bizzXceleration: Performance, Value and Profit

It's time to play another broken record or three on the international economy. Can we get away with putting the "de-coupled" meme to bad, (oops) we meant bed, and moving on and beyond "yeah, right !". It turns out as the US slows so does the rest of the developed world and then the developing world. NOW...beyond normal cyclic behavior and linkages all the foreign economies have a collection of their own problems which are enormously worse than ours. Not least of which is Inflation brought about by exponentiating oil and commodity prices. And the Dragon and the Elephant are biting their own tails. Besides which Inflation in these areas are much worse for them given the impact on the typical consumer's marketbasket. After the break you can find various headlines and exhibits that even on a quick skim will support most of these arguments. Perhaps the one you should pay attention to is the Bank for Int'l Settlements (the central bankers central banker) who just today said the international economy is near a major tipping point. Which Kenneth Rogoff points out means that the risks to sovereign wealth is in growing and potentially serious jeapordy ! Whee, watch out below. The third article that represents a game-changer is the recent WSJ portrait of two senior Saudi oil players who are the exemplars of the emerging "Peak Oil" vs "Tech Will Fix" schools of future planning. This could be really important.

But just to put some context on all this we indulged our penchants for actually looking at the data and then building a nifty little multi-part composite chart. And, as usual and something we kicked ourselves for not digging into earlier, it turns out that de-constructing the standard mythologies reveals some very interesting things indeed. In the top you see int'l trade growing as part of the economy but not really taking off until the '90s. Beyond globalization though notice that while trade was more and more important the trade deficit didn't really take off until around '98. The mid-chart shows the mix of Imports and notice that despite mythologies to the contrary Oil is not the thing that's really killing us. When you look at the Import/Export Balance by those same groups the picture gets even more interesting. It turns out that, except for Autos, the US is still a major manufacturing powerhouse with significant trade and exports in both Industrial and Capital Goods. On the other hand Autos are as big a "problem" as Oil ! Imagine that !! And the real problem is Consumer Goods imports.

Now there's a lot hiding in the background about how trade works that deserves some future discussion but let me share the classic accounting identity from Macroeconomic Theory. Note: this is neither a theory but follows from the basic definition of the national income accounts; i.e. it's not open for debate. AND the data support it as well. That little equation ? Savings-Investment = Net Imports. When we save less than we spend we end up importing more than we export for one thing. And for another we end up having to borrow the money for investment and spending. That seems to be jive pretty well with the charts...at least IOHO ! 

Big Picture

BIS: Economy Nears 'Tipping Point' (WSJ) The global economy may be close to a "tipping point" that could see it enter a slowdown so severe that it transforms the current period of rising inflation into a period of falling prices, the Bank for International Settlements said. In its annual report, the central bank for central banks said the impact of rising food and energy prices on consumers' incomes, combined with heavy household debts and a pullback in bank lending, may lead to a slowdown in global growth that "could prove to be much greater and longer-lasting than would be required to keep inflation under control." "Over time, this could potentially even lead to deflation," it said. For central bankers from around the world gathered in Basel for the BIS annual meeting Sunday and Monday, the report made for chastening reading. Not only does it highlight the difficulty of the dilemma facing central banks confronted with slowing growth at a time when inflationary pressures are rising, it also lays much of the blame for their predicament at the feet of the central banks themselves. The BIS said that in the early part of this decade, central banks had failed to set interest rates high enough to restrain an unsustainable credit boom. It added that if a repeat of the current financial crisis is to be avoided in the future, central banks must be prepared to keep interest rates high even when there are no obvious signs that inflation rates are about to pick up. It also suggested that regulators make banks set aside more capital during boom times -- an approach that could curb their risk-taking and lessen their need to pull back on lending during busts.

Weak economic reports hurt yen and euro against dollar (WSJ) The dollar rose against the yen and euro Monday after disappointing economic reports in the euro zone and Japan transferred investor concerns to economies outside the U.S. The euro tumbled against other major currencies after the widely watched Ifo survey showed that business sentiment had fallen to 101.3 in June from 103.5 in May, well below forecasts. A weak euro-zone Manufacturing Purchasing Managers Index extended the euro's decline. It showed activity in the euro-zone economy fell to its weakest level in five years during June. In a Japanese survey, large companies were more pessimistic about business conditions in the April-June quarter than they were during the previous quarter.

Watch Out for Sovereign Debt Risk Optimists say that emerging-market defaults are a thing of the past. Emerging markets today, the argument goes, are relying more on domestically issued local currency debt, both inflation-indexed and non-indexed. This means their debts are far more stable and reliable than in the recent past, when a much larger share of government debt was issued externally and denominated in hard currency. This argument is wrong. In the past, the combination of high levels of domestic debt and inflation surges has often proven deadly for both foreign and domestic investors. Just look at Argentina today, a country not nearly as prosperous as its abundant natural resources would warrant. If external debt holders think that abuse of domestic debt holders is no cause for alarm, they should think again. Governments do not usually cheat holders of only one type of debt. In April, we published a National Bureau of Economic Research paper based on centuries of debt data from many countries. We found that most countries default on external debt only a bit less freely than on domestic debt. That is, contrary to popular belief, domestic debt holders are not necessarily a cushion for "senior claimants" holding externally issued debt. Emerging markets could be in much greater trouble than the optimistic consensus suggests. If today's tepid growth in the U.S., Japan and Europe begins to take hold in emerging markets, Argentina's miserable indexed bond holders may soon have company.

How to see world economy through two crises [Chart] Two storms are buffeting the world economy: an inflationary commodity-price storm and a deflationary financial one. Last week I argued that exchange-rate regimes were a link between these distinct events. This week, let us look at how to sail on these storm-tossed seas. The place to start is with the world economy as a unit. The more globalised economies become, the more appropriate it is to think of the world economy in this way. So what have we learnt about the world economy as a whole? The answer is that it is running into limits on resources, at least in the short term. Our civilisation is based on fossil fuel. But since the end of 2001, the real price of oil has risen some six-fold. Today, the real price is higher than since the beginning of the previous century. Against this difficult background, what are the right responses and how should they be distributed, across the globe? These need to be divided into the short term and the longer term. In the short term, the biggest monetary policy requirement is a tightening in emerging economies, many of which now have strongly negative real interest rates. A precondition for such a tightening is a relaxation of exchange rate targeting. Monetary tightening is less obviously necessary in high-income countries, though the US Federal Reserve may have cut too far. As important is letting the jumps in energy prices pass through, so forcing the needed adjustments in energy use. The beneficiaries of the subsidies offered by many emerging countries are overwhelmingly in upper-income groups. In the medium to long term, the biggest priority is to release energy constraints on growth. This means increased public and private investment in energy research, particularly in renewables. The challenge is huge, but must be met. The shocks are large. But the more significant one is the high price of energy. The financial crisis was an avoidable stupidity. Rising prices of energy are a bitter reality. The world must adjust to this unpleasant new threat. How imbalances led to credit crunch and inflation

Regions & Countries

Euro Zone Business Activity Falls Business activity in the euro zone contracted for the first time in five years, according to a closely watched business survey, as high oil prices, a strong currency and the threat of rising interest rates take their toll. Business activity in the euro zone contracted for the first time in five years, according to a closely watched business survey released Monday, as high oil prices, a strong currency and the threat of rising interest rates take their toll. The unexpectedly sharp drop in the euro zone's Purchasing Managers Index and a decline in Germany's Ifo Index of business confidence, also released Monday, suggest the global economic slowdown is now seriously affecting the 15-nation euro zone. That will complicate the European Central Bank's job of reining in inflation, economists say. A sharp fall in French business activity contributed particularly to the drop in the index. Even in Germany, Europe's largest economy, the survey suggested recent economic strength is fading. The euro zone's other main economies, Italy and Spain, are already experiencing pronounced economic downturns. The German Ifo Index fell by more than expected to 101.3 in June from 103.5 in May, hitting its lowest level since December 2005. German companies told Ifo, a Munich-based economics institute, they expect business conditions to deteriorate in the coming six months. Soaring oil prices are increasingly hurting the German economy, said Ifo President Hans-Werner Sinn. Germany's key manufacturing industries expect their export business to slow in coming months but not to collapse despite the high euro, he said. The euro-zone economy had until recently proved remarkably healthy in the face of slowing U.S. growth, financial-market turbulence, high energy prices and the euro's strength. That resilience appears to be fading.

• Contraction Possible in Germany (WSJ) German consumer sentiment worsened, a survey showed, while the government warned that the economy could stagnate or even contract this summer.
• U.K. Economic Growth Revised Down to 0.3% as Services Slump to 12-Year Low
• Europe Business, Consumer Sentiment Drops to 3-Year Low; Retail Sales Fall
• French First-Quarter GDP Growth Revised Down to 0.5% as Spending Stagnates

Harvard, Buffett Have Bad News for Asia Bulls: William Pesek There's much relief that Asia is holding its ground as the U.S. economy slows and credit-market woes humble Wall Street's biggest names. While asset markets are heading lower from Tokyo to Jakarta and Shanghai to Mumbai, healthy economic growth has confounded the pessimists -- so far. The knock-on effects are coming, just more stealthily than many expect. Asia is unlikely to get off easy even if the U.S. skirts a recession. The region hasn't decoupled from America as much as some would say. The worst-case scenario -- a prolonged U.S. decline -- could be devastating, particularly at a time when record oil and food prices are hurting Asian households. Billionaire investor Warren Buffett laid it out in a June 25 Bloomberg interview. He's unsure when the U.S. will recover. The idea that Asia will continue to display an impressive immunity to U.S. events ignores how dependent China is on the American economy. It also ignores how reliant Asia is on China's 10 percent growth. Slowing U.S. demand will chip away at that country's export-driven expansion exponentially.

China's Exports Threatened by Rising Costs These pressures are felt by enterprises across China. But none have been hit harder than the companies that feed the vast global appetite for inexpensive goods such as toys, household goods, shoes and clothes. Manufacturers of low-cost products have been a key engine of China's economic miracle, helping to turn the country into the world's No. 2 exporter after Germany. For years, these companies continued to grow by expanding their volumes and trimming margins to undercut the competition. As material and labor costs rise and China's currency strengthens, these manufacturers are among the least able to absorb the costs. The transformation is most apparent in the boomtowns that tied their fortunes to making one product cheaply, from Guangdong province in the south to Honghe's environs in the Yangtze River Delta. Many of these manufacturing centers have seen hundreds if not thousands of factories and workshops close in recent months, industry executives say. In Shengzhou, a city near Shanghai that claims to make one-third of the world's neckties, manufacturers are trying to hold a united front to boost prices. Dongguan, in Guangdong, is seeing makers of toys, shoes and brushes close shop. While painful, such difficulties could usher in a more mature phase of China's economic development. The country's sweater industry, like many others, is arguably overbuilt: Honghe is one of at least six Chinese cities claiming to produce more than 100 million sweaters annually. In such low-cost sectors, analysts predict a coming wave of consolidation that could boost efficiency. They say companies will also be forced to innovate so they can compete on factors other than price.Many Chinese economists and officials think the country has relied too much on cost-cutting and simple production models to boost exports.

India Steps Up Inflation Fight (WSJ) India's central bank raised its key rate a half point to 8.5% and increased banks' reserve ratio, in further moves to curb accelerating inflation. India's central bank raised its key short-term interest rate and the amount of cash banks must keep in reserve, employing both its chief inflation-fighting tools after price rises recently reached a 13-year high. The move was the latest in a months-long campaign by the Reserve Bank of India to curb the impact of rising food prices and the government's recent decision to remove some energy subsidies, which increased most fuel prices by about 10%.Wholesale price inflation, the chief benchmark of Indian prices, touched a 13-year high of 11.05% in the week ended June 7, more than double the central bank's comfort level of 5.5% for the year ending March 31, 2009. This time last year, annual inflation stood at 4.28%.

Dubai's $82 billion aerospace gamble Blessed with fewer oil and gas reserves than its neighbors, Dubai has long had to find other ways of making a living. For centuries not much more than a staging post and pearl-diving port along ancient Middle Eastern trading routes, it has most recently reinvented itself as a playground for the super rich, with a focus on extravagant Las Vegas-style real-estate projects such as the world's first seven-star hotel. A history of success at pulling off such grand schemes has emboldened Dubai of late. After diversifying its economy into real estate, tourism and financial services, it's recently turned its attention to the loftier aerospace sector. And why not? For a sheikdom at the crossroads of Europe and Asia, awash in cash and eager to have a say on the global stage, aerospace could be just the ticket, allowing it to parlay its ideal geographic location and rising international profile into an industry that will create jobs and support its economy in the long term. According to consultancy McKinsey, the Gulf economies need to create more than 4 million jobs over the next decade for its citizens. More than 350,000 new jobs could come from the aviation sector by 2015. While a chunk of the industry likes to portray Dubai as a somewhat clueless teenager indiscriminately spending daddy's money on vanity projects, it would be a mistake to dismiss the emirate's plans too hastily. "The level of ambition and the money and willingness to support it is staggering," said David Stewart, head of the European practice of consultancy AeroStrategy.

Issues: Food, Materials, Oil

Yes, We Will Have No Bananas  ONCE you become accustomed to gas at $4 a gallon, brace yourself for the next shocking retail threshold: bananas reaching $1 a pound. At that price, Americans may stop thinking of bananas as a cheap staple, and then a strategy that has served the big banana companies for more than a century — enabling them to turn an exotic, tropical fruit into an everyday favorite — will begin to unravel. The immediate reasons for the price increase are the rising cost of oil and reduced supply caused by floods in Ecuador, the world’s biggest banana exporter. But something larger is going on that will affect prices for years to come.That bananas have long been the cheapest fruit at the grocery store is astonishing. They’re grown thousands of miles away, they must be transported in cooled containers and even then they survive no more than two weeks after they’re cut off the tree. Apples, in contrast, are typically grown within a few hundred miles of the store and keep for months in a basket out in the garage. Yet apples traditionally have cost at least twice as much per pound as bananas. Americans eat as many bananas as apples and oranges combined, which is especially amazing when you consider that not so long ago, bananas were virtually unknown here. They became a staple only after the men who in the late 19th century founded the United Fruit Company (today’s Chiquita) figured out how to get bananas to American tables quickly — by clearing rainforest in Latin America, building railroads and communication networks and inventing refrigeration techniques to control ripening. The banana barons also marketed their product in ways that had never occurred to farmers or grocers before, by offering discount coupons, writing jingles and placing bananas in schoolbooks and on picture postcards. They even hired doctors to convince mothers that bananas were good for children. Once bananas had become widely popular, the companies kept costs low by exercising iron-fisted control over the Latin American countries where the fruit was grown.

Iron Deal to Lift China's Steel Costs (WSJ) Rio Tinto and BHP won an 85% increase in the benchmark price for iron ore after months of negotiating with China's top steelmakers. For Rio Tinto, the deal will boost profits and help it fend off BHP or force BHP to boost its takeover offer. After months of negotiating with China's top steelmakers, miners Rio Tinto PLC and BHP Billiton Ltd. won an 85% increase in the benchmark price for iron ore, a major ingredient of steel, indicating that steel prices world-wide are likely to stay high and fanning further concerns about inflation. The price increase, which tops the amount that Brazilian rival Cia. Vale Do Rio Doce received, is retroactive to April, meaning steelmakers that purchased iron ore from BHP and Rio Tinto will have to write a check for the difference, which is likely to be in the billions of U.S. dollars. The deal was settled between the miners and Baosteel Group Co., China's largest steelmaker, but it generally applies to all steelmakers that buy iron ore from the two. Prices for steel across the globe have been rising dramatically, doubling in some cases, as costs of iron ore, coal and other raw materials have increased. A backlash by steel buyers, especially those in construction materials, is getting stronger. Some countries are increasing export taxes to encourage local cheap steel to stay at home, while other countries, such as Turkey, Italy, India and Russia are staging protests and work stoppages and passing legislation that freezes steel prices.

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As usual many of the headlines got the underlying realities wrong last week and as usual we're going to dissect a couple of the key data sets for your edification and amusement. After the break you'll find several (a large collection) readings on the Economy, the current cycle, key indicators (Oil, Housing, Confidence, State Budgets, Inflation), the multiple divergent reportings on last week's Harvard's annual Housing Study (whew and whee...did the all read the same report...sometimes you wonder) and a last more strategic excerpt on the Oil strategic situation. Skim them all but the first on why this has been an extraordinarily feeble recovery, what the reasons are and what it means for the future is something you need to internalize big time. It is ENTIRELY consistent with things we've been saying for years, all our analysis and everything posted on this blog since its' genesis. And NOT factored into people's thinkings or policies. The two headlines that we consider, beyond that, to be most important are the reports that Consumption surged and that Dow Chemical is raising it's prices...again !

Consumption

 These composite charts almost speak for themselves - rather than surging REAL personal consumption grew 2% YoY, slightly above the 1.9% last month but a) as low as it was during the '01 nadir and b) on a steepening downtrend that begin tipping over in the Fall though c) not (yet) dropping as sharply as it has in past major recessions. As you can see looking back at the patterns to 1980 (which are quarterly). So tell me again about that stimulus package and what great things it's doing for us !

Inflation

Inflation is a whole other kettle of fish and isn't being well-discussed by and large in either the MSM or the blogosphere; though a few commentators, e.g. Larry Summers, are getting it more than right. Core inflation, which is still important, is not taking off. Which means that inflationary pressures per se are NOT getting built into the economy. On the other hand headline inflation for both the CPI and PPI - which is what you see in your bills - is far above a comfort level. Nonetheless the Fed is likely right in that a slowdown and the accompanying demand destruction will likely lower that as well. We'd better hope so because Inflation is largely due to our importing it from abroad via rising commodity prices, particularly oil. Which are having a worse impact on more fragile foreign economies, especially in the developing world where food and fuel are much bigger proportions of the consumption basket. Then again Europe is experiencing more inflationary pressures than we are as well. The problem is that there's not much the Fed can do about this other than struggle to contain it with higher interest rates which have their own dangers. On the Gripping Hand something we've been afraid of for a long-time is coming to pass in that companies can no longer absorb the price increases for materials, supplies and energy and are beginning to pass them along. As you can up until '04 CPI, CPIx and PPI were moving together and largely benignly but then PPI took off in terms of cumulative growth like a rocket. Largely due to Oil. The chickens are coming home to roost but unfortunately they were hatched on the fringes of an atomic test sight and are big, ugly, misshapen mutants who could eat us up. I'd rather watch a bad scifi flick anyday than live thru this one. 

Economy: Big Picture

A Feeble Recovery: The fundamental economic weaknesses of the 2001-07 expansion  Evidence is mounting that the U.S. economy is in a recession. If this is the case, a complete business cycle from 2001 through the end of 2007 (or perhaps the start of 2008) is now on the books, and the economic performance of the current decade can be held up in comparison to that of past business cycles. By almost all measures, the most recent expansion was the worst since WWII. A variety of recent economic data now show a pattern consistent with the start of a recession. Since 1951, three consecutive months of job declines have always been signals of a recession; the U.S. employment rate declined for the first three months of 2008. Furthermore, the unemployment rate rose from 4.4% in March 2007 to 5.1% in March 2008. Economic output also began decelerating in the fourth quarter of 2007 to a 0.6% annual rate, an anemic pace that continued into the first quarter of 2008. Several of the internal indicators in the recent gross domestic product report—including consumption of goods and business investment—saw outright declines. Other monthly indicators—including industrial production and payroll employment—peaked in either the fourth quarter of last year or the first quarter of this year. Real income (less transfers) has been flat since last September. While it will be many months before an "official" recession is declared, evidence shows that the economic expansion that began in 2001 has almost surely ended.¹ Furthermore, if these trends continue, the start of a new recession will likely be dated either at the end of the last quarter of 2007, or at some point during the first quarter of 2008.² Finally, financial market turmoil, housing price declines, and higher energy costs are all likely to place continued downward pressure on the macro economy, thus leading to a longer period of diminished economic activity. Safely assuming that the expansion ended near the start of 2008, we can compare this cycle's performance to those of the past. The bottom line of such a comparison is that the economic performance from 2001 to 2007 was anemic by most measures, especially in regards to the labor market. For the vast majority of American households—that is, those who depend on earnings derived from the labor market for the bulk of their income—the economy has been seriously mismanaged. Rankings Table Graphic By most widely-accepted and honest measures, the most recent economic expansion should receive a failing grade. Measures of total output, investment, consumption, employment, wage and income growth, all rank at or near the bottom when compared with past business cycles.Worse, these anemic results have been accompanied by rising inequality as well, meaning that the bulk of the (historically weak) gains have accrued to a small sliver of the population. This makes the fruits of the current recovery even smaller for the typical working family. For most American families, this has been a fundamentally weak U.S. economy for some time, and it seems poised to get much worse. Now is the time for a new direction in economic policy. Family Income Trends

• Employment Outlook: Where Have All the Jobs Gone ? Fewer jobs were created because companies were more fearful and therefore careful about hiring and capex. There were more fearful because of growing worldwide competition and the impact on profits of inlfation. This represents a fundamental change in the job strenght of the economy. Which leads to the 2nd sub-chart which shows the consequences of the Red Queen Effect - you know running faster and faster to keep up ? Well the population grows about 1.5%/year so any new jobs below that level means a drop in per capita hiring. When you factor in productivity growth the rough rule of thumb is that the economy must create 150K job per month (450K/Qtr) to keep the Queen in place or she falls behind. We've been falling behind. Net new jobs (New Jobs-450K) dropped abruptly and sharply this last quarter, which is scary and dangerous. Over time (here since 1980) you can look at aggregate new job creation, that is the running total of Net new jobs, and see where we stand for the strategic health of the economy and what consumer demand might look like.

Economy: Realities

This Recession, It's Just Beginning So much for that second-half rebound. Truth be told, that was always more of a wish than a serious forecast, happy talk from the Fed and Wall Street desperate to get things back to normal. It ain't gonna happen. Not this summer. Not this fall. Not even next winter. This thing's going down, fast and hard. Corporate bankruptcies, bond defaults, bank failures, hedge fund meltdowns and 6 percent unemployment. We're caught in one of those vicious, downward spirals that, once it gets going, is very hard to pull out of. Only this will be a different kind of recession -- a recession with an overlay of inflation. That combo puts the Federal Reserve in a Catch-22 -- whatever it does to solve one problem only makes the other worse. Emerging from a two-day meeting this week, Fed officials signaled that further recession-fighting rate cuts are unlikely and that their next move will be to raise rates to contain inflationary expectations. In explaining why that second-half rebound never occurred, the Fed and the Treasury and the Wall Street machers will say that nobody could have foreseen $140 a barrel oil. As excuses go, blaming it on an oil shock is a hardy perennial. That's what Jimmy Carter and Fed Chairman Arthur Burns did in the late '70s, and what George H.W. Bush and Alan Greenspan did in the early '90s. Don't believe it. Truth is, there are always price or supply shocks of one sort or another. The real problem is that the underlying fundamentals had gotten badly out of whack, making the economy susceptible to a shock. The only way to make things better is to get those fundamentals back in balance. In this case, that means bringing what we consume in line with what we produce, letting the dollar fall to its natural level, wringing the excess capacity out of industries that overexpanded during the credit bubble and allowing real estate prices to fall in line with incomes. The last hope for a second-half rebound began to fade earlier this month when Lehman Brothers reported that it wasn't as immune to the credit-market downturn as it had led everyone to believe. Lehman scrambled to restore confidence by firing two top executives and raising billions in additional capital, but even that wasn't enough to quiet speculation that it could be the next Bear Stearns.

• The Muddled Economic Outlook
• Consumer Confidence Tumbles to 16-Year Low

Professor Duy: "This Is Not Good" Tim Duy has another great post on the Fed being caught between inflation and recession: This Is Not Good. Here is his conclusion: This is a no win situation...which way will the Fed turn? The Fed will hold the current policy in place until policymakers becomes sufficiently distressed by the impact of energy price inflation ... Note that market participants are increasingly aware that the Fed’s default policy for the time being is higher inflation, as evidenced by the rise in 10 year TIPS breakeven levels to 254bp today. In theory, the best outcome is to find is a sweet spot that allows global growth outside of the US to decelerate while avoiding a free fall in the Dollar. In the absence of such equilibrium, the US economy can hobble along only as long as the following three conditions hold:

Oil, Housing,... 

Envisioning a world of $200-a-barrel oil. As forecasters take that possibility more seriously, they describe fundamental shifts in the way we work, where we live and how we spend our free time. Besides the obvious effect $7-a-gallon gasoline would have on commuters, automakers, airlines, truckers and shipping firms, $200 oil would drive up the price of a broad spectrum of products: Insecticides and hand lotions, cosmetics and food preservatives, shaving cream and rubber cement, plastic bottles and crayons -- all have ingredients derived from oil. With every penny hike in the price of gas costing American consumers about $1 billion a year, sharply higher pump prices would lead to "significant bankruptcies and store closings,"… The fee increases on the ferry would be nothing compared with the added cost of transoceanic shipping if oil goes to $200. Some experts say high energy costs are altering global trade and slowing the pace of globalization. "To put things in perspective, today's extra shipping cost from East Asia is the equivalent of imposing a 9% tariff on East Asian goods entering North America," said Rubin of CIBC World Markets. "At $200 per barrel, the tariff equivalent rate will rise to 15%."

Housing Abyss: The Worst Is Ahead The housing crisis is entering a new and frightening stage. On June 24, Standard & Poor's announced that the S&P/Case-Shiller 20-City Home Price Index had fallen more than 15% in April from a year earlier. Adjusted for inflation, the decline is the biggest since 1940-42, according to data collected by Yale University economist Robert Shiller. The risk for the financial system and the economy is that the price drop, already horrifying, will start feeding on itself. When home values fall low enough, hard-pressed homeowners become less able or less willing to keep paying their mortgages. That forces lenders to repossess homes and then dump them back on the market at fire-sale prices, which depresses prices further and leads to even more foreclosures. That process has already started in parts of Arizona, California, Florida, and Nevada.

• New Home Sales: Worst Selling Season Ever There was no Spring this year. This year saw the smallest increase in sales from the Winter doldrums, to the Spring selling season, since the Census Bureau started tracking new home sales in 1963. Usually sales increase in the spring - but not this year. The previous worst spring on record was 1982 - in the midst of a severe recession, with 30 year fixed mortgage rates at 17%, and close to double digit unemployment. In 1982, sales picked up late in the year as interest rates declined sharply (30 year fixed rates fell from 17% to about 13% at the end of the year).

• Has Housing Bottomed? Whether there are opportunities right now in the housing market, with Patrick Newport, Global Insight and Matt Garrison, Coldwell Banker [this vidclip is largely for commodity relief especially when one of the talking heads says he’s expecting New Home Sales go up !]
• Home Prices Fall Record 15.3 Percent: S&P/Case-Shiller, Update: Ratio Median House Price to Median Income (2008 Report), Holy Snikes! New Home Sales Fall 40.3%
• Existing Home Sales: Not Seasonally Adjusted
• Sortable Chart: Case-Shiller Prices in 20 Metro Areas

Americans are REALLY stressed out Never in the last 40 years have your fellow citizens been so worried about their financial condition.  In layman's terms, they are freaked out. The Consumer Confidence index measures two primary questions.  How are you today, and what are your expectations for the future. This chart shows the second question; "What are you expecting?" Lining up your neighbor's expectations to what actually occurred later, has always been the most accurate prediction of what's down the pike for the economy. Since July of last year, this index has plummeted. Americans have gotten more and more worried about how they will pay for gas, how they will deal with falling home prices, how they will pay for food, whose price is rising faster than they've seen in a generation.  All this adds up to changing consumer behavior which has already wreaked the housing sector, is in the process of destroying domestic auto production and is cutting deeply into retailers, recreation providers and airlines.  In the next 12 months at least a million Americans will lose their jobs, and 2-3 million over the next 24 months. How the policy makers at the Fed can take this news in stride is astonishing.  Here's Chairman Ben Bernanke on June 9.  "Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so. " On June 9th, he knew the above chart was at 47, just barely above the previous all time low of 45 in 1973.  And he knew that unemployment had jumped 1/2 percent higher. Today of course the index drops even lower to 40.9.  To suppose the result won't be a recession on the scale of 1973 or 1980 stretches the imagination. 

State, city layoffs: 45,000 and counting A squeeze on tax revenues could force local leaders to cut tens of thousands of more jobs. That could add to the nation's economic woes. The latest hit to the economy could come from state houses and city halls as state and local governments across the nation find themselves in their worst budget crisis in years due to the economic slowdown. With revenue from sales and income taxes falling and property tax declines looming on the horizon, states, cities and towns have already laid off tens of thousands of government employees and many expect more job cuts ahead. The American Federation of State, County and Municipal Employees, a public employees union, says about 45,000 government layoffs have been announced this year and far more are likely in the months ahead as public officials struggle with trying to balance their budgets. All but four states are set to begin their new fiscal years on July 1, which means that tough decisions will have to be made soon. Economists say that cutbacks in jobs and spending by local governments could be a major drag on the overall economy in the last half of this year. There are 29 states, including California, Florida and Ohio, facing a combined budget shortfall of at least $48 billion in the fiscal year that starts July 1, according to the Center on Budget and Policy Priorities (CBPP), a liberal think tank. The National Association of State Budget Officers estimates that spending by all 50 states will be up 1% in fiscal 2009. But that would be the third lowest increase in the past three decades. There are nearly 20 million state and local government employees in the country. So a 1% decline in employment at cities, towns, schools and states would result in a job loss of almost 200,000 people, a much larger amount than we've seen from battered sectors such as automakers or home builders in the past two years. Even in states, towns and cities not yet laying off people, hiring freezes and early retirement packages are now common, said Robin Prunty, senior director in the public finance department of credit rating agency Standard & Poor's.

Dow Chemical Raises Prices for Second Time in a Month The Dow Chemical Company said Tuesday that it was raising prices for the second time in a month to offset a “relentless rise” in energy costs, a sign that companies may increasingly have to pass on price increases to their customers. The increase of as much as 25 percent — the largest in the company’s history — comes after a 20 percent rise last month that the company said did not go far enough given the continuing surge in energy prices. Dow, which makes products ranging from pesticides to plastic wraps, also said it would impose freight surcharges of $300 for each truck shipment and $600 for each rail shipment beginning Aug. 1 in the United States. In addition, it will scale back production in plants across North America and Europe.

• Dow Chemical Raises Prices Dow Chemical will raise prices by as much as 25% and will implement freight surcharges, with Andrew Liveris, Dow Chemical CEO

Housing: Multiple Reactions

Over the horizon, a housing recovery The current housing market is bleak: home prices and sales are plummeting, foreclosure proceedings are skyrocketing and mortgage rates are on the rise. When will things be better? A new study from the Joint Center for Housing Studies of Harvard University, "The State of the Nation's Housing 2008," finds the country poised to see an increase in housing demand over the next decade. "The good news is that we still have a growing population," said Nicolas Retsinas, director of the Joint Center for Housing Studies and one of the study's authors. "As long as you have more households, more people are going to need places to live." Social trends - people getting married later and divorced more often - are making single-person households the fastest growing household type, the study finds. In addition, a long-term net increase in potential home buyers will be driven by demographic factors: the aging of "echo boomers" into adulthood, an increased life expectancy for baby boomers and projected annual immigration of 1.2 million. From 2010 to 2020, the number of households in the United States will grow by an average of more than 1.4 million per year, the study finds.

Shaky job market threatens housing recovery Slump, worst in generations, still hasn't run course, report says. And if job losses accelerate in coming months, it could take even longer for local markets to regain their footing, said Nicolas P. Retsinas, director of the university's Joint Center for Housing Studies. Job losses could be "the last shoe to drop, but a pretty heavy shoe," he said in a telephone interview. The center releases its "State of the Nation's Housing" report each year, and not surprisingly, the 2008 edition gave a grim prognosis for housing markets throughout the country.In short, local markets are dealing with drops in housing starts, new home sales and existing home sales -- corrections that are rivaling the deepest slowdowns since the World War II era, the center reported. On top of that, the fall in home prices and the rise in mortgage defaults are the worst on record since the 1960s and 1970s. See the Joint Center for Housing Studies Web site. All this adds up to a downturn that is "the most severe that we have seen," Retsinas said.

Housing Study Says Worst Isn't Over (WSJ) Harvard's annual housing report gave a grim prognosis for housing markets throughout the country. It predicts the housing slump, already shaping up to be the worst in a generation, still hasn't run its full course. Report: US housing slump a prelude to recession

Revisiting the Underlevered American Household But I also found his column instructive in that it forced me to more carefully articulate some ideas I had been kicking around for a while. One year later, that process still resonates with me. Here's my takeaway from our debate last year: 1) Always pay attention to statistical anomalies: They are invariably informative. If for no other reason, they make you think about how we gather and use data. In the "under-levered case," I had to consider different time frames, chew over context. I thought it was important that the savings rate went negative for the first time in three quarters of a century. That oddity got my attention -- and for good reason. Since then, the economy has likely slipped into a recession, and the Dow has fallen 12%. …5) Real, inflation-adjusted income matters: Despite real income being negative, as a nation, we took a long time to adjust our consumption habits. Consuming more than earnings has significant repercussions.  Instead of seeing wage gains being used to raise living standards, we consumed Household equity as if it were actual income. There is an enormous difference between borrow and spend, versus earn and spend. Which is precisely what the negative savings rate was warning those how were paying closer attention . . .

More on Oil

'Oil shock' stems from fears of future shortfall: consultant A "shortage psychology" in oil markets is overshadowing news of fresh discoveries and falling demand to drive oil prices to record levels, the head of influential energy consultancy Cambridge Energy Research Associates said Wednesday. "A lot of what's going on in financial markets is not just looking at Nigeria but looking at the shortfall in supply three, five years down the road," said Daniel Yergin at a Senate Joint Economic Committee hearing in Washington, which was Webcast. Investors are viewing future oil supplies through the prism of expected high-demand growth in China and India, which "tends to be the end of all discussions," he added.These concerns -- that global oil supplies won't be able to keep up with the rapid industrialization and consumer-spending growth of emerging markets -- are overshadowing other fundamental factors that would typically dampen oil prices.These include discoveries of potentially large oil fields in Brazil and a drop in some developed countries' demand for oil, which tend to be "discounted" by the market, according to Yergin. Instead, the market is wrestling with a much thinner gap between supply and demand that had been customary for decades in the past. Curbing expectations for future supplies, the cost of developing new oil and gas fields has more than doubled over the past four years due to a shortage of oil-field professionals and raw materials, he noted. The sum total of global supply disruptions, including frequent oil-pipeline attacks in Nigeria, has amounted to a loss of between 2 million to 3 million barrels a day, Yergin said.

Posted by dblwyo at 08:55 AM | Permalink | Comments (0)

Now that all the market excitement has gone away it's time to return to our roots and talk about business performance some more. Specifically the Auto Industry whom we don't mean to abuse to much but have done so before and will likely have future opportunities. Actually, all things considered, we hope so. Oh wait...the Industry employs 13 million people and is 4% of the GDP. And Goldman just said sell GM after it, or because or something, reached a 53 year low. We'll leave it to you to graph out the stock prices of the Failing 3 but's pretty scary. We've covered the industry several times before and actually had both good and bad things - good in that they were finally gingerly sneaking up on their fundamental requirements for deep structural changes. Bad in that they were sneaking up, were kidding themselves about the state of the industry and economy and we thought they were going to get body-slammed real bad. Ahem....

After the break we've got our little collection of readings from which there are some primary take-aways. Detroit has finally conceded - knowing and doing are two very different things mind you - that the future is NOT pickups and they need to change their model mix. And they're also willy-nilly converting to the high church of not 16 million in annual sales. More interestingly they're starting to be willing to tackle the kind of revolutionary changes needed to survive. The example being GM's Volt - which could be a real game changer. And is the kind of innovation that made Detroit great. The sad things in all this is there's plenty of talented people who knew what was wrong, know how to fix it but opted for incrementalism because the didn't feel the boiling water. No matter how many dashboards run back how many years. One of our favorite quotes suggests that the Industry can't survive at 14 million cars for two years. Check out the chart - they did just fine for three decades between 13-14mil !!! What misplaced fantasy of lease-financing, discount subsidies and over-production of ancient models nobody really wanted made them think it was graven on stone ?

The problem is that the let themselves get trapped in a corner by their own manufacturing - though admittedly there have been major improvements. Here's one of the things that have gotten them into three decades of up and down. When TOY created (actually borrowed from Westinghouse) their Production System (TPS) the changed the traditional economics of manufacturing. Before the lowest unit cost was from processes, then assembly lines and then batch manufacturing. So you made money by keeping the lines running at any cost and shot for enormous scale. By moving to more flexible, cellular manufacturing TOY could run their lines in much smaller sizes, they got lower unit costs and they kept getting better and better. This may seem a little arcane but manufacturing competence is one of the two core requirements for Detroit's success. Just as much as software development should be Redmond's. In all cases start falling down, or loosing ground big time on those core capabilities, and you're writing out your own death warrent. When Kirkkorian put money into GM a while back I though he was nuts because GM was dodging the issue; contrawise when he put money into Ford this spring I thought he was a darn smart risk-taker because Ford under Mullaly is starting on those changes. Now in a matter of a few months everybody's conceeded. Do they have time ? The need to make money at 12-14Mil cars - in fact they need to defend their turf in much smaller corners than that.

Bear with us on this one - it should be worth your while but amateur graphic artists that we are, using PPT and trying to capture ideas in 3D and then blog 'em leaves some challenges open. Nonetheless with a little imagination and sympathy this may be clear - the Auto Industry (or - we emphasize - any) is driven by the key dimensions of its' ecology and their dynamics. Here the dimensions are vehicle type, customer socio-graphic and car size. Detroit had this space all to itself but the Japanese got in in the econo-box and used manufacturing excellence to expand into the rest of the space while Detroit kept retreating to Pickups. The Japanese even did an end around by attacking the flank and creating their own luxury models. When you give up marketspace you lose economies of scale. If you lose economies of scale you need to change your own processes and economics but Detroit was trapped and kept retreating. When you loose marketspaces to a competitor who can make money in smaller niches thru better products where their profit and returns are higher at any concievable scale they become cash-flow generating machines. And you become profit-sucking machines. Instead of milking SUVs and Pickups for profits, x-subsidizing the rest of their products and brands and fighting rearguard Detroit would have been better off re-investing in development,manufacturing, marketing, distribution, logistics and everything else.

They're smart people who're backed into a corner and if they don't make it they'll take a chunk of our economy with them. Not good. As an investor though these are the strategic issues to consider,  unless you want to go back and ride the old roller-coaster with the old Kirk. BtW our two prior posts on the Industry had some interesting charts that flesh out this picture and assessment. (Auto Industry:Boil, Boil, Toil and Trouble) 

GM Reacts to Sales Slump GM plans to extend the summer shutdowns at six plants and boost sales incentives to clear its bloated inventory of large vehicles. The auto maker will also raise prices on its 2009 models by 3.5% on average. Expanding its efforts to address a steep decline in sales of pickup trucks and sport-utility vehicles, General Motors Corp. plans to extend the summer shutdowns at six plants and to offer more sales incentives to clear its bloated inventory of large vehicles. The company will also raise prices on its 2009 models by 3.5% on average, equal to about $1,000 per vehicle, to help cover increased commodity costs, additional vehicle content and fuel-economy technology. GM is continuing to revamp its entire product portfolio and production schedule amid the sharp decline in the sale of pickups and sport-utility vehicles as consumers skip the gas-gulping large vehicles in favor of smaller cars at a time of $4-a-gallon gasoline. GM shares, which hit a 33-year low on Monday, were down 6% at $13 in recent trading. GM's production changes come three days after Ford Motor Co. announced plans to further slash production of large vehicles and delay the release of its redesigned F-150 pickup truck by two months. Chrysler, the other major U.S.-based auto maker, has also said it will scale back production of large vehicles. The Big Three Detroit auto makers have long relied on trucks and SUVs to sustain themselves. The recent dramatic decline in sales of large vehicles has heightened concerns that U.S. auto makers could face increased financial pressure as they burn through cash at a quicker rate. Auto-Parts Firms Face Trouble As Car Makers Retool Production

Nissan's Ghosn: Tough Times Nissan Chief Executive Carlos Ghosn sought to allay fears about the company's declining share price Wednesday, saying the damage was coming from soaring oil costs, a U.S. economic slowdown and other factors that were hurting all automakers. Ghosn, who also serves as head of the Japanese automaker's alliance partner Renault SA, told a shareholders' meeting that a stagnant Japanese auto market and rising steel and materials costs were also to blame. Nissan shares have fallen 37 percent over the last year and a half and 14 percent since the start of the year. On Wednesday, they dipped to 895 yen ($8.30). In outlining Nissan's five-year plan through 2012, Ghosn vowed that Nissan would continue to grow in the years ahead by expanding in emerging markets such as China, Russia, India and Brazil. He acknowledged, however, that the same kind of growth cannot be expected in the traditional markets of the U.S., Europe and Japan. But he said Nissan has good strategies that will not be changed because of share fluctuations. He outlined to shareholders some of those strategies, including Nissan's cheap "entry-level car," promised for 2011, to respond to the needs of emerging markets. The company is also working on a zero-emission electric vehicle to address ecological concerns, Ghosn told more than 2,000 shareholders gathered at a convention center in Yokohama, southwest of Tokyo. The cars Americans love best

Electro-Shock Therapy GM, he tells me, is taking an industrial organization designed to grind out incremental improvements and repurposing it for a technological leap. “I spend 20 percent of my time being a psychologist and counselor,” he says. “I tell people, ‘Yes, there’s a lot of risk. And, yes, that’s OK.’ “It’s not a program for the faint of heart.” When one of the world’s mightiest corporations throws everything it’s got at a project, and when it shreds its rule book in the process, the results are likely to be impressive. Still, even for General Motors, the Volt is a reach. If it meets specifications, it will charge up overnight from any standard electrical socket. It will go 40 miles on a charge. Then a small gasoline engine will ignite. The engine’s sole job will be to drive a generator, whose sole job will be to maintain the battery’s charge—not to drive the wheels, which will never see anything but electricity. In generator mode, the car will drive hundreds of miles on a tank of gas, at about 50 miles per gallon. But about three-fourths of Americans commute less than 40 miles a day, so on most days most Volt drivers would use no gas at all. Because it will have both an electric and a gasoline motor on board, the Volt will be a hybrid. But it will be like no hybrid on the road today. Existing hybrids are gasoline-powered cars, with an electric assist to improve the gas mileage. The Volt will be an electric-powered car, with a gasoline assist to increase the battery’s range. With the Volt, GM—battered, beleaguered, struggling for profitability—hopes to re-engineer not just the car but the way the public thinks about cars, the way the public thinks about GM, and the way GM thinks about itself.

• Can the Volt Save GM? Can the new fuel efficient Volt save General Motors? Erich Merkle, of IRN, and CNBC's Phil LeBeau discuss.

Goldman Cuts GM, Other Auto and Parts Cos. Goldman Sachs downgraded General Motors Corp (NYSE:GM - News) to "sell" from "neutral," and added the stock to its "Americas Sell List," saying the main risks for the automaker included likely equity dilution, dividend cut and cash burn. GM shares, which have lost 47 percent of their value since the start of the year, were down nearly 8 percent at $11.81 before the bell on Thursday. Analyst Patrick Archambault, who also cut his ratings on Lear and Tenneco, said he expects GM shares to continue to underperform as market fundamentals deteriorate which exacerbates liquidity concerns. He cut his 6-month price target on GM stock by $8 to $11. "We think GM's automotive cash flow burn this year and next is likely to lead it to look to raise capital, which we believe could lead to significant shareholder dilution and/or a cut to the company's dividend," Archambault said.

• GM at 53 Year Low A look at how the company has been performing in the past 20 years, with CNBC's Phil Lebeau

Posted by dblwyo at 02:27 PM | Permalink | Comments (1)

Just in case you hadn't noticed the markets got slammed pretty badly today - look up the states anywhere you look. In a spirit of Schadenfreude we could of course try variations on "told 'em so, told 'em so" but that might be a working definition of hubris and brings back memories of old Greek sayings (whom the Gods wouldst destroy...and so forth) so we won't. On the other hand given several of the immediate prior posts (Technology Industry: HPQ/EDS, PCs and Prospects,Markets: Fear, Loathing, Schadenfreude and Cusps on Wall St.,Crime, Punishment, (Profits) and Outlooks: High Noon at the Street ?) which reflected long-running themes of ours a certain level of Prescience might be claimed. That's vulnerable to the same hubris charge though. And to tell the truth we were actually very surprised - probably as much as anyone. While we expected the bear rally to fade we didn't expect it this soon or this much - and who knows what happens tomorrow or next week, after all ? BtW the accompanying graphic is drawn from a composite of two different time periods using StockCharts.com's "Market Carpet" tool. It captures 10-days from early May to the most recent two weeks. Kinda speaks for itself.

So, if we're surprised, was it all luck ? The next graphic is a chart of the SP500 that was one of our amateurish efforts at Technical analysis. The color coded price levels id'd various barriers that had to be reached/breached for the market, which we argued was in a bear rally and was going to top out, had to go thru to settle the issue one way or another. And discussed in this post. So we might be forgiven the argument that it wasn't entirely a matter of luck, though today's surprises certainly are.

What we think is going on are three important things. First off there was widespread mis-readings of the states of the credit markets and of the economy, as well as the consequences that would be working themselves out. Second - our primary point from the "Fear and Loathing" post - is that a major (and we do mean major) re-thinking of the outlook is going on by Mr. Market and all his assorted minions. Bob Pisani captured it perfectly this morning commenting from the trading floors rather early in the day - "the Traders aren't waiting for the analysts or economists to call a recession....they've decided the whole second half outlook is wrong". And the Lord spaketh and the scales fell from mine eyes and lo, I could SEE !

Setting aside the extent of our surprise, and that nobody should be pontificating about a short-term random process where the Gods can here you, after we net all that out there's the matter of a little work. Specifically building and exercising a collection of tools, toolkits and habits of thought for trying to look beneath the headlines. After the break we go a little more in history and review a few of them. The primary goal is to provide a shopping list for you to explore and possibly use. Our real goal here is to present this stuff in such a way that you can go out and independently verify it and apply it yourselves. So we're always happy to be learning and refreshing the tools.

But it might behoove you to read on thru and check it out for yourself. You'll find four things: 1) our Market key factors summary from late April (btw again - just to peak your interest one of the conclusions there was to sell into the rally and position for a downturn, circa Apr29 or so. Somebody might have made some money that way), 2) the most current version of the Market Factors summary from last Sa. which all of a sudden seems to hold up reasonably well, 3) a Macro Risk Factors chart which summaries the major economic barriers we see/saw which is also holding up reasonably too. And 4) a bit of a review on the current Business Cycle and its' major components with particular attention to Capex vs Consumer Spending. The reason being that the two primary triggers of today's catastrophe were the sudden change in perspective on the Financials and on Technology. Now frankly we think the latter is overdone and ahead of itself given the lags between consumer slowdowns and capex declines but we'll take it. And the former is over-due now that everybody's downgrading everybody else because, guess what, a slowing economy means trouble in Financial City and more write-downs, etc. etc. The table kinda bookends the day starting and ending with the AP, "OMG" stories intersperced with the key headlines plus the URL for the CNBC vidclip with Pisani. After all the cheerleading we especially love the "short stocks" notion from CNBC of all people !

Market Assessment Summary: April08

The graphic is a summary of how we saw the major factors playing out back then. As a technical sidebar you have to click on the graphic to expand it - and may have to click again. But then it may be worth reading somewhat carefully (each row btw has the current and previous assessments for comparison). Hopefully it's readable and makes sense. The Table looks at Structure, Fundamentals, Technicals and Sentiment and for each it summarizes the Situation, provides a ranking grade to Evaluate things and lists some major surprises that need to be watched for. We'll point out that many of the surprises are coming to pass - in other words paying attention to deep currents in Structure and Fundamentals has some merit. We also point out the short, throw-away in Technicals about "selling into the rally". Space is at a premium obviously.

Market Assessment Summary: June08

Here's the most recent summary almost literally hot off the press. In case you're curious or want to dig into the notions and approaches some more discussion is in Models, Metaphors, Musical Chairs and Market Outlook , which lays out our thinking and sources. And first seriously exercised here: WRfest 11Nov07: SEE changes and Cusp Points(Markets). So that gives you several samples to do the compare and contrast on and decide if we're smoking something funny - and if you want any.

Bigger Picture: Economy, Markets, Consumers, Business

Those market assessments in turn point back to a deeper look at how the economy is playing out and what the risk factors are there and then specifically how Consumers and Businesses are likely to be impacted. And to impact back on the economy in their turns. The E/M/C/B assessment equivalent is summarized in another table and, IOHO, seems to be holding up fairly well. The related discussions and explanations are in Filterring the Non-Linearities: Sorting the Risk Factors

GDP and the Business Cycle

You can check the key postings tables or economy archives for the history of discussions on GDP and business cycles but we built a new composite chart to link up some key factors to point to the next level down in this toolkit building and assembly process. The top sub-chart shows GDP, Consumption(PCE) and Industrial Production. Notice that PCE has taken a sudden sharp downturn. The middle sub-chart links PCE to Employment and the sum of changes in Wages + Employment - the primary determinant of future consumer demand. Notice what's happening to Employment. The final sub-chart links GDP and Investment broken out into Residential, Structures and Soft/Equip (Capex). Notice that only Structures are doing well and RI is cliff-diving. Now the key question is what happen to Capex.

GDP Component Analysis

Which gets to this next set of charts which breaks out the key components of GDP in Consumption and Investment in an unusual way and makes for another busy little chart that might be extremely valuable to you after a bit of study. The top sub-chart shows the YoY delta between Q107 and Q108 for each component. Notice how far and fast major Consumption elements have been dropping. Now notice that Capex dropped as well - which given the lags in business cycles is a warning sign and brings us full circle back to the NDXisater today, believe it or not. The middle sub-chart shows the % contribution of each component to the YoY change in GDP. So for example Consumer Durables contributed only 2% to GDP growth, a far cry from normal. What does that say about the outlook for consumer related industries and their stocks ? The third sub-chart is even more interesting because it shows the cumulative contribution %, i.e. we add up each component to get a running total. Normally Consumption increases much more than overall GDP - notice how fast it's dropping. Now what about Capex ? We think the handwriting is on the wall, frankly. Finally, notice that Net Xports contributed 46% of the Q1 increase in GDP - partly resulting from a weak dollar and partly from declining domestic demand for imports (oil excepted of course). What happens if/when the $ strengthens ? Or we get a serious slowing in foreign economies as is incresingly visible ? The last prop gets kicked out from under ?

And there you have it - a soup-to-nuts journey thru the analysis toolkit so you can look at the charts and make your own decisions. But we would suggest stepping back from today's surprise factor and asking two key questions:

1) Given what these charts and tables are telling us how much of a surprise should any of this have been ? But conversely clearly a lot of folks were surprised who shouldn't be because doing this work is their job - for which they are handsomely compensated indeed. Hmmm..

2) So, using the charts and your own judgment what do you think looks like the general trend of things ? And wherever you come out with your judgments who's sitting in what other chairs in this musical ? How many of them are going to be surprised by things that should be perfectly visible ?

BtW - a final note. If you'd like to see our faint-hearted attempt at an investment strategy built off this stuff try this:This One's for Jay: Investing Strategies for a Dicey Market

Posted by dblwyo at 05:55 PM | Permalink | Comments (0)

Well putting put up this rather large collection of Finance Industry readings wasn't the planned next step but it segues so naturally from the prior post on market outlooks. Not just because obviously, because the two are so tightly intertwined. But also because if our perspective an a major shift in sentiment is correct when you couple that with the emerging vicious feedback cycle between the economy, credit and losses the Finance Industry is about to get called out. Again..big time. Just in case you missed it a couple of prior posts set out the context and summarize the situation and might be worth re-visiting (Markets and Financials:4 Year Crunch, Broken BizzMods, Markets: Fear, Loathing, Schadenfreude and Cusps on Wall St.) though both are consistent with things we've been seeing and saying for months. So consider the table reset, as the case may be.

After the break you'll find some readings on four major aspects of the outlook for the street: Culture and Crime, Industry Outlook, Lehman and other Players. There was a whole slew of bad news for specific companies last week with large layoffs being announced, more write-downs, more capital raising and so on - and we haven't even see the downturn and those losses start yet ! Wow, deja vu' all over again. Two of the outlook articles are particularly amusing - particularly for afficinadoes of the Marquis, black humor or schadenfreude - the industry's write-offs SO FAR have wiped out profits since 2004. Except for the senior executive escapees. Wrap all that together and you also saw a bunch of bad news on the criminal side of things - not just the indictments against two senior BSC guys either but a big slew of FBI filings against mortgage fraud actions. If this all gets rolling it may make the aftermath of the Tech bust (remember Enron and the rest ?) look like patty-cake. A final piece of macro-new....the pressures for re-regulation are mounting rapidly and exponentially. After all when a Rep. Treasury Secretary who's an ex-CEO of Goldman starts pounding that drum...well we'd say that a broad consensus has been built up.

Other than that we'll just let you skim the readings - between their headlines and what we've already laid it all much pretty much screeches for itself. Going to be interesting though to see what happens, won't it ? One thing we're particularly fascinated by is this whole "business model" discussion - as in broken business model. We've heard and seen that meme really getting traction  just in the last few weeks. As you may know from reading along here we certainly believe it's true.

Bon Appetit' 

Culture, Crime and Punishment

`Cityboy' Unmasks World of Analysts Pushing `Gibberish,' Wrong Stock Bets As a utilities analyst at Dresdner Kleinwort, Geraint Anderson was advising clients how to invest. At the same time, through an anonymous London newspaper column, he was telling readers how analysts wrote ``utter gibberish.'' Anderson, 35, announced on June 2 in his Cityboy column in TheLondonPaper that he'd quit and ended a 12-year stockbroking career: ``I've been wasting my precious time for far too long, working my sweet a** off in a rat race with no end in sight.'' He revealed his identity in the newspaper this week. While for 22 months he used his column, the newspaper's most popular, to describe colleagues as ``degenerate'' and himself as ``boring the pants off clients,'' Anderson also was writing a book about London's financial workers. ``Cityboy: Beer and Loathing in the Square Mile'' will be published next week, and scourges brokers through composite characters and banks. ``We didn't invent greed, us City boys, but we have certainly become its finest exponents,'' Anderson said in an interview. He was ranked the No. 1 stock picker in the U.K. and Ireland for utilities by StarMine Corp. in 2005. London `Cityboy' Says Greed, Arrogance Rife in Banks

Our Tarnished Banking Titans Until about a year ago, the main complaints about investment banks concerned conflicts of interest. By collecting all kinds of financial business under one roof, they created all kinds of opportunities to take advantage of customers. Investment-bank brokerage departments execute buy and sell orders on behalf of outside clients, supposedly at the best price possible. But the proprietary trading desks make money by trading the banks' own capital; the temptation to use knowledge of outside clients' strategies to boost prop-desk profits is, shall we say, considerable. Long-Term Capital Management, the hedge fund that blew up in 1998, was partly a victim of brokers who were copying its trades, making them impossible to exit in a crisis. In 2000, the tech and telecom bubble burst, revealing further conflicts of interest. But the bursting of the credit bubble has conjured fresh concerns: not about banks' treatment of customers, but of their own money. We now know that the models banks have used to measure their investment risks are flawed, to put it charitably. They base assessments of future risk on how markets have performed in the most recent few years, so the inflation of a bubble causes the models to proclaim that the world is growing more stable. Even more bizarrely, the models factor in market behavior only during normal times -- explicitly excluding the most extreme 1 percent of past experience.

Hundreds Swept Up in Mortgage Fraud Arrests More than 400 real estate industry players have been indicted since March -- including dozens over the last two days -- in a Justice Department crackdown on incidents of mortgage fraud nationwide that have contributed to the country's housing crisis. The FBI put the losses to homeowners and other borrowers who were victims in the schemes at over $1 billion. Since March 1, 406 people have been arrested in the sting dubbed "Operation Malicious Mortgage" that saw 144 cases across the country. Sixty people were arrested on Wednesday alone, including in Chicago, Miami, Houston and a dozen other regions policed by the FBI. In a separate sweep, two former Bear Stearns managers in New York were indicted Thursday, becoming the first executives to face criminal charges related to the collapse of the subprime mortgage market. Across the country, reports of mortgage fraud have soared over the past year as the subprime mortgage market collapsed and defaults and foreclosures soared.Banks reported nearly 53,000 cases of suspected mortgage fraud last year, up from more than 37,000 a year earlier and about 10 times the level of reports in 2001 and 2002, according to the Treasury Department's Financial Crimes Enforcement Network. The most common type of mortgage fraud was misstatement of income or assets, followed by forged documents, inflated appraisals and misrepresentation of a buyer's intent to occupy a property as a primary residence. Over the last several months, the FBI has been investigating an estimated 1,300 mortgage fraud cases -- including 19 involving subprime lending practices by U.S. financial institutions. The Justice Department also is expected to ask Congress for more money to help combat mortgage fraud as part of a larger funding request to curb white collar crime and violent crime.

Two Sides to Every Story Make Wall Street a Parable in Cioffi Tale at Bear The arrests of former Bear Stearns Cos. hedge fund managers Ralph Cioffi and Matthew Tannin yesterday show how Wall Street bankers may look out for themselves while hiding bad news from customers. Cioffi, 52, and Tannin, 46, were charged by federal prosecutors with misleading investors about two hedge funds whose collapse last year helped ignite the subprime-mortgage crisis. A companion Securities and Exchange Commission civil suit accuses Cioffi of redeeming $2 million from the funds while Tannin mocked as ``silly'' at least one investor who wanted to get out. In the credit meltdown this year, at least 24 proposed class-action lawsuits have been filed since mid-March against brokerages over claims that investors in auction-rate securities were told their holdings were almost as liquid as cash. The Bear Stearns action ``has similarities with the research-analyst cases, where the government tried to prove analysts said one thing privately but said something different publicly,'' said Michael Missal, a former SEC lawyer now with Kirkpatrick & Lockhart Preston Gates Ellis LLP in Washington. The SEC alleges that Cioffi and Tannin downplayed the risk in their investments. While the funds' monthly summaries typically said about 6 percent to 8 percent of their portfolios was directly tied to subprime mortgages, an internal report in April showed that total exposure, including indirect bets on mortgage-backed securities, amounted to about 60 percent, the SEC said. The men misled clients about the funds' performance and holdings after one of them lost money for the first time in February last year, prosecutors said. During a meeting in early March, Cioffi urged Tannin and two colleagues not to discuss difficulties with others, according to the indictment. Campbell Reviews Charges Facing Ex-Bear Stearns Managers, Cioffi Fund Hoisted in Vodka Toast With Tannin Began Bear Stearns Endgame

Crime and delusion on Wall Street Prosecutors allege two ex-Bear Stearns hedge fund managers misled investors. Perhaps, but Wall Street has long been kidding itself about the credit crunch. The case against Cioffi and Tannin will take a while to play out. But what's clear today - and appears to be central to the managers' defense - is that the Bear Stearns managers were far from alone in failing to warn investors of the sea change in the credit markets. Indeed, top guns on Wall Street have spent a lot of time deceiving themselves about the depth of the mortgage mess. The bad news at Bear should have warned others on Wall Street to dig into their exposure to risky mortgage-related bets. Yet even as the collapse of the High Grade funds was being dissected in the press, other big subprime-writedown losers such as UBS (UBS), Merrill Lynch (MER, Fortune 500) and Citigroup (C, Fortune 500) remained in denial - initially underestimating eventual losses and eroding investor confidence by citing supposedly unforeseeable market conditions. Top execs were forced out at all three firms. Even now, a year after the High-Grade funds started to wobble and months after the house cleanings that cost Chuck Prince and Stan O'Neal their jobs, those simple lessons are still being learned. At AIG (AIG, Fortune 500), CEO Martin Sullivan was forced out after he oversaw two record quarterly losses just months after blithely reassuring investors the insurer's subprime exposure was limited. At Lehman Brothers (LEH, Fortune 500), two top execs were demoted last week after the firm insisted it wouldn't need to raise more capital to offset future losses, only to later do so twice. In both instances, the firms claimed they had a handle on their mortgage-related problems, only to admit otherwise later - at great cost to shareholders. Now Cioffi and Tannin will serve as the criminal test case. And however it ends, the events of the past year have shown that people who should have known better were all too willing to be misled.

Breakdowns and Rebuildings

Big brokers threatened by crackdown on shadow banking system A network of lenders, brokers and opaque financing vehicles outside traditional banking that ballooned during the bull market now is under siege as regulators threaten a crackdown on the so-called shadow banking system. Big brokerage firms like Goldman Sachs, Lehman Brothers, Morgan Stanley and Merrill Lynch, which some say are the biggest players in this non-bank financial network, may have the most to lose from stricter regulation. The shadow banking system grew rapidly during the past decade, accumulating more than $10 trillion in assets by early 2007. That made it roughly the same size as the traditional banking system, according to the Federal Reserve. While this system became a huge and vital source of money to fuel the U.S. economy, the subprime mortgage crisis and ensuing credit crunch exposed a major flaw. Unlike regulated banks, which can borrow directly from the government and have federally insured customer deposits, the shadow system didn't have reliable access to short-term borrowing during times of stress. Such vulnerability helped transform what may have been an uncomfortable correction in credit markets into the worst global credit crunch in more than a decade as monetary policymakers and regulators struggled to contain the damage. Unless radical changes are made to bring this shadow network under an updated regulatory umbrella, the current crisis may be just a gust compared to the storm that would follow a collapse of the global financial system, experts warn.

Read It Here First: Half of Wall St. Profits Are Gone (So Far) Last year, we looked at the issue of risk adjusted gains for the S&P500, and most especially for the Financial sector. At the time, Financials were the largest sector in the S&P500, and had what were described as legitimate, sustainable, normalized risk-based earnings. Since then, we have learned that their earnings were anything but. And, they are no longer the largest S&P500 sector, having been supplanted Technology in Q2 2008. Societe Generale's Jame Montier notes that, even with the loss of leadership, financials remain an exceptionally large component of the market itself. As the chart below shows, today's 17% of market cap may be well off the high of nearly 25% but remains a long way above the levels before this bubble started: CHART Note the correction in Financials in 1987, 2000 and then again in 2007-08. The gains in these big run ups appear particularly vulnerable -- much more so than the rest of the market. These are likely a function of the 35X leverage employed. Note also that a good part of the rise over recent decades has been fueled on assumptions about risk that turned out to be incorrect. The NYT discusses this:"Only a year ago, Wall Street reveled in an era of superlatives: record deals, record profit, record pay. But a mere 12 months later, nearly half of the profits that major banks reaped during that age of riches have vanished.

The numbers are staggering. Between early 2004 and mid-2007, a period of unprecedented wealth on Wall Street, seven of the nation’s largest financial companies earned a combined $254 billion in profits.

But since last July, those same banks — Bank of America, Citigroup, JPMorgan Chase, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley — have written down the value of the assets they hold by $107.2 billion, gutting their earnings and share prices. Worldwide, the reckoning totals $380 billion, much of which reflects a plunge in the value of tricky mortgage investments."

The write-downs are ongoing, and if we are to believe what the Philly Banking Index -- now making multi-year lows -- is implying: We are not nearly through this. That chart above also reflects the US moving from an industrial economy to a services based one. The underlying question is how much mean reversion will happen as deleveraging occurs and risk management returns to normalized levels. CHART

Analysts Slash Bank Estimates as Credit Worsens It's not just banks that have persistently underestimated the scope of the credit crisis afflicting them. So have the Wall Street analysts paid to warn their clients what to expect. Since the start of the year, analysts have slashed their earnings estimates on Standard & Poor's 500 (^SPX - News) financial companies by a respective 41 percent, 28 percent and 25 percent for the second, third and fourth quarters, according to Lab Thomson, a Thomson Reuters research publication. Merrill Lynch & Co's Edward Najarian was the latest to turn more downbeat, amid mounting credit losses and growing uncertainty over banks' abilities to preserve capital and pay out dividends. He slashed his earnings estimates for 12 U.S. banks by an average 22 percent for 2008 and 19 percent for 2009. Najarian joins rivals at Credit Suisse, Deutsche Bank Securities Inc, Goldman Sachs & Co and Lehman Brothers Inc among those in June to slash their outlooks for banks and project more capital raising.Regional banks may face at least three further rounds of capital raising, Credit Suisse said. Goldman, meanwhile, projected that U.S. banks will raise $65 billion of additional capital to cope with credit losses.

• Merrill calls capitulation on bank stocks, slashes outlooks Analysts at Merrill Lynch on Friday said investors appear to be capitulating with regards to banks stocks, frustrated into selling them down to levels below their real values as the credit crisis continues to wreck balance sheets. The analysts also slashed their earnings outlooks for several large regional banks and said they will continue boost loss reserves and cut dividends.

More big bank dividend cuts lie ahead 7:33am:  After a sharp selloff in their stocks, some think BofA, Wachovia and other high-yielders may need to cut their payouts before long. Falling bank stock prices are a warning to investors not to get too attached to those fat dividend checks. The latest struggling lender to sock shareholders is Cleveland-based KeyCorp (KEY, Fortune 500), whose shares tumbled 24% Thursday after the bank said it would slash its quarterly dividend in half to conserve $200 million annually. But with inflation worries driving up interest rates and house prices still tumbling, the market is betting Key won't be the last bank to cut its dividend. Unusually high dividend yields could point to coming dividend cuts at banks ranging from giants Bank of America (BAC, Fortune 500) and Wachovia (WB, Fortune 500) to regionals such as Fifth Third (FITB, Fortune 500) and Regions Financial (RF, Fortune 500). The yield is the result of dividing the annual stated dividend payout by the current stock price. A higher number is typically better for investors, of course, because it means a bigger income stream relative to how much they've invested. But in a credit crunch-obsessed market, a high dividend yield can actually be a warning signal. That's because an increase in the bank's dividend isn't the only factor that can cause the dividend yield to rise. So can a decrease in its stock price. And with banks facing sharply reduced earnings prospects due to rising credit losses and tightening lending standards, a high yield can spell trouble ahead.  Bank Industry Stock comparisons (chart)

• Following the Money Selling in regional bank stocks has intensified today. Details with CN