, between these minutes and last Dec. Take a careful look as you get a sense of what kind of U the Fed's expecting and what they were expecting. Growth has been revised significantly downard in '08 while both unemployment and inflation have been revised significantly upward in '08 and '09. The return to relatively benign conditions '10 may be a bit of whistling past the graveyard but isn't unreasonable. At least on a traditional view of things.

The real surprise here is how surprised the markets were at these numbers since they aren't a) far off those from the last meeting nor b) unreasonble in light of the consistently weak economic numbers we've been seeing. At least when you look thru the headlines. Maybe the real tell here is how much people were fantasizing to themselves that indeed the worst was over and the recovery was easily in sight. Just to knock a couple of the common shibboleths on their respective heads we have indeed past thru the crisis of the market breakdowns but that moves into a real credit crunch where loan standards continue to be tightened further slowing the economy. And conversely increasing bad loans as well as spreading credit losses, e.g. car loans, commercial real estate, credit cards, etc. etc. will feedback. All "perfectly" natural characteristics of a normal business cycle. Of which we're in the early stages as yet - the "dude, where's my recession ?" meme is so ill-informed in terms of cycle timing, patterns and time lags that the journalist who wrote it should be embarrassed. Which he will be eventually. 

After the break you'll find some interesting readings that extend the basic arguments. Part of the problem with the Fed's assumptions is that it's very traditional and well-grounded in history. Unfortunately our domestic monetary policy no longer entirely controls our future given that we've been importing inflation due to structural factors. That really puts the Fed between a rock, a hard place and a rising flood where it needs to maintain or raise rates to contain inflation and defend the dollar. At the same time China, which previously exported deflation, is now reversing because of its' own structural changes.

There are two readings to particularly draw your attention to. One is the "Six Signs of a Rebound" which we include to indulge our sense of twisted humor rather than endorse. The other is about a longer-term outlook, sans all these downside structural and cyclic risks, for an extended period of sub-par growth. That one is really worth thinking about IOHO. 

Economic Assessment

Fed: Slower Growth, Higher Unemployment in '08 The Federal Reserve on Wednesday sharply lowered its projection for economic growth this year, citing blows from the housing and credit debacles along with zooming energy prices. It also expects higher unemployment and inflation. Fed officials viewed economic activity "as likely to be particularly weak in the first half of 2008; some rebound was anticipated in the second half of this year," the documents stated. Under its new economic forecast, the Fed said it now believes gross domestic product will grow between just 0.3 percent to 1.2 percent this year. That's lower than a previous Fed forecast, released in late February, that estimated growth to be between 1.3 percent and 2 percent. With economic growth slowing, the Fed projected that the national unemployment rate will rise to between 5.5 percent and 5.7 percent this year. That is higher than the central bank's old forecast for the rate to climb as high as 5.3 percent. Last year, the unemployment rate averaged 4.6 percent. And, with energy prices marching upward, the Fed raised its projection for inflation. The Fed now expect inflation to be between 3.1 percent and 3.4 percent this year. That's higher than its old forecast for inflation, which was estimated to come in at around 2.1 percent to 2.4 percent.

Fed Minutes Say `Most' Officials Viewed April Rate Cut as a `Close Call'  Most Federal Reserve officials viewed the decision to cut the benchmark interest rate as ``a close call'' in April, judging risks between weaker growth and faster inflation had become more balanced, the central bank said. ``Most members viewed the decision to reduce interest rates at this meeting as a close call,'' minutes of the April 29-30 Federal Open Market Committee meeting said. ``Several members noted that it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term.''

Post-Subprime Economy Means Subpar Growth May Become New Normal for U.S. A normal U.S. economy is likely to look a lot different, and worse, after the credit crisis is over and financial markets settle down. Companies will continue to struggle to raise cash for expansion and innovation as investors and lenders remain focused on conserving capital. Workers, too, may have less flexibility to go after new opportunities, because many will be stuck where they are -- in homes worth less than the balances on their mortgages. The bottom line: The U.S. may have to get used to a new definition of normal, characterized by weaker productivity gains, slower economic growth, higher unemployment and a diminished financial-services industry. Long-term growth in the U.S. may drop to 2 percent to 2.5 percent a year from the 3 percent rate of the last 15 years, according to Peter Hooper, chief U.S. economist at Deutsche Bank Securities in New York and a former Federal Reserve official. A record three-quarters of U.S. banks the Fed surveyed in April said they were charging corporate borrowers a higher premium over what the lenders pay for funds. More than half reported tightening lending standards. Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University in New York, says the nation is ``in the grip of some structural forces that are moving the economy permanently to a lower level of economic activity, with an unemployment rate somewhere between 5 and 6 percent.'' Unemployment in April was 5 percent.

• The future's not what it used to be The way the stock market's been acting lately, you would think that the threat of a recession is a thing of the past and that global warming has reached the previously frozen financial markets. All of this has led some prominent people both in and out of government to declare that the worst is over. But as that great soothsayer, Yogi Berra, used to say, "it ain't over till it's over." As far as the economy goes, I don't think much has changed, notwithstanding the two-month rise in the index of leading indicators reported on Monday. April's retail sales were weaker than expected, payrolls have fallen for four months in a row and are lower today than they were six months ago, prices of imports are soaring and consumers are more dour now than they've been since the bad old days of 1980.
• Consumers can't save the economy Consumers are too tapped out to lead the economy out of its troubles, according to a report on household credit released Wednesday. And even after things turn around, consumers weighed down by debt won't be able to spend as they did in the past. Americans have little money on hand and banks aren't eager to lend anymore… Consumers had the lowest percentage of unspent cash in the first quarter of 2008 since fall 1991, the report found. Sluggish consumer spending power means that the recovery may be a little slower and less vigorous, leaving it to corporations to spur the economy. It will also take years for consumers to straighten out their household budgets since their debt burdens are near record highs. Americans put 14.3% of their disposable income toward debt in the first quarter, near the record 14.5% reached at the end of 2006. By comparison, the rate was 12.3% in 2000. Before the 1980s, consumer spending made up about 63% of the nation's gross domestic product, a key measure of the economy. Since then, it has grown to about 70% as Americans took on more debt to fuel their buying habits. Going forward, consumer spending will likely drift back to about 67% of GDP, Hoyt said. Americans simply can't sustain a near-zero savings rate and an ever-growing debt load.

Other Indicators: Retail, Commercial Real Estate and a "Joke"

Lowe's signals more uncertainty Commentary: Retailer's pain coming from high food prices and shaky jobs. Both Lowe's and its larger rival Home Depot Inc. rode high in the early part of the century, ringing up robust sales during the booming real-estate market boom. But the free-for-all ended as the real-estate and credit markets dried up, and the easy money that once encouraged consumers to refinance mortgages or take out home-equity lines of credit to remodel has become scarce, leaving many in a bind to finance such projects. Earlier this month, Home Depot ratcheted back its growth plan. . Data to be released this week is expected to show further weakening in home sales and prices, and there's no evidence that the declines are going to moderate. With the market moving in this direction -- and people worried about paying for groceries and gas -- the all-important spring home selling season is shaping up to be pretty dismal and there's no relief in sight.

• Anxious Retail Trends  A look at a survey showing the biggest change in consumer priorities, with CNBCs Margaret Brennan

6 signs of an economic rebound By now you've had enough of the endless gloom in today's economic news: record oil prices, slower home sales, deepening loan losses, disappointing corporate earnings. What you're really looking for at this point are a few signs of hope. It's a certainty that the economy, the housing markets and the stock market have to bounce back sooner or later. If you could see that rebound coming, not only could you rest easier about everything from your job to your retirement, you could move forward confidently on all those financial plans you've put on hold until the way seemed clear. You could, maybe, take a chance in the job market. You could think about trading up to a bigger home or downsizing to a place that better suits your needs. And even though you've stood unwavering by your investment strategy as the stock market tumbled - and you have, haven't you? - you could feel good once again about putting your money in something besides a chickenhearted money-market fund. So what are the surefire signs that we're bouncing back? The only honest answer, of course, is that there are no 100% surefire signs. In every cycle there are wild cards that can trump even the best predictions. On the other hand, history shows that some hints of renewal are far more reliable than others. At least one of them is worth watching in every market that matters to you, from stocks to real estate to jobs. Read further to find out where you'll find these harbingers of economic spring, why they work and how you can make the best use of them.

The next building bust Demand for new homes collapsed last year. Next up could be a similar drop in the rest of the construction market -- and that could be the latest drag on an already sputtering U.S. economy. Nonresidential construction, which includes office buildings and retail centers, hotels and institutions such as schools, hospitals or government buildings, remained strong through much of 2007. But a combination of the economic slowdown and tighter credit appears to be putting the brakes on nonresidential projects. Even if work continues on those projects already underway, there are signs that the pipeline of new construction is about to dry up.

• Non-Residential Investment Overview

Energy

The end of cheap gas: Who's to blame It's hard to imagine now, but in 1999 gasoline sold for 90 cents a gallon. How'd we get from there to $4 a gallon? There is no short answer - many things happened, and together they formed a chain of events from cheap gas to $100 tankfuls. One of the most common reasons cited for the price jump is supply and demand - we are using more oil, which accounts for 70% of the price of gas, and finding less of it. Why we are finding less oil and using more of it is partly a result of the low prices during the 1990s. This was illustrated in September 2005, when Hurricane Katrina knocked out a significant chunk of U.S. refining and gasoline prices spiked above $3 a gallon for the first time ever. A new refinery hasn't been built in the United States in three decades, although capacity at existing refineries has been expanded.

Tanaka Says IEA Planning to Lower Oil Supply Forecasts May 22 (Bloomberg) -- Nobuo Tanaka, executive director of the International Energy Agency, talks with Bloomberg's Nina de Roy from Brussels about oil prices and the outlook for global supply and demand. Crude oil rose to a record above $135 a barrel in New York after U.S. stockpiles unexpectedly dropped and traders closed losing trades on bets that prices would fall. Oil has risen 19 percent this month as analysts have increased their price forecasts because of supply constraints and demand growth.

International

The World's Most Competitive Countries Half of the top 10 are European and the U.S. is still No. 1, but Asia's tigers are coming on strong. Asian economies are overtaking the U.S. and Northern Europe to become the most competitive in the world, according to an annual study by one of Europe's top business schools. The 20th World Competitiveness Yearbook, released May 15 by IMD business school in Lausanne, Switzerland, ranks the U.S. No. 1 for the 15th straight year. But the report's author, professor Stéphane Garelli, expects Singapore to take the top spot next year. The small city-state trails the U.S. by less than seven-tenths of a point in the 2008 rankings. While it still has the world's strongest domestic economy, the U.S. is particularly vulnerable because its financial sector contributes 40% to corporate profits. Meanwhile, Asia has proven relatively immune to the financial crisis gripping the U.S. Garelli says that Asia's roaring economies, led by China, will likely raise their competitive edge relative to the star-spangled superpower and slowing European countries this year. "Asia is discovering that it is not so much the hostage of the American economy, that it can have a life by itself," Garelli says. "They make life difficult for European countries, especially because, let's face it, Europe is suffering from the euro." Among the top 20 economies out of the 55 ranked, those in Asia-Pacific posted the greatest gains compared with last year. Malaysia climbed four spots to No. 19, while Taiwan and Australia each jumped five places to No. 13 and No. 7, respectively. Other strong gains were made by Thailand, which rose six spots to No. 27, and the Philippines, up five to No. 40. Table: The World's Most Competitive Countries 2008

Indian Bond Traders Are Misreading Growth Signs: Andy Mukherjee By the end of the week, there were few takers for the ``bond-bull'' scenario as inflation soared to a new 3 1/2-year high of about 8 percent. The Indian economy is slowing, though not to the extent where it makes sense to go long on bonds. For a start, the paltry 3 percent growth in the industrial- production index during March compared with a year earlier may not be an accurate reflection of real output. For instance, the value of cars and sport-utility vehicles produced annually at Indian factories is three times as large as the output of two- and three-wheelers; still, the latter group is twice as important to the index as the former, Chaudhuri wrote. Manufacturing in India is unlikely to fall off a cliff and certainly not because of a collapse in domestic demand caused by the high cost of capital. Where the drop in performance is most telling -- for instance, in cotton yarn, fabrics and textiles -- the culprit is lackluster foreign demand. The challenge for India is persistent inflation. That's what the currency market also seems to be signaling. The rupee has tumbled more than 10 percent in the past three months, the second-worst performer in Asia after the Korean won. government. Policy makers should enhance the productivity of agriculture. Crop yields are stagnating; small landholders with little marketable surplus are gaining nothing from higher food prices. The other bottleneck to sustaining growth is infrastructure: power, roads, airports and seaports. It has been seven years since India started an ambitious program to build 370,000 kilometers (230,000 miles) of village roads; wherever new roads have been built, the local economy and community have benefited.

China's newest export: Inflation It looks like the United States has seen the end of an amazing period of below-average inflation and above-average economic growth. The gradual integration of China into the global economy gave us those good times. And now it looks like the Chinese economy is going to take them away. For better than 10 years, the U.S. enjoyed the gift of low inflation. From 1993 through 2004, inflation averaged 2.5% a year. That was significantly below the long-term U.S. trend of 3.0% from 1926 through 2008. And it was a welcome relief after the above-trend inflation of 4.8% from 1980 through 1992. Because of low inflation, U.S. interest rates gradually fell during those 10-plus years. Interest on a 30-year mortgage dropped from 8.14% in 1993 to just 5.81% in 2004. Businesses and consumers borrowed that cheap money, with the former spending it on new plants and equipment and the latter on new cars and second homes. Economic growth during those years, discounting the gains from inflation (what's called "real" growth) averaged 3.19% a year, even counting the slump in growth after the 2000 stock market plunge. That was a huge half a percentage point higher than 1980-92's average real growth of 2.69%. The lower-than-expected inflation came from low-wage, low-cost manufacturing countries -- China, India, Vietnam, etc. As more manufacturing (and manufacturing jobs) moved from the U.S., Europe and Japan, these developed economies imported larger quantities of low-cost goods. In addition, manufacturers remaining in the developed economies were able to import cheaper subassemblies and cut the cost of their own products. Economists have dubbed this the Wal-Mart effect. Low prices at Wal-Mart Stores and other big-box discounters had a multiplier effect because low prices at these stores acted to depress competitors' prices. But now it looks like the process has gone into reverse. China is now increasingly exporting inflation

Posted by dblwyo at 10:40 PM | Permalink | Comments (0)

We're going to jump the gun on our normal schedule and put up the economic and market news posts early this week instead of toward the weekend. Sorry but there's more than enough for one thing and for another it sets the stage and frees up processing power for more interesting stuff IOHOs. On the other hand, as Whitney Tilson pointed out today on CNBC, this is a bad time to be a stockpicker because everything's being driven by macro-events (Tilson is a pretty well known value investor and Buffett acolyte). So, just in case you haven't noticed, the markets really tanked ~2:30 this afternoon after the Fed's last set of minutes were released with a weaker GDP outlook, higher unemployment and worse inflation; also the strongest statement to date that they're done lowering rates. What surprises us is that anybody was really surprised since those have pretty much been our themes for some time. What we think we're seeing is the underlying realities of the economy and the credit markets beginning to come home.

Start by considering the stock chart at right which shows the SP500 since last Oct. We've drawn in a couple of trend lines as well as indicates various possible limits. Exciting as the last couple of days have been, especially for us realists (popularly known as bearish). Until you look at the chart and realize that all we might be doing is setting up a sideways move around the 50-day MA. Now if more "real" economic news rolls in and it is listened to instead of blown off, we might find out whether we'll go back to pricing the real downturn or continue with this bear rally fantasy. You can judge the likelihood of that over the next days/week+ by which of those little numbers at the side represent a stopping point.

Speaking of reality there's this great meme going around. Actually several and they're all equally dangerous. One is that the credit crisis is over. The other is that this will be a short and shallow recession that was already beginning to be over. We've been trying to poke some holes in those as well. Briefly - yes the market breakdown has been survived but now we work out the real crunch where credit is tightened in a downturning economy. Which means more writeoffs and losses. And yes the econ data hasn't been that scary so far 'cause it's early days in the cycle. We refer you to the category archives for any further backup if you'd care to.

Now 'bout that "the market is forward-looking, is looking thru the downturn and pricing in the upturn" meme. Well if that's true then over a considerable period of time you'd expect stock cycles to precede economic cycles. Now we ask you, looking at this chart, which shows YoY% changes in both GDP vs SP500 whether you'd come to that conclusions. In our judgment it'd be hard to make as they look like there's good correlation but more coincidence than anything, though that appears to shift in different periods. More than anything the stock market is quite a bit noiser and we'd argue you have to understand the economy.

After the break you'll find a rather largish collection of readings discussing some of the issues. Market rally realities vs these points...a lot on other major outbursts of credit troubles (including an interesting chart on a shrinking monetary base that indicates that credit and the money supply continue to decline with all that implies), some interesting stuff on inflation and the dollar. And a concluding excerpt on just who the analysts were who did well this year. We'll give you a hint - it wasn't generally the herd followers nor those who ignored either macro-trends nor business analysis (remember the Mantra: Economy/Industry/Company). 

Markets Realities

Is Market Rally the Real Deal? After a rough start to the year, the Dow Jones Industrial Average has surged close to 11% since March 10. It is down just 8.3% from October's record, a lot stronger than many expected. People like Eric Bjorgen of Leuthold Group, a money-management and research firm in Minneapolis, are wondering whether this rally is something they can invest in for the medium term or just a bear-market bounce that will soon fade. To figure that out, Mr. Bjorgen looked at 10 past stock recoveries. He wanted to know what kinds of stocks usually are strong when the market recovers from serious trouble, and whether those groups are leading today. He discovered some anomalies. Stalwart P/E Shows Stocks Getting Pricey

• Buffett, Trichet: No End in Sight to Market Woes The end to the credit crunch is still not in sight, European Central Bank President, Jean-Claude Trichet and Warren Buffett, the world's most famous stock market investor, warned on Monday.
• Stock Volatility in U.S. Falls to 10-Month Low as Bets on a Rebound Rise

Investors Chase Poor Fundamentals The S&P 500 currently trades at 22.9 times trailing net earnings, but these earnings are somewhat depressed and not representative of normal long-term earnings power. What is more important is that the S&P 500 presently trades at over 20 times normalized earnings (sustainable earnings at normal profit margins). More friendly price/earnings multiples on the basis of “forward operating earnings” or even price-to-peak-earnings are had only on the assumption of a remarkable earnings rebound in the second-half, or a permanent return to the record-high profit margins of recent years. This is a lot like a kid imagining, once airborne on the bike, that a foam pit will suddenly appear to break the impending fall. As of last week, valuations remained unfavorable for stocks. Meanwhile, however, market action continued to hover near the point where speculation could begin to feed on itself. The behavior of trading volume and leadership remains relatively uninspiring, but some popular moving averages have been crossed (such as the 200-day moving average of the S&P 500), which has fed some amount of technical buying. In short, the fundamentals continue to appear very poor, but market action is at something of a crossroads. The reality is that as recessions develop (and I continue to believe the U.S. faces a much more significant downturn than we've observed to date), the data can take months to accumulate to a compelling verdict, and in the meantime, speculative pressures can remain alive.

Oil Companies Threatened by Rising Costs Mask S&P 500's 26% Profit Decline Take away Exxon Mobil Corp., Chevron Corp. and ConocoPhillips and profits at U.S. companies are the worst in at least a decade. Without the $70 billion that oil producers earned in the last two quarters, profits at companies in the Standard & Poor's 500 Index tumbled 26 percent and 30.2 percent, the biggest decreases for any quarter since Bloomberg started compiling data in 1998. Energy companies made up almost half the income growth reported by S&P 500 companies in the first three months of 2008 as oil prices surged past $100 per barrel, the data show. The results leave the benchmark for American equities vulnerable to declines as oil companies' costs balloon and production slips, according to Bank of America Corp., Charles Schwab Corp. and Allianz Global Investors. The industry is getting less profit from a barrel of oil than at any time since 2005, just as the rest of the U.S. economy is sputtering. Still, energy shares posted the S&P 500's steepest gains in the past year, bloating their representation to 15 percent of the index. The divergence in the earnings of oil companies from the rest of corporate America indicates that the S&P 500's two-month, 12 percent rally may not be sustainable… U.S. economic growth ground to a halt in the second quarter, according to economists' estimates compiled by Bloomberg. The last time the U.S. gross domestic product didn't increase was in 2001, during the last recession. S&P 500 index sectors' earnings and stock growth

Credit Morphology

Credit Crisis May Extend Beyond 2009 as Writedowns Grow, Oppenheimer Says The U.S. credit crisis will extend into and even beyond 2009 as banks will write off more than $170 billion of additional reserves by the end of next year, according to Oppenheimer & Co. estimates. ``The real harrowing days of the credit crisis are still in front of us and will prove more widespread in effect than anything yet seen,'' analysts led by Meredith Whitney wrote in a research note today. ``Just as strained liquidity pushed so many small and mid-sized specialty finance companies to beyond the brink, we believe it will do the same with the U.S. consumer.'' Whitney, together with Kaimon Chung and Joseph Mack, cut earnings estimates for U.S. banks ``significantly'' due to ``strained liquidity resulting from shut down in the securitization market'' and on expectations that banks may take provisions of $88 billion in 2008 and $96 billion in 2009. Banks have become reliant on securitization markets to fund consumer lending, Whitney said. With that market shut down in the wake of the credit crunch, banks will struggle to match the funding from their own balance sheets, she added. That will remove about $3 trillion of liquidity from capital markets by the end of the year, and banks' losses will worsen as consumers will be unable to repay debt with fresh loans, she added.

Banks Hide $35 Billion in Writedowns From Income Statements, Filings Show Banks and securities firms, reeling from record losses resulting from the collapse of the mortgage securities market, are failing to acknowledge in their income statements at least $35 billion of additional writedowns included in their balance sheets, regulatory filings show. The balance-sheet adjustments are in addition to $344 billion of writedowns and credit losses already reported on the income statements of more than 100 banks. These companies have raised $263 billion from sovereign wealth funds, their own governments and public investors to shore up capital. The balance-sheet writedowns also reduce equity, which needs to be replenished. Adding the $35 billion leaves the banks with a $116 billion mountain of losses to climb. ``The smart people are the ones who've identified the problems, put them out there in full transparency, and addressed them by raising more capital,'' said Michael Holland, who oversees more than $4 billion as chairman of Holland & Co. in New York. ``There is still billions of dollars of crap out there that hasn't worked itself through the system. Banks need more capital to work that all out.'' Banks Hide and Additional $35 billion in Writedowns

Moody's Stock Suffers Record Plunge on Rating Error Shares of Moody's Corp (NYSE:MCO - News) fell more than 13 percent on Wednesday, the biggest one-day drop since becoming an independent company in 2000, after the rating agency said a computer snafu resulted in incorrect top ratings for complex debt. The Financial Times first reported a coding error resulted in wrong "Aaa" ratings for debt known as Constant Proportion Debt Obligations, known as CPDOs. Moody's shares fell over 13 percent to $37.95 in the largest one-day drop in the stock since it was spun off from Dun & Bradstreet in 2000. A Moody's spokesman in New York said the rating agency is "conducting a thorough review" of its rating methods for European CPDOs specifically, due to the computer glitch. The review of its computer coding does not extend to subprime mortgage debt, collateralized debt obligations or corporate bonds, Moody's said. "Moody's is simply telling the truth slowly, and there's more truth to be told," said Janet Tavakoli, a consultant and president of Tavakoli Structured Finance in Chicago. "Up until now I thought the rating agencies were incompetent rookies in structured products," Tavakoli said. "Now I'm suspicious that they may be crooked."

AAA Express Leaves Municipal-Bond Investors in Dark The question of whether rating municipal bonds on a scale of their own is a scam or not has been percolating in the market now for more than a year. The argument is a simple one and was spelled out in a March 4 letter signed by 15 state and local officials to Moody's Investors Service, Standard & Poor's Corp. and Fitch Ratings. ``State and local governments almost never default on the bonds they issue,'' said the letter. Raise everyone's rating. Now the analysts have weighed in -- as well they might. If everyone, or almost everyone, is rated AAA, why do you need a bunch of analysts? What possible function do they serve? And why do you need three rating companies? The comment is more than simply self-serving, though, and raises a couple of good points. Perhaps the best is the one of timeliness. State and local economies are lagging indicators. The housing collapse, the resulting swoon in property taxes, and the massive layoffs we have seen in financial services are just beginning to tell in Muniland. Maybe, say the analysts, this isn't the best time to see rating standards weakened.

Hedge Funds in Swaps Facing Peril With Fourfold Rise in Junk Bond Defaults CDSs, which were devised by J.P. Morgan & Co. bankers in the early 1990s to hedge their loan risks, now constitute a sprawling, rapidly growing market that includes contracts protecting $62 trillion in debt. The market is unregulated, and there are no public records showing whether sellers have the assets to pay out if a bond defaults. This so-called counterparty risk is a ticking time bomb. ``The sudden failure of Bear Stearns likely would have led to a chaotic unwinding of positions in those markets,'' Fed Chairman Ben S. Bernanke told Congress on April 2. ``It could also have cast doubt on the financial positions of some of Bear Stearns's thousands of counterparties.''  Fitch Ratings reported in July 2007 that 40 percent of CDS protection sold worldwide is on companies or securities that are rated below investment grade, up from 8 percent in 2002. On May 7, Moody's wrote that as the economy weakened, high-yield-debt defaults by companies worldwide would increase fourfold in one year to 6.1 percent by April 2009. The pressure is building. On May 5, for example, Tropicana Entertainment LLC filed for bankruptcy after the casino owner defaulted on $1.32 billion in debt. A surge in corporate defaults may leave swap buyers scrambling, many unsuccessfully, to collect hundreds of billions of dollars from their counterparties, says Satyajit Das, a former Citigroup derivatives trader and author of ``Credit Derivatives: CDOs & Structured Credit Products'' (Wiley Finance, 2005). ``This is going to complicate the financial crisis,'' Das says. He expects numerous disputes and lawsuits, as protection buyers battle sellers over the technical definition of default - - this requires proving which bond or loan holders weren't paid -- and the amount of payments due. ``It's going to become extremely messy,'' he says. ``I'm really scared this is going to freeze up the financial system.'' Andrea Cicione, a London-based senior credit strategist at BNP Paribas SA, has researched counterparty risk and says it's only a matter of time before the sword begins falling. He says the crisis will likely start with hedge funds that will be unable to pay banks for contracts tied to at least $35 billion in defaults.

Inflation & Dollar

TIPS Show Bond Market Sees Bubble Bursting for Commodity-Driven Inflation Treasury bond traders are telling Americans to stop fretting about inflation. Consumers expect prices to rise 5.2 percent in the next 12 months, according to a monthly survey by the University of Michigan in Ann Arbor, the most pessimistic they've been since 1982. Treasury Inflation Protected Securities, or TIPS, show traders anticipate inflation of about 2.9 percent by January, in line with its average of 3.1 percent the last 20 years. The disparity has never been wider. While consumers grapple with gasoline above $3.70 a gallon, record rice prices and the escalating cost of wheat, TIPS say the commodities market is a bubble about to burst. A commodity slump would worsen losses in the $500 billion TIPS market, where investors lost 2.35 percent in April, the most since December 2006. ``The consumers are more right'' than TIPS traders, said James Evans, who manages $4 billion of inflation-linked bonds at Brown Brothers Harriman & Co. in New York. ``TIPS breakevens have continuously underestimated inflation.'' Evans has been buying TIPS maturing in three to five years. Regular Treasuries are also pointing to a slowdown in price gains. In the last six months, yields on 10-year notes traded below the inflation rate for the first time since 1980. Over the past two decades, yields averaged 2.87 percentage points more than inflation.

Dollar Bind: Gulf Rethinks Currency Ties Last year, Kuwait decided to break from its neighbors and fix its dinar to a basket of currencies.There are good reasons for the Gulf Cooperation Council countries -- Saudi Arabia, the U.A.E., Bahrain, Kuwait, Oman and Qatar -- to move away from the dollar. Inflation is high and getting higher in the region: almost 10% in Saudi Arabia, close to 15% in the U.A.E. and 9% in Kuwait.A stronger currency tends to help fight inflation by making imported goods cheaper. A weak currency does the reverse, and the Gulf countries have tied themselves to the weak dollar. Stronger local currencies could help quiet the Indians, Pakistanis, Filipinos and other imported labor that does the heavy lifting from Kuwait to Oman. They have hit the streets in a couple of Gulf nations to protest rising food costs and the falling value of the dollar-linked salaries they send home to their families. Already, the U.A.E. has frozen prices for bread, rice and other staples.

Argentines Rush to Buy Dollars Barely six years after Argentina committed the biggest sovereign-debt default in history and devalued its currency, locals and Wall Street investors are asking an unsettling question: Is it about to happen again? The short answer appears to be: It doesn't have to happen, but it might. With nearly $50 billion of foreign reserves and one of Latin America's fastest growth rates, Argentina has an array of options to keep its currency stable and meet financing needs in the coming years.Nonetheless, troubling signs of financial panic have appeared. Middle-class Argentines are rushing to cash out savings accounts to buy dollars, a sign they think the government is in big trouble and the currency will plunge. Wary that the rush for dollars would become a full-scale run on the banks, the central bank spent nearly $1 billion to defend the peso in the past two weeks.

Analysis

Finding the Way in Rough Seas Call it the year of the newcomer. More than half of the winners in The Wall Street Journal's 16th annual Best on the Street analysts survey are appearing in the rankings for the first time.What they have in common is that in a turbulent year for the stock market, they made recommendations that would have made investors money -- or allowed them to lose less than they would have otherwise. In this unsettled environment, the top analysts managed to navigate the markets to find stocks that outperformed, even for part of the year, and others that were best to avoid. "Original anticipatory thinking" is among the most important attributes for a research analyst, says Candace Browning, president of global research at Merrill Lynch & Co. "Price anomalies do create opportunities, and you need to jump on those quickly."Some of the best calls last year were sell recommendations, especially in the hard-hit financial and housing-related sectors. Goldman's Ms. Conigliaro says there was greater collaboration than in the past among analysts covering a specific sector and between analysts and big-picture market strategists. She says her firm is using more rigorous models for choosing stocks, geared toward finding companies with the ability to generate returns that exceed the average for the rest of the industry, or the entire market.In years past, fundamental analysis was thought of as "companies first and stocks second," says Margaret Mager, a former Goldman Sachs analyst who resigned early this year to run a retail consulting firm, and a Best on the Street winner for her picks in the clothing and accessories sector in 2007. Now, she says, analysts "cover stocks first and companies second."  See the top five stock pickers in each industry and a ranking of research houses, from the Best on the Street report.

Posted by dblwyo at 03:53 PM | Permalink | Comments (0)

The prior post took a look at the multiple wars going on at the bottom of the Telecom value stack. Now we'd like to look at the smaller but growing ones at the top. If you will yesterday's post was on the technology and infrastructure wars while this one is on the content wars and the distribution debates. Just to refresh your memory about the Content & Distribution Wars you might want to look at a prior discussion (WRFest (Telemediatainment): The Content Who Would Be King) which offers up some other examples that play nicely with these. And lays out a "model" of Content value chain, which we have in mind here.

In the last few weeks there have been some startling new developments that continue to accelerate the changes in New Media "cusped" by Iger's coming to terms with Pixar and the Internet a couple of years ago. Now we're talking about the top of this stack where the strategic questions are: 1) who's content will appear on 2) which device and 3) what kind is it ?

TWX and Apple have agreed to have new movies come on iTunes the same time as the DVD while Viacom (cf. the earlier post) is starting up a new channel aimed at, among many other things, doing something similar. Since Paramount is captive they might have an easier time of it even. At the same time Apple is revisiting its' not-too-successful' foray in Apple TV.  It may have a long way to go but they've also got a lot of runway considering everything else that's working well for them. That re-visiting is syngeristic with the iTunability of movies.

Meanwhile Europe is acclerating its' experiments with Mobile TV - think of it as TV on your smart-phone. Back to the 4A paradigm as well as the bandwidth/infrastructure wars. And ATT is following suite in the US. Whee....Katie bar the door. A lot of challenges before the cup really gets to the lip but again consider this, really mixing metaphors, another big canary.

On the other side of the house traditional content generators are still struggline with the problems of migrating to this brave new world. Unfortunately, aside from online web sites and blogging, old media is still struggling mightily to re-think itself for this new environment. That is - they still haven't figured out two key things. First - how to create an interface that takes advantage of the new media instead of just mimicing the old one. And second - how to make money in either/any case. On the latter I'll bet, at least for now, that they end up back at the answer of the last 100+ years - advertising. Maybe with a dash of subscription thrown in. On the former though, as the prior post, discusses at more length, several interesting or key players are beginning to really re-think what can be done online.

This'll be really interesting, eh what ! 

Content & Distribution 

Apple’s new Hollywood deal: Death of the DVD? The news that Time Warner CEO Jeff Bewkes let slip in a conference call on Wednesday — that from now on Warner Bros. movies would come out as video on demand the same day as the DVD — turns out to be bigger than he let on. Apple on Thursday announced that not only would Warner Bros. titles be available for purchase on the iTunes store the same day and date as DVD release, but so too would movies from 20th Century Fox, Walt Disney Studios (DIS), Paramount Pictures (VIA), Universal Studios Home Entertainment, Sony Pictures Entertainment (SNE), Lionsgate, Image Entertainment and First Look Studios. What convinced the Hollywood studios to cut this deal with Apple’s (AAPL) Steve Jobs? According to Time Warner’s (TWX) Bewkes, the company had been experimenting with “day and date” video on demand (VOD) release for several months and found that DVD rentals only fell by 3 to 5 percent and sales of DVDs actually increased. Since VOD is so much cheaper than printing and distributing discs, it looked like a no-brainer. “Taking a customer and moving that person over from rental-physical over moving them to VOD day-and-date is like a 60 to 70 percent margin instead of a 20 to 30,” Mr. Bewkes said, according to the New York Times. “So it’s about a three-to-one trade.”

Steve Jobs Stakes Out the TV Den While a lot of us carry a little bit of Steve Jobs around in our pocket, Apple is now after the remaining bit of life-share that it doesn’t already own, the home front. On Thursday, the company announced deals with 20th Century Fox, Walt Disney Studios, Warner Brothers, Paramount Pictures, Universal Studios Home Entertainment and Sony Pictures Entertainment, among others, to sell movies for download on iTunes on the same day they are released on DVD. The “day and date” downloaded movies (as they are called in industry jargon) will play only on Apple gadgets, but that characteristic may finally give the company the toehold in the American den that it has been looking for via Apple TV. The movie business, because it makes its living on big fat video files that are harder to share than audio files, was able to watch and learn as the music industry shrank under the weight of pirated downloads and then reluctantly embraced a 99-cent solution from Mr. Jobs. And now every song, now and forever, is worth 99 cents, a price that attains for both the red-hot duet by Madonna and Justin Timberlake “Four Minutes,” and the forgotten B-sides he made when he was in a boy band. The music companies still owned the songs, but Apple owned everything else — pricing, format, distribution and the lucrative revenue stream of manufactured devices. When it comes to video, Apple has competition. Microsoft, Sony and Hewlett-Packard are vying to offer Web-enabled TV, while Amazon, Blockbuster, CinemaNow and Netflix sell movies digitally. So unlike the music companies, the movie studios seemed to be holding most of the cards. They still might have blown it.

Mobile TV Spreading in Europe and to the U.S. Tiny TV, the kind that is watched on a cellphone, is spreading beyond Japan and South Korea, where it has been available for about three years. Mobile operators across Europe and the United States are investing in new broadcasting towers, mobile devices, and television programming and promotions, even though it is not yet clear that profit will follow. On Sunday, AT&T Wireless, with 71.4 million phone customers, started AT&T Mobile TV in the United States. The 10-channel service, costing $15 a month, includes Pix, a channel with movies from Sony Pictures. AT&T will sell cellphones made by LG Electronics and Samsung that can receive the TV broadcasts. Britain is auctioning wireless spectrum this month that could be used for mobile TV. France plans to award a license for a 13-channel mobile video service in June. In Germany, Mobile 3.0, an investor group led by a South African-based media company, Naspers, plans to start a video service this year. These services join a handful of other mobile TV offerings like those in Switzerland and Italy, all beamed from special transmission towers to tiny receivers in the mobile phones. Until the mobile broadcasting technology appeared three years ago, cellphone operators had to send video as prepackaged clips to individual customers over high-speed, third-generation phone networks. That proved costly to both operators and viewers, and the large video packets slowed other voice and data traffic on those networks. Direct mobile broadcasting does not tax the so-called 3G networks.

Publisher Tested the Waters Online, Then Dove In The niche publisher I.D.G. has been working out the answers to some big mainstream questions. The biggest: Can print media survive the transition to the Internet? It may be a niche publisher, but the International Data Group has been working out the answers to some big mainstream questions. The biggest one: Can print media survive the transition to the Internet? The question has taken on new urgency lately. A faltering economy is heightening the pressure on newspapers and magazines to find a sustaining future online, as the flight of readers and advertisers to the Web accelerates. Just last week, The Capital Times, a 90-year-old daily newspaper in Madison, Wis., ended its print version and began publishing only online. The journey beyond print is uncertain and perilous, but the experience of I.D.G., the world’s largest publisher of technology newspapers and magazines, suggests that it can be done. A privately held company, whose magazines include Computerworld, InfoWorld, PC World, Macworld and CIO, it appears to have made a profitable migration to the Internet, with revenue from online ads now surpassing print revenue. Advertisers and readers of high-tech publications have moved online more swiftly than other audiences, so I.D.G. may offer a glimpse of the future of publishing. Yet the transition at I.D.G. came only after years of investment, upheaval and changes in its practice of journalism.

Posted by dblwyo at 12:01 PM | Permalink | Comments (0)

Watching the Superbowl this year was an interesting experience this year for lots of reasons, not least of course because it was one of the best games I've seen in a long...long time. But another thing really interested me because my hosts had just gotten a new HDTV which the man of the house was eagerly looking forward to. Unfortunately the sound quality on the HD channel was terrible with most of the announcer's gabble almost washed out in noise.Contrawise the picture was very good but when we switched to the regular channel at his wife's insistence we of course ended up with a mediocre picture. The moral of the story - other than who rules the roost - was despite all the hype and hoopla that the cable company (Comcast in this case) didn't have the bandwidth to support even one good HD channel with the most important sporting event of the year !

Now we've talked for some time about convergence and competition in the telemediatainment industries but underlying a lot of our, and many others thinking, was that the cable companies had an innate advantage because they already had fat pipes into the premise. What that little anecdote tells us is that it just ain't so. Worse, as many of the stories below illustrate, our experience was by no means isolated. We've tried to represent these issues in the Telecom Industry stack chart which shows both the technology requirements and integrated value proposition that all the underlying service providers are wrestling with. We've talked before about the 4As - Anything, Anywhere, Anytime, Any device. If the cable companies are already struggling with things as they are that means $Bs of new infrastructure investment will be required to compete with the traditional phone companies and completely disrupts the entire competitive landscape. The "Bandwidth Wars" are going to take on a whole new character that will determine who wins and looses up and down the entire stack. This dynamic will also impact the extent of the convergence where XoIP, x being anything from Voice to Video and so on, becomes the underlying enabling technology. Just as an example that all means that Seidenberg's strategy to pull fibre for Verizon is looking more and more brilliant, not just gutsy.

After the break you'll find interesting stories about device wars as RIMM struggles to up it's game against Apple's iPhone where ATT/Apple are cutting prices for more functionality ! Whoops indeed. You'll also find an interesting story about the next wave of competition on the services being offerred - which puts tremendous requirements on multiple layers of the stack but is the value proposition requirement to make all these myriad devices and the new media offerrings viable. Then ther'es a popourri of Sprint the Disaster stories - nothing like combining bad strategy with worse execution and abysmal customer service to watch your cusotmers leaves in droves. Hmmm...Telecom and customer service... an oxymoran ? Or just morans ? And then there's a special section reinforcing our point about the Cable industry's struggles and attempts to find strategic alternatives. Interesting times indeed !

Telecom

BlackBerry’s Quest: Fend Off the iPhone R.I.M. is the North American leader in building smartphones, those versatile handsets that operate more like computers than phones. But R.I.M. may have trouble dominating the market’s next phase. Once the exclusive domain of e-mail-obsessed professionals, smartphones are now prized by consumers who want easy access to the Web, digital music and video even more than an omnipresent connection to their in-boxes.
Since the iPhone went on sale last summer, amid long lines of shoppers and media adulation, the contours of the smartphone market have begun to shift rapidly toward consumers. An industry once characterized by brain-numbing acronyms and droning discussions about enterprise security is now defined by buzz around handset design, video games and mobile social networks. That means R.I.M., which has historically viewed big corporations and wireless carriers as its bedrock customers, needs to alter its DNA in a hurry. While business is booming in Waterloo, analysts are raising an important question about R.I.M.’s future: Can a company that defined mobile e-mail for a generation of thumb-jockeys with bad posture also dominate the new consumer market for smartphones? Market Share Graphic

AT&T to cut the price of Apple’s new iPhone AT&T (T) is planning to put some extra shine on the even sleeker new Apple (AAPL) iPhone. When the 3G iPhone is introduced this summer, AT&T, the exclusive U.S. iPhone sales partner with Apple, will cut the price by as much as $200, according to a person familiar with the strategy. AT&T is preparing to subsidize $200 of the cost of a new iPhone, bringing the price down to $199 for customers who sign two-year contracts, the source says. Apple is expected to have two versions of the new iPhone, an 8-gigabyte-memory and a 16-gigabyte-memory model with price tags widely expected to be $399 and $499. AT&T and Apple declined to comment. At $200, the iPhone would be within reach of a much wider consumer market and give AT&T a strong magnet to pull lucrative customers away from rivals like Verizon Wireless (VZ), Sprint (S) and T-Mobile (DT). The $200 rebate or subsidy would be limited to AT&T customers and not available through Apple’s stores. The new iPhone sold by AT&T will likely be locked or programmed so buyers can’t take the cheaper iPhone to another phone service.

AT&T's new operator AT&T has started deploying television services, mostly to compete with cable-TV companies that now offer phone calling; it already sells broadband connections and, of course, wireless services. Stephenson's goal is to tie all those services together using Internet technology, allowing consumers to access their content seamlessly, from work files to home movies, through any device, anywhere they happen to be. Stephenson, for now, doesn't seem to have any big purchases in his sights, not that there are many phone properties in the U.S. left to gobble up. (Verizon, No. 17 on the Fortune 500, has bought up most of the other prime telecom assets.) Instead he'll have to find ways to grow AT&T (ATT) organically, no easy feat for a mature company of its size. Meanwhile, what was once AT&T's main business, local phone service, is shrinking as cable operators continue to grab customers and people ditch landlines altogether. Investors, worried about the economy and a ruinous wireless price war among AT&T, Verizon, and Sprint, have kept the stock down all year. Then there's the specter of Google, which has dabbled in telecom networks and is now spearheading technology that threatens to disrupt AT&T's wildly profitable wireless business. There's another doomsday scenario out there, one in which AT&T and Verizon do keep up with broadband demands, only to have consumers bypass their new cablelike TV offerings in favor of getting their entertainment directly from the Web, simply by going to sites such as ABC.com. AT&T could end up a pure commodity player, supplying the pipes through which others run far more profitable businesses. Already, in telecom circles, Google is referred to as a "bandwidth parasite" - a super-profitable business that rides on the backs of the telcos' networks. ATT sidesteps the soft spots , AT&T launches TV service on new phones, rivaling Verizon

Sprint

Sprint's Wake-Up Call When Daniel R. Hesse was named chief executive of Sprint Nextel in December, he figured that customer service was going to be one of his biggest challenges, given how poorly the wireless service provider had performed on that count in recent years. He quickly found out precisely how big. The lanky 54-year-old walked into his first operations meeting at Sprint headquarters in Overland Park, Kan., and found that customer service wasn't on the agenda at all. He changed course right away. Customer service is now the first item discussed at every one of the weekly meetings. "We weren't talking about the customer when I first joined," says Hesse. Employees like Paula Pryor saw the merger's impact firsthand. The 38-year-old, who worked in a call center in Temple, Tex., says the numbers-driven management approach implemented after the combination led to poor morale and deteriorating customer service. Even bathroom trips were monitored. The toll on Sprint's reputation has been dear. The company has ranked last among the country's five major wireless carriers in customer service every year since the merger in 2005

• Why Deutsche Telekom Wants Sprint Nextel Although a combined T-Mobile and Sprint Nextel would have the largest number of mobile subscribers, it could still struggle against Verizon and AT&T because they are able to offer so-called quadruple play bundles that include voice, data, TV, and wireless services, which neither Sprint nor T-Mobile currently can. That's why Berge Ayvazian, chief strategy officer at technology consultancy Yankee Group, isn't ruling out yet another game-changing scenario: that T-Mobile would join with cable companies and Clearwire to absorb both Sprint Nextel's cellular holdings and its Xohm WiMAX businesses. The combined entity would create a new U.S. giant that would be in a better position to compete against Verizon and AT&T. The latter are promoting their new FiOS and U-Verse services as alternatives to traditional cable-TV and Internet offerings. "This is a moment of change in the U.S. market," says Ayvazian. "The question for T-Mobile is whether they want to remain a fourth-place operator or make a play to become a more significant competitor."

• Sprint Loses Huge Customer Qwest Communications is ditching Sprint as the provider of its cellular service and switching its mobile-phone customers over to Verizon Wireless' network, striking another sharp blow to Sprint's distressed business. The announcement on May 5 came the same day as unconfirmed reports that the German owner of T-Mobile is mulling a takeover bid for Sprint Nextel (S) and that Sprint itself is considering plans to sell off the Nextel business it acquired for $35 billion in 2005. Since taking over Nextel, which was once the toast of the cellular industry with the highest paying customers, the acquired business has shed millions of subscribers who grew frustrated with clogged networks and other service problems. The situation has grown so dire that new Sprint CEO Dan Hesse conceded in February that, "This turnaround will not happen for many quarters."

 Time Warner Profit Falls 35% on AOL Decline; Cable Systems to Be Split Off Time Warner Inc., the world's largest media company, reported first-quarter profit fell 36 percent on declines at the AOL Internet-access business and said it will separate its cable-systems unit. AOL's profit declined, while earnings at Time Warner's cable-systems, publishing and TV networks units increased. By getting rid of Time Warner Cable Inc., Chief Executive Officer Jeffrey Bewkes is responding to pressure from investors to focus on the company's entertainment businesses. ``If you separate out cable, the content business is cheap,'' said Paul Greene, media analyst at T. Rowe Price Associates Inc. in Baltimore, which owns more than 59 million Time Warner shares among its $400 billion in assets. ``If they get cash from cable and use that to buy back shares of the parent company, that's very accretive.''

Cable Industry

Time Warner Refocusing With Move to Spin Off Cable In another era at Time Warner, before a star-crossed Internet merger, the hard-held belief of Gerald M. Levin, then the chief executive, was that “content is and will remain king, but distribution is the power behind the throne.” These days the king seems to be losing his throne. On Wednesday, Jeffrey L. Bewkes, who became chief executive in January, succeeding Richard D. Parsons, said that Time Warner would completely spin off its cable company, essentially shedding the pipes that have underpinned much of the company’s fortune. Although the announcement was largely anticipated by Wall Street — it had earlier spun off a 16 percent stake to shareholders — it still underscored a profound philosophical shift. For years, it was a widely held belief within Time Warner and the media business that there were real financial advantages to owning both the content — television shows and films — and the means of distributing it to people’s homes. But Wednesday’s cable announcement, which came as Time Warner reported first-quarter earnings, spotlighted the company’s future as a pure content provider. From now on the media company will revolve around two core content businesses that have been out of the limelight in recent years: the Warner Brothers movie studio and Turner Networks, which includes the television channels TNT, TBS, HBO and CNN.

HD enthusiasts crying foul over cable TV's crunched signals As cable TV companies pack ever more HD channels into limited bandwidth, some owners of pricey plasma, projector and LCD TVs are complaining that they're not getting the high-def quality they paid for. They blame the increased signal compression being used to squeeze three digital HD signals into the bandwidth of one analog station. The problem is viewers want more HD channels at a time when many cable and satellite providers are at the limits of their capacity, said Jim Willcox, a technology editor for Consumer Reports magazine. While information is nearly always lost when signals are compressed and then uncompressed, the process can theoretically be made unnoticeable to eyes and ears — and Comcast says it should be. But some viewers say they can see it. Willcox said complaints about compression have been showing up on Web forums, including the AV Science Forum, a site for serious audio visual enthusiasts. In a posting on the AV Science Forum, Ken Fowler of Arlington, Va., compared Comcast signals with those on Verizon Communications Inc.'s all-fiber-optic network, which doesn't have the same capacity limitations. Fowler found the higher-compressed HD stations, including Sci Fi, Animal Planet, the Discovery Channel, the Food Network and A&E, fared particularly poorly. He analyzed the signals by recording them on a digital recorder, then transferring them to a personal computer for analysis. He found there was much less data, measured in bit rates, flowing to some channels than others. For example, Discovery's bit rate was 14.16 megabits per second on Verizon's FiOS system but only 10.43 Mbps on Comcast; A&E HD was 18.66 Mbps on FiOS compared with 14.48 Mbps on Comcast. The FiOS system didn't offer Sci Fi HD, which Fowler's testing showed at 12.59 Mbps on Comcast. He found the signals from the major networks and ESPN weren't getting the increased compression.

Comcast pins hopes on mobile As the bloody battle over subscribers between Comcast and its phone and satellite rivals continues at a virtual draw, the cable giant is looking ahead to a new wireless broadband arena: WiMax. The Philadelphia cable shop posted in-line earnings, and once again lost basic video customers - 57,000 in the first quarter. The slide in Comcast's core business however was offset by gains in its phone and Internet subscribers. Comcast added 592,000 new phone users and 492,000 more cable modem subscribers. Cable companies like Comcast and Time Warner Cable are locked in a brutal war over customers with phone companies like AT&T and Verizon as well as satellite broadcasters and DirecTV . As the cable and satellite TV players bulk up their phone service, the telecoms are trying to get subscribers to switch to their new TV services. All of them have the same goal: To become a one-stop shop for cable, phone, TV, wireless and Internet access. Now Comcast is plotting a bold move into wireless broadband via WiMax. Comcast and Time Warner Cable have been negotiating with Sprint, Clearwire, Intel,and Google over the fate of a proposed joint WiMax venture for several months. The plan is to combine Sprint's wireless spectrum and WiMax unit with Clearwire' WiMax network and build a nationwide mobile broadband network -- to be shared by Time Warner Cable, Clearwire, Comcast and Sprint. Intel and Google want to invest in a new generation of wireless devices that use their chips and Net applications. Comcast and Time Warner Cable see the fast wireless network as a key part of their product lineups.

Posted by dblwyo at 12:56 PM | Permalink | Comments (0)

Well basically we're in the 2nd month of a rally....whee. And for those of us who prefer our data fresh and self-analyzed rather than pre-digested, spum and soundbit, a painful one. In fact the sense of things is reminiscent of last year's Panglossian outlooks. Right now we're in a situation where good news is good and bad news doesn't exist. Especially when the bad news, as it has been, is well disguised under sanguine headlines. From AIG to Fedex to Birth/Death adjustments to Real Final Sales in GDP to negative Real Retail Sales there's no good fundamental or structural data. For a thorough review/debunking of reported reality try Northern Trust's Weekly Review. Lull before the storm pretty well captures it though Kasriel's "Eye of the Hurricane" is also accurate.

But we have passed thru the worst of the credit crisis where total breakdown of the worldwide credit markets threatened. Which means we're headed into the credit crunch, ala a normal cyclic downturn, where banks, et.al. tighten credit standards because deteriorating economic conditions lead to more loan losses. Fri. afternoon Sheila Bair of the FDIC made a guest appearance on CNBC to make just that point. Not to mention Jaime Dimon's speech earlier in the week, the implications of which have been widely ignored.

All of which is born out by the accompanying chart. Notice that we've got a sharp short-term rally after the Fed saved civilization where the index is moving up along it's Bollinger band, cycling around resistance at the 200Da MA with the 50Da converging; i.e. a sideways consolidation while we make up our collective minds ? Also notice that the MACD is moving sideways which means the upthrust momentum is petering out. Right now with no themes and a lack of clarity NOT, IOHO, a good time to put money in the market. And possibly a good shot at re-positioning for a downturn, especially if the prior two posts on the general economic situation appeal to you.

Yet all of the underlying structural and fundamental challenges remain. All cleaning up the terminally sclerotic credit markets has done is allow the normal mechanisms to begin working in our view. After the break you'll find a rather wide selection of excerpts on the Strategic Outlook, the morphing of the credit crisis to a credit crunch and some interesting observations and suggestions about the dollar, oil and especially commodities. Speaking of fundamentals this ain't, as so much else, your father's markets. We're facing long-term structural shortfalls in oil and other commodities due to lagging development combined with rising demand. In those where this imbalance is likely to persist lies continued opportunities. On the other hand from Mohamed El-Arrian to Harrison of Marketwatch to Societe Generale' lots of astute observers are flying warning flags while still recognizing the short-term technicals and sentiment are trumping the news. By and large we think our earlier comprehensive survey (WRFest 27Apr08(Market): Three Steps to Two Views) of the factors holds, and holds strongly, in case you'd like to review it. 

The real question is what makes sense to you ? As usual we offer up tools and ways to think about the problem and suggest the conclusions but leave it up to you to do your own assessment and final decisions. Just to put the various excerpts and that argument in further context consider the longer-term chart of the SP500. For all practical purposes all the emergency of the credit crisis did was briefly take us out of the long-term up-trend. If you look at the charts we're only down ~ 10% from the Oct. high, which in turn was a frothiness OVER that trend, despite the crisis being in full swing.

So we're back to the fundamental decision dilemma and the fundamental economic dichotomy. Is all the economic data, and associated earnings outlooks, benign ? Has a real recession been averted ? Obviously we don't think so, nor do many others. In any case does a continuation of the uptrend since '03 in the markets make sense in its' own right ? And is that continuation or even the current position of the markets consistent with the economic data ? Again we obviously don't think so. In fact we'd argue that at minimum we get rational alignment only when the markets correct off the non-fluffed high of ~ 1450. Given that a correction is 20% then .8*1450 = 1160. Returning us to the levels of '03. Oddly btw notice that long-term earnings are very good but PE's have been enormously compressed - which makes you wonder on the implicit consensus on outlook and earnings quality.(Dr. Pangloss Treating Goldie: Markets, Profits & Earnings). While you're wrestling with your views, my views and the market you might benchmark against he survey excerpted below from Prieur du Pleiss of Capetown and the immediately following one on analyst's excess optimism. (The relevant prior post is listed).

Strategic Outlook

El-Erian on Investment Outlook If you don't have secular anchors, you get sucked into bad trades. Today's economic and financial disruptions are part of a much larger phenomenon that is yet to be fully embraced by markets and policymakers. The global system is attempting to accommodate the breakout phase in the growth and wealth dynamics of a number of countries. The system is also trying to absorb the financial innovation inherent in the proliferation of structured products. Too many participants in the global system embarked on this journey with blunt instruments, inadequate monitoring, and risk management systems as well as a backward-looking mindset. We're seeing a much-needed recapitalization. Over the past decade you've seen the balance sheet of the emerging markets get recapitalized. Then it was the turn of the U.S. corporate and industrial sector on the back of Enron and WorldCom. Today we're seeing the recapitalization of the U.S. financial system. This not the time to go out and buy any credit risk. We're saying something different. To use a sports analogy, rather than just play defense or offense, you also need to play special teams. We're focusing on senior parts of the capital structure with very high-quality bonds, including the financial sector as it goes through this healthy recapitalization.

Massive risk looms, but bulls have reason to hope Last week, we offered fresh thoughts on why it might make sense to sell in May and go away. Today, consistent with our never-ending chase to see both sides of every trade, I wanted to offer five things the bulls are banking on. I share these vibes with the understanding that I expect more downside but respect the upside. Treasury Secretary HankPaulson and Federal Reserve Chief Ben Bernanke have a clear mandate. They're willing to mortgage our future with hopes that a legitimate economic recovery takes root. We've seen this movie before (on the back of the tech bubble) but memories are short given our immediate gratification societal mindset. In a reactive tape, technical analysis assumes a greater importance in the collective metric mix. The quantifiable nature of that approach allows traders to define risk and there's comfort in that, particularly in an unsure world. The reaction to news is more important than the news itself. Between American International Group, FannieMae, FedEx, crude, geopolitical unrest, housing malaise, derivative exposure, technical resistance and complacent ranks, the market has (had) every reason to melt like snow cone on a summer day. It hasn't -- yet -- and that might be offering a valuable clue in the near-term. If the S&P, NDX, and Russell can put aforementioned resistance underfoot, the potential for upside exacerbation exists. That could pave the way for a trading rally through Friday as front-month protection expires and the path of maximum frustration manifests. As I edge through the financial media landscape, I continue to be struck by those looking to be told what to do rather than understand how to do it. There are no easy answers, my friends, as the global equation continues to shift.

Positive Thinking vs Skepticism in the Markets The trusting and the skeptical have been doing battle all year, and the stark contrast offered by the market action on Friday and today are only the latest examples. That AIG has sprung a second and massive leak of red ink in as many quarters (which prompted its former Chairman to claim the company is "in crisis" -- see below) was the news that sat so poorly with Mr. Market on Friday. Today looked like it would fare little better when Fed Ex announced yet another shortfall over the weekend and MBIA served up another loss this morning (also below). Market participants would have none of it, and after an opening dip, they powered stocks higher almost all day. Not even a prediction from one of their heroes, Jamie Dimon, that the "recession is just starting" could deter the optimists, nor could a pronouncement from the Carlyle Group that "enormous bank losses" still have yet to be recognized (see below). The rally came, saw, and conquered because of the final quartet of news items you see posted below. HSBC reported lower write-downs than had been feared, Apple announced it was running out of I-Phones, and it was revealed that HPQ has an amorous interest in EDS. It also helped that some retailers posted better than expected results, causing many to think a recession won't visit these shores (see these charts). 

`Short-Sellers' Have Widest Choice of Candidates Since 1990, SocGen Says ``Short-sellers,'' or people who make money when shares fall, have the widest choice of stocks since at least 1990, as corporate finances deteriorate and profit growth slows, according to a Societe Generale SA strategist. About 100 European stocks currently fulfill the triple criteria needed to be a ``short'' candidate, the brokerage wrote in a report to investors dated yesterday. The requirements include an expensive share price, worsening company accounts, and lack of ``capital discipline'' on behalf of management. On average, the ``short'' list has had 20 stocks, Societe Generale wrote. In the U.S., the number has surged to 174 from 30. ``The opportunities are on the short, not the long side,'' the bank's London-based strategist James Montier wrote. ``Perhaps it is time to join the dark side.''

Stock Markets – Which Way José?: Poll Results The following observations are gleaned from the results: 1) The normal distribution of the June results assigns a smaller probability to the outlying index values (i.e. tails). This indicates that most participants are sticking to index values not deviating substantially from the current index level over the next two months. The distribution of the December results assigns a bigger probability to the tails. This points to a larger number of participants expecting the stock market to deviate significantly from current levels by December 31. 2) 84.6% of the participants were neutral (19.7%) or negative (64.9%) regarding the outlook for June 30. The figure decreased somewhat to 74.8% (made up of 11.8% neutral and 63.0% negative) for the December 31 period. 3) The weighted average index level is 12,338 for June 30 and 12,083 for December 31. These figures represent declines from the current index level of 12,970 of 4.9% and 6.8% respectively for the two measurement periods. (This compares with a Citigroup institutional client survey expecting gains of 3% to 5% for the S&P 500 Index by year end.) The results seem to lie in the same direction as one of my [3] previous polls (April 20, 2008) regarding the stock/bond ratio where 70.3% of the participants did not see stocks outperforming bonds over a six-month period. However, a recent [4] Barron’s poll among US professional money managers showed a different result, with 88% of the participants in the “bullish/very bullish” (50%) and “neutral” (38%) categories. Furthermore, 90% of the managers considered the US stock market to be “fairly valued” (35%) or “undervalued” (55%). 

Analysts Again Are Too Optimistic Investors are used to seeing big daily drops in individual stocks, often along with red-faced explanations by executives, when companies' quarterly earnings miss analysts' expectations. With less fanfare, however, the entire market is on an unprecedented streak of disappointment, driven by the financial sector. Most of the Standard & Poor's 500-stock index's first-quarter earnings are in hand and the aggregate profit of the broad measure's components has missed expectations by 2.4%, led by a 36% disappointment in the financials, according to the research firm Thomson Reuters. The S&P 500's quarterly "miss" is its third straight. Before the recent streak, there had been no "misses" for the index as a whole in the nearly 15 years for which Thomson has kept data. That's largely due to the successful massaging of expectations by companies. In fact, in the past decade-and-a-half, the S&P 500's earnings beat expectations by 3.2% on average, because executives generally try to jawbone analysts with cautionary guidance before their companies' earnings releases. The last three quarters of negative surprises point toward a few disturbing conclusions: First, financial firms don't just remain saddled with credit bets gone sour. They're also still having trouble accurately valuing those bets, or else executives would have an easier time playing the cat-and-mouse expectations game.Second, the woes of the financial sector, which represents a fifth of the S&P's market capitalization, are still capable of overshadowing the rest of the market. After all, positive first-quarter earnings surprises in other S&P categories like energy, which has beaten expectations by 26% for the first quarter, haven't been enough to keep the overall S&P's "surprise factor" in positive territory as usual. (Readings (Earnings): The Real Earnings Realities that Ain't...YET)

 Credit Crisis to Credit Crunch

Credit crisis over? Not likely Das' point was driven home last week by Citigroup's announcement of the sale of an additional $4.5 billion worth of shares -- its fifth attempt to raise capital in the past five months, each of which management hinted would be the last. The troubled bank has now raised $40 billion in the most expensive possible way -- diluting current shareholders -- while contending that everything's fine. Analysts at Goldman Sachs said they were surprised at the paltry amount raised in this round, suggesting it was the best the bank could do for now given its worsening prospects. To believe the worst is over, Das notes, you would have to believe that bank managers have obtained a firm grip on their credit-related losses and have written down at least half of the ultimate total, and that declining home values won't create more losses. He thinks this is impossible because the banks own many of the same losing securities yet have variously written off anywhere from 30% to 80% of their face values. Das figures that since few banks likely overestimated their losses, the variance in the write-offs means most banks continue to underestimate their losses. Thus he calculates that the $200 billion raised from outside sources so far is just a down payment and that banks have up to $700 billion more to go -- an amount far in excess of their total earnings over the past half-decade. And it's not just losses on current holdings that are the problem. Das wishes to remind investors of the $1 trillion to $3 trillion that's still in the process of moving onto the banks' balance sheets from related entities where they were hidden. It appears that a real secular, or structural, change has occurred that makes our past understanding of how banks perform outdated. So Das suggests you enjoy occasional two- to three-month advances as the speculative opportunities that they are, but don't be surprised if permanent improvement is much more elusive as financial stocks remain under pressure for at least an additional year or two, and possibly longer.

• Fed Chairman Bernanke Federal Reserve Chairman Ben Bernanke speaks about liquidity.
• Bernanke Highlights Feedback on the speeck, with CNBCs Steve Liesman
• Rubenstein Says `Enormous' Bank Losses Unrecognized
• Roach Says Credit Crisis `Repercussions' Just Starting May 15 (Bloomberg) -- Stephen Roach, chairman of Morgan Stanley's Asia division, talks with Bloomberg's Naga Munchetty in Brussels about turmoil in the credit markets, the prospects for growth in Asia, Europe and the U.S., and the competence of central banks to handle global economic challenges.
• Scholes Says Credit Rout May `Rival the Worst' Crisis May 15 (Bloomberg) -- Myron Scholes, chairman of Platinum Grove Asset Management LP and 1997 winner of the Nobel Prize in economics, talks with Bloomberg's Tom Keene in New York about the outlook for the credit crisis, economic modeling and the need for a new system of accounting.

Is Debt Thaw on Borrowed Time? Slowly but surely, the grease that lubricates Wall Street's deal machine is flowing again. A significant improvement in the credit markets since late March is emboldening more companies to undertake acquisitions and share buybacks that will be financed largely with debt. At the same time, banks and Wall Street securities firms, which have freed up space on their balance sheets to lend again, are encouraging corporate borrowers to take advantage of lower interest rates and hospitable market conditions while they can. Banks and debt investors are treading carefully. While they are more open to financing deals where one corporation buys another, many are still somewhat reluctant to fund leveraged buyouts by private-equity firms. Companies acquired in leveraged buyouts are often loaded up with a lot more debt relative to their cash flow, increasing their risk of default. Although debt issuance is picking up, the activity is so far largely limited to bigger companies or those with relatively strong balance sheets. The average size of new junk-bond offerings is half of what it was a year ago, and bankers don't think the market can yet stomach multibillion-dollar debt sales. There are some encouraging signs regarding the leveraged-buyout overhang. The pipeline of unsold leveraged loans and bonds has shrunk to roughly $100 billion from more than $300 billion last summer, alleviating some strains on the market. Meanwhile, the additional interest that most junk bonds pay over Treasury bonds has fallen by nearly two percentage points since mid-March to around 6.8 percentage points, according to Merrill Lynch data.

A Fear of Big Demand for Corporate Loans Banks have promised scores of companies money for a rainy day. Now that day is here — and the banks, hard pressed themselves, are worried they will have to keep their promises. With the economy struggling, some corporations are starting to tap so-called revolving lines of credit and other forms of backstop financing. If others rush to do the same, the banks might have to lend hundreds of billions of dollars at a time their own finances are stretched, forcing them to raise money to cover the loans. It is unlikely companies will reach for the emergency loans en masse, since such financing typically is used only as a last resort. Still, the worry is that the demand for cash might be greater than banks expect. The potential exposure is enormous. Collectively, banks have pledged to lend companies more than $1 trillion. And because most of those loans have not been made yet, and many perhaps never will be, the banks have not accounted for them on their balance sheets. In recent years, when banks were flush, many lenders promised to extend credit to companies on easy terms in the future if the companies hired them to underwrite securities, advise on mergers or arrange other loans. And as they did for homeowners with weak credit, banks sometimes waived their usual lending rules for the corporate credit lines, making it harder for the banks to wiggle out of them. GRAHPIC of Corporate Loan exposures.

Dollar, Oil & Commodities 

Dollar's decline finally may have ended However, there is a good chance that the recent run-up in the dollar could be more than just a head fake. Indeed, this just might be the start of something big. To see why, let us start with the fundamental reason for the dollar's protracted decline -- the humongous trade deficit that the United States has been running with the rest of the world. That it narrowed by almost 6% in March is only the tip of the iceberg. For when you drill down, the numbers are even more striking. Imports fell by the most for any month since December 2001. What makes this decline even more significant is the fact that it occurred while oil prices were rising sharply. We paid 3% more for the oil we imported in March than we did in February, but actually brought in 3% fewer barrels of the black stuff. Our performance on the export side is also noteworthy. Over the past year, exports have jumped nearly 10% from their levels at this time in 2007 as U.S. goods have become cheaper to holders of rising currencies. These numbers suggest that the dollar may have reached a level that is low enough to start equalizing the terms of trade. Aside from this, there is the question of interest rates. Ever since the markets came to believe that the Federal Reserve would pause in its campaign to push rates lower, the dollar has stopped falling. Part of the dollar's earlier decline stemmed from investors switching to the euro and other currencies looking for higher rates of return. Then there's the open-mouth policy. Some monetary officials on both sides of the Pond have recently voiced concern over the shrinking dollar, while others have said that they think the U.S. economy will soon speed up while the euro zone will slow. The implication of these remarks is that the dollar should rise against the euro, and if the markets don't do this on their own, there just might be some sort of coordinated central bank intervention to push the buck higher that could occur at any time. This has caused currency traders to hedge their bets. In recent weeks there appears to have been a swing to a net long position on the dollar, from years of a net short posture. Indeed, the entire short dollar-long commodities trade seems to be unwinding. Witness the declines in prices of such key commodities as oil, gold and many foodstuffs as the dollar has firmed.

Beijing/Riyadh and the USD A plummeting US currency would also cause chaos globally, as central banks sought to protect the value of their reserves. And after the inevitable overshoot, the currency would snap back, sending financial markets into a tailspin, and threatening a fully-blown global slump.That danger has been averted for now, but could soon come back with a vengeance. And while policymakers in Washington will be content with the current situation, those elsewhere shouldn't be. It's instructive that the main reason for the dollar's "recovery" has little to do with the US economy. The greenback's relative strength is less about the robustness of America, than the weakness of the eurozone.But a slew of bad data has lately challenged such assumptions. Eurozone retail sales fell heavily in both February and March. Last month, the PMI Euro-manufacturing survey dropped to its lowest level since August 2005. New data shows the bellwether IFO index tumbling in April - contrary to market expectations. And in Germany, the eurozone's powerhouse, factory orders have just contracted for the fourth month in a row. But the situation is by no means stable. One reason is that the US has got by far the better end of the deal. The dollar seems to have stabilised, but at a level well below most estimates of its fundamental value. And, anyway, the biggest problem for the US isn't the eurozone: it's the rest of the world - in particular China, the other emerging giants and the Middle Eastern countries which peg their currencies to the dollar. The weak greenback is harming these countries as it forces them to import inflation. All the signs are that their patience is now wearing thin. And, at the same time, these countries now call the shots, accounting for 75 per cent of the world's foreign currency reserves.So my prediction is that the US will soon reluctantly start talking the dollar up even more. But it won't be Brussels forcing them. It will be the likes of Riyadh and Beijing.

The key to commodity profits If you want to be a successful investor in commodity stocks, start thinking like a CEO. Most investors in the sector are still making investment decisions based on the demand side. Will demand in the United States fall? Will demand from China hold up? They calculate their potential risk and profit based on the answers to such questions. The CEOs at commodity companies are much more focused on the supply side. At this point in the commodity cycle, they know that what's important to their companies is how quickly record prices will bring new capacity into production. In past commodity cycles, a surge in production has led the market to swing from scarcity to glut, destroying the economics of their companies. They know that's how commodity cycles end -- with a rapid growth in production that sends prices plunging. A supply-side glut, not a demand-side collapse, is how a commodity boom always comes to an end. These CEOs are watching very carefully for any signs of a glut. Every decision the industry's smartest veteran CEOs are making these days is about the supply side. Take a look at the oil market, for example. A slowing U.S. economy hasn't been the disaster investors feared. The Energy Information Agency of the Department of Energy now projects U.S. oil consumption will fall by 330,000 barrels a day in 2008, yet oil has still climbed to $120 a barrel. Whoops, better make that $125 a barrel. Growing demand from China, the Middle East, Russia, Brazil and India has more than made up the difference. Chinese demand alone is projected to climb 400,000 barrels a day in 2008. Outside the United States, strong economic growth, rising incomes, rising consumerism, government subsidies and price controls mean the oil market has so many sources of growing demand and so many consumers who don't care much about prices that the rising global thirst for oil for the next five to 10 years is as close to a certainty as anything ever gets in macroeconomics.

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

Like the prior post on the world economy we're jumping the gun because instead of our summarizing the week's key economic data somebody else came out with a better report for you to read. In this case the Northern Trust team has recently published it's updated report and their introduction just perfectly knocks on the head all the unsinn running around about no recession and the recovery starting. BtW, just for the record, Kasriel and his team were joined, or re-joined, by Martin Feldstein (excerpted below on data mis-reading) and Jaime Dimon whom we quoted earlier this week (WRFest 11May08(Economy): Jaime Spoke, Anybody Listening ?). Besides the NT excerpt below we also urge you to click on thru to CalculatedRisk's assessment of the Investment Picture and, if you do nothing else, go read the entire NT report. It doesn't get any clearer, simpler or better IOHO. So letting them speak for themselves while summarizing for us...note the  Real  Final Sales  chart which is essentially  GDP - Inventories.  And that it  turned  negative  in  the  first quarter.  We can't suggest  strongly enough that the state of the economy is being widely  mis-read thru  mis-understandings  of the structure and rythm of the business cycle.  Keep that in mind, please  !

In the Eye of the Economic Hurricane There seems to be sentiment developing that the U.S. has weathered the worst of the current cyclical economic storm and blue skies are ahead. We disagree. Any blue skies you see are likely to be short lived. The economy is in the relative calm of the eye of the business-cycle hurricane. The mortgage credit problems are not over. And credit problems in other sectors are just beginning as the housing recession spreads to the rest of the economy. When the economy recovers from the current recession, perhaps in the first half of 2009, that recovery is likely to be muted as financial institutions are still rebuilding their capital and, therefore, will not be able to extend much credit to the private sector. The plus-sign in front of the Commerce Department’s preliminary estimate of the change in first-quarter real GDP was deceiving. Real final sales of domestic product, which is real GDP excluding the change in business inventories, contracted at an annual rate of 0.2% in the first quarter. Except for the negative impact of Hurricane Katrina in Q4:2005, this was the first decline in real final sales since the first quarter of 2002. Real private final domestic sales – i.e., the sum of personal consumption expenditures and private fixed investment expenditures – contracted at an annualized rate of 1.0% in the first quarter, which was the largest contraction since the fourth quarter of 1991 (see Chart 1). So, the housing recession is now spreading to consumer spending, business equipment spending and nonresidential construction spending. 

Now, It's Services vs. Recession As the U.S. economy tries to fight off a recession, has it found a way to avoid a knockout? So far, strength in many service industries is delivering a powerful counterpunch to hits from homebuilding, autos, and other goods-producing businesses. Despite the economy's tepid 0.6% growth rate last quarter, its service sector advanced a sturdy 3.5%. Consumer spending on goods plunged 2.6%, but outlays for housing, medical care, and other services rose 3.4%. Heading into the second quarter, while overall April payrolls shrunk by 20,000 jobs, services added 90,000. And in contrast to the weakness in manufacturing, the Institute for Supply Management says April service-sector activity continued to grow. There's no denying the sector's increasing impact on economic trends. Services make up almost 60% of gross domestic product, up from 55% a decade ago and 52% the decade before that. However, despite that growing influence, the more important engines of the business cycle have always been the goods-producing sector and construction, and they are taking an unusually heavy pounding. On balance, recession forces appear to be getting stronger this quarter, not weaker. That will put even more pressure on the goods sector. And while the service sector's resilience may help to keep the recession mild, it won't necessarily be able to prevent one.

Fearing Red Herring in the Data Only a month ago, a recession looked inevitable. Job cuts were picking up speed, and stock prices were falling. The Federal Reserve was cutting its benchmark interest rate rapidly, in an effort to keep the downturn from snowballing. But the notion that the economy could avoid a recession altogether seemed fanciful. It looks less fanciful today. The economic news hasn’t exactly been sunny lately, but there also haven’t been any nasty new surprises. If anything, the economy seems to have stabilized. The pace of layoffs has eased a bit, stocks have risen and the Fed has signaled that the rate cuts are over for now. And now the economy is being flooded with cash, courtesy of the federal government, and that will surely lift consumer spending in the months ahead. Two weeks ago, the Treasury Department began distributing the tax rebates from the recent $168 billion stimulus package. The effects of the Fed’s interest rate cuts, meanwhile, are still washing over the economy. So you can make an argument that the economy has survived its period of maximum danger. What, then, are we supposed to make of the latest batch of better-than-expected news? Here are four indicators that cut through the daily swirl of data — and provide perspective on the newfound optimism.

• Rising Inflation vs. Slow Growth Insight on whether the economy has taken a detour from recession, with Zachary Karabell, River Twice Research; CNBCs Steve Liesman and Rick Santelli.

Recessions and Industrial Production A decline in industrial production is one of the indicators of a recession (see quote at top). The following graph shows capacity utilization and recessions for the last 40 years. The decline in capacity utilization suggests that the economy could be in recession. Even more important is that industrial production is a key to the depth of the economic slowdown. So far exports have been strong, and the decline in industrial production has been mild. If the global economy slows significantly ("recoupling"), then industrial production and capacity utilization could fall sharply leading to a deeper recession.Also, with capacity utilization below average, this probably means less investment in non-residential structures in the near future.

Retail Sales Dip for Second Time in Two Months Consumers, battling soaring gasoline prices and a slumping economy, cut back further on their spending in April. The Commerce Department reported Tuesday that retail sales dipped 0.2 percent last month, right in line with economists' expectations. It was the second drop in the past three months and was led by a 2.8 percent decline in auto sales, the biggest setback in this category in 10 months. It reflected the problems that automakers are having as a weak economy and soaring gasoline prices cut into demand for new cars. Excluding autos, retail sales rose by 0.5 percent, a better performance than had been expected as sales at general merchandise stores, a category that includes big chains such as Wal-Mart, posted a 0.5 percent increase, much better than the tiny 0.1 percent rise in March. BofA Customers Feel "Significant Economic Pressure", Real Retail Sales

US foreclosure filings surge 65 percent in April More U.S. homeowners fell behind on mortgage payments last month, driving the number of homes facing foreclosure up 65 percent versus the same month last year and contributing to a deepening slide in home values, a research company said Tuesday. Home Foreclosures: Crisis Is Only Getting Deeper

• Home Prices Post Steepest Drop in 26 Years

Non-Residential Investment Overview Here is an overview of non-residential investment and commercial real estate (CRE) from our most recent newsletter. Recently many companies have announced plans to cut capital spending in 2008. This probably means non-residential fixed investments will decline in 2008, as compared to 2007. This decline in investment is an important indicator for the economy, since changes in fixed investment correlate very well with GDP. The first graph shows the change in real GDP and Private Fixed Investment over the preceding four quarters through Q1 2008. A decline in residential investment is one of the best indicators of a future recession, and that has been flashing a recession warning for some time. Now some of the focus is on non-residential investment, especially on commercial real estate, to determine if a recession has started. There is plenty of evidence of an imminent slump in non-residential structure investment. Research firm Reis recently reported that the strip mall vacancy rate have risen to 7.7%, the highest level since 1996. For offices, the vacancy rate has risen to 13.6% nationally according to Grub & Ellis, and they expect the vacancy rate to rise sharply: Clearly the CRE slump is here. Now the question is how deep and how fast CRE investment will decline. One way to think about this is to look at previous declines in non-residential investment. It is very possible - based on tighter lending standards that the decline in non-residential investment will be greater (on a percentage basis) than the previous two busts. However, based on commercial vacancy rates, it doesn't appear that some segments of commercial are as overbuilt as in the '90/'91 and '01 periods. These two factors somewhat balance out, and my guess - based on these two previous busts - is that non-residential investment will decline about 15% to 20% over the next four quarters, from a $501 billion seasonally adjusted annual rate (SAAR) in Q4 2007, to about $400 billion to $425 billion in Q4 2008 - and that most of the bust will happen during 2008.

Economic 'misery' more widespread Americans are feeling a lot more economic pain than the government's official statistics would lead you to believe, according to a growing number of experts. They argue that figures on unemployment and inflation are being understated by the government. Unemployment and inflation are typically added together to come up with a so-called "Misery Index." The "Misery Index" was often cited during periods of high unemployment and inflation, such as the mid 1970s and late 1970s to early 1980s. And some fear the economy may be approaching those levels again. The official numbers produce a current Misery Index of only 9, not far from the low of 6.1 seen in 1998. But using the estimates on CPI and unemployment from economists skeptical of the government numbers, the Misery Index is actually in the teens. Some worry it could even approach the post-World War II record of 20.6 in 1980.

The Fires May Not Be Out Investors in recent weeks have breathed a great sigh of relief about the financial system. But like any patient who has survived a brush with death, the markets and economy now face a long period of convalescence—one marked by rising corporate defaults, mounting bankruptcies, and, even among those companies with solid prospects, continued unease. The underlying problem: Banks, which continue to raise billions for mounting losses, don't want to lend money. Given the high price they're paying for that replacement capital, it could be a year or more before they start to loosen their purse strings, much less lend at normal levels. And investors still have little appetite for risky corporate debt. That has painful implications, especially in the midst of a recession. Corporations, many of which borrowed to the hilt in 2006 and 2007, will find it hard to refinance their debt, sparking a wave of trouble, particularly among those companies that depend on consumers' discretionary dollars. When Small Biz Can't Get a Loan

Posted by dblwyo at 12:15 PM | Permalink | Comments (0)

We're gonna jump the gun a little on the "weekend" economic readfests...partly because enough has been accumulated to make moving faster worthwhile, partly because there are a couple of key thoughts we want to plant. But mostly because some stories/reports/etc. have come out that perfectly summarize and reflect our opinion.

In general, for those of you paying attention, the meme is back to "dude, where's my recession ?". Something we've tried to disabuse (here and here) with a look at the real data and which we were going to take another pass at (btw real retail sales was negative this weak and industrial production had its' biggest drop on a YoY basis in a year...sorry, couldn't resist). The answer is watch the wave, dude. See that mother offshore building up ? It's all about rhythm, timing and pattern. Or business cycle structure, timing lags and lack of grasp.

Below are some excerpts from a variety of sources on the world economy from Germany to Japan to China, et.al. As it happens the last quarter in the developed world was pretty darn good while China continues to wrestle with it's standard problems of rapid growth vs inflation vs and so on. But speaking of leads, lags and links it turns out a) the world is still linked, i.e. re-coupled (as we've been harping on for a long time now) and b) it lags the US by the usual, if not a little longer (headsd up all you Brazil enthusiasts....now may not be the time to go in). We pause to make those points because the UN economic group, which is in fact pretty competent and respected, just came out with it's latest world outlook revision. Bear in mind that the reporting below is backward looking while the UN report is forward-looking....beyond that let's let them speak for themselves..

UN: World economy to grow by 1.8 percent in 2008 The world economy is "teetering on the brink" of a severe downturn and is expected to grow only 1.8 percent in 2008, the United Nations said in its mid-year economic projections Thursday. That's down from a global growth rate of 3.8 percent in 2007, and the downturn is expected to continue with only a slightly higher growth of 2.1 percent in 2009, the U.N. report said. The mid-year update of the U.N. World Economic Situation and Prospects 2008 blamed the downturn on further deterioration in the U.S. housing and financial sectors in the first quarter, which is expected to "continue to be a major drag for the world economy extending into 2009." But the U.N. said developing countries will suffer as badly: They should grow by 5 percent this year and 4.8 percent next year, compared to a robust 7.3 percent in 2007, the report said. The U.N. economists said the deepening credit crisis in major market economies triggered by the U.S.-led slump in housing prices, the declining value of the U.S. dollar, persistent global imbalances and soaring oil and commodity prices pose considerable risks to economic growth in both developed and developing countries. However, it said the final figure will largely depend on developments in the United States.

Global growth this year could fall to 0.8 percent if the U.S. sub-prime mortgage market turmoil has a more serious impact on developing countries and countries in transition, the U.N. report said. But if the monetary and fiscal measures the U.S. government has taken to stimulate the economy -- including tax refunds and lower interest rates -- boost consumer spending and restore confidence in the business and banking sector, the world economy could only slow to 2.8 percent growth this year and 2.9 percent in 2009, it said. The report, prepared by the U.N. Department of Economic and Social Affairs, forecast that U.S. economic growth will decline from 2.2 percent in 2007 to -0.2 percent this year, with only slight recovery in 2009 to 0.2 percent growth. As for other developed countries, the U.N. forecast that Japan's economic growth will decline from 2.1 percent in 2007 to 0.9 percent in 2008 and that Western Europe's growth rate will drop from 2.6 percent last year to 1.1 percent this year. Despite the slowdown in global economic growth in 2008, the U.N. said global inflation is expected to accelerate this year to 3.7 percent.

Global Economic Outlook Improved in May Amid Signs Credit Crisis Is Easing Confidence in the global economy improved for the second consecutive month in May on signs the worst of the credit squeeze may be over, a survey of Bloomberg users on five continents showed. The Bloomberg Professional Global Confidence Index rose to 22.7 from April's 14.5, with respondents becoming less pessimistic in every region. A reading below 50 indicates negative sentiment. The measure fell to as low as 13.1 in March. ``Conditions are not quite as jittery in markets as they were, so we may be through the worst,'' said Ross Walker, an economist at Royal Bank of Scotland Group Plc in London, who took part in the survey. Participants in the U.S. and Europe reversed their predictions of a dollar decline after the Federal Reserve indicated it's ready to pause cutting interest rates. Wall Street chief executive officers including Jamie Dimon of JPMorgan Chase & Co. said in the past month that the credit crunch is easing.

• EU Ministers Say Consumers `Suffering' as Food, Oil Erode Purchasing Power
• Bank of England Says Inflation Will Accelerate, Overshoot Government Limit
• China's Industrial Production Growth Cools; Yuan Falls on Export Concerns
• China Factory, Property Spending Rises 25.7%, Adds to Overheating Concern

European Economic Growth Accelerates More Than Estimated, Led by Germany European economic growth accelerated more than economists forecast in the first three months of 2008 as stronger expansions in Germany and France masked slowdowns in Spain and Italy. Gross domestic product in the euro area increased 0.7 percent from the previous three months, when it rose 0.4 percent, the European Union's statistics office in Luxembourg said today. The pace exceeded the 0.5 percent median of 32 estimates in a Bloomberg News survey and the 0.1 percent growth rate in the U.S. Growth quickened to the fastest pace in 12 years in Germany and was higher than analysts expected in France, providing strength at the core of the euro-area economy as Spain suffered its weakest expansion in almost eight years. That justifies the decision of the European Central Bank to hold off cutting interest rates for now as it tries to conquer inflation.

• Germany's Expansion Accelerated to Fastest in 12 Years in First Quarter

Slower Growth Exposes Risk on Europe Fringe Emerging markets along Europe's fringes are getting deeper into financial hot water as the global economy slows, raising the risk of market turmoil to come. Among the most vulnerable are economies with free-floating currencies and deep deficits in their external accounts, making them reliant on foreign investment to finance trade and overseas debt. A raft of weak economic data from the region signals that Europe's slowdown won't be kind to emerging-market economies or their financial markets. Romania, Turkey, South Africa and Iceland have regularly reacted the most to bouts of risk aversion coursing through global markets. But each also has ample homegrown economic threats for investors to worry about. Romania on Friday reported another widening in its trade deficit in the first quarter. Industrial production grew at an annual pace of only 2.9% in March, while the output of durable goods actually contracted.

Posted by dblwyo at 05:58 AM | Permalink | Comments (0)

Let's take a look at the big tech news from the last week or so (deferring the HPQ/EDS discussion for now) and focus on the APPL vs MSFT and MSFT vs YHOO campaigns. In both of which there was some big news everybody covered and some that may have passed you by. In an earlier post/survey (WRFest 27Apr08(Tech Ind): Innovators, Survivors & Also-rans) we introduced some ways/weighs of thinking about innovation and typical patterns. You may want to refer back to that as here we're going to build some more charts to dig into some other patterns to set the stage for our discussion. You might also find reviewing the earlier discussion (Sailing Into the Storm: From Execution to Innovation) of innovation a worthwhile review, especially if you buy the argument that Innovation is not just an issue in the Tech Industry but is both a general requirement and the biggest challenge beyond Execution facing all businesses. And one that most are failing at. We think the framework for analyzing what works and is required vs the typical barriers applies to P&G just as much as to MSFT...a view which, judging from public statements and observable behaviors, P&G agrees with.

So consider the chart at right which shows how many companies face the "Renewability Challenge". Chrysler is almost the perfect poster child, along with MOT, of a company who lurches from breakthru hit to hit and hopes it survives the downturn. That behavior is apparantly deeply seated in its' culture. What you'd like to do is have good strategy, translate that into excellent and on-going execution and, on that foundation, build up a repeatable capability for innovation. And better yet embed that capability into the core of the Company. A path that Lafley at P&G appears to be well along on after close to seven years of hard and sustained effort.

There are two big questions. First, can you get the Innovation process going on a regular and speedy cycle show that new products and offerings begin to take off before the old starts into decline. And second, and as or more important, is the question of what path is the Company on. That is are innovations moving the company forward, marking time or eroding despite apparent cleverness.

When you think about the Big Three here you reach very different conclusions. Apple appears to have created a sustainable culture of Innovation with one hit following another. Admittedly largely due to Steve Jobs...yet none of the major innovations Apple has produced are from a one-man band but represent the efforts of entire teams. And even more interestingly, in a rather Disney-like fashion, Apple is beginning to see cross-feeds and synergies. The iPod effort led to the iPhone which was and is a major breakthru in the entire Telecom business model. Both together are causing a rapid growth in Mac sales. Even more importantly big business is beginning to give serious consideration to Apple computers. A critical strategic enabler is a brilliant decision on the Operating System which is modular and scalable. All Apple lacks now is a portfolio of small business applications along with a good development platform. That would allow them to become a major player in the empty dumbell space of ill-served SMBs. (WRFest 2Mar08(Technology): Small to Large - IT Industry Structure)

In contrast MSFT has not only failed in its Yahoo acquisition - which you may recall we thought was a disaster from the get go.(B2C Wars:Yhoo/MS Merger - Disaster in the Making ?) But it really hasn't had any major successes in any of its' new endeavors in years. Instead it's milking the cash cows and monopoly positions it enjoys in OS share and Office Suites. And doesn't appear to have made much, if any, headway in the SMB space. Largely we're given to understand because of a lack of cultural understanding of the applications development process. Now apps are different from middleware, culturally as well as technically. Yet at the end of the day MSFT's core competence MUST be software development. Yet we ended up with a new OS (Vista) that was grossly de-featured from the original innovations promised in Longhorn, has been rather badly recieved, even resisted as it doesn't provide significant advantages over XP and throws open the door to competitors. Particularly in the business marketspace. 

How 'bout that YHOO ? Well after the initial breakout as the most successful portal,with a business built around display advertising it failed to find a way to grow that business. Terry Semel was brought into to provide a little adult supervision, which he did and effectively, but his "new media" initiatives, which presumed that increasing the portal attractiveness and thereby number of eyeballs, both built on the display advertising theme and failed. Meanwhile of course GOOG's wild, and unexpected, success with search-based advertising blind-sided them completely. So what does Yahoo do now ? So far it's failed to take its' huge footprint and sustain it, failed in developing its' own superb search engine (though admittedly with major improvements) and faces an incredibly daunting uphill battle given Google's share, penetration and street cred. Nor can it tell us what it wants to be when it grows up.

Looking at the chart and the three different timepaths illustrated we could just about assign names to each path: Apple, Microsoft and Yahoo. These interesting times are really tough. From a stakeholders perspective you'd have to argue that Apple has found a sustainable path that appears to make it a great place to work but one that's more than fully valued in the markets. That MSFT is sufferring from Red Queen syndrome with major investment after investment that have not succeeded in major incremental growth opportunities. Which makes it an intermediate-term value play and a long-term question mark. For Yahoo the future is now - they appear to be locked into downward path that may metastasize into a death spiral if they don't pull themselves together, execute enormously better and deliver value to existing users/customers and find new paths (vistions, value props, strategies, business models) forward. At best this is a "turn-around" opportunity but it'd take time, money, blood and enormous effort. 

APPL vs MSFT

Sun Microsystems' third-quarter loss stuns Wall Street Wall Street expected Sun Microsystems Inc.'s global sales base to help it weather the U.S. economic slowdown and turn a profit in the first three months of the year. Instead, the Santa Clara-based server and software maker stunned investors Thursday by reporting a loss in its third quarter, caused in part by sagging sales to U.S. consumer-oriented companies that are putting off big-ticket spending for better times.Sun's shares were quickly punished, dropping almost 15 percent in after-hours trading. The company also forecast flat revenues for the fourth quarter and revealed plans to jettison between 1,500 and 2,500 jobs as it tries to snap out of a sudden financial funk. Sun said after the market closed Thursday that it lost $34 million, or 4 cents per share, in the three months ended March 30. That's down from a profit of $67 million, or 7 cents per share, during the year-ago period.The results for the latest quarter include costs of 4 cents per share from Sun's $1 billion acquisition of open-source software company MySQL AB, a purchase that gives Sun a foothold in the rapidly expanding market for database software for Web-based companies.

How Apple is preparing for an iPod slump Still, the number of iPods sold in the quarter grew only 1 percent from the same quarter a year ago. And sales of the low-end iPod Shuffle have been falling sharply. In response, Apple lowered the price of the 1-gigabyte shuffle from $79 to $49, helping to stanch the decline. Apple executives speaking on a conference call Wednesday afternoon gave few details, as is their custom. For some companies, a mature market and downward pressure on prices could lead to a nasty death spiral. But Apple has used its amazing six-year run with the iPod to nurture enough new business lines that it will be able to withstand a collapse in the MP3-player market as well as can be imagined. First of all, it has a continuing revenue stream from the iPods that have already been sold because of the iTunes Store. Apple sold $881 million worth of music and accessories in the last quarter. Second, Apple has created product upgrades that are so different that they may well appeal to a significant number of iPod users. The iPhone, of course, is a product bundle that –- if you want it — is completely different from a standalone iPod. Third, and perhaps most significantly, Apple’s entire adventure with the iPod is helping it sell computers, although the magnitude is impossible to calculate. Apple sold 2.3 million Macs in the quarter for $3.5 billion. That is an increase of 51 percent by units and 54 percent by dollars. Not so bad when the economy is more than a little shaky. Apple’s computer sales have been growing 2 to 3 times as fast as the overall market. But this quarter the company says it grew 3.5 times faster than the PC market overall. Apple’s retail stores are part of this success story, and they sold 458,000 Macs in the quarter. I don’t think these stores would be as mobbed with tourists and other gawkers if they just sold computers and not iPods and iPhones as well. When we look at all the companies that have stagnated along with the products that made them successful — from AOL to Microsoft — Apple stands out as one company that has been able to flip its business forward so well that it is in a great position to thrive, even if its iPod problems become more than little.

The Mac in the Gray Flannel Suit Millions of consumers are seeing the Mac in a new light. Once an object of devotion for students and artists, the Mac is becoming the first choice of many. Surging demand for the machines led Apple to predict revenues will rise 33% in the second quarter, to $7.2 billion, even in the face of an economic slowdown.What's less obvious is that the enthusiasm is starting to spill over into the corporate market. It's a people's revolution, of sorts, with workers increasingly pressing their employers to let them use Macs in the office. In a survey of 250 diverse companies that has yet to be released, the market research firm Yankee Group found that 87% now have at least some Apple computers in their offices, up from 48% two years ago. The iPhone may be Jobs' entrée into corporate offices. It's the one product for which Apple has created an explicit plan for reaching corporations. And it plans to deliver a software upgrade in June that will let the iPhone work with popular corporate e-mail systems such as Microsoft Exchange and allow customers to create their own customized iPhone programs, say, for checking inventory or logging expenses. Apple says more than 160 major corporations are testing the software. Apple is getting help from an unlikely rival: Microsoft. Vista, the latest version of the software giant's Windows operating system, looks like it could turn out to be one of the great missteps in tech history. Not only does it lack compelling new features, but analysts say Vista requires companies to buy more expensive PCs, incur hefty training costs, and to deal with maddening glitches. About 90% of office workers still use its previous operating system, XP.

• Apple Suits Up for Business: Companies are starting to give in and get Apple computers for employees. Andy Hargreaves, of Pacific Crest Securities, and Arik Hesseldahl, of BusinessWeek, discuss.

Microsoft's Vista problem Microsoft keeps insisting that Windows Vista is a winner, but the questions keep mounting — and Thursday’s quarterly report only added to the doubts. Revenue from the company’s so-called client division — PC operating systems mainly — came in at a bit under $4.03 billion. That was about $300 million less than most analysts had expected. It only makes sense that with the economy weakening, corporate technology managers are pulling back from plans to upgrade to Vista from the previous version of Windows, Windows XP. An IDC survey of 300 chief information officers, published earlier this year, found personal computers at the top of the list of hardware spending that companies would cut back on in an economic slowdown. In software, spending on operating systems — like Vista — and Microsoft’s Office suite of productivity programs would be the first to be put off, they said. Vista, given the more powerful processing power it requires, represents both a hardware and a software upgrade. No surprise, then, that there has been a rising chorus among corporate technology customers who want Microsoft to keep licensing Windows XP, with its less-demanding hardware requirements, beyond the phase-out date for most new licenses on June 30. InfoWorld’s “Save Windows XP” campaign, begun in January, now has collected more than 160,000 signatures to its online petition.

MS/YHOO War

Microsoft Abandons Its Yahoo Bid After Disagreement on Price of Takeover

Microsoft's Failed Yahoo Bid Raises Pressure on Ballmer for Plan on Google Microsoft Corp.'s decision to drop its pursuit of Yahoo! Inc. increases the pressure on Chief Executive Officer Steve Ballmer to make his money-losing Internet business succeed against Google Inc. Ballmer's bid for Yahoo, the most-visited Web site, signaled that Microsoft was making little progress against Google in Internet search advertising, said Charles Di Bona, a Sanford C. Bernstein analyst. Ballmer withdrew his bid over the weekend after Yahoo refused a sweetened offer of almost $50 billion, leaving investors asking what his online strategy will be. ``They've got to come out sooner rather than later with a pretty well articulated vision,'' said New York-based Di Bona. The danger for Microsoft is that Google, owner of the most popular Web search engine and winner of the most online advertising dollars, will expand its dominance while Ballmer plans a new course. Google gained 10 percentage points of market share in Internet queries since June, providing 59.8 percent of the searches done in March, according to researcher ComScore Inc. in Reston, Virginia. A Step Back for Microsoft

Yahoo CEO facing possible rebellion after spurning Microsoft Yahoo Inc. Chief Executive Jerry Yang is convinced that the company he started in a Silicon Valley trailer 14 years ago is worth more than the $47.5 billion that Microsoft Corp. had offered for the Internet pioneer. Now he may only have a few months to convince Wall Street that his rebuff of Microsoft's takeover bid was a smart move -- and if he can't, analysts won't be surprised if Yang is either replaced as CEO or forced to consider accepting a lower offer if Microsoft comes knocking at his door again. Disillusioned shareholders are bound to question whether the rejection of Microsoft's sweetened offer was driven more by emotion and ego than sound business sense.Despite such negative sentiment, Yahoo shares are unlikely to immediately fall back to their $19.18 pre-bid price, partly because some investors may still be holding out hope that the software maker will renew its takeover attempt if Yahoo continues to struggle. Accompanied by fellow Yahoo co-founder David Filo, Yang flew to Seattle on Saturday to inform Ballmer that the company wouldn't sell for less than $37 per share -- a price that Yahoo's stock hasn't reached since January 2006. Analysts and investors were left to wonder why the two sides couldn't compromise at $35 per share.

• Yahoo Must Find New Ways to Profit

Posted by dblwyo at 09:52 AM | Permalink | Comments (0)

Hopefully you've had the chance to take a look at yesterday's post on Citigroup. By this point most of the MSM, et.al. commentary is in. Now I'll admit that an in-depth post on Citi and it's deep-seated structural deficiencies has been on my to-do list for a very long time. And interestingly commentators like Jim Jubak and Meredith Whitney have been less than positive (their vidclips are at the bottom of the intro btw...worth watching). However after reviewing the Analyst presentation from last Fri. IOHO they may in fact be dead wrong. Note - we're saying may. If you think back to our template of business business performance (Performance Assessment Basics: Five Fundamental Factors) we argued that a business had to have a strategic vision/business model, execution capabilities that supported it and the ability to manage the outcomes. All of which Citi has lacked for years. Instead it's operated as a discombobulated set of isolated, conflicting and self-serving silos. Even if you believe the breakup thesis each of these silos needs to be turned into an efficient and effective business in its' own right. Then you get to the synergy question.

What we saw in Pandit's presentation starts to answer the mail in each of these areas. Just by way of compare and contrast here's two dloadable files from the old regime and the new. The first is so confusing it's scary. The second is so well-structured, thoughtful and straightforward it's scary in a whole other way. If you dload nothing else take it because of what it tells you first off about Citi. Secondly because of what it shows us about how to think thru a complex business looking to turn itself around. And third because it's as a good an overview of the worldwide finance industry and key strategic trends as you're likely to find. In the same way that looking at IBM's pitches gives you a broader insight so does this. What we show at right is our template of the Fundamental Performance Factors used to create a foward-looking map of what Citi should look like. And which we think Pandit's presentation goes a long way toward speaking to.

Below we have two analysis sections you might find worth looking at. One is a review of real historical performance vs. the common wisdom using long-term stock prices. The second are excerpts from the presentation of key and critical charts with a little discussion wrapped around them. The bottomline here is that major challenges remain - primarily putting in a good management system and changing the culture from one of self-interested aggrandizement to measured collaboration. As Lou Gerstner admitted in his book changing the culture is the hardest part and he left it too late to have much impact. We'll have to see. And as Pandit admits this is NOT an overnight effort nor should it be. Furthermore there's a lot more short-term pain to come from the economy and markets as well as company specific. Nonetheless we think what we see is the beginnings of a Buffet-like long-term value investment opportunity. 

• Whitney Says Pandit Faces `Impossible Feat' at Citigroup May 12 (Bloomberg) -- Meredith Whitney, an analyst at Oppenheimer & Co., talks with Bloomberg's Margaret Popper and Carol Massar in New York about Citigroup Inc.'s business strategy, capital position and earnings outlook, and the performance of Chief Executive Officer Vikram Pandit. David Darst, chief investment strategist at Morgan Stanley Global Wealth Management, also speaks. (Source: Bloomberg)
•  Jubak’s Journal: Citigroup’s real problem Citigroup says the financial supermarket created in the 1998 merger was never fully integrated. Citigroup now has the tough task of selling $400 billion in “hobby” businesses.

Well we've had our apparantly isolated opinion about the economic situation and outlook - that is we're not in a recession, we are early in the cycle and the real downturn is just beginning. Also that Housing has a long way to go to bottom out, the credit crisis has morphed into a credit crunch and credit restraint will link and feedback with bad loans to accelerate a slowdown. A view shared only by folks...never mind...you've seen our little list. Anyway just consider the feedback loop implied by this chart as loan standards are growing increasingly stringent and put it together with Dimon's comments.

But apparantly it's really....really official now because Dimon of JPM has basically come out and confirmed all that. Actually we're sorta serious - we're just watching the game with our little white chip. He's got a big stack of blue and red and gold ones. Here's what Magister Jaime had to say:

JPMorgan Chase CEO: Recession is Just Beginning JPMorgan Chase & Co.'s chief executive said Monday that while the crisis in the credit markets appears to be three-quarters over, he believes a U.S. recession is just beginning. "Even if the capital markets crisis resolves, it does not mean that this country will not go into a bad recession," said CEO James Dimon, whose bank saw its first-quarter profit fall by half due to the recent collapse of the U.S. mortgage market. "The recession just started." "We don't know if it's going to be mild or severe," he continued, speaking at a conference in New York hosted by Swiss bank UBS AG. "We're thinking there's a third of a chance that it's going to be pretty bad ... closer to the 1982 recession than the very mild recessions we had in 2001 and 1990."

 After the break we've got our usual collection of readings excerpts for your skimming pleasure starting with Prof. Feldstein's point that .6% GDP growth was QtQ changes and doesn't mean that in fact in Q1 things didn't slow down rather abruptly and drastically. A point we'd support from our own figures and stats btw. The other recent economic indicator that got people all excited entirely out of reason was a monthly drop in jobless claims. Below you'll find an interesting chart from Northern Trust that pretty well shoots that one in the head. As well as a superb Economist must-read on the state of the Housing market. Aside from being short and very nicely done it's the first major MSM piece we've seen the recognizes what CalculatedRisk and a few others have been telling us for some time - there's a long way to go in the Housing downturn...especially measured by prices.

There's also a section on the World Economy where Europe is beginning to slow appreciably while the credit crisis impact on lending appears to be spreading there as well. The last few readings speak to some major trend issues that are really worth paying attention to. First off the other data that was misread was exports where growth appears to be slowing. But more importantly are two big structural changes that are beginning to emerge. One is the confluence of major problems that need worldwide management to deal with, meaning that all the risks are increasingly on the downside. The other deep changes is the continuing slow erosion of the dollar's status as the default world currency. This won't happen overnight or even in a few years but it is beginning with possible serious consequences for our freedom of manuver in monetary policy. 

US Economy

Misleading growth statistics give false comfort Prepositions matter. The recent government report that US gross domestic product increased 0.6 per cent in the first quarter was very misleading. It implied that economic activity was rising in January, February and March. But the increase actually refers to the rise from the average level in the fourth quarter of 2007 to the average level in the first quarter. Monthly data since January indicate that economic activity and GDP have been declining since the start of this year. Private sector payroll employment peaked last November and has fallen five months in a row, shedding more than 300,000 jobs. Industrial production was lower in March than in December and January. Real personal income net of taxes and transfers is also lower than in January. Real retail sales have fallen since the start of the year. Private housing starts are down 13 per cent in just the two months since January and 36 per cent from a year ago. Although the government does not provide monthly estimates of GDP, Macroeconomic Advisers, a private forecaster, constructs them using the same conceptual approach as the government uses for its quarterly estimates. The company estimates real GDP based on the price level of the year 2000. Its most recent estimates (revised figures to be published this month) show that real GDP rose from an annual $11,649bn last October to $11,701bn in December and $11,777bn in January but fell to $11,686bn in March, a decline of about $100bn in two months. Although GDP declined during the first quarter, the average of the monthly figures in the first quarter ($11,711bn) is higher than the average of the monthly figures for the final quarter of 2007 ($11,675bn). The misstatement that the economy expanded in the first quarter creates an inappropriately sanguine view of the months ahead and therefore reduces the prospect of strong action to prevent the deep decline that may otherwise occur. Although the tax rebates now under way may provide some temporary help, the combination of falling real incomes, declining household wealth and a dramatic drop in consumer confidence suggests further falls in consumer spending and GDP. But the most serious risk is that the rapid fall in house prices – down more than 12 per cent in the past year and falling at a 25 per cent rate in the past three months – will raise the number of negative-equity mortgages, leading to widespread defaults and foreclosures.

Why inflation is not the big problem as painful as higher prices are for consumers, there's reason to believe that economic weakness will be the heftier burden for the economy as the year goes on. Even if financial firms avoid another crisis along the lines of the near-meltdowns earlier this year of Bear Stearns and Countrywide some economists say problems in the financial sector are only beginning to be felt on Main Street."The real economy hasn't yet taken the hit," says Northern Trust economist Asha Bangalore. She says she expects unemployment, recently at 5% after falling into the low 4% range in the housing-fueled economic expansion earlier this decade, to rise to 6% before the current slowdown ends. Bangalore points to Monday's release of the Fed's Senior Loan Officer Opinion survey, which showed tightening standards for all sorts of consumer and commercial loans. "The net fractions of domestic banks reporting tighter lending standards were close to, or above, historical highs for nearly all loan categories in the survey," the Fed said. That means less money is going into the economy to feed consumer spending and business expansion. While a 10% drop in house prices sounds severe, it's easy to see how prices could fall even further if a recession leads to rising job losses - a trend that could send defaults even higher. Blum also notes the companies' thin equity cushions - losses of just 5% on the firms' massive mortgage portfolios could wipe out shareholders - and the accounting problems earlier this decade that resulted in regulatory capital-surplus rules that are only now being rolled back. "There are lots of ifs with these companies," he says. "Their track records aren't especially good."

• Surprise jump in consumer borrowing, Americans barely surviving on credit
• Rebates Will Fail to Spark U.S. Economy as Fuel Prices Soar, Survey Shows

Weekly Unemployment Claims: Continuing Claims at 3 Million Here is our monthly look at unemployment claims. Note that continuing claims has now reached a four-year high of 3 million. This graph shows the weekly claims and the four week moving average of weekly unemployment claims since 1989. The four week moving average has been trending upwards for the last few months, and the level is now solidly above the possible recession level (approximately 350K).
Labor related gauges are at best coincident indicators, and this indicator suggests the economy is in recession. Notice that following the previous two recessions, weekly unemployment claims stayed elevated for a couple of years after the official recession ended - suggesting the weakness in the labor market lingered. The same will probably be true for the current recession (probable).

(!!!) Map of misery The discrepancy between supply and demand suggests that prices could fall a lot more. By historical standards there is a huge glut of unsold homes on the market. The homeowner-vacancy rate—which includes all vacant homes for sale—has soared to a record level of 2.9%, which means that there are some 1.1m “excess” houses for sale compared with the average between 1985 and 2005. Although the inventory of new homes is falling as builders have slashed their production, the supply of homes for sale is being pushed up by foreclosures even as demand from new homeowners remains weak. By most measures, prices are still above the levels implied by the fundamentals. Using a model that ties house prices to disposable incomes and long-term interest rates, analysts at Goldman Sachs reckon that the correction in national house prices is only halfway through. They expect an 18-20% correction overall, or another 11-13% decline from today's levels. But their models suggest that six states—Arizona, Florida, Virginia, Maryland, California and New Jersey, could see further price declines of 25% or more. Given the typical pace of rental growth, Mr Feroli reckons house prices (as measured by the Case-Shiller index) need to fall by 10-15% over the next year and a half for the rent/price yield to return to its historical average. Again, that suggests the national housing bust is only halfway through. And, given the scale of excess supply, house prices—particularly in hard hit areas—are likely to overshoot.

FedEx Lowers Fourth-Quarter Profit Forecast Because of Surging Fuel Costs FedEx Corp., the second-largest U.S. package-shipping company, said fourth-quarter profit will miss its forecast after surging fuel prices raised costs by at least $100 million more than estimated. Earnings will be $1.45 to $1.50 a share in the quarter ending May 31, compared with its previous target of $1.60 to $1.80, FedEx said in a statement. The shares fell 3.3 percent after the Memphis, Tennessee-based company said the slower U.S. economy is curbing express and freight shipments. Yesterday's forecast marked the second time FedEx pared its outlook this fiscal year under the strain of the rising price of oil, which set records each day this week, and a possible U.S. recession. United Parcel Service Inc., the largest U.S. shipper, last month lowered its forecast as well.

World Economy

European Retail Sales Decline by Record as Faster Inflation Curbs Spending European retail sales declined 1.6 percent in March, the most since at least 1995 and twice as much as economists forecast, as soaring fuel and food costs sapped consumer spending. The drop in euro-area retail sales from the year-earlier month is the largest since the data series began more than a decade ago, the European Union's statistics office in Luxembourg said today. From the prior month, sales declined 0.4 percent. Economists had forecast a 0.7 percent annual decline and a gain of 0.2 percent from the previous month, according to Bloomberg News surveys. A doubling of crude-oil prices in the past 12 months and soaring prices for food such as wheat and rice have undermined consumer sentiment across the 15 nations that use the euro. The European Central Bank, which meets tomorrow to decide on interest rates, has refused to follow its counterparts in the U.S. and the U.K. in lowering borrowing costs after inflation surged since August, reaching a 16-year high of 3.6 percent in March.

• U.K. Factory Production Unexpectedly Drops as Economic Slowdown Spreads
• German March Factory Orders Unexpectedly Decline for Fourth Month in a Row

European Corporate-Loan Demand Begins to Wane  A new European Central Bank survey of bank lending in the euro currency zone suggests the global financial-market turmoil that started last summer is now taking a direct toll on corporate Europe. Until now, strong corporate investment and hiring in the euro zone -- often by exporters still selling strongly into emerging markets -- has propped up the region's economy, even as housing markets and consumer confidence have soured. That period, however, now appears to be ending. Friday's ECB survey of lenders in the 15-nation euro zone showed that European banks are tightening lending standards while demand for loans from companies is slowing sharply, a combination that suggests the region's economic slowdown is broadening, analysts say.

Be careful -- real export growth looks to have slowed Unless your family is in the wheat or beans business (wheat and soybeans exports have more than doubled when q1 08 is compared to q1 07; total food and feed exports are up 50% y/y), there actually wasn’t a lot to like in this month’s trade release. Yes, the headline deficit fell relative to February, but February looks to have been a blip. The rolling 3m deficit has been stable at around $59.5b since December. And much of the fall in the deficit came from a big fall in the volume of imported petroleum. Petrol imports (in volume terms) were running ahead of last year’s pace in January and February. The real problem though was on the export side. Export growth looks to be slowing. The headline nominal growth numbers look good. Y/y non-petrol goods exports are up by a healthy 14.8% -- far more than the 3.3% growth in nominal non-petroleum imports. But if the rise in agricultural exports and exports of industrial supplies (petrol, chemicals, metals) is stripped out, export growth was only up 5.2% 8.8% in nominal terms (oops; my bad). Slower growth among those exports whose price hasn't obviously increased is a warning sign. The data bounces around a lot, but it certainly seems that the pace of growth in real US goods exports is slowing. March real goods exports fell back below their level last June (see Exhibit 10). The usually reliable FT missed this part of the story, opting to highlight ongoing growth in nominal exports ("second-highest monthly" total in history despite the down tick from February) rather than the not-so-strong real growth. Dollar depreciation helps, but a slowing world economy hurts. Countries that are spending more on oil may have a bit less to spend on other goods. Plus, in some sectors the US may be hitting capacity constraints. Boeing is a case in point: it needs to get its 787 assembly line sorted out.

A turning point in managing the world’s economy In all, growth of the world economy is forecast to slow considerably, from 4.9 per cent last year to 3.7 per cent in 2008 (measured at purchasing power parity exchange rates). In terms of growth at market exchange rates the slowdown is more significant, down from 3.7 per cent in 2007 to 2.6 per cent. Even so, global growth would remain well above levels in 2001 and 2002 (see chart). This, then, would be a case of “large earthquakes; not too many hurt”. Yet these forecasts coincide with two huge events: the financial crisis and the commodity price shock. The first is described by the WEO as “the largest financial shock since the Great Depression”. The second is the result either of a gathering inflationary storm or of reaching limits to the rate of growth (or, more plausibly, of both). Not surprisingly, the WEO concludes that risks are tilted to the downside. So many can be listed: worsening financial conditions; inflation risks; further adverse shocks in the oil market; and disorderly unwinding of global payments “imbalances”, particularly if investors decide that the Federal Reserve has abandoned its duty to conserve the purchasing power of the dollar. What has brought us to this point has at least five components: the accelerated growth of emerging economies, especially China; the emergence of a huge surplus of savings over investment in significant emerging economies, particularly China and the oil exporters; a long period of low inflation and relatively stable economic activity in high-income countries; financial liberalisation and innovation; and accommodative monetary policies. Emerging economies have been the engines of growth over the past five years: China accounted for a quarter; Brazil, India and Russia for almost another quarter; and all emerging and developing countries together for about two-thirds (measured at PPP exchange rates) of world growth. Yet what shine out to me from this analysis are four longer-term policy questions. This year is a turning point. It is up to us to make it turn in the right direction. It will not be easy.

• Hoenig Says `Serious' Inflation Pressures May Compel Fed to Increase Rates

Posted by dblwyo at 03:24 PM | Permalink | Comments (0)

Citigroup has been a poster child for many things in the last few months...actually over the last decade. As such they make a good example of digging into a company to examine it's current situation, performance and outllook. Now they've faced a myriad of problems and bad news, much of it self-inflicted, as it turns out. And the bad news keeps on coming with recent writeoffs, more layoffs and more and more MSM media coverage of the sort "can anybody run Citi ?".

The standard story that's been built up is that Sandy Weill put together a giant financial super-market thru astute deal-making but his successors have failed to translate that vision into executable reality. There's a lot of truth to that story but even for a standard mythology it tells us only about 1/2 and reinforces the storyline that Weill himself has been selling.

As a start for digging into it we've collected a bunch of readings from fairly recent reports on the writedowns and earnings, key analysts take on capital and dividends and headline stories on the workability of Citi. Where this all comes together is that this year is the 10th anniversary of Weill's legerdemain and the newest CEO, Vikrim Pandit, just gave his first major presentation to the investment community telling us what he's found, what's being done to fix things and where they're going. Not surprisingly much of the reaction to his pitch is..."oh no, not that same old leaner, meaner story again". Actually we happen to think that the presentation, which we have reviewed is superb, simple, both broad and deep and, if properly executed, indicates the beginnings of the same kind of turnaround that Alan Mullaly is orchestrating at Ford. And by the same approach.

Consider the chart of Citi's stock at right as being the initial starting point and main evidence for the Weillology of "my successors" screwed it up. On the surface it would seem to support his argument. At least until you take a closer look. Notice that the giant runup in price began in the early 1990s, not with Weill's magic touch. Which means a great deal of it had to do with the overall runup in the markets in the '90s. The other thing one would want to ask when looking at a chart of this length is what would inflation-adjusting it tell us ? A third small detail to notice is that once the economy slowed and the bubble in mainstream stocks starting deflating Citi, on Sandy's watch, didn't do particularly well. At minimum he wouldn't appear therefore to have created a vast differential in performance.

What we think happened is that he put a lot of stuff together, ran off the key operating/strategic exec (Jaime Dimon) who was required to turn that mess into an integrated whole and left a whole bunch of organic problems to his hand-picked successor. When Prince took over he ended up having to jettison a lot of businesses. clean-up $Bs of legal and operational problems and try to repair the lack of controls and management system as well as the culture. Unfortunately while he did pretty well on the first part the second wasn't his forte. And worse he let himself be seduced by the performance Sirens into making some really dangerous decisions. Summarized in the "while the music's playing you've got to keep dancing" quote. Well actually not. What they pay the senior executives for is to dance with style, grace and skill, to know which dances they're good at and which not, to sit out the bad ones and to leave before the party's over. Looking back it looks like Prince got it all wrong.

So what's Pandit going to do ? If you'll recall we've suggested two major mantras, dashboards or filters for thinking about things. The first is the Economy-Industry-Company mantra. In other words  the continuing downturn in the Economy will continue to impact Citi's performance while the fundamental re-thinking of the Finance Industry that needs to go will, or should, trigger major changes in strategy, operations and business models.

The other major dashboard/evaluation mantra we've suggested is that a high-performing company  needs to: 1) Have a fundamental value proposition and a Business Model/Strategy that translates that into specifics. And 2) it needs to be able to execute against the strategy in an aligned way at the most fundamental level. And finally, 3) it requires a management system that makes sure everybody is marching to the same drumbeat and rhythm where people are held accountable for delivering on their responsibilities. And conversely that the things they are held accountable for are the things they are responsible for, i.e. have control over.

Citi as an entity failed all those tests thruout the last decade. Now the question is can Pandit fix them. We'll take that question up in our next post. 

Citigroup  Readings

Citigroup stumbles again -- Citigroup delivered yet another devastating quarterly loss Friday, this time losing more than $5 billion due to troubling results in its fixed-income business and higher consumer credit costs. The New York-based company also recorded $12.1 billion in writedowns, nearly half of which came from subprime-related direct exposures.But Citigroup (C, Fortune 500) shares gained nearly 7% in pre-market trading as its quarterly revenue topped expectations. At the time, the company also announced a number of drastic cost-cutting measures, including slashing its dividend and plans to eliminate roughly 4,200 jobs from the company's massive global workforce. This time around, the company did not announce any plans to cut additional jobs, nor did it announce any new capital raising plans. Citi, however, did offer some surprises, by reporting better-than-expected top line growth. The company reported revenue of $13.22 billion for the quarter, up sharply from the previous quarter, but nearly half of $25.46 billion a year earlier. Analysts had expected the company to report a loss of 95 cents a share on revenue of $12.77 billion, according to analysts surveyed by earnings tracker Thomson Financial. Citigroup CEO Vikram Pandit blamed the results on ongoing market turmoil and tough credit conditions, adding that Citi would continue to implement its recent strategy of shedding those parts of the company that did not fit its core business model. Citigroup Reports $5.1 Billion Loss, to Cut 9,000 Jobs

Citigroup May Scrap Dividend, Raise Capital as Losses Rise, Whitney Says Citigroup Inc., the biggest U.S. bank by assets, may cut or eliminate its dividend as losses escalate this year, Oppenheimer & Co.'s Meredith Whitney said.The analyst tripled her 2008 loss estimate to 45 cents a share and reduced her 2009 profit estimate to 90 cents a share from $2.50. New York-based Whitney in October correctly predicted two months in advance that Citigroup would slash its dividend to preserve capital. ``The company has seriously constrained earnings power,'' she wrote in a report today. This may force Citigroup to ``seek additional capital from outside investors.'' Citigroup Sells $6 Billion of Hybrid Bonds to Boost Capital After Losses

Citigroup's Reorganization Strategy Explained  Citigroup is reorganizing its Wealth Management Units and Mortgage Units. Let's see what we can learn about its silo busting and silo building strategies, starting with wealth management. Reuters is reporting Citigroup reorganizes U.S. wealth management unit. “Citigroup Inc is reorganizing its U.S. wealth management unit to focus on helping clients based on their net worth, according to an internal memo dated Monday.” Exactly how does this eliminate silos? It seems to me that 4 silos were created out of one bigger silo. Worse yet, there is now duplication between silos. Are "high net worth" clients now second class citizens getting second class service or even second class advice? Does it take special skills to handle an "ultra-high net worth" client vs. a "high net worth" client? Does it take different skills to handle a "high net worth" client vs. an "emerging affluent" client? When someone moves up from "emerging affluent" to "high net worth" exactly what is the handoff procedure? The best way to eliminate silos would be to sell the entire Smith Barney unit while something can be gotten for it. I said the same thing to GM about GMAC, but they pissed away time and money and still made the wrong decision to keep half of it. Citigroup's Two Part Strategy Explained Big silos will be split into small silos Small silos will be combined into one big streamlined silo This is an ingenious plan. Not many could have come up with it. It will be a travesty of justice if big bonuses are not handed out for this fine effort. What’s Pandit’s plan at Citi?, Citi hits the private equity ATM

Can anyone run Citigroup? Can any CEO, this newest one included, actually manage Citigroup, a company that simply may be too big and complex for any boss to wrestle to the mat? On that, we can give you the opinion of one particularly interested and well-placed individual. Talking in April to Fortune in his minimally decorated Manhattan office, a few floors above Park Avenue's constant traffic, Pandit himself said that without question Citi can be managed. It is only a matter, he said, of people, organization, and execution. And by the way, he's not going to break it up. Right now, there's no way to know whether Pandit truly has this job scoped out or has just been overly influenced by having the levers of the Citi franchise suddenly in his hands. Decisive answers about the company's manageability will come into view only over time, amid the certain attention of regulators, competitors, and just plain followers of high business drama. In this story, for which we interviewed many current and former key players at Citi, we'll take a hard look at how the banking giant arrived at its current condition and hear from Pandit about his plans to revive it. Lurking behind those dueling views is the Lost Decade, the period from the euphoria of April 6, 1998 - announcement day for the merger - to today's subprime sinkhole.

Blue-Light Specials at Citigroup as Its New Chief Plans a Revival Since becoming chief executive in December, Mr. Pandit has been clearing out the corporate attic of weak businesses and unloading worrisome assets at bargain-basement prices. In an effort to streamline the sprawling company and placate restive shareholders, Mr. Pandit has sold or closed more than 45 branches in eight states. He has also disposed of Citigroup’s headquarters building in Tokyo and its investment-banking base in New York and ditched more than $12.5 billion in loans used to finance corporate buyouts. And he has jettisoned the Diners Club credit card franchise, Citi’s commercial leasing divisions and a big pension administration unit. Mr. Pandit is not done yet. After months of false starts, Citigroup is now trying to sell Primerica Financial, a life insurance and mutual fund company, according to people close to the situation. He is also looking to sell its back-office outsourcing unit in India and its Smith Barney brokerage firm in Australia. Some speculate he also may try to sell 340 bank branches in Germany, possibly to Deutsche Bank. Together, all these sales could raise billions of dollars for Citigroup at a time the bank is feverishly raising capital. Yet the moves also reflect a crucial shift in how Mr. Pandit plans to run the bank. Mr. Pandit is intent on keeping Citigroup together, rather than carving up the financial conglomerate, as some investors are urging. But in a break from the financial supermarket model championed by Sanford I. Weill, who built Citigroup through acquisitions in the late 1990s, Mr. Pandit plans to focus on businesses and regions where Citigroup can generate the fattest returns. At the same time, Mr. Pandit vows to “break apart the culture” and demand better performance. To do so, he has brought in executives and overhauled compensation so his managers have incentives to focus on what is best for the entire company, rather than their own corner of it.

• Pandit's Turnaround Plan for Citigroup May Lead to Asset Sales, Staff Cuts
• Citigroup's Pandit Plans to `Wind Down' About $400 Billion of Bank Assets
• Citigroup targeting 9 percent revenue growth

Pandit of Citigroup Plots a Turnaround But Not a Breakup In his first major presentation to investors and analysts since taking over in December, Mr. Pandit confirmed Friday that he has no interest in breaking up the financial conglomerate, though it will dump about $400 billion in assets during the next two to three years. Mr. Pandit's affirmation of the supermarket strategy -- at Citigroup's core since the 1998 merger that created the New York company -- came with a vow that he would push to build the cohesive corporate culture and integrated back-office and technology systems that Citigroup has lacked. "In a sense, the 1998 merger was never completed," he said, leaving Citigroup with 16 different database centers -- when it really needs just two or three -- and roughly 25,000 employees to oversee the disparate systems. "We're finally going to merge it all," Mr. Pandit said at the 3½-hour meeting.The remarks left some analysts and investors, who were crammed into an auditorium at Citigroup headquarters in midtown Manhattan, with a sense of déjà vu. Last year, Mr. Pandit's predecessor, Charles Prince, emphasized a leaner, meaner approach, even as skepticism was mounting on Wall Street.

Posted by dblwyo at 10:41 AM | Permalink | Comments (0)

Let's focus on the Auto Industry which is important, and still gigantic, in its' own right but also the exemplar of much that goes on in the business world. Now in case you haven't noticed the US auto market is facing a severe and accelerating downturn which appears to have been somewhat unanticipated, particularly by GM. On the other hand the turnaround team at Chrysler at least claims to have positioned itself for a sharp drop in total demand and a major shift in its' structure. And Ford, who'd have thunk it, actually did pretty well all things considered. In fact we'd argue that Ford, relative to what might have been reasonable expectations, is turning in an amazing performance.

Yet all told all manufacturer's are experiencing a very bad and worsening market (& if you don't think that says something about the economy we need to revisit the Into to Macro discussions...). Below in the readings you'll find an overview from Ghosn, some specific stories (BMW, Daimler, GM, Ford) that support these points including the applause for Ford and some big picture discussions of Toyota's structural and strategic advantage as well as the issues with completely re-thinking the stables of brands that need to be downsized. Those last two should be taken together as they define the Yin and Yang of the Auto Industry. At the end of the day, beyond the Business Model - Strategy - Execution - Accountability mantra we've defined for performance what're the necessary changes ? At their heart Auto companies really do one (two) things. They build cars, which more properly broken down, they design and manufacture cars. And coming from the industry that defined the world's model of manufacturing excellence those roots seem to have been lost.

Let's consider manufacturing excellence and the state of the world using the graphic at right. Where this is important is that the argument applies to any manufacturer anyplace in the world so as stakeholders in any such, whether the Auto guys, John Deere, Caterpillar, or whomever here's a simple model to think about. When you think about it you can make things as 1-Offs, that is completely to order, like a new prototype or an F1 Racer. Or start with some basics but go thru extensive customization like, for example, the Bugatti Veyron. There's a reason that a Veryron is so expensive or a suit from an English bespoke tailor will look great but cost you. The next alternative is to run in batches - that is invest in some capital equipment and make more than one of pretty much the same thing. Make enough and pretty soon the cost/unit is less, and then far less. Which suggests that if you set up a manufacturing assembly line you can just churn those suckers out for lower and lower unit cost. Finally there's the notion of making things a continuous process, as say, an oil refinery or chemical plant does. Or for that matter, in a way, Intel or TI do. The reasons more don't do that is pretty obvious - not everything's a barrel of oil, a gallon of chemical or a one of a million chips. (admittedly stretching the point). So for most things where market size, product characteristics and manufacturing technology dictate you end up choosing between custom, batch or line processes.

What Toyota introduced many years ago was a manufacturing process that didn't require a giant, rigid, very high volume, inflexible and non-interruptible manufacturing process. Otherwise known as the Toyota Production System or "Lean Manufacturing". What they discovered was a way to organize manufacturing where one could achieve comparable economies thru more flexible and cellular manufacturing. Which by it's very nature was also more flexible in terms of both setup and interrupt and different models. In other words it was profitable to make just enough to suit a particular market and then switch to different models. Now in the first picture what you see is the shift of unit manufacturing cost, that is direct operating cost, as the result of this innovation until a Lean Manufacturer can beat a line manufacturer on direct costs. Sadly we've known about all this for several decades. More sadly of the companies who've started Lean initiatives some 70-80% are abandoned. But the consequences are even more dire.

Because you see we were talking just about direct manufacturing costs. If you're committed to a full-roar line process you keep it pumping no matter what - which means you build as much as possible and stuff the market with stuff the customers may not want so you end up with lower prices. And worse yet because you're running these giant machines you've got these equally huge procurement and distribution operations that are just chock-a-block full of inventory, costs, delays and disruptions. On the other hand a Lean Mfg who's running in much smaller lots, who can stand to be interrupted, who can start & stop, change models, etc. etc. and doesn't mind as much idling his operations enjoys benefits in Total Operating costs and Revenue per unit. The end result is two strategic benefits. One is a much higher unit profit than a traditional manufacturer. The other is a long-term dynamic advantage as and if they keep improving - able to make more and more profit from more and more targeted products that add value and command higher prices.

Now we've argued that the US Steel Industry was a perfect model for what the Auto Industry is going to have to go thru. It looks like Ford and Chrysler have finally realized that and are well-started. But what other industries and companies need to get on this bandwagon. Give it some thought. Better yet ask who's on this journey to a complete re-think and re-work of manufacturing operations. Those will be the folks you want to invest in. Contra wise the ones who aren't, or who abandon these sorts of initiatives, are going to face an increasingly inhospitable world.

Outlook 

Nissan's Ghosn Sees Prolonged US Car Market Slump The U.S. car market, the world's largest, won't recover before 2011, Nissan Motor Co. Chief Executive Officer Carlos Ghosn said. ``The U.S. is slumping in 2008,'' Ghosn said today at a news conference in Portugal. ``At best, in 2009 and 2010 we'll see a stabilization.'' Like larger Japanese rivals Toyota Motor Corp. and Honda Motor Co., Nissan depends on North America for more than one- third of sales. Honda leads the pack with a 54 percent contribution last year. An increase in the value of the yen against the dollar has also hurt Japanese automakers by reducing the value of U.S. sales converted back into yen. The European and Japanese car markets will continue to stagnate or decline, said Ghosn, who also heads Renault SA, the French carmaker that owns 44 percent of Nissan.

• Nissan to report 24% gain While Detroit will report another month of steep declines, Japan's auto makers saw April gains, led by Nissan's Altima, Murano and Versa.

Companies

BMW First-Quarter Profit Falls 17% on U.S. Economic Slowdown; Sales Climb ``The international financial crisis worsened and the climate for consumer spending became gloomier,'' BMW said in today's statement, adding that profit was hurt most by the U.S., which accounts for one-quarter of deliveries. Unit sales in the world's largest economy fell 5.4 percent to 27,404 in March, led by an 8.7 percent drop at the main BMW brand. Federal Reserve Chairman Ben S. Bernanke said April 2 that gross domestic product may contract this half. ``BMW is putting on a brave face, but one has to wonder when a turnaround in U.S. sales will be seen,'' said Stephen Pope, chief global strategist at Cantor Fitzgerald in London. ``The margin for a luxury brand is with top of the range models and that's where the bulk of withering demand is seen.'' Pope has a ``sell'' recommendation on the shares.

Daimler Net Drops 32% as Chrysler Stake Weighs On Profit, Truck Sales Fall -- Daimler AG, the world's second- largest maker of luxury vehicles, said first-quarter profit dropped 32 percent, more than estimated, after a stake in former U.S. unit Chrysler dragged down earnings and truck sales fell. Net income declined to 1.33 billion euros ($2.07 billion), or 1.29 euros per share, from 1.97 billion euros, or 1.89 euros, a year earlier, Stuttgart, Germany-based Daimler said in a statement today. Analysts had predicted a profit of 1.46 billion euros. Revenue barely rose to 23.5 billion euros.Daimler's 20 percent stake in Chrysler, the third-largest U.S. automaker, wiped 491 million euros from earnings as a slowing economy hurt sales. Revenue at the truck business, the world's largest, fell 13 percent to 6.33 billion euros as U.S. deliveries plummeted 47 percent. Mercedes-Benz Cars boosted both profit and sales. ``The relatively weak truck sales clearly show that this business is not a one-way street,'' said Juergen Meyer, who helps oversee 1.2 billion euros, including Daimler shares, at SEB Asset Management in Frankfurt. ``The profit development at the passenger cars unit was, on the other hand, quite pleasing.''

Facing reality at GM Truly determined optimists purported to divine good news amidst the wreckage of General Motors' $3.25 billion first-quarter loss. To be sure, the financial results were better than some had expected, GM made money everywhere except in North America, and the automaker is doing better controlling its costs. But what was notable about the earnings announcement, as well as the subsequent conference call with analysts and journalists, was how difficult the quarter really was in North America -- and how hard GM is finding it to face up to that reality. The big news came when newly named president Fritz Henderson more or less admitted that GM markets and distributes cars under too many brands - but can't cut the underperformers because doing so would cost too much. On Wednesday, Henderson let the cat out of the bag, in effect saying that it wasn't the strength of the brands that kept them in business, but the cost of getting rid of them. Several other first-quarter events made a mess out of any immediate plans to return GM North America to profitability. The big one was GMAC, its once-dependably profitable finance arm, which lobbed losses of $276 million onto GM's operating statement, and added to the injury with a $1.5 billion non-cash impairment charge. Sluggish auto finance hurts GMAC, GM posts big loss as U.S. sales hurt

Ford's Profit Shows Mulally May Do for Automaker What He Did for Boeing -- Ford Motor Co. Chief Executive Officer Alan Mulally may be pulling a repeat: Turning around the No. 2 U.S. automaker in the same way that he helped revive Boeing Co., the world's second-largest aircraft maker. At Boeing, Mulally slashed employment as head of the commercial airplane division by more than half, to about 50,000 in eight years. He sped production of a more fuel-efficient jetliner, the 787, and helped lay the groundwork for record orders. In his current post, Mulally has eliminated 46,300 jobs in North America over the past two years as Ford has closed or scheduled to close nine plants to match its shrinking manufacturing footprint. One shut plant will be re-opened. Mulally still hasn't shown that he can boost U.S. demand for Ford products. The company has posted just three monthly sales increases in its home market since Mulally took over. Ford now claims 16 percent of U.S. sales, down from about 25 percent 13 years ago. Kerkorian Buys 4.7% of Ford, Seeks More Shares as He Backs Mulally's Plans

Ford Gets a Big Vote of Confidence This is the first time that Mr. Kerkorian has made a major automotive investment because he actually believes in the company's management and direction.The people who should be concerned are the executives at General Motors. Mr. Kerkorian's latest move might spotlight concern that GM's own turnaround effort, which appeared well underway until last fall, is hitting potholes just as Ford's seems to be accelerating. The turnaround efforts at both companies – not to mention Chrysler, which as a private company no longer reports financial results – still have a long way to go. But the bottom line is that Ford appears to have pulled ahead. Mr. Kerkorian's latest automotive investment is best viewed as proof of that.

Strategic Re-structuring

Toyota's Open Secret of Success Calling Toyota an innovative company may, at first glance, seem a bit odd. Its vehicles are more liked than loved, and it is often attacked for being better at imitation than at invention. Fortune, which typically praises the company effusively, has labelled it “stodgy and bureaucratic.” But if Toyota doesn’t look like an innovative company it’s only because our definition of innovation—cool new products and technological breakthroughs, by Steve Jobs-like visionaries—is far too narrow. Toyota’s innovations, by contrast, have focussed on process rather than on product, on the factory floor rather than on the showroom. That has made those innovations hard to see. But it hasn’t made them any less powerful. At the core of the company’s success is the Toyota Production System, which took shape in the years after the Second World War, when Japan was literally rebuilding itself, and capital and equipment were hard to come by. A Toyota engineer named Taiichi Ohno turned necessity into virtue, coming up with a system to get as much as possible out of every part, every machine, and every worker. The principles were simple, even obvious—do away with waste, have parts arrive precisely when workers need them, fix problems as soon as they arise. And they weren’t even entirely new—Ohno himself cited Henry Ford and American supermarkets as inspirations. But what Toyota has done, better than any other manufacturing company, is turn principle into practice. In the nineteen-nineties, a McKinsey study of companies that had put quality-improvement programs in place found that two-thirds abandoned them as failures. Toyota’s innovative methods may seem mundane, but their sheer relentlessness defeats many companies. That’s why Toyota can afford to hide in plain sight: it knows the system is easy to understand but hard to follow.

• The Machine That Changed the World: The Story of Lean Production-- Toyota's Secret Weapon in the Global Car Wars That Is Now Revolutionizing World Industry by James P. Womack, Daniel T. Jones, and Daniel Roos

• Lean Thinking : Banish Waste and Create Wealth in Your Corporation, Revised and Updated by James P. Womack, Daniel T. Jones, James Womack, and Daniel Jones

Posted by dblwyo at 05:06 PM | Permalink | Comments (0)

Just an admin note for faithful readers and other checkers by. We intermittently get service interruptions where we're unable to post for "a while". Since out host is Yahoo...ahem, ahem,...., Tech Support is ATT.... and real Tech Support is Movable Type the chain of causality and responsibility is often murky at best. Unfortunately this outage has gone on for around 24+ hours instead of the usual 2-3.

We hope to get some major posts up "real soon now" as our hero Jerry Pournelle used to say and we'll be right back.

Clearly our discussion of Customer Service and its' role in Enterprise Performance and L.T. profitability is overdue. Right ? 

Posted by dblwyo at 04:22 PM | Permalink | Comments (0)

The meme running around the Street and the Treasury is, of course, that the worst is over. As we've noted previously that's a bit more than disingenuous (WRFest 4Apr08(Markets): Do We Stay, Do We Go..Jimmy,Readings (Finance): It's Over, It's Over...Yeah Right). The worst of the credit crisis in terms of a deep structural breakdown is over which just leaves us with a re-pricing of risk, de-leveraging and a burgeoning economic downturn that will lead to more writedowns, balance sheet pressures and losses from more bad loans and be based on feedback from the real economy. As opposed to internal dysfunctions in the broken credit markets. The real worst is yet to come and nobody's paying any attention. Us usual ?

Well not quite or entirely. Finally we're seeing some serious consideration of that feedback loop as well as a variety of articles finally addressing the real fundamentals of the Finance Industry. Are their business models broken ? We think so. And as a result there's going to have to be some very deep and fundamental re-thinking followed by some even deeper re-building, re-structuring and painful changes. Otherwise we'll just go thru this again...and again...and again.

All of which is reflected in the various company stories of continuing writedowns JUST dealing with the aftermath of all that bad paper. Some very serious players from JPM to Wolfensohn see more serious trouble ahead. Banks are going to be seeking and needing even more capital with all that implies about dilution, earnings pressures, tighter lending standards and so and so on. We've collected a bunch of stories that support that line of argument but conclude the excerpts with two poster children. On Fannie Mae who's recent announcements of surprisingly large losses, more trouble ahead and more capital raising were greeted by a stock price jump, of all things ! Which grossly misses the real, deep-seated damages done and the work to be faced. Our other poster child is Citigroup which, under Vikram Pandit, has made the right emergency moves but now everybody wants a clear, quick fix to make it all right. After four months in the job he's supposed to lay out the workable strategy for the next decade ?!

Give me a break. It's this kind of thinking that created all the problems in the first place. While the jury is out and will be for some time to come he seems to us to be taking some of the right, small steps. As he says you've got to get some of the immediate, small and operational improvements in place before you start re-engineering the super-structure. And Citi is a badly broken as they come, at least IOHO. For those of sufficiently long memories this reminds us of the early days of Gerstner's time at IBM when everybody wanted a vision and a strategy. As he said, "that's the last thing we need right now". Ditto for Citi. We'll see where Pandit goes but in our book he's started right. The question is...is anybody else getting it ? 

Finance Industry Futures

Is Finance's Economic Role Ebbing? The role of finance may be ebbing, after three decades of growth in which the sector staked a substantial claim of the U.S. stock market, profits and the overall economy. For the past three decades, finance has claimed a growing share of the U.S. stock market, profits and the overall economy. But the role of finance -- the businesses of borrowing, lending, investing and all the middlemen in between -- may be ebbing, a shift that would redefine the U.S. economy. "The role of finance in the economy is going to come down significantly in the coming years," says Carlos Asilis, chief investment officer at Glovista Investments, a New Jersey money manager. "From a societal standpoint, we got carried away with finance." The trend already has hurt companies beyond banks and Wall Street firms. In the 2000s, finance went into overdrive, creating an alphabet soup of derivatives that, it turned out, didn't have the risk-reducing properties they were supposed to have. Mr. Philippon compares some to "sheep with fifth legs -- something you would see in a zoo and wonder what Nature was thinking." For finance workers, this shift could resemble the 1980s, when manufacturing lost its pole position in the U.S. labor market and thousands found that skills they had honed over the years were less marketable.

Danger Ahead: Fixing Wall Street Model Proves Hazardous to Earnings Growth Wall Street's money-making machine is broken, and efforts to repair it after the biggest losses in history are likely to undermine profits for years to come. Citigroup Inc., UBS AG and Merrill Lynch & Co. are among the banks and securities firms that have posted $310 billion of writedowns and credit losses from the collapse of the subprime mortgage market. They've cut 48,000 jobs and ousted four chief executive officers. The top five U.S. securities firms saw $110 billion of market value evaporate in the past 12 months. No one is sure the model works anymore. While Wall Street executives and regulators study what went wrong, there is no consensus solution for restoring confidence. Under review are some of the motors that powered record earnings this decade -- leverage, off-balance-sheet investments, the business of repackaging assets into bonds bonds through securitization, and over- the-counter trading of credit derivatives. Without them, it will be difficult to generate growth.  ``Investment banks leapt into commercial banking without the deposit base, while commercial banks went into investment banking without knowing risk management, and this is where we end up,'' said Brad Hintz, a New York-based analyst at Sanford C. Bernstein & Co., referring to the credit crisis.

Morgan Stanley see big bank woes just beginning Morgan Stanley (NYSE:MS - News) analysts on Monday told clients to "sell the rally" in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning. In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates. "More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline," analysts led by Betsy Graseck wrote in a report. "We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91." A growing number of investors, and industry executives including Morgan Stanley Chief Executive John Mack, in recent weeks have predicted markets are closer to the end of the current mortgage and corporate credit crisis than to the beginning. These more upbeat comments, and recent efforts by banks to bolster their balance sheets, helped spark a rebound in bank stocks last week. Wolfensohn Is `Pessimistic' on Banking Crisis, Sees $1 Trillion of Losses , `Underwater' Subprime, Alt-A Mortgages to Swell by Midyear, Barclays Says

Banks Seek More Capital The recent raft of capital raisings by large banks, including Wednesday's $4.5 billion stock sale by Citigroup Inc., signals that the credit crunch has further to run, dashing bullish investors' hopes that profits at banks will return to normal soon. That doesn't bode well for banks' 2009 outlooks and may prove the recent run-up in financial stocks to be just another head-fake. The KBW bank-stock index, for instance, has climbed 10% since the dark days of mid-March when Bear Stearns Cos. collapsed.This rally ignores what are likely to be mounting credit losses for both consumer and commercial loans because of the weakening economy and the continuing housing crisis. That means any assumption of a return to normal profit levels is about three years too early, according to a report earlier this week by Morgan Stanley analyst Betsy Graseck. Recent capital raisings by J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup are "an acknowledgment that the cycle has a way to go before it's going to turn," said Ms. Graseck, who said she believes more capital raising and dividend cuts might be in store for big banks.Bulls counter that banks are properly taking advantage of a new sense of calm in markets to raise money while they can. This will let banks withstand losses better and even pursue opportunities that might arise as the market tumult creates bargains.

Companies 

Pandit's `Closer to the End' Means No Escape From LBOs' Depreciating Loans If the credit crunch really is close to ending, as Citigroup Inc. Chief Executive Officer Vikram Pandit says, then why is he offering below-market terms to rid the bank of some of its $26 billion in leveraged buyout loans? Citigroup sold $8 billion of the debt to private-equity firms this month only after giving buyers $6 billion of financing at cheaper rates than it can borrow itself, according to people familiar with the transaction, who declined to be identified because the terms aren't public. Deutsche Bank AG and Royal Bank of Scotland Plc are also offering credit to buyers to help cut their holdings. While the deals helped shrink the global overhang to $91 billion from $230 billion, don't expect banks to open their doors to new borrowers anytime soon, said Nigel Sillis, director of fixed-income and currency research at Baring Asset Management in London. That's because the arrangements shift one type of loan for another. Until banks can shed last year's LBO commitments, they'll be unable to make new loans, sacrificing the ability to earn fees that average 2.5 percent on high-yield debt, the most lucrative part of the capital markets, according to estimates by Mercer Oliver Wyman, a financial-services consulting firm in London. "A lot of financial institutions have big holes in their balance sheets and haven't begun to scratch the surface yet,'' Rubenstein said. ``We may be getting closer to the bottom but it may be that the bottom is a number of months away.'' Bank lending has already slumped 73 percent in the past year, according to data compiled by Bloomberg. U.S. banks made $85 billion of leveraged loan commitments in the first quarter, down from $320 billion in the same period in 2007. Citigroup Offers $3 Billion of Stock as Pandit Raises Capital; Stock Drops, Citigroup Falls as $3 Billion Share Sale Will Dilute Investors' Holdings

Deutsche Bank Posts First Loss in Five Years After $4.2 Billion Writedown The Frankfurt-based company had a first-quarter net loss of 131 million euros after earning 2.12 billion euros a year earlier, according to a statement on its Web site today. Earnings were lifted by almost 1 billion euros from selling stakes in companies and a tax gain. Deutsche Bank fell as much as 1.6 percent in Frankfurt trading. Chief Executive Officer Josef Ackermann avoided the worst of the subprime contagion because of early bets against U.S. housing and said today there are ``encouraging'' signs that markets are stabilizing. By contrast, UBS AG, the largest Swiss bank, recorded almost 38 billion Swiss francs ($36.7 billion) of markdowns since July, while Credit Suisse Group last week posted its first loss since 2003 on 5.3 billion francs of writedowns. The world's biggest banks and securities firms have reported credit losses and writedowns of about $312 billion linked to the U.S. subprime meltdown, data compiled by Bloomberg show. UBS, Citigroup Inc. and Merrill Lynch & Co. led banks seeking about $217 billion from investors to replenish capital. Germany's largest banks may announce further markdowns of 10 billion euros to 12 billion euros for the first quarter, Standard & Poor's said in a report today. Full-year pretax earnings for the industry this year could decline by as much as 20 percent on average, S&P said.

• HBOS Plans to Raise as Much as $8 Billion in Share Sale After Writedowns
• Allianz Earnings Slump 66% on Subprime-Linked Writedowns at Dresdner Bank
• UBS May Eliminate 8,000 Jobs as First-Quarter Net Loss Exceeds $10 Billion
• Fannie Mae Has $2.19 Billion Loss, Plans to Raise $6 Billion, Cut Dividend

Fannie Mae Has $2.19 Billion Loss, Plans to Raise $6 Billion, Cut Dividend  -- Fannie Mae, the largest U.S. mortgage- finance company, reported a wider loss than analysts estimated, cut the dividend for the second time in six months and said it will raise $6 billion in capital as the worst housing slump since the Great Depression deepens. The first-quarter net loss was $2.19 billion, or $2.57 a share, Washington-based Fannie Mae said in a statement. Analysts were expecting a loss of 64 cents a share, the average of 12 estimates from a Bloomberg survey. ``They are now starting to realize the fact that their credit losses will be considerably higher than they were in 2007,'' said Ajay Rajadhyaksha, head of fixed-income strategy for Barclays Capital, who is based in New York. ``Things in the housing and credit markets are deteriorating very fast.''

Poster Children

Fannie Mae is Fantastic ! Their loss of $2.2B was 4X greater than expected ($-2.57B v.s. $-.640m expected) • FNM accounted for 81% of the home-loan market in Q1 2008 • Shareholder equity dropped to less than zero for the first time in 15 years (from $20.5 billion in Q4) • Subprime exposure:  $51.2B • Alt-A exposure:  $344.6B • Fair market value of assets dropped to $12.2 billion last quarter from $35.8 billion in December. This includes $56.1 billion in Level 3 assets; • Moody’s downgrades FNM’s financial strength one level to ‘B’ • Credit and derivative losses rose fivefold to $8.9 billion; expects bigger credit losses in 2009;• Estimates for credit losses in 2008 were boosted to 13 basis points to 17 basis points (up from 11 to 15 basis points). Each basis point, 0.01%, = 15 cents of earnings/sh (Morgan Stanley)• Company issued $6B in securities to shore up balance sheet

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

Well time to review the last week's market news. Not surprisingly the range of news reflects the uncertainties between the optimists who think "the worst is over" and those of us who think, as Warren says, this recession will be longer and deeper than anybody thinks (of course excepting our lists of usual suspects which we won't repeat). All of this is reflected in the charts and the readings. Take a look at the busy little chart to the right. We've been talking about the staircase down (remember pennants ?) which got a decisive up-break with this little rally. Is this a sucker's rally ? Well that'll depend...mostly on whether or not the worst is indeed over. We've also highlighted in color codes what might be four key levels (based on the limits in Fibonacci analysis which borrows from nature to argue that movements tend to follow certain natural patterns; e.g. the fall from the Oct. highs to the Mar. lows have been "recovered" by about 50%. The other "limit" numbers are used to generate the key numbers.). If we keep going above 1400 the next interesting technical barrier is 1480. If we rally to that then we are indeed in a new regime. Contrawise the first number down is 1340 or so, followed by 1320. Right now it looks like we're entering a sideways market while we wait to see how the uncertainties resolve.

Another interesting little tidbit to bear in mind is that there's a lot of folks sitting around with a lot of money burning holes in their pockets who make more if this is a rally, mostly all the Street guys talking their books. As we should all know by this time this has been a very liquidity-driven market, not one based on sound fundamentals or structural outlooks. Being awash in liquidity is really what held things up last year when the economy was already showing significant signs of slowing down. So much for the "Market is forward-looking" meme ! A key driver, aside from leverage and bad business practices, has been the int'l carry trade, that is Japan's extremely low interest rates which causes a lot of the huge pools of excess savings to head offshore to find higher returns. That results in a lot of Yen heading abroad which in turn leads to a key, critical but round-about link between the carry trade, as it's called, and the US domestic markets. Which is reflected in the incredibly close correlation between the ratio of the Euro:Yen. Notice that that's not only true historically but the recent rally, surprise..surprise, is again highly dependent on the carry trade. So any time you're thinking this is all about fundamentals keep that in mind.

All those issues from repair of the credit markets to int'l money flows to Finance Industry futures. Our bottomline is that indeed the collapse crisis of the credit markets is indeed over - the Fed has managed to a self-arrest and keep from us all tumbling over the cliff. ALL that does though is free up the credit markets to re-price risk and de-leverage. And in fact, as prior posts have shown, what we're now facing is a slowing economy which will likely cause real economic feedbacks to lead to increased loan losses, more write-offs, and on and on. But take a look for yourself and decide.

The one single excerpt though that we think you ought to think about above all others is the shortes....the Fed just reported today that credit standards continue to be tightened. Think about it. We've covered the issue a few times before but when no money is available to loan the real economy starts freezing up which makes more bad loans and so on...

BtW...just found this great CNBC vidclip which perfectly captures the Yin/Yang of things. Notice the guy worried about a downdrop is talking fundamentals while the guy talking uprun is talking technicals, i.e. months and quarters vs days and weeks. Both are right IOHO you just have to put in the right context:

A Suckers Rally? : Debating whether the current market really is real, with Ryan Detrick, of Schaeffers Investment Research, and Jean-Marie Eveillard, of First Eagle Global Fund

Markets & Investing

Dollar Slide Drives Burgeoning U.S. Deficit as Japanese Desert Treasuries Add another ailment to the U.S. misery index of soaring gasoline and wheat costs and falling home values: a federal deficit that is burgeoning as foreign investors led by the Japanese recoil from the slumping dollar. The Japanese, who own $586.6 billion, or 12 percent of U.S. government debt, had their worst quarter in Treasuries this decade, losing 7 percent in the first three months of the year as the dollar fell to the lowest since 1995 versus the yen, Merrill Lynch & Co. indexes show. Dai-ichi Mutual Life Insurance Co., Meiji Yasuda Life Insurance Co. and Sumitomo Life Insurance Co., three of the nation's four-biggest insurers, would rather accept the world's lowest bond yields in Japan than buy U.S. debt. After raising their holdings by $9.2 billion to $620.6 billion between March and July 2007, Japanese investors trimmed that stake by $34 billion through February, the Treasury said April 15. America relies on foreign investors, who own more than half the U.S. government debt outstanding, to finance a deficit that New York-based Goldman Sachs Group Inc. predicts will expand to a record $500 billion for the year ending Sept. 30, after a $163 billion gap last year. Without their support, long-term interest rates would be 0.9 percentage point higher, a 2006 Federal Reserve study found. Asian investors outside Japan are also pulling back. Money managers in China, the second-biggest overseas holder of Treasuries, with $486.9 billion, and South Korea say they favor debt in Europe, equities or commodities. Beijing-based ICBC Credit Suisse Asset Management Co., controlled by China's biggest bank, said last week Treasuries are ``not attractive'' because of currency risks. South Korea's $220 billion National Pension Service in Seoul said yields on the debt have lost their ``charm.'' U.S. borrowing costs will rise in the ``longer term'' because central banks may slowly cut their holdings of dollars to about 30 percent of their reserves in 15 years, from less than 60 percent now, said Kenneth Rogoff, a former chief economist at the International Monetary Fund in Washington.

Playing Chicken with the Fed -- the smart way With the FOMC meeting upon us, the kitchen sink has been brought to the forefront of our collective psyche. Inflation in things we need, deflation in things we want, credit dependency, cumulative imbalances and the notion that we must choose between asset-class deflation and dollar devaluation all seems to come down to a singular question. After the Federal Reserve cuts interest rates by 25 basis points -- which is less aggressive than what we've seen since the financial crisis began -- will the collective perception be that they're proactively operating from a position of strength or defensively posturing as a function of need? Through that lens, the magnitude of this week's rate cut pales in comparison to the influence of auction facilities, lending windows, working groups and other policies currently in play. Therein lies the subtle yet important distinction when weighing the reaction to whatever the Fed says on Wednesday afternoon. While the structural metric will be in the spotlight, the psychology surrounding it will tell the tale. Why wasn't the equity sell-off more severe given the risks in the system. I would offer that it would have been had it not been for massive government intervention. Mind you, I'm not rooting for dire times or market spirals. I'm simply stating that in order to effectively navigate this market, we must understand the rules of engagement have shifted. Unseen influences remain in play. With the structural, technical and psychological metrics ready to collide, volatility is about to tick upward in a major way. The current juncture is akin to a giant game of chicken, with powerful agendas on one side and cumulative concerns on the other. Something is going to give and it'll likely happen this week.

Is the worst over? A belief is growing that the turmoil in credit markets that began last August could finally be abating. “The first quarter was the roughest I have ever seen in nearly 20 years of being in the business,” says Bruce Thomson, co-head of capital markets at Bank of America. “But there are now signs that we are working our way through the issues that have caused such widespread problems.” This improved sentiment can be seen in many corners of the credit world, leaving some observers hoping that the green shoots of recovery are about to spread through the financial system as a whole. Even the municipal market is showing signs of improved heath – though perhaps too late for Jefferson County. This switch in sentiment is pulling more investors back into these markets. Stocks have rallied too – cheered by a perception that a feared collapse of the financial sector has been averted by aggressive central bank intervention and banks’ own willingness to confess to their losses, take writedowns and raise fresh equity to bolster their balance sheets. The markets are still plagued by some startling pricing anomalies, which reveal the continued sense of dislocation and fear. While hedge funds and other investors used to rush to take advantage of such quirks, and thus trade them away, most remain too nervous to jump back in yet. Bank of England Says Crisis May Abate as Investors' Risk Appetite Returns, Paulson Says Credit Crisis `Closer to the End,' Joining Wall Street Bosses, World's Central Banks `Averted the Worst' of Credit Crisis, Goodhart Says

At the End of the Beginning of the Credit Crisis Phew! The credit crunch is over – or at least we're through the worst of it. According to the Bank of England, so pessimistic has the financial community become that it has overcompensated for the trouble ahead. Sure, the economy is in for a rough ride over the next couple of years but – compared with the current negative outlook – the prospects are positively rosy. That, at least, was the message from the Bank in its Financial Stability Report. One point of consensus, however, is that economic conditions will worsen. As we work our way through the credit crunch, economic woes will replace funding problems as the main source of anxiety for lenders. What the Bank fears is financial markets not returning to normal in time to withstand the economic storms ahead. JPMorgan says no near end to financial crisis: report, Downgrades Show Storm Isn't Over

Wolfgang Münchau: A painful global adjustment So this crisis is about to end, right? There are two failsafe ways to justify a solid dose of optimism: define the crisis in a sufficiently narrow way; and, even better, look at the wrong crisis. In that spirit I am happy to state my optimism about the prospective end of the subprime crisis. But this would be disingenuous. It is no accident that our multiple crises – property, credit, banking, food and commodities – have been happening at the same time. The simple reason is that they are all part of same overriding narrative. The mother of all these crises is global macroeconomic adjustment – a rare case, incidentally, where the word “crisis” can be used in its Greek meaning of “turning point”. It is a huge global macroeconomic shock. How long the financial part of the crisis will go on will depend to a large extent on how bad the economic part of the crisis gets. The economic part of the story started more than a decade ago with a liquidity-driven global boom. Property, credit and equity bubbles were all part of this. But even if we take six years as an estimate of the peak-to-trough period, that means the housing downturn will last until 2012 in the US and a couple of years longer in the UK. It is difficult to see how either of these countries could grow close to trend as long as the housing market is in recession. When you look at the global macro side, you are looking at similar timescales of adjustment. An important part of the adjustment will be a rise in the US and UK household savings rates. That, too, might take several years to accomplish, during which period economic growth could be below trend. The really important question about the US economy is not whether the official recession starts in the first or second quarter, but how long this period of economic weakness will last overall. In Japan and Germany macroeconomic adjustment of similar scale took more than 10 years, starting in the 1990s. Even if you believe that the US is structurally stronger, the country will probably not replenish its savings in a couple years.

Sell what in May and go away? April was a strong end to an otherwise wretched six months in which the Dow industrials lost 8%. That's the worst 'best six months' performance for stocks since 1973, when the Dow fell 12.5% between Nov. 1 and April 30, amid an OPEC oil embargo, according to the Stock Trader's Almanac. And if market indicators hold up, May through October could be a tough period, as per the old Wall Street saw 'sell in May and go away.' But in an unusually difficult year in which the housing and credit crises have sent the economy into a tailspin, the old indicators may not apply. Also, the forward-looking stock market may be on the verge of anticipating the start of an economic recovery, despite weak first-quarter growth.This year is an anomaly. April was the only one of the 'best' months to see gains.Because the stock market is forward looking, that means it was already pricing in the economic slowdown and the systemic risk to the financial system at the end of 2007.The calendar flip-flopped five years ago, during another period of great uncertainty. October 2002 through March 2003 was bumpy at best, driven by questions over if and when there would be war in Iraq. As the war drew nearer, stocks began to rally. The Dow gained 15.6% in the 'worst six months' period eventually leading to a multi-year bull market. A true rally may be a ways off but the markets are now starting to benefit from a lifting of some of that fog regarding the breadth of the crises, said Joe Clark, chief investment officer at Financial Enhancement Group.

Economic Clouds? Wall Street Sees Signs of Sunshine Main Street may be struggling, but Wall Street is on a bit of a roll. Despite a drumbeat of bad economic news, the stock market is up — almost 11 percent in the last few weeks. Junk bonds, those risky corporate I.O.U.’s, are rallying. The value of financial shares, bank loans, tricky credit derivatives — up, up, up. Many on Wall Street, the epicenter of the credit mess, seem to think that the worst is over. For the first time in months, analysts and executives sound upbeat again. Many of them see a broad, sustained recovery in both the economy and the financial markets coming in the second half of this year, a prediction some market strategists call hopeful at best. It is a remarkable reversal in attitudes from just a few months ago, when the broader economy seemed relatively healthy but Wall Street was traumatized by billions of dollars in mortgage-related losses. Now, bankers and investors appear ready to look past the crisis to more profitable times, while consumers find themselves in a more precarious position as the job market weakens and banks make it harder to borrow money. It is, of course, not uncommon for Wall Street to run ahead of the broader economy. Investors, after all, make money by anticipating the future. The job market, by contrast, improves more slowly than other aspects of the economy. But specialists say the two sides will eventually converge. Either the markets will give up their recent gains or, if the optimists are right, the broader economy will show greater strength as tax rebate checks and lower interest rates stimulate the economy. Analysts expect a sharp upturn in profits in the second half, in part because the earnings will be compared with weak results from 2007 but also because exports are surging. The $117 billion in federal tax rebates that will start going out this month should also help bolster profits.But some specialists say that the market’s expectations for profits are too lofty. They assert that slowing consumer spending will offset the gains corporate America is reaping from rising exports, which may also suffer because economies in Europe and Asia are starting to slacken.

(!!!) Fed: Banks Still Tightening Loan Standards The Federal Reserve reports that more banks are tightening lending standards on home mortgages, other types of consumer loans and business loans in response to a spreading credit crisis.The Fed reported Monday that the percentage of banks reporting tighter lending standards was near historic highs for nearly all loan categories. The survey, conducted in April, found that nearly two-thirds of banks surveyed had tightened lending standards on traditional home mortgages with 15 percent saying those standards had been tightened considerably. Fed: Lending Standards Tighten, Loan Demand Declines

`Suckers' Rally' Signaled by Options After S&P 500's Best Month in 4 Years The biggest rally in the Standard & Poor's 500 Index in more than four years is luring investors to equities from cash, just as options traders are betting the advance will evaporate. Jean-Marie Eveillard, who runs the $22 billion First Eagle Global Fund, is skeptical the gains can last because the worst housing slump since the Great Depression will reduce earnings. S&P 500 companies were valued at 22.7 times profit last week, the most in four years. Options traders are paying 63 percent more to protect against a drop in the S&P 500 than to bet on a gain, the widest difference since at least 2005. ``It may be a suckers' rally,'' said Eveillard, who is based in New York. ``Investors want to believe. But if I'm right, then there's truth to the argument that this is the worst financial crisis since the end of World War II. The same kind of reflex is the wrong reflex.'' The climb hasn't dispelled concern among traders of U.S. options. Implied volatility, the measure that calculates expected price swings of an underlying asset and is used as a barometer of options prices, shows that many investors are betting the U.S. stock market will falter. The implied volatility on options that lock in gains if the S&P 500 drops at least 10 percent in three months reached 24.67 on April 30, Bloomberg data show. That compared with 15.1 for options that pay out if the index rises at least 10 percent. The 63 percent difference indicates the highest demand for options insurance since at least 2005, according to data compiled by Bloomberg. A decline of 10 percent from the S&P 500's closing price last week would take the measure down to 1,272.51, below its March 10 low of 1,273.37. Investors are currently paying the highest prices relative to earnings since March 2004 and 15 percent more than when the S&P 500 reached its all-time high in October. Rally Signaled by Options After Surge (charts !!)

Posted by dblwyo at 10:23 AM | Permalink | Comments (0)

Boy were the headlines good on the major economic news this week, whether it was GDP, Payrolls or Housing. In each case there are two salient facts you really need to pay attention to. One semi-obvious with a little work, which is the trends were much weaker than most of the headlines. The single exception we saw in the MSM media of somebody who parsed out the GDP coverage correctly and in a balanced fashion was the WSJ. Halleleuh...about time...Bravo Zulu. On the other hand the headlines about Payrolls, which were amazingly benign, needed more of that because the trends weren't particular good. We're going to invest a little energy here in de-constructing some of these though we put up two major posts (Real GDP: How Good are the Numbers ?) earlier on the subject that we highly recommend you re-visit.

Because they get at the heart of the second and deeper problem which is what's happening down in the engine room. Our post on the component structure of GDP (Crossing the Ripping Point: Breaking Down GDP Components) should make the case clear that Consumer Demand is dropping sharply and rapidly and will likely drop more as the drivers (growth in real wages and employment) continue to decelerate at an increasing pace. THE biggest problem is in Employment figures which were not good in the first place. But when you do the hard work of backing out the Birth/Death adjustments they were definitely bad. Which work has been done for us by Northern Trust and their chart is reproduced below. The other economic factor that NOBODY is getting right in general is the length and duration of the likely downturn, and the consequences, of Housing where we're really just getting going. Fortunately our good buddy CalculatedRisk has come to the rescue again...but trust me on this one. There's nothing out there in any of the MSM or other analysis we've seen that's as clear as his recent stuff.

Let's try and parse out a bunch of the other data to put some points on it. The key to all this is Consumer Demand which, based on the GDP numbers, would appear to be holding up. Take a close look at this chart where real consumption (PCER) is beginning to tip over but not as steeply as real disposable income. More importantly real Retail Sales is starting to drop sharply - and bear in mind it was Service consumption that held up to any extent. We can expect the accelerating drop in Sales to begin to be reflected in PCER in the next few months. Particularly given what's going on with real wages and employment.

 Irrespective of the headlines, and setting aside the B/D adjustment issue, the trends in jobs and unemployment are also definitely tipping over. Here you can Employment slowing and (on a reverse scale) Unemployment increasing. In YoY% terms Employment growth is nearing zero percent. And Unemployment is now increasing at nearly 10% on a YoY basis - a rate of increase which is always associated with a real recession. Make sure you check out NT's chart below. In the 2nd sub-chart you can see the YOY% changes in Wages plus Employment...not pretty is it.

So to answer the guy (a major national editor for a major national business magazine no less) who wanted to know, "Dude, where's my recession ?" we answer. It's here Bro only you can't see it. The difference between surfering SoCal 3'ers and hangin with the chickies and having the skills to go to Mavericks. 

General & Special

Peter Bernstein Doesn't Like What He Sees Peter Bernstein has witnessed just about every financial crisis of the past century. As a boy, he watched his father, a money manager, navigate the Depression. As a financial manager, consultant and financial historian, he personally dealt with the recession of 1958, the bear markets of the 1970s, the 1987 crash, the savings-and-loan crisis of the late 1980s and the 2000-2002 bear market that followed the tech-stock bubble. Today's trouble, the 89-year-old Mr. Bernstein says, is worse than he has seen since the Depression and threatens to roil markets into 2009 and beyond -- longer than many people expect. Mr. Bernstein sees two culprits. One is the abuse of securitization -- the trend for banks to hold fewer loans on their books and instead turn them into securities that were sold to other investors. The other is simply years of overborrowing by financial institutions and consumers alike. When you think about how all of this will work out in the long run, we are going to have an extremely risk-averse economy for a long time. The lesson has painfully been learned. That's part of the problem going forward. You don't have a high-growth exit from this, as you've had from other kinds of crises. We won't have a powerful start, where the business cycle looks like a V. Here, the shape of the business cycle is like an L, where it goes down and doesn't turn up. Or like a U, a flat U. The reason for that is that people aren't going to get caught in this bind again. They will tell themselves, "I'm too smart to do that again." And everyone else is going to be saying the same thing. It is, in fact, going to be a wonderful environment in which to take risk, because there aren't going to be any excesses.

• Byron Wien’s Ten Surprises of 2008

Economy

Buffett says recession may be worse than feared Warren Buffett, the world's richest person, said on Monday the U.S. economy is in a recession that will be more severe than most people expect. Buffett made his comments on CNBC television after his Berkshire Hathaway Inc (BRKa.N) (BRKb.N) agreed to invest $6.5 billion in the takeover of chewing gum maker Wm Wrigley Jr Co (WWY.N) by Mars Inc in a $23 billion transaction. "This is not a field of specialty for me, but my general feeling is that the recession will be longer and deeper than most people think," Buffett said. "This will not be short and shallow. "I think consumers are feeling gas and food prices," he added, "and not feeling they've got a lot of money for other things."

Rebates: Too little, too late? Tax rebates are starting to arrive in bank accounts. But many economists doubt that they  will keep the economy from recession. The stimulus package, passed with overwhelming bipartisan support earlier this year, will give rebates to about 130 million Americans, costing the U.S. Treasury more than $110 billion. Married taxpayers earning $150,000 or less will get up to $1200 while single taxpayers earning $75,000 will receive up to $600. But since the measure passed Congress, there have been growing signs that the U.S. economy has already fallen into recession. "This is will not avert a recession, because it is too late," said Lakshman Achuthan, the managing director of the Economic Cycle Research Institute. "For this to have kept us out of what was an avoidable recession, it needed to happen a couple of months ago, in January or February." In the past three months, employers have cut 232,000 jobs from their payrolls. The unemployment rate has climbed to 5.1% from 4.7% as recently as November.

Dude, Where's My Recession? Out: Recession. In: Expansion. That's my quick take on today's first-quarter gross domestic product number, which showed that the economy grew 0.6 percent in the first quarter. Now that's not a robust number by any means, but it's not so bad given all the worry out there that the economy is headed off a cliff. Before you declare a recession, as many economic pundits have, shouldn't the economy, well, actually recess a bit—if only for a quarter? As a movie buff, I keep looking for the right cinematic analogy for the American economy. Try this one: It's like the Terminator. Not the Schwarzenegger one—the other one, the Terminator from the second film. You could empty a shotgun—or in this case, an imploding housing market, credit crunch, and high oil prices—into that morphing metal dude, and before you know it, the thing's all healed and chasing you again.

Low Spending Is Taking Toll on Economy For months, beleaguered American consumers have defied expert forecasts that they would soon succumb to the pressures of falling home prices, fewer jobs and shrinking paychecks. Now, they appear to have given in. On Wednesday, the Commerce Department reported that the economy continued to stagnate during the first three months of the year, with a sharp pullback in consumer spending the primary factor at play. With the overall economy growing at a mere 0.6 percent annual rate for the second quarter in a row, consumer spending advanced by only 1 percent, the government estimated. That was down sharply from the 2.9 percent gain for all of 2007 and the 3.1 percent gain for 2006. It was the weakest showing since 2001, the last time the economy was ensnared in a recession.Even more ominously, Americans cut back on a wide variety of discretionary purchases, conserving their cash for necessary spending. In the dip, economists saw evidence that the basic laws of arithmetic are now impinging on millions of households. As real estate prices plunge, so does the ability of homeowners to borrow against the value of their homes, crimping a major artery of spending. As banks grow tighter with their dollars in a period of uncertainty, families are running up against credit limits, forcing many to live within their incomes. And as companies lay off employees and cut working hours, paychecks are effectively shrinking. The only factors preventing the economy from sliding backward were the growth of American exports — aided by a weakening dollar — and a swing in business inventories from shrinking to swelling. Putting exports and inventories aside, the final sales of goods and services produced domestically dipped at a 0.4 percent annual rate in inflation-adjusted terms, the first such decline since the end of 1991. Personal income slips, but spending jumps, Manufacturing in U.S. Shrank a Third Month in April as Companies Cut Jobs

GDP Expands Slightly, But Gloomy Signs Persist The economy expanded slightly in the first quarter, but its faint pulse didn't allay concerns the U.S. is in or headed toward recession. The gross domestic product -- the nation's total output of goods and services -- increased at a 0.6% annual rate, the same as in the fourth quarter of 2007. But underlying data -- on consumer spending, business investment and construction -- paint a picture of a deteriorating economy, one that expanded only because of a rise in exports and a buildup of inventories. Excluding inventories, GDP shrank at a 0.2% pace, the first contraction in more than 16 years. Excluding inventories and exports, the economy contracted at a 0.4% rate after increasing 1.3% in the fourth quarter. "It would be a grave mistake to interpret [the GDP] number as even suggesting the economic and financial crisis is over," said Bernard Baumohl, managing director of the Economic Outlook Group LLC. "Clearly, this economy will remain in a recessionary environment for the rest of the year." Many economists said the economy is likely to contract this quarter. Morgan Stanley economists predict GDP will decline 2%.

Employers Cut Fewer Jobs in April, Jobless Rate Falls The economy showed off unexpected signs of resilience Friday as job losses slowed, the dollar gained a bit of muscle for a change and there were even indications that food prices may be easing. The unemployment rate dipped, though that may not last. The latest barometers flashed encouraging signs that the economic slowdown may not be as pronounced as some had feared. Still, there's much caution -- about housing, credit and other problems. Employers eliminated 20,000 jobs in April -- not nearly as many as the 81,000 in March, and the fewest monthly losses so far this year, the Labor Department reported. The unemployment rate dropped to 5 percent, from 5.1 percent. Stresses were still evident. It was the fourth straight month that employers cut jobs -- bringing total losses to 260,000.

• Analysis from theBigPicture: Job Loss Trend Dismal (Job Trend Comparison Chart), NFP Minus Birth Death Adjustments
• April 2008 Employment Situation:  Details More Pessimistic Than Headlines (Northern Trust Daily Commentary) [a thorough, short, readable dissection including taking out the B/D adjustments]

Housing

KB Home Co-Founder Eli Broad Says Home Prices in U.S. May Drop Another 20% Eli Broad, a philanthropist and co- founder of KB Home, the fifth-largest U.S. homebuilder by revenue, said he expects home prices to drop another 20 percent. ``I don't think we're anywhere near a bottom in housing,'' Broad told Bloomberg TV at the Milken Institute Conference in Beverly Hills, California. ``We're going to have a big inventory of unsold, unoccupied homes that's going to take three or four years to clear out.'' Homebuilders, hurt by banks' stricter requirements for granting home loans and concern over the rising number of homeowners failing to pay their mortgages, have begun work on the fewest number of houses since 1991, according to the U.S. Department of Commerce. Home Prices in U.S. Fall 12.7%, Most Since 2001, Case-Shiller Survey Says, S&P price index and outlook (vidclip), Orange County, CA Prices: From Front Page to Short Sale (this has a great chart which puts the REQUIRED future price declines in inflation-adjusted context).

• Housing Bust Duration: Update The peak and trough for the Los Angeles bubble are marked on the graph. Prices are falling faster this time, probably because the bubble was larger. It might be reasonable to expect that the dynamics of the current bust will be similar to the previous bust. After another year (or two) of rapidly falling prices, it's very likely that real prices will continue to fall - but at a slower pace. During the last few years of the bust, real prices will be flat or decline slowly - and the conventional wisdom will be that homes are a poor investment. The Los Angeles bust took 86 months in real terms from peak to trough (about 7 years) using the Case-Shiller index. If the Composite 20 bust takes a similar amount of time, the real price bottom will happen in early 2013 or so. (But prices would be close in 2010).

Foreclosures spike 112%, no end in sight One out of every 194 U.S. households received a foreclosure filing in the first three months of 2008, according to the latest figures released Tuesday by RealtyTrac. There were nearly 650,000 foreclosure filings - which include notices of default, auction sales and bank repossessions - issued during the first quarter of 2008. That's up 23% from the last quarter of 2007, and up a staggering 112% from the same period a year ago. So far this year 156,463 families have lost their homes to bank repossessions. "Foreclosure activity hasn't slowed down yet," said Rick Sharga, spokesman for RealtyTrac, "but I was a little surprised that foreclosure filings more than doubled since last year."

US Home Vacancies Rise to Record on Foreclosures  A record 18.6 million U.S. homes stood empty in the first quarter as lenders took possession of a growing number of properties in foreclosure. The figure is 5.7 percent higher than a year ago, when 17.6 million properties were vacant, the U.S. Census Bureau said in a report today. The vacancy rate, the share of homes empty and for sale, rose to 2.9 percent, the highest since the bureau started keeping count in 1956. About 2.3 million empty homes were for sale, compared with 2.2 million a year earlier, the report said. The worst U.S. housing slump in more than a quarter century is deepening as falling values encourage buyers to delay purchases in hopes of getting a better deal. The median U.S. home sale price may drop 5.8 percent in 2008, the most on record, followed by another 4.7 percent decline next year, Fannie Mae, the world's largest mortgage buyer, said April 7.

Posted by dblwyo at 06:20 AM | Permalink | Comments (0)

Time for a little Su. reflection as well as a rather large collection of readings with regard to business performance. Now over the last few weeks we've put up some posts on analyzing business performance and associted readings to illustrate some key points. Ranging from understanding the necessary balances between strategy and execution (Business Performance III(Readings): Sad Stories, Good Stories & "Fixes") to the critical role of innovation(WRFest 27Apr08(Tech Ind): Innovators, Survivors & Also-rans). These readings extend those arguments and provide in the company stories specific examples of many of these themes, along with several of our prior dissections of particular industries, e.g. Airlines or Technotainatronics [:)]. By this time we hope enough machinery has been provided to enable and encourage you to wrap each story with the big picture of Economy-Industry-Company mantra.

We've divided the excerpts into three sections. Long-term Perspective, Key Issues and Companies. And while the stories weren't deliberately selected to support the themes we've been striking it's nonetheless true that they do in fact align extremely well. Which suggests perhaps that the machinery might be relatively powerful.

If you think back over the last several years the investments that have done well have done so as the result of anomolies. That is as the result of some sort of deep, sometimes, structural change in the economy, industry or company. Think of real estate, commodities or energy all of which went or are going thru major structural shifts. Or think of Emerging Markets which are well beyond their emergence into relatively full, sophisticated and sound participation in the world economy. Albeit with some major risk factors still remaining as the last two posts on the World Economy show.

In the LT Perspestives, with articles on earnings quality, PE valuation and Buffet's accelerating shopping spree you find what we think is a fundamental theme now and for the future. How good are earnings, what are they likely to do and what'll they be worth. After several years of passing by stocks Buffett is putting big money to work because he's finally seeing opportunities in a combination of performance improvement and lowered prices. The section starts with one of the great financial analysts assessment - which boils down to "worst credit crisis since the '30s" and "very low earnings quality". We'd strongly suggest keeping those two signposts in mind.

In the Issues section we see several major strategic concerns from the impacts on morale and performance of the pay gap between worker bees and executives (Aholes, Shirkers and Performance: a Draft People Principles Policy) to major challenges and shifts in the emerging markets - the combination of rising labor costs and skills shortages with an effort/need to move up the value stack. And then two excerpts on the critical role of Innovation which is rapidly becoming a required core competency...only it's not.

In the Company section everything from Retailing to Airlines to Big Oil and Steel to Disney and Kodak are covered. Each story representing more than just the company in question. Many of the best Big Box retailers are hoping to seize the opportunity created by this downturn to continue enterring new markets and expansion. We'll have to see how that holds up if the economy, as we expect, turns down farther and longer than many are anticipating. Nonetheless this is a bold strategic move which suggests these are candidtes to put on your Buffett list. As a retailing counter-example Starbucks got badly scalded but is still looking for int'l expansion. The question is going to be can SBUX do for itself what MickeyD's did several years ago - self-arrest, recover and transform ? On that fundamental question hangs it's future value, as for so many others.

In complete contrast there's AMR, losing $3M/day, as proxy for an industry which is direst need of the most fundamental rexamination of business models, strategies and, most especially, network structure. An initiative which does NOT appear to be even being considered by any players. Instead they're moving ahead to re-arrange the deck chairs as the soles of their shoes are getting soaked.

As examples of another sort consider Oil and Steel (On Being a Boiled Frog: the Strategic Outlook for US Industries). The latter is our poster child for an old-line industry who's been reborn thru long, hard, painful and disciplined effort. Who'd have thought. Yet many of their troubles were self-inflicted by avoiding and delaying necessary changes for decades. Lessons that many other industries are having to learn the hard way. Obviously Airlines but also Autos. Big Oil is facing some similar challenges, strangely enough. Not because they're incompetently run. Just the opposite in fact. The problem is that their environment is changing where new oil discoveries are lagging, they aren't replacing reserves as fast as they're using them, national oil companies and politics are controlling the agenda and are doing so for short-term political goals and their exploration and production costs are escalating rapidly. Whee....talk about changes....and differences from the headlines.

Finally there are two stories of Renewal. One from Disney which we consider a poster child of both the innovative new mediatainment company and a superb example of what self-arrest and transformation should look like. The other is Kodak which continues to change but also to struggle. Disney had to re-discover itself. Kodak has to create a new self - a much...much harder problem. Made harder by, again, denial and willful ignorance. In the last few years they seem to have worked thru that after a decade of avoidance but now it's a race between creating the new Kodak and getting enough speed down the runway to get in the air. Remember V1 - the speed where you're moving fast enough to rotate the nose wheel ? You'd better hope there's enough runway left, especially if you're still too heavy with historical baggage. (Auto Industry: Pressures, Changes & Outlook - Finding V1) 

Long-term Perspectives

Thornton Oglove on investing If you haven't heard of Oglove, who recently turned 75, that is understandable. He retired from the investment industry in 1990, but not without leaving his mark in the form of a book, "Quality of Earnings: The Investor's Guide to How Much Money a Company Is Really Making." On the current environment: "In my view, and I've been investing for 50 years, this is the worst credit crisis since the '30s. There's too much debt relative to equity." What about the current crop of earnings? "The market is influenced by earnings, and earnings have held up." What happens if you remove the benefit many multinational companies have received from the cheap dollar? "I would say you would have a very low quality of earnings," meaning much profit would be lost in translation against a stronger greenback. Speaking of which, what role should earnings quality play in the analysis of a company? "I think the balance sheet is 10 times more important these days. The less leverage a corporation has, the better off they are." What are some of your favorites? "I own the Swiss Helvetia closed-end fund, which is selling at a 13% discount. It owns Swiss stocks, but these are Swiss francs I'm invested in. I like Barrick Gold, but it took it 20 years to kick in. I like General Electric. These analysts are all down on Immelt because they want instant gratification every quarter. They are upset that the company missed, and they want the company to break itself up. That's insane. What do they know about managing GE? It still pays a good dividend, and a large portion of future appreciation will be these dividends."

Look to the margins when using the price/earnings ratio I love the price/earnings ratio, but like all investment tools, it is flawed. This is because it is only as good as the numbers that go into it. There is no debate about the "p" in the equation - price is quoted every second. But the "e", though readily available, is only as good as the best estimates. Many people describe the stock market as cheap. After all, at 18 times earnings, p/es are half of what they were eight years ago (those bubbly valuations are not coming back anytime soon) and only three points above their long-term average of 15. However, the "e" is temporarily inflated by all-time high (pre-tax) profit margins, which are at 11.5 per cent, or about 35 per cent higher than their multi-decade average of 8.5 per cent. Historically, every time profit margins have become overextended, they have reverted towards the mean (that is, declined). This is because capitalism works. One company's excess profits are another's potential opportunity - increased competition puts pressure on profit margins. This time round is no different. If profit margins fell and stopped when they reached the average level - an aggressive assumption as historically they have overshot and gone lower - the market's p/e would rise from 18 to 22. Don't abandon the p/e ratio, but adjust the earnings for high margins. Take a close look at the profit margins of the stocks in your portfolio and ask yourself if today's margins are sustainable. If you adjusted margins to the historical average, would the stock still look cheap?If you own a stock that belongs to the "stuff" or financial services groups, assume its high margins won't last.

$40 billion burning a hole in his pocket Berkshire Hathaway, the insurance focused conglomerate run by billionaire Warren Buffett, has been sitting on more than $40 billion in cash since 2004. When stock markets climbed and the housing market soared from the end of the dotcom bust in 2003 to the middle of last year, Buffett struggled to find attractive investments as he followed his own advice of being fearful when others are greedy and greedy when the market is running scared. Now, as thousands of Berkshire shareholders prepare for their annual pilgrimage this weekend to the company's headquarters in Omaha, Neb., some are hoping Buffett has the crisis he's been waiting so patiently for. Berkshire has already snapped up some securities that have been particularly hard-hit by the credit crunch. In February and March, the company built up a $4 billion position in auction-rate securities, Buffett told Fortune magazine in early April. Berkshire has also made big bets on high-yield, or junk bonds, which have suffered in recent months from the credit crunch. The company owns derivatives contracts that require it to pay up if certain junk bonds default. They expire from 2009 to 2013. The company collected $3.2 billion in premiums on these contracts last year and paid $472 million in losses, Buffett reported in Berkshire's latest annual report. Buffett: 'Why I go to work in the morning'

·         Buffett Plots $40 Billion Spree as Credit Crunch Hinders Competing Bidders Buffett spent $4.5 billion last month for a 60 percent stake in the Pritzker family's Marmon Holdings Inc. He committed $6.5 billion this week to help finance Mars Inc.'s takeover of Wm. Wrigley Jr., the world's biggest maker of chewing gum. The deal includes $2.1 billion for a minority holding in Chicago-based Wrigley that Berkshire will get at an unspecified discount. At the center of Buffett's European efforts is Angelo Moratti, scion of the founding family of Italian energy company Saras SpA. Moratti is organizing visits to Milan and Madrid. For the past seven years, Moratti traveled to Omaha at least four times a year to brief Buffett on companies and issues in Europe. Buffett has said in recent years that investments meeting his criteria and big enough to make a difference to Berkshire have become scarce, prompting him to look abroad. He said at last year's annual meeting that he would welcome a $40 billion to $60 billion deal. Buffett also has said he expects the dollar to depreciate, making earnings in other currencies more important.

• Wilbur Rosss World Tour Fresh from his around-the-world tour, Wilbur Ross grants CNBCs Maria Bartiromo an exclusive interview.

A Time to Mourn–or a Time to Mine?  Like the sample of the cut plastic, many “gems” can be unearthed across the world, especially in Asia and Europe, due to the current credit crisis. They are companies that have great growth potential when cut and polished and are fundamentally solid, but have been affected by the credit crunch. This presents opportunities for strategic acquirers to dig and buy the gems at a discount, especially now that the miners who had been most active in digging them out over the past four years—the private equity firms—are finding it increasingly difficult to finance their acquisitions with cheap bank loans. For example, in Europe, the valuations of private company sales to private equity has fallen by 14 percent in the third quarter of 2007 to a multiple of 15.3 times a company’s earnings. Meanwhile, the valuations of private company sales to corporates fell by just 2 percent to 13.4 times earnings. A decade of corporate restructuring, economic integration and international expansion in Europe has created a region with many hidden gems. The European gems are like rubies—the second hardest gemstone after diamonds—in that they have built up strong foundations over the years and are generally well-run. Asian firms, on the other hand, are keen to seek investment and technology partners to upgrade and expand abroad. In China, and to a certain extent in India, many companies are started and managed by young entrepreneurs. Not interested in selling their companies yet, they nonetheless pursue high-trajectory growth paths. In many instances, this means they are interested in accepting capital and technology transfers to aid expansions

Strategic Issues

Pay Gap Fuels Worker Woes The gap between top executive and employee compensation has never been greater. That's triggering lower morale and productivity on some corporate staffs, and making it more difficult to attract and keep talent, even in a slowing economy. Last year, payouts hit record highs despite efforts by corporate directors to put the brakes on perks such as overly generous signing bonuses and exit packages. According to the Congressional Research Service, the average pay for CEOs was more than 180 times average worker pay, up from a multiple of 90 in 1994. For many employees, the higher cost of gasoline, health care, education, food and other daily expenses has left them with the feeling that they are treading water. Hard-charging CEOs, who have spent decades climbing the ladder by putting in 80-hour workweeks, say they deserve to hit the jackpot when they gain the corner office. But ambitious employees have similar feelings, and figure their best chance to close the earnings gap is to keep zigzagging among companies and industries. "When executives talk about a talent shortage in their ranks, they're really talking about a commitment shortage," which stems partly from pay inequality, says Rakesh Khurana, an associate professor at Harvard Business School. "The greater the inequality, the less willing employees are to learn specific company ways of doing things that aren't going to be useful to their next employer." He says less than one-third of M.B.A. graduates from elite business schools are pursuing corporate management jobs, compared with two-thirds in 1970.

Help Wanted: Managers U.S. companies in China say recruiting talented managers for their local operations has become their biggest business challenge, a finding that highlights the continuing gap between the skills taught in China's universities and what businesses here are actually looking for. A joint survey by three American chambers of commerce in China showed "a continued worsening of human-resource challenges as companies expand," said J. Norwell Coquillard, chairman of the American Chamber of Commerce in Shanghai. Difficulty in finding, training and retaining managers was named as the top operational problem by 37% of the 324 companies responding, more than issues such as regulation, bureaucracy or piracy. U.S., European and other foreign business executives in China have grown increasingly worried about talent issues as they have expanded their local operations.

Importing Design Talent Mr. Ng's talent search is part of a push by Chinese apparel makers -- from yarn and textile manufacturers to those that stitch the garments -- to break into new territory: offering the world's biggest brands design expertise rather than simply following their instructions. By hiring in-house designers, the Chinese companies' thinking goes, they can turn around clothing collections faster, gain an edge in the fierce domestic competition and charge more for their services. At the same time, these companies are discovering the difficulties of nurturing creative talent. "It's not easy to work with designers," Mr. Ng said. No longer content with simply manufacturing low-cost goods for other companies, Chinese companies in a range of industries are trying to move up the value chain -- with varying degrees of success. Fashion brands have been making their goods in China for years, yet homegrown designers are in short supply. Design is still a new field for young Chinese, and local designers often struggle to grasp Western tastes. Now China's growing appetite for creative talent is making Western universities into feeder schools for textile manufacturers.

The Future of R&D: Leveraging Innovation Contrary to conventional thinking, R&D is a very manageable driver of corporate success. In large companies, of all of the things that are done, innovation tends to be managed with the least discipline of any function. "[Consulting firm] Booz Allen Hamilton reports that of all of the core functions of most companies, innovation had the most competitive value, but is managed with the least discipline," Maxwell observes, "and I agree with that. When I looked around the company [Parker Hannifin] and saw what was going on, it wasn't that people weren't innovating; rather, serendipity seemed to rule. Missing was the disciplined rigor of order and metrics common to the rest of our operations, like running a factory. In the manufacturing function we constantly measure our performance. Maxwell's approach with the Parker R&D program, called Winovation, puts a lot of things in place to create a corporate environment to enable and facilitate the innovation process. "That resulted, for the first time, in a standardized process by which we would evaluate projects and align them to our strategic growth objectives and track them in real time via the Web." The result: "For the first time Parker Hannifin could see itself. I could see every single project in the entire company and there was a rush of communication and collaboration among the divisions." Another outcome was the development of metrics that document the product development process. "What we're really measuring is our ability to grow -- top line growth and our bottom line profitability. Previously, without this real-time reporting of metrics, the situation was analogous to flying an airplane without gauges."

Larry Page on How to Change the World If you ask an economist what's driven economic growth, it's been major advances in things that mattered - the mechanization of farming, mass manufacturing, things like that. The problem is, our society is not organized around doing that. People are not working on things that could have that kind of influence. We forget that it really does matter that we don't have to carry our water; it's not that much fun to walk miles and miles to try to find water and then carry it back under human power. And our ability to generate clean, accessible water is based on basic technologies: Do we have energy? Can we make things? My argument is that people aren't thinking that way. Instead, it's sort of like "We are captives of the world, and whatever happens, happens." That's not the case at all. It really matters whether people are working on generating clean energy or improving transportation or making the Internet work better and all those things. And small groups of people can have a really huge impact. Many leaders of big organizations, I think, don't believe that change is possible. But if you look at history, things do change, and if your business is static, you're likely to have issues. Look at the auto industry: It took the Japanese to convince people you can have a reliable car. Then they started pushing the product cycles shorter and shorter. Instead of making a car in five years, they made them in one year or two years. That's a big change. What kind of background do you think is required to push these kinds of changes? I think you need an engineering education where you can evaluate the alternatives. For example, are fuel cells a reasonable way to go or not? For that, you need a pretty general engineering and scientific education, which is not traditionally what happens. That's not how I was trained. I was trained as a computer engineer. So I understand how to build computers, how to make software. I've learned on my own a lot of other things. If you look at the people who have high impact, they have pretty general knowledge. They don't have a really narrowly focused education.You also need some leadership skills. You don't want to be Tesla. He was one of the greatest inventors, but it's a sad, sad story. He couldn't commercialize anything, he could barely fund his own research. You'd want to be more like Edison. If you invent something, that doesn't necessarily help anybody. You've got to actually get it into the world; you've got to produce, make money doing it so you can fund it.

Companies

Big-box retailers undaunted by slow economy While a select few retailing giants -- namely home-improvement retailers -- have had to curtail expansion plans, others are continuing as if recession talk is nothing more than idle chatter. Companies like Target Corp., Costco Wholesale Corp. and Best Buy Co. are carrying on with expansion plans at virtually the same pace as in years past. For the most part, today's retail giants don't suffer in the same way that most retailers do when gasoline prices climb and pocketbooks get pinched. While they may make adjustments, they're big enough to absorb the shock, according to industry experts. "They really are looking through the economic time because their stores will open after the bad economic times have passed," said Jim McComb, president of retail consultancy McComb Group based in Minneapolis, home to Best Buy and Target headquarters. The biggest box of all, Wal-Mart Stores Inc., is curtailing its expansion efforts, although company executives insist that it's not recession-related. The world's biggest retailer is beginning to saturate the North American market, so now it's looking to grow more quickly overseas. Companies that seem to be clinging to good times are Best Buy, Costco and Target. Best Buy said that it could stand to build another 500 stores in its various markets, so it plans to open 130 to 160 of them over the next fiscal year. That's about the same pace at which Best Buy has grown over the past several years, according to company spokeswoman Sue Busch.

McDonald's Net Tops Estimates; Sales in U.S. Drop First Time in Five Years McDonald's Corp., the world's largest restaurant company, said first-quarter profit rose more than analysts estimated after record European revenue gains outweighed the first drop in U.S. comparable-store sales in five years.

Consumer slowdown scalds Starbucks The Starbucks (SBUX) turnaround is going to take some time. The Seattle-based coffee company warned Wednesday afternoon that it expects second-quarter earnings to fall short of Wall Street’s expectations due to “the sharp weakening in the U.S. consumer environment.” Shares of Starbucks, which have dropped 45% over the past year, dropped an additional 10% in late trading after a brief halt for the release of the bad news. “The current economic environment is the weakest in our company’s history, marked by lower home values, and rising costs for energy, food and other products that are directly impacting our customers,” said CEO Howard Schultz, who returned earlier this year to lead the company’s turnaround efforts after a spell of weak results under the departed Jim Donald.

Starbucks looks to international stores to fuel earnings Starbucks plans for more global growth after 2Q profit sinks 28 percent on US economic woes. Starbucks Corp. is dialing back expectations for its U.S. stores in light of economic uncertainty but has a three-year plan for snazzy new drinks and future profit growth fueled by aggressive international expansion. As expected, the company said Wednesday its fiscal second-quarter profit sank 28 percent as U.S. consumers responded to rising food and gas prices by making fewer latte runs. The coffee purveyor slashed 30 additional store openings from its already-scaled-back plan for 2008 and said it will open fewer than 400 stores per year in 2009 through 2011. International openings will increase at a far faster clip, though, with 975 this year and a projected 1,300 in 2011. Starbucks expects to have 21,500 stores worldwide by the end of fiscal 2011.Starbucks' financial goals for the coming years reflect worries about a protracted U.S. economic downturn and rely on international stores -- particularly ones run by licensed partners rather than Starbucks itself -- to drive profit.

American Air loses $3.3 million a day "While mergers may play a role in solving some of the fragmentation and capacity problems that plague the industry," he scribbled, "they are not the panacea for solving all the industry's problems and may create a few new ones." Then he looked at me, smiled, and said, "But that doesn't mean we aren't looking or don't have options." Then, as if it had been timed, we hit a patch of turbulence. That's a gentle word for what American's CEO has experienced of late. In the past month Arpey, 49, has dealt with picketing pilots calling for his resignation, FAA inspectors decertifying 300 aircraft, the merger of two large competitors, and $110-a-barrel oil that contributed to a $328 million loss for the first quarter. Since January, nearly every flight the airline has flown has lost money - analysts estimate it is losing $3.3 million a day. Of course, red