bizzXceleration: Performance, Value and Profit

Well with a lot of the economic news and analysis posted we can segue back to business analysis but let's keep in mind that one feeds the other - a fact, for example, that all the most lauded names in value investing have lost sight of. And paid some terrible penalities for. Again the mantra: Economy - Industry - Company. In other words you can never neglect the macroecon news in general but right now the metastasizing worldwide economic slowdown is driving everything. Just to put it in context and remind you we offer up this little tidbit from the WSJ:

Personal Income Falls, Sentiment Is Weak  Falling personal income and weak sentiment suggest consumer spending, the juggernaut of U.S. economic growth, could be headed for the first sustained decline in nearly two decades. "Consumer spending is poised for a major slowdown," Wachovia Corp. economist Mark Vitner said in a note to clients.

Auto Industry Outlook

The executives of Detroit have been wrestling with the consequences of decades of bad decision making - struggling might be a better word. They've trimmed up their legacy costs by taking retirees off the healthcare gravy train and re-negotiated their labor agreements. They're also downsizing to reduced total sales and much smaller market shares, among other major moves we'll talk about. Unfortunately they didn't anticipate as bad a downturn as they're getting and left key decisions very late in the game. It wasn't until about late Spring apparantly that they true magnitudes of the downdraft came to them. This chart shows YOY% changes and absolute auto sales for two timeframes. The first strategic oopsie was that these guys set themselves up for a 16million unit sales year with the downside being 15mil when you read their annual strategy presentations. They started to change that to 14mil with a headge in some cases, primarily Chrysler's team, for 13mil. Well as you can see those were wildely optimistic. And - if you find any credence to any of our economic analysis - shouldn't have been a surprise. In fact when you look at these numbers - a point we've made before - 16mil is aberrational. In fact they should have been strategically re-building themselves to make money at 12-13mil. But actually the situation is even worse than these charts make it appear.

 Mike Donnelly over at CEO Economic Update put together this fascinating chart a while back where he takes the same long-term timeframe but adjusts sales by looking at the % of the workforce buying a new car. While my charts would indicate major strategic problems and a dismal outlook Mike's tell you that the industry has crossed a major tipping point into a whole new buying environment. One that they are, despite all the headline announcements NOT positioned for. Nor one that they appear to be anticipating yet.

Auto Industry Business Performance

One of those key announcements is that all the majors will start making smaller cars in the US and will do so rapidly by first selling marks they're already making in Europe while they invest in and ramp up domestic manufacturing capabilities. Two things struck us as really total astonishing about this. First, that they could make announcements with such short timeframes for serious transitions, which imply they've had the capabilities for years but have avoided committing to them. And second that they waited until the wall was knowcked down on them and ignored the handwriting for as long as they could. The old George Carlin joke that "the '60s were good to them" seems to be entirely true and, sadly, they just now seem to be enterring into the drug rehab program from whatever they were smoking since then. On a strategic and operational basis they're facing three clusters of challenges. First, they've got to survive the next 3+ years, not 1-2 like they keep saying, and find the financial wherewithal to keep themselve alive. That by itself looks extremely unlikely, at least for all of them. Can you spell bankruptcy - which would be a disaster for them and us. Second they have to start selling and then making decent sized, high-quality and appealing small and mid-size cars asap. Preferably in 3-5 years or sooner. Bear in mind the design and development cycle for cars is 3-6 years long so shortening it up is a huge problem and they'll have to depend on what they can quickly lay they hands on that's already in the pipeline or production. Third, in the long-run, they need a complete re-tooling of operations, development and the product/market mix which again requires money they haven't got. In a previous post we pulled all this together using our performance analysis framework to assess the industry on the whole and the individual players, with the results you see here. Which may turn out to be too optimistic even yet.

Paradoxes of Performance

Charlie Rose recently did a three evening set of interviews on the Auto Industry starting with a session on design which was very interesting and encouraging. More so if we thought something would come out of those discussions quickly enough to have an impact. The set concluded with Bob Lutz talking about design in general at GM and the Volt in particular. GM's versions of a high-stakes, high-reward, very high-risk "Manhattan" project. Gutsy and courageous and illlustrating a return to their roots IOHO. But the most interesting and valuable was the middle show which was an hour-long interview with Rick Wagoner. Talk about a guy facing enormous pressures and coping well. And starting to do some of the right things. We urge you to watch that one in particular and reach your own conclusions. But some of ours would include a sense of sadness and shock that he rationalized the commitment to big SUVs and cross-overs as the result of the CAFE standards and the unwillingness of Americans to buy and the unintended consequences of too low gas prices. A nice thesis but one that falls on the simple fact that Toyota, Honda and Nissan have been very good mid-size and smaller cars that are attractive, appealing, high-quality and innovative and profitable for years. And as a result have started in one part of the auto industry ecology and gradually taken over more and more of it. Hondo in particular illustrates what happens when you define a strategic vision, translate that into good design and back it up with superb operational execution and functional capability. In their case that's particularly true of their commitment to flexible manufacturing which gives them a capability to switch what they make from what's not selling to what is. If you want some interesting backup on these assessments watch the several prior interviews with Wagoner and notice the evolution of the rationalizations and explanations !

The bottom lines here are that the Auto Industry is facing as big or bigger a set of challenges as the Finance Industry who we've taken such "joy" in bashing, runs a serious risk of bankruptcy in the near-term, faces major investment requirements to switch over their product mix and more to re-engineer their operations. All told they may in fact be an even less appealing investment than the Finance Industry ! Auto Industry Failure Odds

Strategic Outlook

How Bankruptcy Would Wreck GM and Chrysler Car sales are in a tailspin on account of $4 gas and a swooning economy, and as usual, the Detroit automakers are suffering more than their competitors. Overall, sales are down about 11 percent so far this year, according to J.D. Power & Associates. But at the Detroit 3, sales are down an outsized 18 percent. The biggest reason is an over-reliance on big trucks and SUVs and a dearth of small cars that consumers actually like. Ford has been hit hard, but looks to have enough cash to ride out a worst-case downturn and survive until 2010, when the market should rebound and recent labor cutbacks will start to pay off. But cash-flow problems are more precarious at General Motors and Chrysler, where analysts think a Chapter 11 filing is a serious possibility if the car business stays weak through 2009. To some, that seems like no big deal: Other companies, including four big airlines, auto-supplier Delphi, and retailer Kmart have used bankruptcy to rein in bloat, slash costs, and get healthier. But for GM or Chrysler, declaring bankruptcy would be more like slashing their own tires. Customers would flee, consumers would be unsympathetic, and the government would probably do little to help. Here's why bankruptcy would be such a dire scenario for any one of the Detroit 3: The automakers, by contrast, don't have a major problem funding their pensions. And they've already negotiated deep wage and job cuts with their unions, and cut billions in costs. "They're not being crushed by wage and benefit costs," says Mark Oline of Fitch Ratings. "It's about revenue and products now. It's a business model issue." Bankruptcy might allow Chrysler or GM to offload some debt--but it wouldn't do anything to increase revenue, speed the arrival of must-have new products like slick compact cars and family-oriented crossovers, or fund technology breakthroughs like GM hopes the Chevy Volt plug-in hybrid will be.

Big Three Auto Makers Seek More Help From Washington  Battered by high gasoline prices and weakened earnings, the Big Three auto makers and their suppliers are now seeking significantly more help from Washington in the form of government-backed loans than the $25 billion they had previously been authorized to receive. The $25 billion in loans were approved as part of an energy bill last year, but now General Motors Corp., Ford Motor Co. and Chrysler LLC will need "well north" of that, a GM spokesman said. The loans have yet to be funded. Following an extreme run up in gas prices that has crushed U.S. vehicle demand, auto executives are now making the case that Detroit could need far more money in order to fund critical initiatives. "There's a real urgency in that all of the progress we have made on these new vehicles could come to a standstill if we can't get capital at reasonable rates," the GM spokesman, Greg Martin, said, without giving a specific figure. People familiar with the discussions said there is no consensus dollar amount that auto executives are demanding at this point. Various reports have suggested the domestic auto industry now seeks between $40 billion and $50 billion. The auto maker's would like to have a funded plan in place by the end of 2008. Unlike the federal Chrylser bailout of 1979, under which the government backed $1.5 billion in loan guarantees so the auto maker would avoid skidding into bankruptcy, the current initiative is positioned as a way to make the Big Three more competitive in a global technology race in which they could otherwise be unable to effectively participate in. The companies are struggling financially and hope to use the loans to accelerate the development of new technologies and vehicles.

Car buyers' satisfaction with US brands stumbles U.S. car buyers are growing less satisfied with their purchases from domestic automakers while their Asian and European competitors continue to improve, according to a recent survey. Consumer satisfaction with U.S. auto brands slipped as Lexus and BMW tied for first place, followed by Toyota and Honda, according to the University of Michigan's American Customer Satisfaction Index released Tuesday. General Motors Corp.'s Buick and Cadillac brands, and Ford Motor Co.'s Lincoln and Mercury lines, fell from their No. 2 perch at a time when U.S. companies are struggling to outshine their competitors and reverse their shrinking sales and market share. That's an unsettling sign for domestic automakers, said Claes Fornell, the University of Michigan business professor who heads the annual survey. Traditionally, U.S. brands improve their customer satisfaction scores each year, just not as much as their overseas counterparts. Now, the domestic companies' ratings are declining while their competitors' scores continue to climb. "This is somewhat of a double whammy here," Fornell said. "The struggling companies are getting an even tougher road in the near future. The question also is do they really have the resources, the cash here" to adapt. Still, the auto industry has maintained a good reputation overall. Customer satisfaction has increased steadily over time and its overall score of 82 - unchanged from the high set a year ago - is higher than many other industries the index tracks. In addition, just 11 points separate the best-scoring brand from the worst, but domestic automakers are having the hardest time adapting to high gas prices and a shift in demand toward more fuel efficient vehicles, and that is manifesting itself in weaker customer satisfaction.

Key Players

Owner Gives Executives Time to Fix Chrysler The smallest of Detroit’s Big Three, Chrysler — which also owns the Jeep and Dodge brands — is famous for its big V-8 Hemi engines and rugged sport utility vehicles, and was woefully short of the fuel-efficient cars that consumers wanted. As a result, its sales in the United States are down 23 percent this year, more than twice the industry average. And its market share, as high as 13 percent in 2007, fell below 9 percent last month. Adding to its difficulties, Chrysler is still recovering from a painful divorce a year ago from its German partner, Daimler, and is in the midst of a huge restructuring under its new owner, Cerberus Capital Management. With all Chrysler’s problems, the industry has been rife with speculation about whether Cerberus would decide it had made an ill-timed bet and sell the company. But top Chrysler executives say they are determined to fix the company, and Cerberus executives say they will get the chance. Their plan hinges on a wave of new offerings beginning in 2010, and a mix of cars better suited to the times, to help spur another comeback for a company with a long history of them. Since Cerberus acquired Chrysler one year ago, the automaker has been a cost-cutting machine. It has announced the elimination of 28,000 jobs, sold $500 million worth of assets such as real estate and a California design studio, and cut shifts and plants that reduced its North American manufacturing capacity by more than a million vehicles. Chrysler is not revealing its overall savings, and as a private company it doesn’t have to. With limited access to financial data, analysts are skeptical of its overall health.

Chrysler Seeks Partnerships To Expand Globally  Chrysler LLC will aggressively pursue partnerships with other auto makers to expand its global reach, and its president dismissed the idea that joint ventures may damage the value of Chrysler's own brand.Mr. LaSorda pledged that every joint venture will either produce an entirely new vehicle not already in Chrysler's lineup or it will be limited to a slightly modified car or truck made or designed by the partner but that doesn't compete with an existing Chrysler model in the same market. Chrysler also announced a $1.8 billion investment to convert one of its two Detroit plants to build a car-based crossover vehicle based on a design developed with Daimler AG's Mercedes-Benz. That vehicle will replace the aging Jeep Grand Cherokee and retain its name yet will include a more fuel-efficient V-6 "Phoenix" engine when it hits showrooms in 2010, Mr. LaSorda said. Mercedes won't build vehicles at the Detroit plant but expects to use the same platform architecture to make its own vehicles, he said. That effort, Mr. LaSorda said, will be augmented by a series of other partnerships to take advantage of Chrysler's expertise in truck and minivan production in the U.S. At the same time, Mr. LaSorda said, Chrysler will make small cars in new markets with foreign auto makers.

GM invests $500 million, bets small car can make money General Motors Corp on Thursday said it would invest $500 million to build a new fuel-efficient, small car the automaker says will show it can make money in head-to-head competition with its Japanese rivals as it fights to return to profitability. The new Chevrolet Cruze, which also will be sold in Europe and Asia, will be built at GM's Lordstown, Ohio assembly plant, a facility once threatened with closure that also makes the suddenly hot-selling Chevy Cobalt and the Pontiac G5. "We are here to stay, and today's announcement is the latest evidence of our commitment," GM Chief Executive Rick Wagoner said at an event to mark the investment. Wagoner, who unveiled a full-scale model of the Cruze at the Lordstown plant, said the new compact would get "significantly" better mileage than the most efficient Cobalt it replaces -- pushing it toward 40 highway miles per gallon. That gain, he said, would allow GM to move closer to meeting new federal fuel economy standards and to hike sticker prices. Raising prices on the car would allow GM to make money on its launch, something it has not done with the Cobalt. Cobalt sales have jumped 16 percent this year, making the small car a standout bright spot in a GM line-up that still tilts heavily toward the SUVs and trucks that American consumers are abandoning in the face of high gas prices. The new investment marked a dramatic reversal of fortune for 4,600 workers at GM's sprawling Lordstown, Ohio plant who had been told just two years ago their jobs could be lost under a GM plan to send small car production to Mexico. But a cost-cutting labor contract that United Auto Workers union officials negotiated with GM and the boom in small car sales saved the Lordstown plant, GM and union officials said.

• GM Plans Formal Talks for Sale of Hummer

For GM, what might have been According to recent interviews with parties involved in the discussions, as well as a confidential analysis prepared for the deal that was obtained by Fortune, the tie-up could have produced as much as $10 billion in operating earnings per year for GM (GM, Fortune 500) by 2011. That's a pretty attractive number for a company that has rung up $18.7 billion in losses in just the first six months of this year and needs to borrow $10 billion to $15 billion just to stay in business until 2010. But the alliance's savings might have come at a steep price for GM's senior management. One proposed strategy called for a "repopulation" of GM's executive ranks with outside talent. That presumably would have forced some incumbent managers out of their jobs - a shocking development at a company where executives seem to enjoy lifetime employment regardless of their performance. The strategy also called for the creation of a 30- to 50-person SWAT team separate from day-to-day management that would drive the implementation of the pact - another huge blow to GM's status quo. What is clear is that the proposed pact represented bold action - something GM has long needed but so far been unwilling to take.

Toyota Executive Predicts Gradual Recovery in U.S. Sales  A top Toyota Motor Corp. executive predicted U.S. auto sales will eventually return to about 17 million cars and light trucks, but he said it will happen more gradually than auto makers originally hoped. To support his forecast, Bob Carter, group vice president and general manager for the Toyota division at Toyota Motor Sales U.S.A., cited the rising U.S. population, which he said would increase by 32 million to roughly 332 million in the next 12 years. His assumptions also include gasoline stabilizing at $3.50 a gallon through 2010 and then climbing after that, possibly above $5 in the longer term. He also expects the restoration of full-size light-truck sales to two million vehicles. The estimate for truck sales this year is 1.45 million vehicles, down more than a million from its peak in recent years. Mr. Carter's comments at an industry conference Thursday will contribute to a continuing debate over the true demand for cars and trucks in the U.S. marketplace. Starting in 1999, auto makers sold roughly 17 million vehicles, establishing a trend that many claimed to be the new norm. Now, several analysts argue that level was an artificial height, achieved through extreme incentive programs and cheap gasoline that were both unsustainable in the long term. Even if the 17 million figure is reached and exceeded, most auto makers expect it will take at least several more years. Mr. Carter said recovery could start in 2010, but the 17 million mark might not be hit until 2020. In the interim, the Big Three auto makers of Detroit especially are expected to struggle in North America through at least next year, prompting concerns about whether the manufacturers will have enough cash to weather the storm. The uncertainty comes as other, once-growing auto-sales markets in Europe, China and Russia have begun to soften. Based on trends this year, the current estimate for 2008 U.S. sales of cars and light trucks is at or below 14 million, well under the 16 million figure considered healthy by the industry. Today, the auto industry is in a "perfect storm," buffeted by rising costs and slumping orders for new vehicles, Mr. Carter said. But he added that "turbulence is always going to be a part of this business." Mr. Carter said he has changed his thinking about the nature of the current drop in U.S. sales. Once he believed that a sharp drop in sales would be followed by a dramatic increase, forming the shape of a V on the sales chart. Now, Mr. Carter said, he thinks the trend will look like the Nike logo's "swoosh," with a more gradual recovery not taking real hold until 2010.

• Toyota to cut 2009 sales forecast to 9.8 million units

Even Toyota Trims Goal in Shift From Big Vehicles Even Toyota is not immune to the slowdown in the global economy.The Japanese company, which is battling General Motors for the title of the world’s largest automaker, cut its sales forecasts on Thursday, warning that higher fuel costs and a slowdown in the United States and Europe would probably hold back the auto business at least through 2009. “We have been going at top speed up to now,” the Toyota president, Katsuaki Watanabe, was quoted by The Associated Press in Tokyo. “It is time to set more cautious targets.” The Japanese group, which includes Daihatsu Motor and Hino cars, now expects to sell 9.7 million cars and trucks in 2009, 700,000 fewer than its previous forecast. That is still 2.1 percent higher than the 9.5 million Toyota expects to sell this year. A big reason for the more bearish outlook is the 10 percent reduction, to 2.7 million vehicles, in Toyota’s 2009 sales target for the United States, where Toyota has invested heavily in trucks and sport utility vehicles. Those have fallen out of favor as consumers shift to smaller vehicles that get better gas mileage.Toyota said it would also be cutting production in Britain and Poland to bring output in line with slipping demand in Europe. Toyota is only the latest of the global automakers to acknowledge suffering as inflation and economic weakness in their major markets undermine consumers’ buying power, and high gasoline prices cause a shift toward more fuel-efficient, and in many cases, less profitable, vehicles. Auto sales are slumping in the world’s two most important markets, North America and Western Europe. American auto sales fell 10.6 percent from a year earlier in the January-July period, according to Ward’s Automotive Group, as the rate of decline accelerated in the second quarter. Western European sales fell 2 percent in the first six months, according to the European Automobile Manufacturers’ Association.

Honda Stays True to Efficient Driving During the glory days of big pickups and sport utility vehicles, one automaker steadfastly refused to join the party. Despite the huge profits that its competitors were minting by making larger vehicles, Honda Motor never veered from its mission of building fuel-efficient, environmentally friendly cars like its Accord sedan. But in today’s fuel-conscious automotive market, Honda is reaping the rewards for its commitment. No major automaker in America is doing better than Honda, whose sales are up 3 percent for the first seven months of this year in a market that has fallen 11 percent. By comparison, General Motors is down nearly 18 percent, Ford Motor has dropped 14 percent, and Toyota has slid 7 percent. While competitors are scrambling to shift their product lineups to build more small vehicles and slash their bloated inventories of trucks, Honda can barely keep up with demand, particularly in the subcompact category. Sales of its tiny Fit have soared 79 percent so far this year, and interest in the vehicle is so strong that Honda accelerated the introduction of the 2009 model, which will go on sale Tuesday. Honda’s focus on fuel efficiency is paying off on the bottom line as well. The Japanese automaker reported a record profit of 179.61 billion yen ($1.68 billion), during its fiscal first quarter that ended in June, an 8.1 percent jump from the previous year. Sales of Honda’s crossovers, minivans and pickups have dropped this year along with the overall market. But the surge in sales of its cars has more than made up for the shortfall. Unlike many other automakers, Honda has been able to capitalize on the switch in demand to cars because of the flexibility of its assembly plants. Honda, Better Off Than Most

Possible Futures

Auto Makers Take Own Ways Designing Fuel-Efficient Cars  Auto makers are angling to carve out their own niches in fuel-efficient design, from expansion of the gasoline-electric hybrid technology already available in the Toyota Prius to the new plug-in hybrid vehicle known as the Volt under development by General Motors Corp. Hot off its success with its Prius sedan, Toyota Motor Co. said Friday that it would make hybrid engine systems available on all of its models by 2020. Ford Motor Co., which has few hybrid options among its vehicles, plans to double its hybrid-vehicle lineup and production next year. And Honda Motor Co. said last week at an industry conference in Traverse City, Mich., that in 2009, it will import a new hybrid to compete directly against the Prius in the U.S. market -- and at a lower price. The Chevrolet Volt still is scheduled to go on sale in 2010, and its chief designer, Bob Boniface, gave the Center for Automotive Research's management briefings seminars an early look at the most recent styling changes adopted to create a sleeker front end and to extend its range on battery power through better aerodynamics. The Volt will be able to go at least 40 miles on its lithium-ion battery, but the vehicle also will contain a small gas tank that would recharge the battery if necessary. Consumers would be able to recharge the vehicle at home using a conventional household outlet. The auto industry has scrambled to meet shifting U.S. consumer demand toward small, fuel-efficient cars and away from trucks and sport-utility vehicles. Even though gasoline prices have recently retreated from above $4 a gallon, most auto makers have said they consider the shift toward small cars to be more or less a permanent change in the overall mix of vehicles customers want. And the companies intend to build them. Toyota and Ford have said they haven't been able to build enough hybrid vehicles to meet consumer demand. Though most auto makers are assumed to lose money on hybrids, Toyota's Bob Carter, head of North American sales, said in an interview that his company makes a profit on its Prius hybrids, which recently exceeded sales of one million units globally.

Jaguar's Great Leap Forward When Ford sold Jaguar to Tata, it left behind a major new design. For 30 years, Jaguar design has been mired in what Aaron Bragman, an auto analyst for Global Insight of Troy, Michigan, calls "English drawing-room style"—as in, conservative sedans and sports cars accented with traditional wood and leather. The average Jaguar buyer was almost 60, and they were mostly loyalists who'd owned the cars before. The stodginess was somewhat understandable, since for many years the managers at Ford Motor had a host of other problems to tackle. After paying $2.5 billion for the fabled British carmaker in 1989, their first task was to fix the horrific quality of the cars. There were also thousands of excess workers, ancient factories, and outdated, expensive production methods. Ford added new models in order to expand sales, but the S-Type midsize sedan of 1998 was only a modest hit. The X-Type compact sedan, launched in 2002, was savaged by critics. Plans that called for more than doubling Jaguar sales—to 200,000 a year, across four models—were left in the dust. Two years ago, the company decided Jaguar—by then hemorrhaging cash—would have to become a much lower-volume maker of more exclusive and expensive cars. Then this month, Ford completed its sale of Jaguar and Land Rover to India's Tata Motors for far less than Ford had paid. Now, a brand-new model is charged with blowing that dusty old image into the weeds and reviving Jag's old reputation as a maker of fast, beautiful cars that cost less than the competition. Launched in the U.S. just three months ago, the XF midsize sedan is the first Jaguar with avant-garde styling in, well, decades. View slideshow.

Auto Makers to Make Public Push for Loans Executives at Detroit's Big Three auto makers are considering making a more public push to lawmakers in the near future as they seek about $50 billion in low-cost loans that would greatly overhaul their product portfolios, people familiar with the matter said. Top executives at General Motors Corp., Ford Motor Co., and Chrysler LLC -- each racking up significant losses as industry sales decline -- will likely wait until after Labor Day, following this summer's political conventions, to travel to Washington for meetings on the loans, these people said. They are expected to soon give a more concrete figure to Washington in terms of what size of a loan package is needed, they said. The heads of GM, Ford and Chrysler started making highly-publicized trips to Washington a couple of years ago in order to press the case for aide from lawmakers and other decision makers. Health care costs, energy policies, and foreign exchange had been key issues Detroit was seeking support on. But now, as high gasoline prices have boosted demand for fuel-efficient cars, the auto makers and some domestic parts suppliers are seeking low-interest loans to help them ramp up fuel-efficient car and truck development. Because GM, Ford and Chrysler are rushing to meet stricter emissions regulations being imposed in coming years, they feel they can easily put the entire sought-after $50 billion in assistance to work in current and future product plans. Last year, Congress passed an energy plan that would lend $25 billion to auto makers for fuel-efficient development, but that plan has not been funded. Now, the domestic Big Three are quietly pushing for about twice that amount because of the dramatic decline in demand for their most profitable products -- trucks and SUVs.

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Well let's take another little trip into economic reality. After the break you'll find three sets of readings excerpts collected: Overall Domestic Economy, Key Data and the International Economy. After two major economic posts earlier this week (GDP, Jobless Claims, Markets, Oh My: Still Tipping Over !,Tech Trends II (Analysis): What're the Drivers and Outlooks) we should be in a position to build on them and move forward. The single most important economic number that came out this week, IOHO, was the consumption and personal income data, which we'll dive into in a minute. The other thing though is that we need to take a careful look at this giant data conspiracy theory about distorted GDP numbers that's going around. So we're going to spend some time on that. The other thing we want to mention is the international news which we've been covering extensively, and apparantly popularly. While the world's economies continue to slow and the only thing that kept us out of a recession was growth in exports the factor that's really getting neglected is the return of really ugly geo-politics. And not just the point we made earlier that Russia's Georgian foray cuts off Central Asian oil, nor the fact that Iran, Syria, et.al. just got more room to maneuver because the chances of coordinated world policy against there adventures just went out the window. No...the OTHER thing you need to start worrying about is cold war-like tensions in the international economy as Russia starts retaliating for all the perceived slights it's received and starts trying to damage its' trading partners in pursuit of nationalist mercantilism, ala the 17thC ! Which has already started BtW. Think about it - and then remember however painful you think globalization has been remember that cheap WMT lamp from China wouldn't have been possible without international trade agreements and stability & peace. Let's hope this doesn't get to damm ugly indeed.

GDP and the Anti-Conspiracy

There's the most amazing meme that's circulating about the GDP numbers are bogus because the estimate of inflation built bears no resemblance to what people experience. The issue is a tad complicated and we'll do our best to de-construct it here (having just spent five hours on data collection and analysis). What's really scary is how widespread and virulent the attacks are getting from normally sound sources who pride themselves on being data-grounded: Alan Abelson on Barron's front page(Sizing Up Sarah), Barry Ritholz at BigPicture (GDP: Lowest Inflation Rate in 5 Years)and Jeff Saut in a BNN interview. It doesn't get more sound, data-driven and respectable mainstream than that. And unfortunately as best we can tell they are all grossly in error thru failing to exercise a little due diligence. Menzies Chin of EconBrowser (Why Does It Feel Like a Recession?)put us on the right track and we'll take our shot at an explanation. This should be a tempest in teapot if everybody were looking at real GDP on a YoY basis and ignoring the headlines. Instead it's turning into a Cat5 storm making landfall, at least in terms of noise obscuring understanding. So without further ado...we give you

Output, Purchases and Trade 

 The key difference lies between what we make and what we buy. GDP is the sum of all domestic economic activity. When you add in what we sell abroad and subtract what we purchase the result is Gross Domestic Purchases. Now we bet the data to death and ran it back to 1929 and the root of the apparent discrepencies lies in the fact that GD Purchases are now much larger than GDP and the difference has never been this large in history (which btw explains trade balances, doller weaknesses, savings shortfalls and on and on...this exercise is worthwhile just for that understanding !). The top chart in this composite shows GDP vs Purchases the difference. Notice that it confirms everything we've been saying, and the readings reinforce, about exports having been our salvation. The real catch here in the arguments over inflation is that domestic inflation is under control - this is not a wage-spiral. It's an import largely due to rising commodity prices, and potentially from bad monetary policies abroad. For the first time in our history the rate of inflation domestically vs foreign purchases is not only seperating. It is diverging in magnitude and direction. Fortunately the BEA does us the favor, which is hard, time-consuming and expensive, of developing price indices and deflators for every major component of the national accounts including these. Which leads us to the third part of the chart - the YoY% changes in GDP and Purchases. Like we've been saying GDP weakened from Q1 to Q2 with growth dropping from 2.5% to 2.2%, which doesn't yet meet our definition of a growth recession. Oddly enough, right about the time oil prices rode the rocket, it was in lock step with Purchases right up until 2007. When it began to diverge, i.e. the economy we experience day-to-day, began to weaken faster and more than GDP was telling us. And from Q307 it's been getting much worse much faster. For the last four quarters the respective growth rates are GDP (2.8,2.3, 2.5 and 2.2%) and GDPurchases (1.7,1.4,1.1 and 0.4%). A growth recession by any measure. Too bad that all the sturm und drang that's floating around will cause so many to miss what's really going on but at least you read it here ! :)

Consumption and Recession

While the GDP data may not fit the definition of growth recession just yet it will. As we can pointing out, it's trade (exports) you-know-what :). And as this little sidetrip make crystal clear enormously more so than even we were arguing. It should be beyond question that domestically we're in or headed for a real recession and, as the rest of the world tanks, well...you know the rest. The real key indicator is what happened with real consumption. Here's our normal comparisons of Consumption and Real Consumption - monthly back to 99 and, given the seriousness of the situation, quarterly back to 1960. Notice that the drop in real spending is seriously below the '01 recession, almost as bad as the '90 recession and appears to be headed for a drop as bad as the 1980 or 1975 recessions ! Now that's scary. And notice that the whole Tipping Point argument is reinforced by how steeply and rapidly it's dropping on that scale.

This has been a very unusual cycle in many ways with a prolonged slowdown, that many ignored, a lack of organic, self-sustaining growth in the aftermath of the Tech Bubble's investment bust and the Leveraged Liquidity Bubble, which is now managed but not finished. Unfortunately that slowmotion slowdown is beginning to turn into a real cyclic downturn. Now our best guess was that we were looking at growth around 1% in Real GDP thru 2010. But if we seriously cross this tipping point and a self-reinforcing consumer-driven downturn gets going things could get seriously ugly. 

Domestic Economy

The economic growth mirage Despite all the talk about the U.S. economy falling on hard times this year, experts are predicting that the economy grew at a more solid pace during the second quarter. The government will release an update to the second-quarter gross domestic product report Thursday. Economists surveyed by Briefing.com are forecasting an increase of 2.7% in the quarter, up from the 1.9% growth first reported last month. The GDP is the broadest measure of the nation's economic activity. Economic growth between 2.5% and 3.5% is typically viewed as the norm for a healthy economy. But that doesn't mean that the United States has avoided a recession, some economists say. In fact, there are growing concerns that weakness will extend through the rest of this year and even into 2009. Among the factors behind the likely upward revision to growth in the second quarter: More business inventories than originally estimated and improved trade figures. The trade picture was helped by reduced spending on imports other than oil and by strong exports due to a weak dollar that made U.S. goods more attractive overseas. This may also prove to be fleeting. "With slowing of economies abroad, that gain from trade doesn't look sustainable," said Keith Hembre, chief economist with First American Funds. With all this in mind, several economists say they are certain the U.S. is in recession and that no one should be fooled into thinking otherwise by a strong second-quarter GDP report. That's because it will be hard for the economy to rebound until the housing, banks and credit markets start to recover from the upheaval of the past year. "This is a head fake," said Kevin Giddis, managing director of investment bank Morgan Keegan, about the expected rise in GDP. "You have to reach a bottom in housing before you'll see a turn."

U.S. Economy Grew Faster Than Estimated in Second Quarter on Export Gains The U.S. economy expanded at a faster pace than previously estimated in the second quarter, helped by surging exports and a smaller decline in inventories. The 3.3 percent annualized increase in gross domestic product from April through June was higher than forecast and compares with an advance estimate of 1.9 percent issued last month, the Commerce Department said today in Washington. The economy grew 0.9 percent in the first quarter. Record exports and the temporary stimulus from the tax rebates prevented the economy from stalling as housing slumped and companies cut expenditures. Consumer spending is now waning and slower growth abroad dims the outlook for foreign sales, signaling last quarter will be the year's highpoint. ``The overwhelming story is that the export numbers have offset this domestic weakness in consumer spending and business investment,'' John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, said before the report. Outside of exports, ``we have a domestic recession.'' The smallest trade deficit in eight years was the biggest contributor to growth. The trade gap narrowed to a $376.6 billion annual pace and added 3.1 percentage points to growth, the most since 1980. Excluding trade, the economy would have expanded at a 0.2 percent pace after growing 0.1 percent in the first three months of the year. The boost from trade may wane in the rest of the year as growth among some of the U.S.'s biggest trading partners slows. Europe and Japan both shrank last quarter. Private economists aren't the only ones taking a dimmer view. Federal Reserve staff also ``marked down'' the central bank's forecast for growth in the second half of 2008, according to minutes of the Federal Open Market Committee's Aug. 5 meeting released this week. Fed policy makers also said recent reports pointed to ``softer export demand,'' according to the minutes.

• "Export Driven" Q2 GDP Revised Up to 3.3%
• Economy shows vigor, but seen flagging, Spring's economic rebound unlikely to last,
• Strong GDP Report 'High Watermark' for U.S., Not Sign of Upturn, Economist Says

Export Strength Can Make Growth Feel Like Recession The U.S. may have just completed one of the most unsatisfying 3%-growth quarters ever. That’s because the source of almost all that growth, net exports, doesn’t have the same kind of effect on employment and purchasing power that sectors more sensitive to domestic demand do, meaning the economy still may feel like a recession even if — in a gross domestic product sense — it’s still growing comfortably. “In a technical sense, [export and domestic demand] are created equal, but just in the sense of judging the health of the economy they’re not created equal,” said Abiel Reinhart, economist at J.P. Morgan Chase.Last month the government estimated that GDP grew a modest 1.9%, at an annual rate, between April and June. But government statisticians didn’t yet have the June trade data then. With those figures in hand, Wall Street economists say GDP probably grew 3% or even higher last quarter. Even averaging in a subpar first quarter the economy still grew around 2%, at an annual rate, in the first half of the year.Barry Bosworth, an economist at the Brookings Institution, explained the dichotomy between how GDP growth looks and how the economy may feel to households this way: “if you’re looking at the output data, the economy’s holding up surprisingly well,” thanks largely to exports. However, Bosworth said “if you were just looking at the employment data, you’d be concluding that the U.S. is in a recession.” The U.S. has lost jobs for seven-straight months. Of course, if it weren’t for exports, that recession call would be a no-brainer. “GDP excluding the foreign sector, you’ve had pretty bad numbers,” noted Reinhart. To be sure, “whether you’re selling to a domestic consumer or abroad, it’s still production,” Reinhart said. But differences between export versus domestic production still matter for consumers and their purchasing power. Even if the prices of many goods and services U.S. exporters produce are going up, they’re not keeping pace with the prices of things Americans import, due largely to the huge spike in energy prices. Indeed, according to government price data, prices of U.S. imports swelled 20.5% in the 12 months ending June, while export prices increased only 8.6%.“It’s a terms-of-trade effect,” explained Bosworth. “When you measure (household) wages .. in terms of their output prices it looks good; when you measure it in terms of the things they want to buy, it looks bad,” he said. “What we export buys less and less in terms of imports,” agreed Josh Bivens, economist at the Economic Policy Institute. That’s “one reason why the economy maybe feels worse than headline GDP says,” Bivens said, since a reduction in purchasing power is offsetting the growth in GDP. That trend may persist as the economy goes through a necessary rebalancing brought on by the weaker dollar. “We’re starting from a place where we’ve done far too little manufacturing production,” Bivens said. To reverse that “we’re going to have a couple of years where consumption drags behind GDP,” Bivens said.

• Why Does It Feel Like a Recession?

Key Economic  Data

Unemployment: Continued Claims over 3.4 Million The DOL reports on weekly unemployment insurance claims: In the week ending Aug. 23, the advance figure for seasonally adjusted initial claims was 425,000, a decrease of 10,000 from the previous week's revised figure of 435,000. The 4-week moving average was 440,250, a decrease of 6,000 from the previous week's revised average of 446,250. And continued claims are now above 3.4 million for the first time since 2003. The advance number for seasonally adjusted insured unemployment during the week ending Aug. 16 was 3,423,000, an increase of 64,000 from the preceding week's revised level of 3,359,000. By this measure, the economy is clearly in recession.

Consumer Spending in U.S. Slowed in July as Prices Rose Most in 17 Years Spending by U.S. consumers slowed in July as the impact of the tax rebates faded and a pickup in inflation eroded Americans' buying power. The 0.2 percent rise in purchases matched forecasts and followed a 0.6 percent increase in June, the Commerce Department said today in Washington. Prices rose by the most in 17 years. Americans, faced with rising unemployment, soaring food and fuel costs and falling home values, are cutting back on big- ticket items like automobiles and furniture. The federal tax rebates, the bulk of which have now gone out, will no longer keep spending, the biggest part of the economy, going, economists said. ``The consumer is going to be in worse shape by year-end,'' Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York, said before the report. ``You can expect much slower growth in the third quarter and even slower in the fourth.''

Retail Group Sees Slow Sales Well Into 2009 U.S. sales will stay sluggish through the holidays and well into next year, despite hopes consumers would get earlier relief from higher food and fuel prices, the National Retail Federation said on Thursday."We are very, very cautious about the rest of the year. We don't foresee a turnaround until at earliest the second half of next year and even that may be a bit optimistic," spokesman Scott Krugman said during a call with analysts. Consumers who find their budgets pressured by rising prices and a housing slump "are clearly concentrating on the essentials," Krugman said. The NRF will release a holiday forecast next month. Overall retail sales are expected to slow, with total growth for 2008 at 3.5 percent compared with last year's 3.7 percent increase, Krugman said.

How a housing fix backfired Back in February, Congress passed into law a quick fix for the housing market. Unfortunately, it hasn't done much good. As part of the economic stimulus plan, lawmakers raised the limit on the size of home loans mortgage giants Fannie Mae and Freddie Mac can guarantee, from $417,000 to as high as $729,750 in some of the most expensive U.S. markets. That was supposed to bring down mortgage rates on jumbo loans and help goose sales in cities across the country - mostly on the East and West coasts - where even outhouses go for close to half a mil. So just how much help has this change been for homeowners? Not much. Six months ago, the rate on a $500,000 30-year fixed mortgage was 6.73%. Today the rate today is only slightly lower at 6.69%. No surprise then that the housing market is still stuck in reverse. But rates haven't fallen for those hoping to get a larger mortgage, and they've actually risen for everyone else. The average rate for a mortgage of $417,000 or less is now at 6.57%, while loans larger than that have rates about 0.12 of a percentage point higher. Sure, the spread narrowed, but only because rates are going up for everyone. Several factors are at work. Since Fannie and Freddie look shakier than ever, fewer investors are willing to buy their bonds - even with the government's guarantee. And the raised caps forced the mortgage giants to spread their limited capital across a much larger market of mortgages. Add in the new fees that Fannie and Freddie have tacked on to their mortgages since the housing crisis hit, and most borrowers are paying more than they were six months ago.

Fundamentals of Residential Real Estate Market Bottoms My best guess is that we are two years away from a bottom in RRE prices, and that prices will have to fall around 10-20% from here in order to restore more normal price levels versus rents, incomes, long term price trends, etc. Hey, it could be  worse, Fitch is projecting a 25% decline. Not all of the indicators that I put forth have to appear for there to be a market bottom. A preponderance of them appearing would make me consider the possibility, and that is not the case now. Some of my indicators are vague and require subjective judgment. But they’re better than nothing, and keep me in the game today.  Avoiding the banks, homebuilders, and many related companies has helped my performance over the last three years. I hope that I — and you — can do well once the bottom nears. There will be bargains to be had in housing-related and financial stocks.

• Heads Out of the Sand, Homeowners!

International  Economy

Russia: Cold turkey on U.S. chicken Russia could cut poultry and pork import quotas by hundreds of thousands of tons, the country's agriculture minister said Wednesday. The move could hit American producers hard and comes amid heightened tensions between Moscow and Washington over the war in ex-Soviet Georgia. "It is time to change the quota regime and reduce imports, which have unfortunately built up in recent years," Alexei Gordeyev told reporters, according to the ITAR-Tass news agency. He said domestic producers could make up the shortfall if imports were reduced. Any substantial cuts would likely have a significant impact on U.S. poultry producers, for whom Russia is the biggest market. Russians sometimes refer to U.S. poultry imports as "Bush's legs," a reference to the frozen chicken shipped to Russia amid economic troubles following the 1991 Soviet collapse, when the current U.S. president's father was in office. Earlier this week, Prime Minister Vladimir Putin backed proposals to freeze some of the agreements - particularly in agriculture - relating to its efforts to join the 153-member World Trade Organization. Officials claim Moscow agreed to certain conditions with member countries in return for their help in fast-tracking Russia's entry. "Agreements signed more than three years ago as part of the negotiations on WTO accession are unfortunately no longer in Russia's interests," said Gordeyev. "To put it mildly, we've been deceived."

The Best Central Banker in the World Today Imagine a country whose central bank responded to growing inflation by raising interest rates, strengthening the currency and trying to win investor confidence. This may be shocking to some U.S. investors, but proper monetary policy is still being practiced. Just not here in the United States. I’d give the award for Best Central Banker in the World Today to Mexico’s Guillermo Ortiz. This is a story that truly ought to be better known. Mr. Ortiz has now been at the helm of the Mexican central bank for over ten years and despite many obstacles (consider that 70% of Mexicans don’t even use banks), he’s emerged as the anti-Greenspan. Mr. Ortiz previously served Finance Minister where he helped clean up the mess surrounding the peso devaluation in 1994. Make no mistake; the Mexican economy has its share of problems. Growth is slowing and inflation is on the rise. Of course, much of this is understandable considering their raucous, hung-over neighbors to the north—nearly 80% of Mexico’s exports go to the U.S. The thing about finance, public or private, is that it’s really an issue of establishing confidence. If investors think you’re serious, then they’ll invest with you. So far, Ortiz seems to winning the battle of establishing credibility. The yield on Mexico’s long-term benchmark bond recently fell to its lowest level since June 6. Mexico is a country with many deep rooted economic problems, however, the country has taken many steps in the right direction. For example, the election of the pro-market government of Felipe Calderon (cue Larry Kudlow) is helping to bring long-overdue economic reforms like privatizing the oil industry. Unfortunately, Calderon supports some poorly considered ideas like price controls. Unlike the United States, the Mexican government seems to be serious about fiscal discipline. Their legislature...er, not so much.

Chinese Companies Turn From Stock Market to Bonds Corporate China is turning to debt now that its years-long love affair with stocks is on the rocks. Many of mainland China's major companies are issuing billions of dollars in corporate bonds, even as the rest of the world shies from debt. Investors are encouraged by expectations of a rising yuan, which would goose returns for foreign bondholders and also helps Chinese firms issue bonds on less-costly terms. Less-established, cash-strapped Chinese companies, which had been counting on initial public offerings that were scotched by declining stock markets around the world, are finding hedge funds to be the lender of last resort, although the loans sometimes come at a heavy price to the borrower. China's ailing stock market, skittish bank lenders and Beijing policymakers hoping to tame growth and slow inflation have curtailed other routes to raising capital. After nearly doubling in 2007, the benchmark Shanghai Composite index is down more than 55% this year. Mainland China's corporate-bond issuance has jumped almost 53% this year to date from the same period in 2007, with Chinese companies selling about $25 billion in bonds, according to Thomson Reuters. Bankers say their China pipelines remain flush for the next few months. "We are expecting issuance to be twice as big as it was last year," Mr. Ge said. China's bond market is still tiny in comparison to the U.S., which has sold $1.2 trillion in bonds this year. Still, issuance in the U.S. is down 41% from last year, according to Thomson. In Japan, corporate-bond issuance has fallen 6% in dollar terms. The credit crunch has reduced demand for higher-yielding, higher-risk debt, while corporations of all stripes have come under pressure to reduce the amount of debt on their balance sheets. China has helped send Asian corporate bond issuance to record levels. Proceeds from corporate debt sales in Asia, excluding Japan, stand at $91.01 billion so far this year, up 3.6% from a year earlier, according to Thomson.

India's 2Q Economic Growth Slows to 7.9 Percent India's economic growth slowed to 7.9 percent in the April-June quarter from 9.2 percent in the same period last year amid a slump in manufacturing, the government said Friday. Growth, which has averaged 8.8 percent over the past five years, is at its slowest pace since 2004, government data showed. The decline in the growth rate was widely anticipated and comes after months of monetary tightening, as authorities have tried to reign in surging inflation. "These are numbers that shouldn't surprise," said Saumitra Chaudhury, a member of the Prime Minister's Economic Advisory Council and chief economist at the credit rating agency ICRA Ltd., a Moody's affiliate. "When you have monetary tightening, you do get lower growth. That was expected," he said. "But it's not terribly low; 7.9 percent is still high by historical standards." The benchmark Sensex index jumped 3.7 percent to 14,564.53, as some investors had been bracing for worse numbers. Banks led the rally on moderating inflation figures released Thursday. "Sentiment took a robust turn," said Gul Teckchandani, an independent financial advisor based in Mumbai. "Personally, I'm cautiously optimistic." Second-quarter growth, however, was far shy of the 10 percent growth rate Prime Minister Manmohan Singh said India needs to achieve. "Our economy must grow at the rate of at least 10 percent every year to get rid of poverty and generate employment for all," Singh said, speaking on India's Independence Day, Aug. 15. In 2005, 456 million Indians -- 42 percent of the population -- were living on less than $1.25 a day, according to the World Bank. Subir Gokarn, Standard & Poor's chief economist for the Asia-Pacific, said such bounding growth is not likely to return to India until the government embraces tough reforms to encourage private investment in infrastructure and to liberalize the labor market.

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Let's pick up where we left off with dissecting the outlook for Technology, having started with the computer industry per se, segued into a deep dissection of the environmental pressures and side-tripped into economic data, it's probably time. We're going to try and weave three major strands together because the reinforce one another. First, what're the trends in the Telemediatainment Industry, how does Dell's surprising performance illuminate that and what's the future of content. You might recall our mantra is Economy - Industry - Company. In other words don't fight the tide because you'll drown. Or put differently Dell's results are more about a growing worldwide downturn than they are about them. On the other hand once you're caught in a riptide you'd better be a good swimmer. There are some great wars going on right under our noses that'll create challenges and opportunities in all these areas.

Telecom Stack and Industry Trends 

You might recall this graphic which shows how the Telemediatainment Industry is structured from the networks that provide the bandwidth for distribution to the applications, services and content that create and deliver value to the end users and their growing myriads of alternative end-point devices. After the break you'll find the readings excerpts organized roughly along these lines. Here are a few observations to go with.

1. Networks - the traditional phone business is dying but the replacement, wireless, is saturated in this country and Europe so the "future" likes in finding new applications/services to drive higher usage. The iPhone was a revolutionary cusp point trigger and no everybody's going gang busters after smart mobile devices, from INTC to MSFT to HPQ to ATT. You name it they're chasing it. At the same time you still need some sort of pipe into the home and the fatter the better. The cable guys were winning 'cause they had lots of spare pipe but it turns out it doesn't scale. Which indicts this whole argument and makes the operating companies new infrastructure investments brilliant, courageous and risky. Ivan Seidenberg may be the next hero.

2. Mobility - as the result of all this everybody is going after the next big platform - MID or Mobile Intelligent Device. This is literally a center piece in the annual strategy presentations of all the companies named. It's also why Apple's 3G announcement coupled with the open software platform for applications is so game-changing. Even mighty IBM has announced a major packaged solution to after large-scale mobility opportunities; though in their case they're bundling stuff they've been building at in services engagements. In any case welcome to the brave new world.

3. Content Wars - at the end of the day consumers and businesses will judge value not by bright shiny things but what you've done for them lately. In other words by the entertainment or business value of the applications, content and information. They theory being that ubiquitous and cheap bandwidth would make any content deliverable anywhere/anytime/anyhow...the 4A's. Which if true completely turns over the entire business model of the traditional media. And one which they're struggling to proceed with. And haven't figure out as yet.

Dell's Results and Implications

At the end of the day the relative performance of any of these players will depend on developing the right strategy, the right operating capabilities and delivering results thru superb execution. Earlier we took a very deep dive into Dell and argued that a major re-engineering was well started there and the early indicators were promising. We stand by those conclusions and think, in fact, that yesterday's earnings results bear them out in a way. But it also illustrates the power of the mantra. At the time we suggested Dell was a target to keep on the front-burner, not a purchase, because the economic and industry situations said otherwise. We stand by that argument as well and consider yesterday's results - when you dig into them - to bear it out. AND, most importantly, serve as a model for the kind of investigation that one needs to do into any of these players. Powerpoints are one thing, delivery is another. When you do dig in you'll find that many of their product, market and geographic initiatives resulted in outstanding growth, absolutely and relatively. They got hurt on gross margins and operating margins. The latter especially because they have quite a ways to go in re-factoring their operations. But they appear to know that and are moving "smartly ahead". Which is not what the press coverage or analyst comments would have you believe. In effect Dell is investing in market share, this time on a sounder strategic footing with more aligned products and services, and taking the penalties to buydown future gains. They call that value-investing don't they ?

Magic Answers and Zuckervision

One executive who admits he doesn't know the answers but is running a tight ship while investing in explorations of the alternatives if Jeff Zucker of NBCU, which just had a great real-time lab test with the Olympics. As well as their on-going experiments with HULU in conjunction with FOX. There are two Charlie Rose interviews that we recommend as the best candid discussions of the issues and challenges facing the industry and what they're doing about it. These are a bunch of smart guys who have taken the first, in some ways biggest and hardest step. They've recognized that change is required AND they're doing something about. That includes Zucker, Peter Cherin at FOX and Bob Iger at Disney - who helped kick start this whole thing with his early commitment to iTunes for movies. We forget how revolutionary iTunes was for music and how big a leap going from music to video was and is. But unlike the old-line industries of movies, newspapers & magazines and music these guys are out there doing all the right things to find out what works, test many alternatives and invest in the experiments. This is as big a structural change for them as the creation of their media was when it was born. Most of the traditionalists are loosing or have lost. We think these guys will figure it out but you decide for yourselves.

Jeff Zucker on Charlie Rose

Peter Chernin on Charlie Rose  

Network Problems

Comcast to Make Monthly Internet Use Cap Official Comcast Corp., the nation's second-largest Internet service provider, Thursday said it would set an official limit on the amount of data subscribers can download and upload each month. On Oct. 1, the cable company will update its user agreement to say that users will be allowed 250 gigabytes of traffic per month, the company announced on its Web site. Comcast has already reserved the right to cut off subscribers who use too much bandwidth each month, without specifying exactly what constitutes excessive use. Customers who go over the limit are contacted by the company and asked to curb their usage.Comcast floated the idea of a 250 gigabyte cap in May and mentioned then that it might charge users $15 for every 10 gigabytes they go over, but the overage fee was missing in Thursday's announcement. Curbing the top users is necessary to keep the network fast and responsive for other users, Comcast has said. Comcast stressed that the bandwidth cap is far above the median monthly usage of its customers, which 2 to 3 gigabytes. Very few subscribers use more than 250 gigabytes, it said. A user could download 125 standard-definition movies, about four per day, before hitting the limit. The cap is also above those of some other ISPs. Cox Communications' monthly caps vary from 5 gigabytes to 75 gigabytes depending the subscriber's plan. Time Warner Cable Inc. is testing caps between 5 gigabytes and 40 gigabytes in one market. Frontier Communications Co., a phone company, plans to start charging extra for use of more than 5 gigabytes per month.

AT&T’s Rivals Are Happy to Attack Over iPhone’s Network Woes Apple sold more than a million iPhone 3G cellphones its first weekend — with some stores running out — and two million more since then, analysts say. But its July debut has been nothing less than a public relations headache for AT&T, with eager buyers complaining about dropped calls and poor network connections. Some fingers point to Apple, which has tried to deflect the complaints. But many others point to AT&T’s cellular network. Whatever the source of the problems, AT&T’s rivals, long irritated by all the attention the iPhone has received, are on the attack and happy to exploit the discontent. “A phone is only as good as the network it’s on,” said a full-page Verizon Wireless newspaper ad on Thursday, lobbing a shot at AT&T’s 3G, or third generation, high-speed network. A Verizon executive sent an e-mail to Wall Street analysts last week: “So much for a ‘new’ way of doing business at the old AT&T — your father’s phone company.” For AT&T, the nation’s No. 1 wireless carrier, which exclusively offers the iPhone, the situation is especially tricky because the stakes are so high. Apple’s customers are largely forgiving of any foibles of the iPhone’s maker. But wireless companies like AT&T and Verizon are afforded no such a luxury. The 3G network is supposed to make it easier to surf the Web and watch videos online. With nearly 90 percent of all Americans owning a mobile phone, there is little room to grow and these rivals can ill afford to lose customers. Further aggravating consumers, neither company has fully explained why calls were dropped and the network was slow. Theories abound, which is causing even more confusion — and finger-pointing. Is it a problem with the phone itself? Richard Windsor of Nomura Securities surmised in a research report that a new radio chip made by Infineo

Mobility Platforms and  Wars

Platform Wars: Battlefield Mobile During the “platform wars” of the 1980s, tech companies duked it out over which computer operating system would emerge from a crowded field. Now there’s a new platform war being waged, but this time the battleground is mobile devices. The bad news for businesses looking to standardize on a winner: The most likely outcome is multiple survivors. Many businesses initially saw mobile devices as a way to check email and make calls on the go. But it’s become clear over the last few years that these devices are small computers, capable of accessing the Web and running software just like a PC. The software piece is the challenge for businesses: As in the PC world, software written for one platform doesn’t run on another. This isn’t really a problem for PCs, since just about every business runs Microsoft Corp.’s Windows operating system. But the mobile-device world is still fragmented: Many businesses use Research In Motion Ltd.’s BlackBerry, but hardware that runs Microsoft’s Windows Mobile operating system are gaining in popularity. Apple Inc. is storming onto the market with its iPhone and associated software, and Google Inc. is about to enter the field with its Android operating system for mobile devices. Operating systems from Palm Inc. and Nokia Corp.’s Symbian PLC are also popular. In fact, rather than consolidating, the number of platforms for which developers can write mobile-device software keeps growing, says Benjamin Gray, an analyst at Forrester Research. That’s a challenge for businesses, in part because workers increasingly want to be able to choose the device that they think is the best fit for their life.

Intel thinks small with Atom chip, but how big is the risk? At Intel Corp.'s big developer conference this week, the chip giant was extolling the virtues of its newest little chip called the Atom.The Atom has surprised both company executives and analysts with its popularity among hardware makers. The chip was introduced in March and is aimed at an emerging market of very low-cost mobile devices, especially in developing countries. The Atom is helping foster this new category of portable devices, which Intel calls mobile Internet devices, or the lovely acronym MIDs. One product area is NetBooks, which are essentially smaller laptop computers with fewer capabilities than a full machine but offer increased functionality than a smart phone. Big factors driving interest in the chip is its low power consumption, lower-cost and ability to run software that is compatible with Intel's standard chip architecture, known as the x86. And even though the chip is inexpensive, it provides decent margins for Intel, and customers can use it to create Internet surfing devices that sell for as low as about $200. With the efficiencies resulting from its latest manufacturing process, Intel can yield about 2,500 Atom chips from one silicon wafer, compared with a relative yield of only several hundred units of its larger chips. But the Atom, as Intel is quick to point out, is not as powerful a processor as its other chip families. But the risk for Intel is that a growing slice of the market may find that a $10,000 car is all they need. The bulk of growth for the PC sector today is coming from developing countries, which are passing over desktop computers in favor of smaller, cheaper laptops. Indeed Intel executives admitted that they would not be working with 80% of their Atom customers if they did not have their cool little chip. If Intel succeeds with the Atom, it could make an interesting business school study on a company dealing with the classic "innovator's dilemma," a conundrum faced by many technology companies, as well as other industries. Leaders in their market often get caught off-guard by new disruptive technologies that are typically cheaper and "good enough."

Mobile Devices for Enterprise Apps, Part 1The emergence of smaller, more powerful handheld devices and the spread of high-speed mobile networks have enterprise software developers scrambling to meet demand for portable versions of their flagship applications. Research In Motion got a jump on the market with the BlackBerry's secure and reliable e-mail delivery capabilities. Competitors, including Motorola ,Nokia and Sony Ericsson, are all vying for a share of the market. Given recent enhancements made to the iPhone, Apple has to be added to the list of contenders. But is the current crop of smartphones and PDAs really up to the task? The biggest names in enterprise software -- Microsoft , Oracle and SAP prominent among them - are developing more powerful portable versions of their applications. Business intelligence (BI), customer relationship management (CRM) and enterprise resource planning (ERP) applications are notoriously and somewhat necessarily heavyweight applications, however, and mobile enterprise users -- primarily salespeople and field servicestaff -- are looking for more than simply scaled-down, lightweight versions of them. "Besides apps that are used for e-mail and personalized contacts and calendar, we're seeing some additional traction amongst CRM apps -- sales, field service. There are also sparks of interest amongst inventory management and logistics apps," Forrester Research principal analyst Peter Marston told CRM Buyer."From a features and functionality standpoint on the CRM apps, organizations aren't looking for the applications to do complicated algorithms, rather they are looking to the mobile apps to provide field users with more customer related information, such as service call information that the customer has asked for in the past, and what sorts of things that a customer has purchased before."

IBM Kicks Mobility Play Into High Gear IBM has undertaken an aggressive foray into workforce mobilization with the release of a software and services bundle that allows users to access robust enterprise applications on handheld devices, while providing companies with the services needed to support an ever-more-scattered army of employees. IBM has rolled out a mobile software and service offering that builds upon several announcements it made earlier this year at the annual RIM Wireless Enterprise Conference. The offering, called "Mobility@Work," is a package of new software tools that allow developers to run existing desktop applications on a mobile device, together with new mobile consulting services aimed at helping companies implement and manage a mobile work environment. Built on open standards, IBM's software can be used with most mobile platforms including BlackBerry, iPhone, Windows Mobile and Symbian. These new products build on IBM's existing mobile software offerings -- such as IBM Cognos 8 Go! Mobile, which lets users view and interact with BI data. IBM has also expanded its relationship with AT&T, Sprint and other wireless carriers to provide broader e-mailaccess to customers who use IBM Lotus Notes and Domino software on their handheld devices. AT&T and Sprint have certified for use IBM's Lotus Notes Traveler software, which replicates Lotus Notes e-mail, calendaring and personal information management data on select smartphones. The devices from AT&T that have this capability are the AT&T 8525, AT&T Tilt, Moto Q Global, Palm Treo 750, PantechDuo (Mustang C810), Samsung Blackjack, and Samsung Blackjack II (i617). Sprint is including it on its HTC Touch, HTC Mogul, Samsung Ace, Palm 700W and Palm 800W. With this multilayered mobility rollout, IBM is positioning itself for an anticipated surge in demand for corporate mobile applications, Dunderdale said.

TV vs Internet: the Content Wars 

Saving TV When Harbert talks about television, it’s with the sober clarity of someone who has looked at life from both sides now and has seen that only one business model is working. Cable networks target just those viewers who want what they have to offer. Broadcast networks want everyone. And the business of wanting everyone has never been worse. At the end of last season, ABC, CBS, and NBC reported their smallest combined audience ever, an event that has become a gloomy yearly occurrence. Meanwhile, cable—counting both basic channels and pay services like HBO and Showtime—now receives 55 percent of the total viewership. It may be time to perform an autopsy on network TV, which some have pronounced officially dead at age 60, the victim of a lifetime of big spending, hard living, and bad planning. Here’s the coroner’s report: The evening newscasts have been mowed down by cable’s heat, spin, and round-the-clock immediacy. In prime time, nobody watches reruns anymore—and reruns, along with syndication, used to be the only way comedy and drama series, the heart of a network’s prime-time business, made money. (The way they make money now is...well, the networks will get back to you as soon as they figure that out.) Conversations about the future of television tend to vault way past next week or next year into a world where schedules don’t exist and 10,000 programming options are all available at any moment, half of them fully inter­active. (Not enjoying this episode of Law & Order: Moonbase? That’s okay—you can change the plot!)  It sounds like fun. But in reality, the number of cable channels has topped out. And the number of households that subscribe to basic cable—about 65 million—hasn’t budged for a decade. That’s roughly 58 percent of all American TV households and it’s a much higher percentage of the total households that advertisers actually care about. People who have something to sell are attracted to viewers who have already demonstrated their willingness to buy something (like cable TV). The cable business is booming: Annual advertising revenues have jumped from $8.1 billion in 1997 to a projected $28.6 billion this year. So before the death knell tolls, let’s consider some ways broadcast TV might be reborn. Creating substance-free shows because you think your audience has no attention span is a sucker’s game. And streaming shows for free is, so far, doing a lot more for viewers than it is for a network’s balance sheet. Instead, the networks should try to make TV shows for people who want to watch TV shows. There seems to be no shortage of viewers out there: For all the hand-wringing about how new media are sapping television’s audience, the average viewer of online video in April watched fewer than eight minutes a day. By contrast, the average household has its TV on for eight hours and 14 minutes daily. That’s a record.

Is the Internet finally killing TV? More than 80 million Americans have watched a TV show online. By 2013, a research group says, scheduled programs will account for less than half of all video viewed. Is this the summer that the Internet finally kills television as we once knew it? Most industry observers are stopping short of that prediction, citing some significant hurdles still in the way. But the growing number of new deals and new devices being announced suggests that a profound change in the way people watch video -- and what video they watch -- is under way. The line between "television" and video via the Internet already has blurred and may disappear in coming years. At least one industry analyst has declared "TV is dead" and welcomes Americans to a new age of video everywhere. Increasingly, Americans are watching video when they want to, and on the screen that suits them at the time. And more programming is from new sources that threaten to unlock Hollywood's domination of content. Video is now delivered on displays and devices of every shape and size, from gigantic theater screens and ever-larger home projector screens to flat-screen HDTVs and from desktop and laptop computer monitors to tiny personal screens such as those found on iPods and mobile phones. Meanwhile, NBC Universal is touting its coverage of the Summer Olympics in Beijing as "the single most ambitious digital event coverage ever." Along with video coverage on several of its cable TV networks, NBC is streaming 2,200 hours of live competition in 25 sports on the NBCOlympics.com Web site.

 A Surprise Winner at the Olympic Games in Beijing: NBC The Olympics has become the hottest event of the summer, drawing an average audience of about 30 million a night on NBC, far beyond the network’s expectations. After a string of disappointing years in prime time, NBC executives had high hopes for a turnaround with the Beijing Olympics; but those hopes were tempered by a string of concerns. Would China display some of its repressive political tendencies and potentially embarrass NBC? Would a protest or incident mar the feel-good atmosphere? Most of all, would enough viewers show up to justify the $894 million NBC Universal paid for the American television rights? With so many concerns, the network’s sales department felt compelled to scale back the ratings guarantee it offered to advertisers. The network also withheld some commercial inventory for use as what is known as make-good ads — free commercials offered to compensate advertisers for under-delivery of an audience. They won’t need them. The Beijing Games have become the hottest event of the summer, with numbers that so far have been certifiably big — far beyond the network’s expectations. The Games have drawn an average audience of about 30 million a night on NBC itself, millions more on NBC’s cable channels, 30 million unique visitors to NBC’s Olympics Web site, 6.3 million shared videos from the coverage streamed on the site and an ultimate profit that network executives project will surpass $100 million. Late last week, the chief executive of NBC Universal, Jeff Zucker, released the additional inventory to clamoring advertisers, especially movie companies hungry to put their latest releases in front of viewers. “We don’t have any more costs, so that will go straight to the bottom line,” Mr. Zucker said. He also argued that the success of the Games showed the future of network television might not be quite as dismal as had been forecast. “It’s a great story for network television,” he said. “This proves the pipes still work.” He added, “When you have an event that transcends popular culture, the only place you can aggregate these audiences is network television.” Not surprisingly, some competitors agree. Leslie Moonves, the chief executive of CBS, who sent a note of congratulation to Mr. Zucker last week, said in a telephone interview, “Anybody who doubts the viability of network television after this is nuts.”

• NBC's Online Snub, Web Audience for Games Soars for NBC and Yahoo

NBC Universal president and C.E.O. Jeff Zucker has a lofty goal: to rescue television. But saving the industry will mean the end of business as usual. Despite overseeing NBC, the network of Cheers, Seinfeld, and Friends, Zucker is relentlessly focused on the future. He is unsparingly harsh about the prospects for broadcast television—gloomier than any other TV executive out there. In his view, the era of growth in network TV, the period of the megahit, is over. Growing his business, then, means investing in cable, digital video, mobile—anything other than network TV. In cable, Zucker has gone on a multibillion dollar acquisition spree, buying Oxygen last year for $925 million, the Weather Channel in July for $3.5 billion and, moving into the international markets, a $150 million stake in India’s fast-growing NDTV network this year. In digital media, he acknowledges that nobody is sure how digital content will be displayed, viewed, and, most important, monetized. So he’s trying just about anything to see what sticks. In March, he partnered with Fox to provide NBC content for free on a video-streaming site called Hulu. And he’s experimenting with all sorts of new distribution channels, with screens of all sizes in unexpected places—spooning out a few minutes of NBC content to video displays on gas pumps and in the back of taxicabs.  As he scrambles to do all this and to prepare for NBC’s Olympics coverage, Zucker is in a vise. Just as he needs to spend his way out of network TV’s crisis, he’s facing pressure from above, as his bosses at General Electric are demanding that he keep costs down and produce higher profits. To cut costs, Zucker has dramatically reduced the number of pilots that NBC produces each season—a move that hasn’t gone over well in hidebound and spendthrift Hollywood. Whether it’s because of the outside pressure from G.E. or his own internal drive to counter critics who say he’s risen too quickly, Zucker is clearly the fastest-moving mogul in television. He has taken the lead in articulating the fears of many other media executives and stating candidly that he is not sure what will work. “I would rather be honest about the realities of this business, whereas so many people want to just sweep that under the rug and perpetuate what has been,” Zucker says. “Look, we don’t know what’s gonna work. Predicting what the media world is gonna look like in eight years is incredibly daunting. I defy anybody to do that.”

Posted by dblwyo at 01:41 PM | Permalink | Comments (0)

Well the markets are just roaring ahead this morning in combination with yesterday's durable goods numbers and today's surge in GDP and drop in weekly jobless claims. Lest you think we're absolutely nuts we're going to parse out the revised GDP data so you can see what's going before resuming the scheduled dissection of the Tech Industry outlook. Since our assessments there were based on slowing growth, declining domestic capital spending, a slowing worldwide economy and the disappearance of huge declines in the dollar they're rather intimately coupled, indeed !

Now as you probably now by this time we prefer YOY% changes because it steps away from seasonality and makes patterns and trends much clearer. But we're going to start with a slightly more traditional view which is closer to what you'll see in the media. But first let's let someone else set the stage for us - and note that this isn't the only person to make these observations.

U.S. Economy Grew Faster Than Estimated in Second Quarter on Export Gains The U.S. economy expanded at a faster pace than previously estimated in the second quarter, helped by surging exports and a smaller decline in inventories. The 3.3 percent annualized increase in gross domestic product from April through June was higher than forecast and compares with an advance estimate of 1.9 percent issued last month, the Commerce Department said today in Washington. The economy grew 0.9 percent in the first quarter. Record exports and the temporary stimulus from the tax rebates prevented the economy from stalling as housing slumped and companies cut expenditures. Consumer spending is now waning and slower growth abroad dims the outlook for foreign sales, signaling last quarter will be the year's highpoint. ``The overwhelming story is that the export numbers have offset this domestic weakness in consumer spending and business investment,'' John Silvia, chief economist at Wachovia Corp. in Charlotte, North Carolina, said before the report. Outside of exports, ``we have a domestic recession.''

As it happens we entirely agree with this assessment and will also point you to EconPics for a detailed breakdown ("Export Driven" Q2 GDP Revised Up to 3.3%) and CalculatedRisk to get the straight skinny on the unemployment claims picture (Unemployment: Continued Claims over 3.4 Million ). Between them they may help disabuse you of some the notions being put about by the headlines. Though, to be fair, the various commentators and stories have gotten it more right this time than in years....which is a major indicator in itself. EVERYBODY is starting to see the weakness in the domestic and international economies and we're no longer shouting in the wind. Taking a look at the traditional QtQ growth annualized a few points - yeah, we did grow, notice that we also were kissing cousins to a recession in late '06. And investment continues to tank, largely due to real estate BUT capital investment is slowing rather abruptly as we spent a whole bunch of time arguing yesterday.

If we go back to our preferred YoY% change charts what you see is pretty much what we've been saying - GDP is slowing, there was no big YoY jump but just a continuation of the slowdown, employment continues downward and Consumption doesn't look good at all. Though the rate of decrease may have stopped accelerating. We'll see how the revisions work out and what the trend turns into. With declining real wages, dropping employment and no stimulus you can expect future Consumption to start hitting real negative numbers. So, rather as usual around here, the headlines were fun but there's no real change in the patterns or trends and therefore we stand by our outlooks.

Speaking of which what about the Investment picture - which we're so concerned about for its' own sake as well as for the impacts on the Tech Industries. Well, repeating a chart from yesterday but using the revised data, again no surprises. Investment continues to head south on the back of terrible real estate spending and slowing business investment. Sorry no joy there either.

As Mr. Silvia noted it was the surge in Net Exports that saved us this time around and we are more than likely in a domestic recession. What do you think happens when the worldwide slowdowns catch up with us ? Or, alternatively, what's going on in the structure of the GDP numbers ? That's a question we take apart quite a bit more after the break by looking at the YoY changes in each of the major components. And, we would argue very strongly, something you need to understand for your own job, business and investment planning and decision-making. Does the tipping point still show up in the data ? We think so but check it out for yourselves. Please. 

Major GDP Component Revisions

What we've done is taken one of our standard charts that looks at YoY changes in each of the major GDP components and compares it to the overall GDP change. And instead of looking at several quarters of data we only compare the prior GDP to the current revision numbers. BtW, and for the record, let's get some of those numbers straight. On a YoY basis real GDP went up $249B, or 2.2%. Which is actually less than the Q1 increase of $291B and 2.5%. In other words the real economy actually slowed further, no matter what the headlines told you. The two biggest revisions that should just leap out at you are that Exports were much higher and Inventories didn't drop as far. After that though you should notice the scariest revision - estimated Capex dropped significantly !

Component Contribution

This next chart looks at each component's YoY change as a % of the GDP change - in other words how much did each contribute to the increase or decrease in GDP. Sometimes some rather revealing numbers pop out when you take a careful look here. For one thing the stimulus wasn't as important as we thought since Non-durables and Services contribution wasn't as large. And the damage from RI not as bad. Fascinatingly though, while trade was the critical component, the % contribution was slightly smaller than in the preliminary numbers. Hmm...that's interesting isn't it ?

Component Aggregate Impact

Another way to look at the component impact and figure out what's going on with the business cycle is to take a look at the cumulative impact. Bear in mind as we work our way across the components we are also working our way around the economic feedback loops. In other words Capex is responding to prior quarters demand - positively or negatively. So, as we add up the changes, what do we get ? Mr. Silvia is righter than he knows - across all the Consumption and Investment components growth was effectively zero. We are in or as close to a domestic recession as you'd care to get, though we're going to get closer. Indeed it was Trade and only trade that saved the day. In other words unless the rest of the world keeps buying more of our stuff while the dollar stops falling and they trip over into their own recessions we haven't got anywhere else to look.

Aggregate % Contribution

This next chart may simply be telling the same story as the last one but using % instead of numbers. But two things might be pointed out. First off when you look at these % Trade didn't give us that big a change despite the revisions - it was as good as it was in other words. No surprises. On the other hand the drop in the aggregate impact of Services consumption and Capex are NOT encouraging, at least IOHO. In fact that drop in Capex's contribution is really pretty discouraging, like we previously mentioned. The word was scary wasn't it ?

 So bottomlines there - the various members of the commentariat are beginning to see the light, for one thing. For another real economic growth continued slowing, not increasing. For a third, pra for trade. And forth pray that all those buybacks start going into equipment purchases 'cause capital spending is really looking to start tipping over. We'd have to conclude that the answer to "are we still tipping over" is a strong yes. Wouldn't you say ?

Posted by dblwyo at 11:27 AM | Permalink | Comments (0)

Consider this a direct continuation of the prior post on Technology since there was too much ground to cover in one post, even one of mine. :). Which also provides a great opportunity to debunk the received wisdom for today - obviously the markets took off and the only possible explanation was, of course, the surprise jump in durable goods orders. Let's parse that out a little because it sets the table for so much else that we need to dissect. First off on the markets - judging from sector ETFs the real news was Finance (XLF +1.9%), Homebuilders (XHB +3.7% !!) and Energy (XLE, 1.6%). Now if capital spending were the thing that'd be some different sectors. In reverse order you've got a hurricane - likely temporary, fantasies about a surge in mortgage applications and the fact that Fannie fired three top execs today. Sometime likely in the middle of the day when the markets surged "for no observable catalyst" before falling back at the end of the day. And bear in mind Finance is still 21% of the SPX and Energy about 10%. There you have it folks - unsinn as usual.

So moving away from nonsense what we'd like to do is trace thru the outlook for Technology spending by asking what's the outlook for capital spending, under which it falls. Bear in mind the prior discussion about the severe earnings jeapordy we see coming from the disappearnce of currency conversions on foreign revenues as well as falling international demand. And the fact that the markets seem to be getting nervous, i.e. aware of, that little fly in the ointment. So that boils the question down to what's investment going to look like ? And in parallel how's that going to impact demand in each of the major Tech sub-industries, in line with our "Dumbbell Ecology" discussion about who plays at what level of the layers and in which markets (yes, I'm afraid this may mean reviewing the prior post:Tech Trends I (Readings): Big Picture to Key Players).

Durable Goods and the Tech Outlook

So what did the DG numbers tell us this time ? Well take a gander at the accompanying chart. YoY% changes in new orders for durables, capital goods ex-aircraft and industrial production, montly to Jan04 and quarterly to Jan99. Which should clearly establish it's a business cycle related data series, that they three of them move together with the cycle and, recently, some interesting things have happened. IndProd is headed down - so much for domestic industrial activity and therefore future domestic cap spending. Reflected in a flattish Durable orders curve. Notice that capital goods have jumped short-term, though not noticeably in the longer timeframe. Can you spell exports and oil equipment ? We thought so and think that pretty well explains things. If you'd like a more detailed breakdown a superb one is on EconomicPic Data:Durable Goods - July.Well worth your time.

IBM as Earnings Exemplar

 After the break we continue this line of inquiry by diving deeper into investment in the business cycle big picture, looking specifically at Software & Equipment and then look at stock price performance for some bellweather tech companies. But we want to conclude with a dissection of IBM's last earning report just to close the loop on the currency conversion and foreign revenue issues. You've got to give IBM enormous credit for the clarity and honesty of their materials - this lays things out so explicitly we can analyze and comment on it. And that's not true in many cases. Since we can, we did. And take a look at the major comments. And then think about the fact that almost every other Tech company is exposed to the same pressures and risks. In other words what we have to seay about IBM applies to everybody else as well !!

Investment and the Business Cycle

The three major components of Investment in the national accounts are Residential, Structures and Equipment/Software. The latter two are business spending and our primary concern. Typically RI precedes a downturn while the latter two lag it. Let's look at how we're doing now. No real big surprises - RI is in the tank and headed for worse (still can't believe the Homebuilders...). Anyway, guess what Structures aren't doing badly but Equipment and Software spending has turned down pretty sharply. In fact it looks to us as if Eqp/SW (Capex) turned down almost as sharply Q106 as it did at the beginning of the Tech Bust.

We might also want to ask so what ? Part of the explanation is that Structures really got hurt badly in the last downturn - nobody was building new plants or warehouses. And part of the uptick this time around is that Oil Field facilities gets rolled up there as well - e.g. offshore drilling platforms.

There's another interesting little factoid one needs to consider - Structural investment isn't relatively a big deal. In fact the whole Tech Bubble was concentrated in the Eqp/SW category. For all practical purposes Structural spending is nice, it's cute but it's not a swing factor. Just so you get a sense of perspective remember that terrible market crash - well ask yourself how significant that little dipsy doodle was in late '01 and thru '02 in tech spending ?

Equipment/Software Detail

Courtesy of our friends at Northern Trust here's Eqp/SW spending back to '00 quarterly showing the QtQ% change at a seasonally adjusted annual rate. Take a real good look and ask yourself how healthy you think capex is anyway ? And bear in mind that QtQ data is "jumpy", i.e. volatile. You need to run an average thru the middle of those bars. By and large that looks to us as if capex was pretty poor from Q207 forward and is really beginning to get worse, fast. In other words domestic demand for Tech Spending is beginning its' own private little downturn though you may not hear John Chambers tell you that for a couple of quarters. Now would be a good time to start preparing though.

Stock Performance: Bellweathers and Sectors

The chart below is a tracking portfolio of what we think are representative bellweather stocks in the US technology industry. It's worthwhile to look at the key stats and compare the day's change (from Tu. 8/26) to the 50da moving average differences to the distance form the one year High/Low numbers. Notice that some pretty sound companies are running above their 50Da averages still, e.g. HPQ, Dell, and others. Now our opinion of Dell's turn around is a matter of record since we devoted an entire long post to dissecting the details of that strategy. And judging by the readership stats many people find it interesting every day. One could/should perform a similar analysis on the others and see what their invidual cases are. We'll leave you with one big observation and two questions. First off notice that only three companies are slightly below their one-year highs: ORCL, SAP and IBM. The first two because the thesis is that companies will keep spending on application software because it saves money in a downturn. If you believe that you may have a buying opportunity. If you believe this logic chain you might have a shorting opportunity. The other "high-performer" is IBM which is managing the company for EPS numbers. Later we'll get into the strategic consequences. But with the currency impacts and slowing international revenue growth, well what do you think ? And don't take IBM as an isolated case - take it as representative of just about every company on this chart. And with all that in mind notice there's another bunch who're down for the year in line with the index (~ 15%), including Dell, HPQ, and APPL. Now ask yourself is that likely to remain the same or not ?

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

Oddly enough the logical next step from international economic news is considering how that might impact business, specifically big technology businesses. The linkages are threefold - a slowing US economy further slowed by feedback from slowing foreign economies will lead to lower capital spending, which we've talked about. That's a little in-direct though. There are two direct impacts to consider. First, all the big tech companies have been claiming that major portions of their growth comes from abroad. That means there's a direct link that will see foreign sales start to come under pressure in the next periods. Not something that's being factored in by executives, investors or the markets so far, as best we can judge. Second - all those foreign earnings have enjoyed huge currency conversion benefits. If foreign earnings went up 13% half of that was currency. Now even if the dollar just flattens out or drops back to the level it was at the free ride is over. In other words you might be looking at a 50% drop in foreign earnings, which might be 35-50% of total earnings, for many of the big tech players. And that's without any real economic impacts.

Well there's something funny beginning to happen in the Tech Markets that popped up last week and got reinforced a bit this week. In case you didn't notice the NDX didn't drop relatively as far as the SPX, by a longshot, climbed rapidly back and has been relatively immune to the gyrations of the more traditional businesses and their stocks. All on the thesis that earnings would hold up. We think the market's beginning to notice because there's several days recently where the tech indices have in fact gone down while the oldline indices have not. Most of which you can see on this chart of the NDX, if you believe it's a decent tech proxy. Thought notice that the XLK ETF which mirrored it for so long is considerably below recently. Telling us that the big names are holding up while the industry is starting to hurt, perhaps ?

We'd like you to keep that in mind as we swerve to the other side of the Tech road and talk about the "inside baseball" issues which impact all of that nasty stuff like how much you actually sell and how much money you make off it. After the break you'll find two collections of readings. The first on "big picture" industry issues and the second on news on specific players. The former sets the stage for the latter in many cases once you translate what you're reading into guidelines for evaluating it. Which, hopefully and perhaps the Industry Dumbbell will help with.

What it tries to show is how well tech industry customer's requirements are satsified where those requirements are defined by the stack picture we've put up before that layers them together. Starting with the box (chips, OS, etc.) at the bottom, with middleware like databases, integration and development tools, etc. next, followed by applications and then the interface on top. For very small businesses often something like a spreadsheet, a contact manager and a word processor plus QuikBooks solves their entire problem and runs easily on a bunch of PCs. For very large businesses things are orders of magnitude more difficult, complex and expensive. But strangely enough their needs are satisfied by huge servers, say mainframes from IBM, ginormous database programs from Oracle or IBM, huge suites of ERP and other software and so on. The poor schmoos in the middle have hard, complex problems but the stuff at either end doesn't scale very well, either up or down. And none of the attempts to work around those problems have worked out very well. In particular below you'll find:

1. The whole Software as a Service, i.e. hosting it on a server ala the old-style time-sharing services, doesn't work well when you actually try to solve real business problems and get multiple different packages to work together. Which creates huge barriers for such folks as Salesforce or GOOG's attemps, even when it's liteweight apps. And also explains why SAP backed off their mySAP efforts years ago. 

2. Meanwhile the big software packages turn out not to solve every problem (the gap between what's claimed, what's delivered and what businesses needs could fill up several textbooks - in fact it does but never mind for now). And in those niches you're finding a lot of small companies busy trying to make some money. And oddly, they're using a lot of very good programming talent from India, Russia, Eastern Europe and so on. Hm....

3. Meanwhile the mid-size Tech departments who are the most under-served. Someday somebody will crack that code and make a lot of money.

4. At the same time when Intel and the rest ran into speed limits on single-core chips they created something with multiple-cores. Unfortunately they forgot to tell the software people how to write for the new architectures so your fancy new "Intel Inside" isn't much faster than your old box. Hint, hint. On the other hand the big server guys have been solving these problems for decades. Gee, what happens if the big-server guys figure out how to scale their boxes down to go after the medium-sized companies that the PC-farms can't handle very well.

Looks to me as if every layer of the Dumbell is up for grabs over the next few years. Wonder what that does for earnings ? As you read thru the excerpts we suggest you keep both sets of factors in mind - the external economic ones and the internal technical ones. Both are telling us that some wild rides may just be getting started.

Economic News 

Durable-Goods Orders in U.S. Unexpectedly Climbed 1.3% in July on Exports Orders for U.S. durable goods unexpectedly increased in July, indicating growing demand from abroad is still helping companies weather a slump in consumer spending. Sales overseas have helped U.S. factories withstand the three-year housing slump and tighter lending rules that have caused Americans to cut back. Still, economies abroad are now also weakening, signaling companies will not be able to count on sustained gains in exports. `Exports have thrown manufacturing a lifeline,'' Ryan Sweet, an economist at Moody's Economy.com in West Chester, Pennsylvania, said before the report. ``The big question for exports and manufacturers is how long the global economy will hold up.''

Tech Industry Issues 

SaaS's Impact on the Enterprise ERP Market A recent report from Gartner throws a big bucket of cold water on software-as-a-service ERP hype, especially for larger enterprises. Gartner analyst Denise Ganly writes in the "SaaS Impact on ERP" report that enterprises' dire need for a suite of integrated ERP solutions is not something that SaaS vendors can reliably deliver right now. "Because of the complexity of ERP suites, SaaS offerings for administrative and operational functions typically have provided functionality that is confined to one domain, such as sales force automation, or one business process, such as payroll," Ganly writes. "Thus, ERP SaaS suite offerings are still immature." (To read about an on-demand ERP provider's nascent efforts, see "PeopleSoft Vets Born Again: Can Two Legacy ERP Guys Get IT Executives to Buy into On-Demand Applications?".) Some of her other findings include: SaaS ERP suites won't be viable options for large enterprises during the next five years. "Except for use in two-tier ERP deployments," she notes, "large organizations should ignore this space."

• Salesforce.com shares slide after results, Salesforce.com Tries to Buy Its Way into Call Centers, Is Salesforce.com Dara Torres or Michael Phelps?

Helping Thousands of Software Firms Bloom Reading the business pages, one might get the impression that every software company in the world had been rolled up to be a part of Oracle or some other giant. Not so. While scores of mid-sized companies have been gobbled up, thousands of small programming shops are springing up around the globe, many in India, China and Eastern Europe. They might not be putting SAP out of business, but they are developing all manner of programs–to run Web services, make animated creatures appear on cellphones, run doctors’ offices and government agencies. Who says so? Well, one is Ray Lane, the onetime No. 2 man at Oracle who is now a venture capitalist at Kleiner Perkins Caufield and Byers. “I would say the best developers in the world are now independent developers,” he tells us. Programmers at big companies are mostly extending existing products, making incremental advances–“taking out the garbage,” as Lane describes it–while the little guys are trying the risky ideas, taking the big chances. Lane’s views are shared by Kim Polese, a former star among fans of the Java programming language world and his partner in a startup called SpikeSource. “Five years ago people were saying software is dead,” she says. “We see a huge disruption and incredible innovation and expansion of the software industry.”

Life Is Tough for Midsize Tech Departments Information-technology leaders at midsize companies say they could compete with bigger companies, if only they had more money. And staff. And the freedom to focus on long-term projects. Instead they’re fighting to keep up. That’s according to a survey of 200 tech leaders at businesses with 500 to 3,000 employees by Arrow Enterprise Computing Solutions, which sells computer gear to the consulting companies and resellers who target these companies. The survey doesn’t paint a pretty picture of life in the midmarket. The tech leaders surveyed are trying to get by on limited resources. For example, when asked who they rely on for advice, the top response was–no surprise–internal staffers (59% of respondents). But that was followed by cut-rate alternatives: Forty percent said they relied on Internet research; 31% said peers at other companies; and 30% said magazines and journals. So it’s not a shock that tech leaders at these midsize businesses aren’t wholly satisfied with the job they’re doing. Only 19% said they’re very satisfied with how their business addresses IT (71% are somewhat satisfied) and only 20% are very satisfied with how they’re going about cutting costs, which is far and away the top priority for these businesses. Only 65% of tech leaders said their businesses are keeping pace with technology, while 21% said they’re behind the times. One bright spot: The slumping economy doesn’t seem to have too much of an impact on midsize companies – perhaps because they’re already bootstrapping it. A plurality said the economy has just made their jobs more stressful (43%) while 34% say it’s had no impact at all. And 61% anticipate being able to spend more on IT next year.

A chip too far? Could faster chips translate into slower computers? That's the sales-threatening prospect furrowing brows in every corner of the PC business, from industry titans such as Intel, Microsoft, and Apple (AAPL, Fortune 500) to major centers of academe. For decades the PC industry has juiced performance - and sales - with a regular two-step dance. First, chipmakers jacked up the speed of their latest offerings. Then the software brains figured out how to turn all that processing power into faster operations and cool new functions. But the latest generation of chips, known as multicore, are so complex and so qualitatively different from their predecessors that they have flummoxed software developers. "We've gone through changes in the past," says Craig Mundie, Microsoft's chief research and strategy officer. But this one, he says, is the most "conceptually different" change "in the history of modern computing." The change was set in motion four years ago when Intel (INTC, Fortune 500) and others reached a point where they could no longer make single processors go faster. So they began placing multiple processors (or "cores") on a single chip instead. That design, however, dramatically raises the level of difficulty for software developers. If they want to get the full oomph out of multicore chips, their applications need to break tasks apart into chunks for each core to work on, a process known as parallel computing. (Programs running on supercomputers have employed this technique for years to simulate atomic explosions or model complex aerodynamics.) But programming in parallel is simply too complex for the average code writer, who has been trained in a very linear fashion. In conceptual terms, traditional coding could be compared to a woman being pregnant for nine months and producing a baby. Parallel programming might take nine women, have each of them be pregnant for a month, and somehow produce a baby. That's a dramatic change, and battalions of techies from Redmond, Wash., to San Jose are struggling to figure it out.

Key Players

A Bellwether Rings True The rest of the world wants laptops, too. That’s one of the takeaways from H-P’s earnings. One product that had a big quarter: laptop computers. Sales of the machines grew 26% year-over-year, while sales of the desktop variety only grew 6%. Printer sales were down, servers and storage devices sold to businesses were up somewhat; sales of software and consulting services were up big. H-P’s earning also reassert the company’s role as a bellwether for the technology industry, albeit a bellwether that consistently outperforms the competition. On Monday, tech researchers Gartner released an updated forecast for worldwide tech spending. It was as if they got a sneak peak at H-P’s balance sheet. Software sales are up across the industry, albeit 10% globally compared with 29% for H-P. But in both cases, they only represent a small fraction of total sales. Hardware sales make up a much bigger percentage of the overall tech spend, and a much bigger percentage of H-P’s revenue. In both cases growth is slower, 7% globally, compared with 5% for H-P. (This isn’t quite apples-to-apples, because H-P counts PC sales separately and doesn’t distinguish between sales to businesses and sales to consumers.) Many of the corporate tech leaders we’ve spoken to say that they’re delaying hardware purchases until the economy get better. Lastly, businesses are buying more and more tech services. It showed up globally, where Gartner forecasts services growth of 10%. H-P reported an increase of 14% in sales of these services from the year-ago quarter. Expect this number to increase sharply for the current quarter when H-P will finalize the acquisition of consulting company EDS.

Dell's comeback machine Over the past three years its position in the PC industry has gone from dominator to underdog, as shoddy customer service, weak international distribution, and outdated designs have cost it the title of global market leader. (That isn’t all it cost, as investors will tell you; Dell has also lost nearly $35 billion in stock market value since December 2004.) One of the clearest signs of change is this redesigned Latitude laptop, the company’s flagship model, which will be its first business laptop line to come in rainbow colors. The laptop’s core design gets updated only every four or five years, making its debut a supremely important moment. Get this right, and Dell can shore up a weak spot where rivals have taken market share, and surge ahead as corporate buyers upgrade from desktops to laptops. Get it wrong and the company can kiss its comeback goodbye. Michael Dell himself was clearly aware of the stakes a couple of weeks ago when we talked about Dell’s future –he singled out the Latitude as a strategically important product. Once it started losing ground and its stock dipped, the detractors piled on with all the old put-downs: Dell doesn’t innovate. Dell’s marketing sucks. Dell designs machines with corporate IT departments in mind, not real people. Back when Dell was whipping everyone in the PC industry, it was easy to shrug off the insults. Dell innovates where it matters, execs would say, in the supply chain and with its direct sales model. Now it’s easy to imagine the talk is hitting a nerve. Why? Because in a maturing PC market, Dell’s traditional weak points have become must-win areas. In the early days of the PC market, when computers were expensive, every new Intel chip offered a major performance boost and every Microsoft operating system seemed to offer must-have features. Back then, Dell’s IT department focus, direct-sales efficiency and price leadership trumped everything else. But these days, chip and OS upgrades are no longer major events, and PCs are mainstream enough that much of the growth is in the consumer market, and consumer trends even influence business purchases. Now, design, innovative features and broad distribution matter more than price cuts, and Dell is scrambling to adjust.

• Lenovo's Big Bet: China's largest computer maker is betting big on this Olympics to help boost its profile, with CNBC's Darren Rovell

Hewlett-Packard Takes Design Cues From Milan to Lift PC Profit, Beat Dell -- Hewlett-Packard Co. is drawing inspiration from Milan designers to maintain its lead over Dell Inc. in the personal-computer market. Instead of building workhorse machines in utilitarian cases, Hewlett-Packard strives to create sleeker, more stylish PCs by looking to the fabrics and shapes in Italy's furniture showrooms, said Stacy Wolff, director of notebook-computer design. ``The notebooks are a lot slimmer and a lot nicer than the big bulky boxes people lugged around three years ago,'' said William Fearnley Jr., an analyst with FTN Midwest Securities Corp. in Boston. ``Hewlett-Packard's designs have helped them.'' Demand for PCs, which account for about a third of Hewlett- Packard's $104.3 billion in annual sales, may help the Palo Alto, California-based company post an 8.1 percent gain in third- quarter revenue today, according to the average estimate of 21 analysts in a Bloomberg survey. Chief Executive Officer Mark Hurd eliminated about 15,000 jobs, or 10 percent of the total, to save $1.9 billion a year. He combined data centers to save another $1 billion and aims to cut real-estate expenses one-third by 2010. Those reductions allowed Hewlett-Packard to match or beat Dell's PC prices while improving designs. Putting form and function before component costs mirrors a strategy by Apple Inc. Chief Executive Officer Steve Jobs, whose aluminum-clad desktops and notebooks have propelled the company to its highest PC market share in at least a decade. In January, the company introduced the MacBook Air, which is less than 1 inch (2.5 centimeters) thick. Hewlett-Packard and Dell announced their own ultra-thin notebooks after that.

Apple Flubbed MobileMe, But the Mac Is Making Inroads Into Enterprise Market In the accompaning video, Henry and I talk about this uncharacteristic misstep for Apple, as well as some better news for the company: A record quarter for Mac sales and a growing presence in the enterprise market. Can Apple fill the gap left by Windows' crumbling hegemony? Or will Dell and HP finally figure out that it's all about design and beat Apple on price?

Microsoft Corp., weary of being cast as a stodgy oldster by Apple Inc.'s advertising, is turning for help to Jerry Seinfeld. The software giant's new $300 million advertising campaign, devised by a newly hired ad agency, has been closely guarded. But Mr. Seinfeld will be one of the key celebrity pitchmen, say people close to the situation. He will appear with Microsoft Chairman Bill Gates in ads and receive about $10 million for the work, they say. The new ad effort is expected to use some variation of the slogan "Windows, Not Walls," according to several people familiar with the matter. Those people say the point is to stress breaking down barriers that prevent people and ideas from connecting. The campaign, said to debut Sept. 4, is one of the largest in the company's history. The attempted image overhaul comes as Microsoft executives privately acknowledge that Windows -- the company's most important brand -- has grown stale and has been battered by Apple's "Mac vs. PC" ads. Those ads, created by Omnicom Group Inc.'s TBWA/Chiat/Day, feature a nerdy PC guy getting upstaged by a hip Mac counterpart. Microsoft's immediate goal is to reverse the negative public perception of Windows Vista, the latest version of the company's personal-computer operating system.

China challenges Microsoft Most often, Microsoft Corp.'s biggest rivals in the Chinese market have been black-market versions of its own products. That could change for the company's Office software suite, a key product that includes its word processing and spreadsheet tools. Wuxi, China-based Evermore Software is expected to release its latest Office competitor in late August. And while EIOffice 2009 is based on a file format standard promoted by the Chinese government and costs a fraction of Microsoft's offering, it also comes with a new legal threat. Evermore Chief Executive Gus Tsao said he's prepared to pursue Microsoft under a new anti-monopoly law that took effect in China on Friday. The law is widely expected to be used to curtail the dominance of foreign companies doing business there, such as Microsoft. Evermore's assault, while coming from a tiny challenger, underlines the sensitive position of Microsoft's Office franchise relative to Windows. While a legitimate rival to Windows for PCs is unlikely any time soon, Office has increasingly attracted competition. Google Inc., for example, has released a rival Web-based product in the U.S. and other markets. In its recently-ended fourth quarter, Microsoft saw weaker sales growth for Office than anticipated, as customers favored lower-priced versions. The unit that includes Office nonetheless produced more than $3.3 billion in profit in the quarter.

Is Something Rotten at Apple?  In its ubiquitous TV ads, Apple claims that its new iPhone is twice as fast as the original version and just half the price. Neither is true. The half-price fib has been obvious for some time: When you add the price of AT&T's required two-year contract, the new phone costs slightly more than the old phone. Apple has reluctantly acknowledged flaws in the iPhone and has quietly promised to correct them, but there's no sign that it's taking the complaints very seriously. The lawsuit might be just the kick it needs to fix the world's broken iPhones. But the company's troubles go beyond the iPhone. Last month, Apple launched MobileMe, a $100-per-year online service that aimed to sync documents and e-mail across computers and Internet devices. MobileMe failed spectacularly in its opening weeks, with some users reporting losing years of saved e-mail. In a widely circulated post, Techcrunch's Michael Arrington claimed last week that Apple's PCs aren't doing so well either. Arrington, a longtime Apple fan, says he's had four new Macs break in different ways—one refused to connect to Wi-Fi networks, one suffered a keyboard flaw, and two shut down mysteriously. Is something rotten at Apple? Is it "flailing badly at the edges," as Arrington argues? Years of savvy brand advertising and a string of genuinely great products have helped Apple build up a well of good-feeling; as a result, people are more willing to overlook the company's occasional failures. Besides, many Apple products still beat their rivals, hands down. You may hate Apple for selling you an iPod with a battery that dies, but what are you going to do when you go looking for a new music player—get a Zune? Not likely. What's troubling, though, is Apple's tendency to milk this advantage—when it does screw up, it prefers secrecy over full disclosure, and it expects customers to quickly forgive any slight.

Google's tough sell to Corporate America Eighteen months after making a push into corporate software, only a handful of Fortune 500 and mid-sized companies have started using Google's programs - mostly anti-spam or calendaring tools - and none have embraced Google Apps in its entirety, preferring instead to stick with Microsoft Office or its distant competitors. Microsoft (MSFT, Fortune 500) last year sold $12.2 billion worth of Office software, according to research firm Gartner. Google pulled in just $4 million from Google Apps. One reason for Google's tough slog is simple inertia. Switching from one set of corporate software to another is hugely time-consuming. But Corporate America's reticence also stems from Google's overarching goal: to replace packaged store-bought software loaded on a desktop with programs that reside remotely on Google's servers and are accessed via the Internet. A lot of companies, from IBM (IBM, Fortune 500) and Oracle (ORCL, Fortune 500) to Hewlett-Packard (HPQ, Fortune 500) and Salesforce.com (CRM), are betting that Web-based, or "cloud," computing is the future of software (consumers already use it to access their Yahoo or AOL e-mail). Merrill Lynch estimates that online business applications will grow to a $95 billion market within five years. Even Microsoft, which has a lock on 98% of the market for desktop office software, is getting into the game.

Shift at the Top Emphasizes SAP’s Bottom Line The company is indeed shifting toward more of a focus on the bottom line, and less on the multibillion-dollar investments in technology that helped make it the market leader in the lucrative field of business software. The goal, it seems clear, is for SAP to show that it can not just produce sophisticated software that companies depend on to run their businesses but also do as well as its American archrival, Oracle, in satisfying the demands of investors. SAP can take heart that it controls a larger market share than Oracle, according to Albert Pang, an analyst with IDC, a Boston-based technology consulting firm. In 2007, SAP had about 10 percent of the $88 billion market in revenue for business software, while Oracle lagged with 6.6 percent. In subsets of the market — like enterprise resource planning, which tries to oversee many basic operations — SAP laid claim to 22 percent, almost twice Oracle’s 12 percent. But, analysts said, investors have seized on the question of margins and SAP has fed the story unabashedly. . Large companies first bought SAP products to manage inventories, track sales leads and handle vacation requests. Later, SAP clients ramped up their use of software for more analytical tasks, like divining sales patterns or ferreting out kinks in global supply chains. And by and large, SAP developed the products itself, eschewing the big acquisitions that were a signature of Oracle. SAP invested slightly more than the industry average of 10 percent of its revenue in research and development. In the last three years, R.& D. spending ballooned to 14 percent as SAP raced to bring new products to the market. In particular, it invested heavily in Business ByDesign, an online software suite aimed at expanding the market by appealing to very small businesses that cannot afford a pricey I.T. department. Now, SAP is betting that it can raise its profit margins without conjuring up, as is often the case in Germany, the specter of mass layoffs to contain costs. Mr. Kagermann said SAP would keep hiring, while curbing its costly use of outside developers. “We can continue to hire people because we continue to grow at double digits,” he said. “You just have to invest less than in the past.” This shift away from a period of rapid investment has raised expectations that SAP, which was born in 1972 when a group of executives bought out IBM’s German operations, is beginning to look a little less German. The company’s heavy spending on new technology may have dragged down margins, but its intense focus on maintaining the spirit of German engineering won SAP a reputation for understanding its clients’ businesses like no one else. On the downside, the programs were so detailed that it often took months to install them and train employees to use them. But SAP products generally avoided the heavy rounds of debugging and fixing that often plagued competitors like Oracle and Microsoft.

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Let's get the week's collection(s) - emphasis plural there's so much but it all interacts together - on the international situation up as part of the context. After the break you'll find some rather harsh views on the worldwide outlook setting up some specific country news, including Japan, Hong Kong, India and China. In these two parts there are several critical harbinger stories you need to think about. But the overall foundation or context is defined, courtesy of Northern Trust in the accompanying chart. While all of that chatter about the rest of the world beginning to lead its' own separate existence was going on last year the US was an increasing share of the world's GDP. Now that flattened out in terms of growth but still left the US economy, i.e. US consumer excess consumption, as a driving engine of growth. As it's been tanking so does that source of growth.

In the two sections pay particular attention to the discussion of US exports though - which have primarily helped out the agricultural sector and not the rest of the economy. Which actually doesn't bode well for positive feedback to the domestic economy beyond a narrow range. Also pay attention to the discussion of falling commodity prices and a rising dollar helping out with developing world inflation. That's all true but then you need to couple it with the downstream consequences. First, a rising dollar will dampen, along with declining world economic growth, demand for US exports and negatively impact all those big company earnings that have coasted on foreign sales and currency conversions. Second many of the major foreign players CAN NOT AFFORD to have their economies weaken to far for political reasons and are shifting the emphasis back to growth oriented policies. Which means a likely rise in domestic inflation, increases in commodity prices re-igniting if not in the short term, a fall in their currencies and a relative strengthening in the dollar and so forth. Which means that we may have seen all the air come out of commodity prices that we're going to for a while until developing world inflation re-kindles the whole feedback cycle all over again.

Yet a drop, for example, in China's growth from 11% to 9% doesn't make the demand for commodities go away. All it does is cause huge swings on the margins. In the long-run we're in a structural bull market for commodities as long as so many have structurally constrained supplies and increasing demand. Remember they're priced on the margin and on the margin these are big swings. We're likely shifting into a world where top-down macro-trends and speculative influences will still be important but where the Supply/Demand balances situations in individual commodities will be more so. And as you can see from this cute little chart, just to take China, they will continue to account for a lot of the marginal swing. Which also means that as they re-inflate their economy that demand for whatever they're buying will go up.

 As an illustration and specific example of how this might all play out in the oil market consider the accompanying chart of oil prices thru last Friday's close. You might want to pay attention in the excerpts to some of the BNN vidclips where this sort of thing is discussed in more detail and very astutely IOHO. In any case what you see is a 1-Year chart of oil prices (W.Tx. Intermediate - WTIC) with three price limits guesstimated in. There's a technical theory running around based on something called Fibonacci numbers, named for an Italian mathematician who noticed recurring ratios and patterns in nature. For example in the spirals of Nautilus shells. Technowonks use it give themselves comfort by applying those ratios to estimate how much of rise or fall is likely to be re-traced. For whatever reasons, aside from warmth and comfort, they seem to work a little. So you you see three oil prices - the lowest of which would still be vastly above where it was and economically painful. Meanwhile we'll point out OPEC is starting to cut back production to protect the $100 price level. You might consider this as representative of what'll go on in all the commodity markets.

One key part of which is Oil where the increasingly dominant characteristic is things we've talked about before. First off the world oil majors command less and less of the world's oil reserves which means that oil is increasingly insulated from pure market forces and more and more managed, at least in part for geo-political reasons. Second, wherever it's at Oil is increasingly hard to get to and it takes more and more investment to both find it and produce it. Third more and more of the world's reserves are sequesterred behind political barriers which, in turn, has adverse impacts. The oil that's developed in Russia for example is in fields in pronounced decline. The oil that is developable is in areas hard to reach and extremely expensive to develop. Which then means, in turn, that Russia's recent display of military aggression could backfire on it, the world oil supply and therefore on us. Just as a way to capture the dynamics of these all plays together we'll offer up this little exercise in conceptual graphics. It shows  various bands of known and developed energy/oil resources at increasing non-linear costs, including alternative energy sources,e.g. oil sands. When Russia cuts off Central Asian oil and natural gas they're cutting off big chunks of that new swing supply. The other thing you need to know is that while the whole Peak Oil argument is debatable in the aggregate it's proven out well in the known and developed fields, i.e. the stuff we've already brought on line. Bottomline - resources we can get to are in decline. Resources we haven't gotten to are unknown. Think about it. If the key point(s) don't leap out - if it's behind a red band then it's hard to get to. And if it's behind a red band we need to get to or increasingly go without.

World Economic  Outlook

Global Recession & Falling Energy Prices The probability is growing that the global economy �" not just the United States �" will experience a serious recession. Recent developments suggest that all G7 economies are already in recession or close to tipping into one. Other advanced economies or emerging markets (the rest of the euro zone; New Zealand, Iceland, Estonia, Latvia, and some Southeast European economies) are also nearing a recessionary hard landing. When they reach it, there will be a sharp slowdown in the BRICs (Brazil, Russia, India, and China) and other emerging markets. This looming global recession is being fed by several factors: the collapse of housing bubbles in the US, the United Kingdom, Spain, Ireland and other euro-zone members; punctured credit bubbles where money and credit was too easy for too long; and the severe credit and liquidity crunch following the US mortgage crisis; the negative wealth and investment effects of falling stock markets (already down by more than 20% globally). Some other contributing factors are: the global effects via trade links of the recession in the US (which still counts for about 30% of global GDP); the US dollar’s weakness, which reduces American trading partners’ competitiveness; and the stagflationary effects of high oil and commodity prices, which are forcing central banks to increase interest rates to fight inflation at a time when there are severe downside risks to growth and financial stability. This G7 recession will lead to a sharp growth slowdown in emerging markets and likely tip the overall global economy into a recession. Those economies that are dependent on exports to the US and Europe and that have large current-account surpluses (China, most of Asia, and most other emerging markets) will suffer from the G7 recession. Those with large current-account deficits (India, South Africa, and more than 20 economies in East Europe from the Baltics to Turkey) may suffer from the global credit crunch. Commodity exporters (Russia, Brazil, and others in the Middle East, Asia, Africa, and Latin America) will suffer as the G7 recession and global slowdown drive down energy and other commodity prices by as much as 30%. Countries that allowed their currencies to appreciate relative to the dollar will experience a sharp slowdown in export growth. Those experiencing rising and now double-digit inflation will have to raise interest rates, while other high-inflation countries will lose export competitiveness.

Eurozone plight creates global tipping point There are moments in the financial markets when, abruptly, the conventional wisdom among investors about where the global economy is, and where it is headed, gets severely disrupted. Last week was one of those moments. All at once, a raft of preconceptions about the state of the world economy and its prospects was thrown into a state of flux, sparking seismic upheavals across the financial markets. The catalyst for last week's drama was the realisation that the outlook for key industrial nations, and the global economy as a whole, had become much darker than previously imagined. A double whammy of bleak news came from the eurozone and from Japan, with official figures revealing that both economies shrank in the second quarter.The figures shattered the misplaced assumption by many participants that the worst of the financial and economic trauma besetting America and Britain could remain largely confined to the Anglo-Saxon world. The entire developed world was shown to be teetering on the brink of recession. Developments in the eurozone most disrupted the slightly complacent consensus in the markets. An admission earlier this month by Jean-Claude Trichet, the President of the European Central Bank, that the eurozone had been caught out by the pace of deterioration in conditions in the 15-nation bloc had caused some concern among investors. However, Thursday's confirmation that gross domestic product (GDP) in the eurozone economy had fallen in the second quarter by 0.2 per cent, its first contraction since the inception of the single currency in 1999, forced many investors into a drastic reappraisal. With the eurozone's annual growth rate also cut to an anaemic three-year low of 1.5 per cent - less than half the pace set 18 months ago - the illusion that Europe could remain if not immune then at least substantially insulated from the economic woes afflicting the United States in the wake of the credit crisis was destroyed. The big question now confronting the markets and policymakers is how much worse things in the eurozone might become.

Falling Commodities Prices Ease Fears of Inflation in Developing Countries  A sharp drop in commodity prices is raising hopes that inflation is peaking in many parts of the developing world, especially in Asia, providing welcome relief for the fragile global economy. Lofty prices for oil, food and other essentials remain a big challenge, especially for poor developing countries such as Haiti, Egypt and India, where earlier this year soaring costs triggered violent street protests, transport strikes and other unrest. But recently, many of those prices have fallen significantly. Oil fell $1.24 a barrel on Friday to close at $113.77, 22% below its record price earlier this year. Rice, a staple for the developing world, is down about 40% since May, while palm oil, a source of cooking oil, is down a similar amount since peaking in March. Wheat, copper and a host of other commodities also have seen sizable drops. With economic growth slowing across the world, including in China, and demand for raw materials easing, many analysts believe it is unlikely the commodity-market highs of earlier this year will be tested again soon. That is an important change for developing nations, whose industrial economies are often far more commodity-intensive than the U.S. and Europe, and where inflation rates are heavily influenced by the direction of commodity prices. Economists caution that volatile commodity prices could easily rise again, especially if fresh geopolitical problems or unforeseen weather disasters emerge to drive them higher. Even if prices don't rebound, they are still dramatically higher than a year or two ago, meaning continued hardships for many poor consumers. At its current price, rice is still nearly twice as expensive as in 2007. But the downturn in prices for many commodities marks a sharp change from earlier this year, when inflation seemed to be spiraling out of control, especially in China and other parts of Asia, leading to fears of "stagflation" -- a dangerous phenomenon in which growth is sluggish but prices keep rising.

Export Boom Helps Farms, but Not American Factories A surge in U.S. commodity exports is a relief in an otherwise bleak economy, but it is an unreliable prop for an industrial power. Exports are the bright spot this year in an otherwise bleak economy. But the world is not suddenly snapping up made-in-America goods like aircraft, machinery and staplers. The great attraction is decidedly low-luster commodities like corn, wheat, ore and scrap metal. This helps explain why manufacturing jobs are continuing to disappear by the tens of thousands and factories are closing even during a miniboom in exports. While the surge in commodities is a welcome relief, it is an unreliable prop for an industrial power. Commodity sales have been helped greatly this year by rising prices, particularly for grains, and also by the decline in the value of the dollar, which reduces the cost of American exports in other currencies. Both trends, however, have recently reversed, suggesting that the rise in commodity sales will not be sustained, and that exports might shrink, weakening the economy another notch. An analysis of trade data by the federal Bureau of Economic Analysis illustrates just how lopsided the gains have been between manufactured goods and unprocessed commodities. All exports of goods and services in the first half of the year rose at a $52 billion annual rate, adjusted for inflation, up 7.1 percent. Commodities accounted for 41 percent of the increase and manufactured products contributed just 12 percent, the bureau reported. (The figures strip out such items as arms sales and exports to American territories, like Puerto Rico and the Virgin Islands.) Such unevenness, favoring commodities, is unusual, given that manufactured products, even by this definition, account for 40 percent of the nation’s exports, while commodities make up only 26 percent and services 30 percent. Indeed, not since the bureau began compiling detailed trade data in 1977 have commodities outpaced manufactured exports for two consecutive quarters. Weakening demand abroad accounts for some of the decline. But the manufacturers themselves acknowledge that they gradually undercut their ability to export as they moved more and more production to factories overseas. Bringing that production back to this country, so that it could be exported, would dismantle global networks constructed relentlessly over the last 25 years. Many American manufacturers argue that as factories spread across the globe, exporting is no longer an effective means of competing against sophisticated and ever more numerous local manufacturers. In addition, as American companies set up operations in, say, China, they insist that their suppliers locate nearby, for quick and efficient delivery — and that draws more manufacturers overseas.

Countries

Japanese Downturn Appears Likely to Be Shallow but Lengthy   Just how bad will Japan's economic downturn be? Economists say it likely won't be too sharp -- but might carry on for a while. Japan posted its worst quarterly report on gross domestic product in seven years last week: The world's second-largest economy contracted at an annualized rate of 2.4%. A look at the causes shows no single, large problem hammering down, but a number of factors coinciding to push the economy into contraction. This, economists say, means Japan likely won't be battered as hard as it was during its most recent previous downturn, but it could take a long time to recover.The current quarter and the October-December quarter will see just 0.1% expansion over the previous quarters, forecasts Kiichi Murashima, an economist at Nikko Citigroup. If Mr. Murashima's prediction turns out to be right, Japan won't meet the common criterion for a recession of two straight quarters of economic contraction. But it would put it on course for anemic growth in 2008. Mr. Murashima predicts expansion of just 0.8% this year, followed by 0.6% in 2009. "The recovery won't come until the second half of 2009," he says. The stagnation "will likely be protracted." A long, moderate slowdown would mean no quick, V-shaped recovery to boost stock prices. Tokyo's Nikkei Stock Average of 225 companies has fallen 15% so far this year, and analysts hold out little hope for improvement soon. The index climbed 0.5% Friday to 13019.41. It also would mean Japan's super-low interest rates continue for even longer than expected. After abolishing an emergency target of zero for short-term rates in 2006, the Bank of Japan last raised its target in February 2007 -- to just 0.5%. Some economists now think it won't raise the rate until 2010, meaning limited increases in long-term borrowing rates and less support for the yen. The bank is expected to leave its rate target steady at a two-day policy-board meeting that ends Tuesday, but it might downgrade its assessment of the economy.

• China displaces U.S. as Japan's biggest customer

Hong Kong's quarterly drop in GDP marks first in 5 years  Hong Kong's economic growth slowed more quickly than expected in the second quarter, showing its first quarter-to-quarter decline in five years as the effects of financial problems elsewhere spilled into the territory. Gross domestic product dropped by 1.4% on a seasonally adjusted quarter-to-quarter basis -- the first such decline since the second quarter of 2003, when Hong Kong was hit by an outbreak of severe acute respiratory syndrome, which brought some segments of the economy almost to a halt. The government said GDP rose by 4.2% when compared with the second quarter last year, but was down sharply from a revised figure of 7.3% for this year's first quarter as the territory started feeling the pinch from slowdowns in major economies and turbulence in financial markets. The growth figure came in well below a median forecast of 5.3% from 12 economists surveyed by Dow Jones Newswires, and marked the slowest year-to-year growth rate for any quarter since the third quarter of 2003. The government acknowledged the economy likely will keep slowing until next year.

Growth Wanes for India's Tech Titans India's information-technology industry, the engine of the nation's economic resurgence, is losing steam. A decade ago, a host of Indian companies -- led by Infosys Technologies Ltd., Wipro Ltd. and Tata Consultancy Services Ltd. -- shot to global prominence by helping fix the "millennium bug" that threatened to crash many of the world's computers at the end of 1999. Often growing at 40% a year or more since, they quickly helped build a global tech-outsourcing industry that has changed how the world does business and how it views India. Now that growth is slowing sharply. The credit crunch and spending slowdown in the U.S. are hurting the companies' biggest market, while a cheaper dollar shrinks their profits. Longer-term problems are surfacing. Competition is rising from other low-cost nations, ranging from Eastern Europe to the Philippines and Vietnam. And India's own success has raised labor expenses, cutting into the companies' low-cost advantage just as their revenue growth is slowing.Infosys expanded its corps of software engineers by one-third between 2006 and 2007, adding 15,000 people. Its average salaries are rising 12% a year, and increasingly high turnover is forcing the company to spend more on training. Growth in profits fell to 18% in the most recent fiscal year, which ended March 31, compared with 56% the previous fiscal year. Tata Consultancy Services posted just a 4.9% increase in net profit in its latest quarter, compared with 37% in the same period a year earlier. Wipro's earnings growth slowed similarly, to 11.6% in the fiscal year ended March 30, down from 42.3% in the previous year.

China priming the pump  -- Beijing is likely to implement post-Olympics stimulus measures to offset a slowing economy and spur jobs growth, taking advantage of a benign inflationary backdrop and an energized national mood in the wake of the Games. Tuesday's announcement that Beijing would raise wholesale electricity prices roughly 5%, effective immediately, is the first of likely several new measures due to be unveiled in coming weeks, analysts said. The higher tariff, marking the second time China has lifted electricity prices in two months, does not apply to retail prices, thereby isolating consumers and businesses from higher costs. Still, the rate hike will help power producers offset higher fuel costs, while electricity wholesalers will bear the squeeze on margins.Beijing is considering a stimulus package of as much as $58 billion, in addition to other monetary-policy-easing measures, according to a research published by J.P. Morgan Tuesday. "The top leadership is carefully considering an economic stimulus package of at least 200 billion yuan to 400 billion yuan [or $29 billion to $58 billion]," wrote the brokerage's head of China Research, Frank Gong.Gong said the spending is in addition to plans to spend up to 600 billion yuan on rebuilding earthquake-affected areas and could include tax cuts and other moves to shore up the financial and real-estate markets. Easing inflows of hot money, a shrinking trade surplus and cooling inflation are providing a backdrop conducive to monetary easing, Gong said, setting the stage for a possible reduction of in the ratio of reserves banks must set aside as deposits, in addition to lower interest rates, later this year. Monetary-policy makers tasked with managing the nation's $1.8 trillion stockpile of foreign-exchange reserves were also coming under growing pressure to pull funds out of the U.S. debt market and put them to work at home, Gong added.

Currencies &  Commodities

Dollar's Rebound Offers Conflicting Investor Paths The dollar's rise should help damp domestic inflation and interest rates and put the brakes on commodities prices -- a plus for profits. But U.S.-based multinational companies such as GE and Coca-Cola will face additional earnings pressure. After struggling for several years, the dollar is back in vogue. It has gained 8% against the euro in the past month. On Friday, the dollar rose again and one euro equals $1.4673. Last month, a euro was at $1.60, and bullish analysts say a euro could be $1.40 by next summer. The dollar has rallied the same amount against the British pound and a bit less against the yen.
Behind the surge: slowing economies across Europe. Data released last week show the euro-zone economy contracted 0.2% in the second quarter, the first decline since before the euro's introduction in 1999. Falling oil prices have helped, too, since softer energy costs reduce inflationary pressures and make it easier for the European Central Bank to begin cutting interest rates to deal with the slipping economy. Earlier this summer, investors were betting the ECB would raise rates to combat inflation. Currency moves have broad and often conflicting impacts on interest rates, corporate profits, commodity prices, and mergers and acquisitions, particularly if investors believe the trend will continue. Here's how a rising dollar could play out:. But a stronger dollar could hurt U.S.-based multinational companies such as General Electric Co. and Coca-Cola Co., because profits earned overseas will be worth less in dollars.These companies already are facing earnings pressure from the economic weakness that is spreading from the U.S. to Europe and Japan. When the dollar was in the dumps, U.S.-based multinationals didn't complain because the goods and services they sold overseas brought in an increasing number of greenbacks. That flowed through to the bottom line. That is the short-term impact. If the dollar continues to strengthen, the boom in exports that the U.S. has experienced in recent years could end as U.S.-made goods get more expensive.

Buck Up In terms of markets, the most obvious change over the past three weeks has been the stunning rally in the US dollar. While Macro Man has previously noted that his anticipated three themes for August were in some ways correct, he will readily concede that he did not foresee the dollar's reversal of fortune. Now that it's occurred, of course, the two obvious questions are 1) Why has it happened, and 2) What happens next? Macro Man intends to sketch out his initial thoughts below. WHY HAS THE DOLLAR RALLIED? While an exclusive focus on post-hoc explanation can be misplaced, Macro Man is a firm believer in the concept that you have to understand what you have seen before you can forecast what you're going to see. In that vein, Macro Man understands the dollar's rally as a confluence of five different factors:

The key to our wild market: Asia At the core of the current wave of volatility are investor worries that growth is slowing in the Asian economies, which have been driving the global economy forward since the U.S. economy dropped into low gear in the fourth quarter of 2007.Investors have been expecting that Asia's export-driven economies would follow suit. Lower growth in importing economies must lead to a slowdown in exports from Asia, right? Recent figures suggest the slowdown has finally arrived. Growth in China slowed to an annual rate of 10.1% in the second quarter of 2008 from 11.9% in 2007. The pattern is similar in other Asian economies, big and small. India, where gross domestic product grew 9.1% in the fiscal year that ended in March, will see growth of 7.1% this fiscal year, according to Morgan Stanley. All the economies of the developed world, including the United States, would kill for growth rates like those, but it's not the absolute level that matters. A drop from a 9.1% growth rate to a still high 7.1% is enough at the margin to cut demand for the commodities that fuel these economies. And that explains the price drop in commodities from oil to fertilizer to copper. But while the slowdown in growth in Asia is pretty much what Wall Street has been expecting ever since the U.S. economy started to slump, the slowdown doesn't seem to be happening because growth in the U.S. economy has slumped. Instead, soaring inflation in Asia seems to be at the root of the slowdown, and the damage to Asia's economies is largely self-inflicted. We're seeing the beginning of a shift away from the fight against inflation that has contributed to a slowdown in economic growth in Asia back toward more growth-at-any-cost policies in the region. In the short run, that will act to stabilize prices for most commodities near current levels. And even after recent 20% drops, those levels are well above the prices that Wall Street analysts are projecting for 2008 and 2009. That means, in my opinion, that on the fundamentals we've seen most of the decline in the prices of commodities. In the long run, the shift away from fighting inflation and toward growth at any cost is going to accelerate global inflation. Note that the battle against inflation in an economy such as China's has hardly been won. Inflation dropped to 6.3% in July at the consumer level but is running at 10% or better at what's called the factory gate in China (roughly equivalent to producer prices in the United States). That means the next wave of inflation will begin from a higher base rate. A move back toward growth in Asia at this time almost guarantees that global inflation will accelerate to dangerous levels in the next few years. In that environment, you want to own commodity stocks and other inflation hedges.

Endurance test DURING the six months to the end of June commodities posted their best performance in 35 years, rising by 29%. In July they had their worst month in 28 years, falling by 10%. The slide continues: an index compiled by Reuters, a news agency, shows that prices are almost a fifth below the pinnacle reached in early July. The Economist’s index, which excludes oil, has fallen by over 12%. Breathless headlines have hailed the bursting of a bubble. But most analysts are more reticent. They cite various reasons for the recent drop in prices, chief among them the darkening economic outlook in rich countries. In recent weeks it has become clear that Europe and Japan are faring even worse than America, and so are likely to consume less oil, steel, cocoa and the like. But that does not necessarily presage a collapse in commodity prices, they argue, thanks to enduringly strong demand from emerging markets such as China. Oil consumption, for example, has been falling in rich countries for over two years. Goldman Sachs expects them to use 500,000 fewer barrels a day (b/d) this year than last. But it reckons that decline will be more than offset by an increase of 1.3m b/d in emerging markets. It predicts China’s demand for oil will grow by 5%. A similar story could be told of many commodities. Marius Kloppers, the boss of BHP Billiton, a huge mining firm presenting its results this week, argued that emerging markets were much more important to the firm’s fortunes than rich ones were. Developing countries, he said, consume four to five times more raw materials per unit of output than rich ones do. He predicted that China’s use of steel, already greater than any other country’s, will double by 2015. China’s continuing and rapid industrialisation, he argued, would outweigh any temporary slowdown in exports owing to the weakening world economy—although demand for metals that are used in consumer goods, such as aluminium and nickel, may suffer somewhat.
As Mr Kloppers pointed out, emerging markets, and China in particular, now account for the lion’s share of growth in global demand for raw materials, and a good chunk of overall consumption (see chart).

Oil

New oil network very capable An oil terminal and pipeline network expected to be built off the Texas Gulf Coast in about two years would be capable of handling nearly 20% of the nation's daily imported oil. Demand from expanding refineries along the coast, from Freeport to Port Arthur, is driving the $1.8 billion project, executives of the joint partnership said Monday. It will be the second offshore port in the Gulf of Mexico. The Texas Offshore Port System, or TOPS, is a joint venture of Enterprise Products Partners LP and Teppco Partners LP, both based in Houston, and Oiltanking Holding Americas Inc., a subsidiary of Germany's privately held Marquard & Bahls AG. The terminal will allow huge oceanic tankers to unload crude about 36 miles off the coast of Freeport, avoiding sometimes fog-shrouded coastal areas and other hazards. Two floating buoys at the terminal will be connected to a pumping facility anchored in 115 feet of water, which will move the oil to shore via an undersea pipeline. Once ashore, another pipeline network will carry the oil to storage tanks and refineries. Altogether, the pipeline network is expected to be 160 miles.

As Oil Giants Lose Influence, Supply Drops Oil production has begun falling at all of the major Western oil companies, and they are finding it harder than ever to find new prospects even though they are awash in profits and eager to expand. Part of the reason is political. From the Caspian Sea to South America, Western oil companies are being squeezed out of resource-rich provinces. They are being forced to renegotiate contracts on less-favorable terms and are fighting losing battles with assertive state-owned oil companies.And much of their production is in mature regions that are declining, like the North Sea. The reality, experts say, is that the oil giants that once dominated the global market have lost much of their influence — and with it, their ability to increase supplies. “This is an industry in crisis,” said Amy Myers Jaffe, the associate director of Rice University’s energy program in Houston. “It’s a crisis of leadership, a crisis of strategy and a crisis of what the future looks like for the supermajors,” a term often applied to the biggest oil companies. “They are like a deer caught in headlights. They know they have to move, but they can’t decide where to go.”
The sharp retreat in all of the commodities’ prices over the last month, about 20 percent, reflects slowing global growth and with it reduced demand for more oil in the short term. But over the next decade, the world will need more oil to satisfy developing Asian economies like China. The oil companies’ difficulties suggest that these much-needed future supplies may be hard to come by.
Oil production has failed to catch up with surging consumption in recent years, a disparity that propelled oil prices to records this year. Despite the recent decline, oil remains above $100 a barrel, unimaginable a few years ago, causing pain throughout the economy, like higher prices at the gas pump and automakers posting sizable losses. The scope of the supply problem became more clear in the latest quarter when the five biggest publicly traded oil companies, including Exxon Mobil, said their oil output had declined by a total of 614,000 barrels a day, even as they posted $44 billion in profits. It was the steepest of five consecutive quarters of declines.While that drop might not sound like much in a world that consumes 86 million barrels of oil each day, today’s markets are so tight that the slightest shortfalls can push up prices. Along with mature fields, the companies have contracts with producing countries whose governments allocate fewer barrels to oil companies as prices rise.

• The Street : Energy Gut Check Oil has slipped more than 20% from its all time high in July. Ann Kohler, managing director, Caris & Company, discusses why it could fall even further.
• Power Breakfast: Petrobank Energy Unconventional energy assets are becoming a mainstream source of supply. BNN talks to John Wright, president and CEO, Petrobank Energy, about his company's presence in the hot new frontiers of exploration.

To mix oil and profits, think small There's a crisis in the oil industry -- at least among the publicly traded oil companies of the United States and Western Europe. Falling oil prices aren't the cause of this crisis. And rallying oil prices aren't going to fix it. I think this summer's correction in oil prices is just a pause in the long-term upward trend. I stand by my April prediction that oil will hit $180 a barrel by April 2010. But higher prices won't solve the production problems facing the big international oil companies. The stocks that most investors think of when they think of investing in oil -- and the oil stocks that make up the biggest share of energy exchange-traded funds and mutual funds -- aren't going to be the best performers in the sector over the next decade. I think you'd do much better owning a mix of the shares of more-obscure and smaller oil producers, the shares of a few publicly traded national oil companies and the shares of oil drilling and service companies. In this column I'll explain why I think investments in those shares will outperform money plunked into the shares of the Western majors and give you some stocks to consider for your portfolio. The crisis facing the major Western oil producers isn't the result of the 22% drop in the price of a barrel of crude from the intraday high of $147.27 on July 11 to the Aug. 19 close at $114.53. That Aug. 19 close was, after all, still a huge 59% above the August 2007 spot price of crude, according to the U.S. Energy Information Administration. The big oil companies are in crisis because their production is falling. You'd figure that with oil at $114 or $147 or even last August's $72 a barrel, the big companies would be doing everything they could to pump more oil to boost profits. And that they'd be doing everything they can to find more oil and to get the new discoveries into production. But that's exactly what isn't happening. For the second quarter of 2008, the five biggest publicly traded oil companies -- ExxonMobil, BP, Royal Dutch Shell, Chevron and ConocoPhillips (COP, news, msgs) -- reported earnings of $44 billion and a decline in oil production of 614,000 barrels a day. The decline marked the Western majors' fifth consecutive quarterly drop in oil production. During the same period, the oil producers that make up the Organization of Petroleum Exporting Countries have been able to jack up production to an estimated 32.6 million barrels a day in July, an increase of 2 million barrels a day, or about 7%, since June 2007. That increase in supply plus a drop in demand in the U.S. and Europe due to higher prices and slower economic growth led to this summer's retreat from the July high. (OPEC now seems to be in the process of unwinding that increase in order to prevent oil prices from falling much further.)

Geo-politics

Escalating Russia tensions yet to hit market One of oddest things about financial markets is how they can overreact to a rainstorm in the Gulf or the earnings forecast of a tech company yet completely overlook something like the beginnings of a global political crisis. The Russian siege of Georgia provoked yawns on Wall Street in its first few days last week, overshadowed by the Olympics in China and a brief summer rally in financial stocks. As my colleague Darrell Delamaide points out in his political column this week, that's because many global investors see Russia as an emerging market, where Russia sees itself as an aggrieved superpower. Make no mistake. The hostilities in Georgia might soon come to an end. But a major fault has opened up in relations between East and West that threatens not just global securities markets, but the economic health of Europe and the foreign policies of the major industrialized countries. Markets cannot ignore this forever. Continued Russian aggression -- right or wrong, depending how you look at Russia's point of view -- has the potential to impact emerging markets, established markets, debt markets, commodities markets, currencies markets and any other markets that cross borders. The flare-up may well settle down. But the issue is now squarely on the table, for Bush, the next president and all global markets. For now, it's a war of words, blusters and veiled threats. If Russia decides to play its energy card, and threaten Europe's oil, it becomes much more. When markets have slept through events like this in the past, they usually have awakened with a jolt, and it's never pretty.

Investors Looking To Leave Russia?  On Friday, Russia's central bank announced that its foreign currency reserves — a key part of its economic stability and an indicator of foreign investor support — had plunged $16.4 billion in the most recent week, to $581.1 billion (see chart). Until Russia's move into Georgia, there seemingly had been only massive capital inflows, thanks mainly to the rising price of oil, which makes up 20% of Russia's gross domestic product. Now, it seems, investors are fed up with the rampant militaristic nationalism, red tape, corruption and anti-investor sentiment in Vladimir Putin's Russia. Some have decided to head for the door and take their money with them. Last week's decline was the largest since Russia's 1998 currency crisis, which led to a collapse of the ruble and rampant triple-digit inflation. So far this time, there's no major visible impact on Russia's economy. But if the flow of money leaving Russia turns into a flood, it could send Russia's markets into a tailspin, creating massive problems for Prime Minister Putin and his handpicked president, Dmitri Medvedev. Any continued movement of capital out of Russia could prove disastrous. As we noted above, Russia really is a hollow economy, its growth kept afloat by soaring oil prices and a commodity boom which have both boosted investment in Russia and made its overall economy look much better than it is. In fact, Russia is an economic nightmare in slow motion. Due to poor health care and widespread alcoholism, its population is declining by 500,000 a year — a trend that's expected to accelerate in coming years. Inflation is revving up again, after declining for several years, and now is growing at about a 14% yearly rate — and rising. Moreover, data from the European Bank for Reconstruction and Development show that, despite the oil-fed boom, Russia's GDP per capita is just 2% above where it was when the Berlin Wall fell. That means, essentially, there has been no growth at all for 20 years. Of the 15 former Soviet republics that got their freedom after the collapse of communism, 11 are growing faster than Russia. This is Russia's big vulnerability under Putin. With oil prices falling, Russia's reserves will come under more pressure — and the import boom that has kept the new class of Russian oligarchs happy will come to a screeching halt.

Posted by dblwyo at 06:07 AM | Permalink | Comments (0)

Well we'll savor just a small smidgeon of feeling prescient today. Not only are the markets being led down by the Finance sector but one of Bloomberg's lead-off articles (picked up and reinforced as a must-read by BigPicture) was on the re-emergence of the credit squeeze. This morning's other major economic news was Existing Home Sales, which when you take it apart was about as bad as it could be. The headline, as usual for the MSM when dealing with such profound subtleties as recurring seasonal patterns visible for decades, was far off base: Existing Home Sales Top Estimates But Prices Plunge.The real goto is of course CalculatedRisk July Existing Home Sales: Record Inventory . There'll you find that the news was about as bad as it could be with a significant rise in months of sales inventory, a severe price decline, a dominance of foreclosure and short sales and a severe YoY drop in sales. You may recall our post on the crisis coming to head with Fannie and Freddie, perhaps this week which concluded with a promise/threat to take a deep dive review of the structural problems facing the Credit Markets and the Finance Industry and the chart above. What that charts shows in looking at the inflation-adjusted monetary base is that as THE result of the credit crisis liquidity is fast disappearing. While conversely the spread between 10Yr Treasures and Fed Funds, which normally shrinks during a downturn along with a drop in the Monetary Base in a previously predictable pattern, has jumped significantly. A kind of reverse conundrum where instead of long-term rates staying low when they shouldn't as the result of worldwide liquidity excesses they're increasing as those excesses are being drained from the system.

After the break we pull together several prior analysis of the various structural aspects of the crisis so you can see them all in one place and get a better handle on how they all play out together. But we want to start you with a selection of the weekend's headlines, to which you need to pay some careful attention.

Libor Signals Credit Seizing Up as Banks Balk at Lending in Money Markets Most of the bond strategists and salesmen that Resolution Investment Management Ltd.'s Stuart Thomson talked to last August expected the credit crunch to be long over by now. Instead, money markets show there's no end in sight, and it may even worsen. ``It's like an ongoing nightmare and no one is sure when we're going to wake up,'' said Thomson, a money manager in Glasgow at Resolution, which oversees $46 billion in bonds. ``Things are going to get worse before they get better.'' In a replay of the last four months of 2007, interest-rate derivatives imply that banks are becoming more hesitant to lend on speculation credit losses will increase as the global economic slowdown deepens.

Freddie, Fannie Failure Could Be World `Catastrophe,' Yu Says A failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac could be a catastrophe for the global financial system, said Yu Yongding, a former adviser to China's central bank. ``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic,'' Yu said in e-mailed answers to questions yesterday. ``If it is not the end of the world, it is the end of the current international financial system.''

View of economy somber from Fed mountain retreat 

"This turmoil is not going to go away quickly and will require serious efforts to overcome it," John Lipsky IMF

"The financial storm that reached gale force some weeks before our last meeting here in Jackson Hole has not yet subsided, and its effects on the broader economy are becoming apparent," Bernanke

"That's where we are today, in the middle of a financial crisis, with the economy sliding into recession, with monetary policy at maximum easing, and fiscal transfers impotent," Martin Feldstein, Harvard, NBER"More than a year into the most challenging financial crisis of our times we now face a complex and interlocking combination of rising inflation, declining growth, tightening credit conditions, and widespread liquidity tensions," Mario Draghi , ECB, Bank of Italy

A Shallow Recession -- Then a Shallow Recovery Is there a sign of a bottom in financials?The leverage in the financial-service industry is going to be wound down a lot, and I don't think the return on equity for these companies is going to be as great as it has been in the past. So the earnings for these companies in the next up-cycle aren't going to be as good. Maybe the financials have gone down as far as they are going to go down, but I don't think they are going up with any verve. And it sounds as if you see the business model changing for these firms, and becoming less profitable in the post-credit-crunch world.When I came into this business in the mid-1960s, what a doctor made or what I made as a securities analyst or what a lawyer made working at a big firm was all the same. Five years out, our compensation had increased -- pretty much in parallel. But in the period from 1982 to 1999, the compensation in financial services expanded much more rapidly than it did in any other field. I don't know that a securities analyst is a whole lot smarter than a lawyer at a major law firm, and I don't see why securities analysts or investment bankers should be paid so much more. So I think there's going to be a convergence of compensation.

 They start with the aforementioned Bloomberg story about the resurgence of tough credit market conditions. Followed by what should be the scariest of them all - a quasi-official warning from a Chinese economist that the Chinese government is counting on being made whole in any FNM/FRE rescue. In other words the credit worthiness of the US government is on tender here - the alternative being a credit implosion that would make the BSC collapse a Su. walk in the park. Then of course the sages and gurus have issued their findings from the mountaintop and see nothing but continued trouble ahead. And finally an excerpt from a Barron's interview with Byron Wien in which he tells us the adjustment process of drying out the liquidity excesses will go on for years and that the Finance Industry as we knew it will disappear for ever.

After the break we walk thru the spreading credit contagion (the Rocks in the Pond or RiP Model), the linkages between credit and economic conditions, the bad feedback between the credit contagion and the economy and the implosion of Finance Industry business models. Needless to say we're making three key points.

1. This isn't over by a long shot.

2. There is a developing vicious feedback loop between credit problems and the economy which is likely to get worse before it gets better.

3. The Finance Industry as we've known it for almost 25 years is about to go thru an enormous re-structuring. 

Rocks in the Pond

 Let's start with our infamous "Rocks in the Pond" conceptual model which shows how failure in one market and asset class ripples up a chain of synthetic debt instruments to destroy value. At least in one dimension. And ripples across other credit markets as the whole mechanism is brought into question, even when the markets being impacted are not apparently directly related. Oddly enough this appears to be exactly what's happening and, as sadly anticipated, one asset group after another is rocking then toppling until we reach our current state of continuous chaos. (Cramer's Anniversary: Continuing Credit Metastasis and Economic Outlook)

 Vicious Cycles: Credit  Breakdown and  Economic  Feedbacks

When you put this back in the context of Finance Industry business operations and models you get a situation where all the players are exposed to further writedowns and loan losses. In fact "ALL" we've seen so far is the consequences of, say, the first few rows of the RiP model where a small subset of real estate related loans and instruments have gone bad and taken the associated synthetic debt with them. In other words as the economy worsens what you're going to see is increased losses in real estate, business and commercial loans and consumer loans. Which lead back to further credit tightening which engenders further economic weakness and so on and so on. The systems theorists call that a feedback loop, or after they've been drinking a vicious cycle.

Vicious Cycle II: Multiple Feedbacks and the Death Spiral Effect

The thing that everybody is missing - well one of the things actually - is that ALL we've seen so far is the breakdown internal to the credit and finance markets and the Finance Industry as the liquidities are dried up. That loop has yet to run it's course. But there are two that are just beginning. The first is the credit market - economy feedback which'll work thru the mechanisms outlined above. The next is the feedback connections normal to a business cycle where weakening consumer demand leads to a drop in business spending. (News Alert: Vicious Credit, Economy, Market Cycle Spotted) And in this case where globally spreading recession takes away the prop of exports from the US. The Credit Loop is in the danger zone while the other two loops are in the Warning (Yellow) Zone but are more than likely headed for the Red Zone as well. Hence our earlier warnings that the economy is beginning to cross the "Tipping Points" of a "normal" cyclic downturn. (Tipping Points, Blindsides, Ouches: Tough Times Getting Tougher,LT Business Cycle De-construction: Time to Pay the Piper)

Finance Industry Performance: Broken Business Models

Since 1980 the Finance Industry has taken an increasing share of US corporate profits and, as Wien points out, has done so on no clear fundamental or sustainable long-term basis. What drove that performance - which jumped post the bursting of the Tech Bubble - was leverage. When you look at the major lines of business of the industry as a whole what you see is that a primary difference between traditional banking or finance was the amount of leverage. In basic banking where deposits are re-loaned the leverage was 10:1, 10X. In Investment Banking the other major revenue source was basically advice and technical expertise. After the dust settles and the blood is sponged up we'll see a return to basics. But that's a long way away. The business models where leverage was driven to 30:1 or, using synthetic instruments, 70:1, are not only going away to never return. But the process is far from even started nor is the damage begun to be offset. In the near-term we can expect Lehman to disappear as an independent entity and Fannie & Freddie to be first Federally funded and then re-built (we sincerely hope). But that'll just be the beginnings of consolidations and buyouts, business models changes and a general de-leveraging and risk re-pricing. The Industry archives have extensive surveys, collections and analysis of all this and it's worth your while to at least just skim them over. But we'll particularly draw your attention to a couple of key postings. (Riding the Storm - NOT: Breakdowns, Culture & Malfeasance in Finance,Markets and Financials:4 Year Crunch, Broken BizzMods,  Red Sky Mornings, Investor Take Warning: More Finance Industry, Bad Times, Bad Companies: More Finance Industry)

Background on the Liquidity Crisis

 Market Drivers: Liquidity, Liquidity(Buyouts) and Buyouts (Buybacks)

Markets Drivers 2 (Buyouts): the Carry to Cash Economy

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

 $Trillion Losses: the Minsky Moment Continues

Credit Mess and the Fed: Understanding the Strategic Posture

Galt vs the Fed II: Credit Disequilibriums, Broken Markets and Economic Implosions

Posted by dblwyo at 10:35 AM | Permalink | Comments (0)

The threatened next post was going to be on a deep analytical dive on the nature of the credit crisis and the consequences for the Finance Industry. So that would appear to make reviewing the weeks economic news a sidetrip but it's actually not for a couple of reasons. Three actually. The deteriorating economic situation will be driving the worsening pressures on the Finance industry, both independently and inter-dependently the credit crisis is both on-going and worsening, at least in the sense of settling in, becoming more widespread (endemic not epidemic, that is persistent not an interruption) and we're in transition from a financial crisis into an economic slowdown. Finally we wanted to put up the "economic" news on the prorogation and characteristic of the widening credit problems which are now beginning to show up in the headlines to set the stage for the deep dive to come.

After the break you'll find the usual readings for review broken up into the Outlook, Key Indicators on Inflation, the Leading Indicators and Housing - including the on-going investigations into what turns out to be widespread fraud, and a whole slew of readings on various aspects of the credit markets and problems. One thing we find interesting is that at this point our view of the outlook is now widely shared and fleshed out by a collection of informed, astute and much better known observers from the Financial Times to Warren Buffett to the Goldman economics team. Must be a pony in there somewhere. All of which is best summarized by one of the key observer/players and demonstratably one of the most astute and critical, Prof. Ben: "The current financial and economic environment is one of the most challenging to Fed policymakers "in memory". Keep that one in mind - likely for the next three years or so. With all that setup out of the way we want to dive into some of the key data, where as is often the case, the reporting got it wrong to really wrong. That turns out to be especially true with regard to Unemployment Claims.

Unemployment Claims

 There was a reported drop in weekly claims, largely due to some administrative adjustments but as this chart makes clear the timetrends indicate a weak and weakening employment market (we trust you've now got a really good grasp on how dangerous that is). Sorry about the readability - an experiment that turned out not quite right. Anyway the top shows YoY changes monthly since Jan94, covering the last two mild downturns. No big spikes this time, yet, but it's getting serious. A point reinforced in the middle which show quarterly numbers back to 1Q87 - not there yet but gradually really climbing into the red zone. The bottom goes back to YoY changes to compare quarterly changes to GDP in case the message requires reinforcing.

Leading Economic Indicators

The next chart links YoY changes in the LEI to GDP, courtesy of Northern Trust. This is a particularly revealing chart as the LEIs are too often dismissed, or not taken seriously enough. And on a monthly basis that's fair. It turns out when you filter them thru the right transformation they are a revealing and powerful indicator of what's going on. What we see is the same trends that we saw in Unemployment claims - a steadily worsening picture, moving down steeply but not as sharply as prior downturns - reflecting the unusual nature of this cycle, a core economy not yet reflecting that downturn fully but likely to. EconPicData does his usual outstanding job of graphics in showing the recent data in this post, which brings home the abrupt drop in this month's measurements:Leading Economic Indicators (July). His posts on de-constructing the inflation indicators are also well worth your time.PPI (July): Mom Finished Goods up 1.4%, PPI (July): Finished Goods up 9.8% YoY.

Housing

We find it beyond ironic that one of the industries which jumped up in Friday's markets was the Homebuilder's, which rose ~2.4% and is still 38% over its' year low. Talk about optimism being the triumph of hope over experience ! Well the accompanying chart from Merrill Lynch's econ team via (H/T) Barry Ritholz and Big Picture should disabuse anyone of mis-placed, dare we say mis-priced, optimism. If anyone thinks we're done with the Housing collapse think this one thru. Starts are indeed catastrophically down, as they should be after a bubble. But inventories are historically, anomalously, extraordinarily high. UNTIL that backlog gets worked down...well you know the rest. The key thing to realize and factor into your own thinking is that these fundamental structural facts on the ground are NOT widely built into anybody's financial or macro-analysis.

In fact, taken on the whole, most of this analysis is not reflected in the general thinking as far aw we can tell. 

Economic  Outlook

Insight: Patience the virtue of difficult times Impatience is often the undoing of Shakespeare's characters, and the same applies to investors in contemporary financial markets. The credit crunch has been under way for more than a year, recession has been in the air if not in the data for what seems like an eternity, and it is tempting to see risk assets as cheap or oversold. The decline in oil, copper, corn and other commodity prices is a case in point. Cheaper commodities are unequivocally favourable for the economy. And if prices stabilise or fall further, positive headline inflation surprises will cause even greater repricing of interest rate futures contracts, lower policy rates will ensue and equities will have something to shout about. However, it is far too early to give the all-clear, because this economic downturn is unusual, and about much more than simple gross domestic product accounting. Here's why. This downturn is unusual because it is fundamentally about asset deflation and deleveraging, specifically in the banking and household sectors, following an exceptionally long and virulent credit boom. This type of cycle has self- reinforcing characteristics and typically lasts for years rather than months. The economic impact is only now beginning to become apparent in the US, Europe and Japan. By 2009 the global economy could be in recession, growing by little more than the 2.5 per cent deemed by the International Monetary Fund to qualify as one. Recession or not, there is unlikely to be any material economic recovery until after 2010. Notwithstanding the losses taken and the capital raised to date, banks have to do more of both. Losses on traditional assets such as mortgages, credit cards and consumer and corporate loans have yet to be taken. Central bank lending surveys, such as the US Federal Reserve's Senior Loan Officer survey, point to high credit aversion by banks through the first half of 2009. Since April, bank asset growth has stalled or fallen. Falling house prices destroy net wealth and are weakening consumption, while more limited access to dearer credit will force a rise in household savings rates. The sharp rise in headline inflation, globally, may now subside but it is likely to remain uncomfortably high in many emerging nations, leading to downside growth risks. Growth in non-Japan Asia, for example, is expected currently to slip to 6.8 per cent in 2009, about 25 per cent lower than in 2007. In aggregate, emerging market inflation has now risen to 12 per cent, while policy rates are barely 8 per cent on average.

• Nobel Laureates Scholes, Stiglitz Predict Slowdown; Goldman Sees Recession
• Goldman Sachs Economists Say Half of the World's Economy Faces Recession

Buffett sees economy weak into '09  Warren Buffett said the U.S. economy is unlikely to improve before 2009, and there was a "reasonable chance" that Fannie Mae (FNM.N) and Freddie Mac (FRE.N) shareholders would be wiped out though the companies themselves are too big to fail. Speaking on Friday on CNBC television, Buffett, the billionaire investor, said some businesses in his Berkshire Hathaway Inc insurance and investment conglomerate are struggling as the economy suffers from past excess in making credit available. "You always find out who's been swimming naked when the tide goes out. We found out that Wall Street has been kind of a nudist beach," said Buffett, who was called the world's richest person by Forbes magazine. Referring to credit deterioration, Buffett said, "Right now the situation is still getting worse, and I would say that I don't see any early end to that." He also said Federal Reserve Chairman Ben Bernanke "does not have any magic wand" to bolster an economy facing weak growth and mounting inflation. "In my judgment it won't be any better five months from now," he said.

Key Indicators 

Wholesale Prices Surge at Fastest Pace Since 1981 Wholesale inflation surged in July, leaving prices for the past year rising at the fastest pace in 27 years, according to government data released Tuesday. The Labor Department reported that wholesale prices shot up 1.2 percent in July, pushed higher by rising costs for energy, motor vehicles and other products. The increase was more than twice the 0.5 percent gain that economists expected. Core prices, which exclude food and energy, rose 0.7 percent. That increase was the biggest since November 2006 and more than triple the 0.2 percent rise in core prices that had been expected. The bad news on wholesale prices followed a report last week that consumer prices shot up by 0.8 percent in July, leaving consumer inflation rising at the fastest pace since 1991. The July price pressures reflected in part the big surge in energy costs during the month that pushed crude oil prices to a record of $147.27 per barrel and sent gasoline pump prices to an all-time high of $4.11 per gallon.

Double-digit Inflation in 2009? Growing evidence suggests American consumers, businesspeople, and political leaders should all be bracing for double-digit inflation, probably as early as 2009. The relative price stability of the past 15 years is giving way to worsening inflation, despite the recent softening of oil prices. The Consumer Price Index for all items shows the inflation rate averaged 2.6% a year from 1992 through 2007 but has doubled since January, reaching an annual rate of 5.6% in July. By next year, the monthly figure could hit double digits, and the inflation rate for 2009 overall could triple 2007's 2.85%. I say this not only because I have looked at a broad range of statistics that point in this direction. I also run a private equity investment firm that owns companies in a number of industries -- including restaurants, the manufacture of gardening tools, oil and gas exploration services, and distribution of entertainment products such as books and videos -- that are already being forced to pass price increases on to the consumer. The skyrocketing price of oil is obviously a central element in the accelerating price spiral. But a sea change in China's role is beginning to have a huge impact as well. With commodity costs rising for so long, why are we feeling the impact so suddenly? The answer is that China can no longer bail us out with low-cost manufacturing. For years, American manufacturers and retailers offset rising costs by sourcing more products from China, where they could be made cheaply. That kept prices down for American consumers and also restrained pressures on wages, abetting price stability. But now costs are rising quickly in China, too.

U.S. July Leading Economic Indicators Index Declines More Than Forecast The U.S. slowdown will deepen in the second half of the year as housing continues to slump and unemployment rises, according to a measure designed to predict the economy's direction. The Conference Board's index of leading indicators fell 0.7 percent in July, more than triple the drop forecast by economists surveyed by Bloomberg News. Separate reports today showed the number of Americans collecting unemployment insurance remained near a five-year high last week and manufacturing in the Philadelphia region shrank for a ninth straight month. ``The economy has really shown one sign after another of weakening,'' Martin Feldstein, a Harvard University economist, said in a Bloomberg Television interview in Jackson Hole, Wyoming, where he's attending an annual Federal Reserve conference. Feldstein said he is ``much more pessimistic than a year ago'' about the outlook.

Housing Starts Fall by Most in 17 Years Home building projects started in July fell 11 percent to the lowest annual rate in more than 17 years, while building permits tumbled 17.7 percent, the Commerce Department reported on Tuesday. The annual pace of housing starts at 965,000 slimly beat Wall Street's expectations of 960,000, but it was the lowest since a 921,000 unit rate in March 1991. In June, housing starts rose 10.4 percent, revised up from the previously reported 9.1 percent. Building permits, an indicator of future construction, dropped to an annual rate of 937,000, well below the 970,000 analysts polled by Reuters had forecast. The magnitude of the drop in permits was the biggest since a plunge of almost 24 percent in February 1990, while the number was the lowest since March this year, when they were 932,000. Single family homes, which constitute the bulk of new housing, were especially weak. The annual unit rate of 641,000 single family homes started in July was the lowest since January 1991, when they were 604,000. Building permits were 584,000, the lowest since 523,000 in August 1982.

Zillow Q2 2008 Real Estate Market Reports Press Release U.S. home values in the second quarter posted the largest year-over-year decline in the past 12 years(1), dropping 9.9 percent from the year-ago quarter and 1.7 percent from the first quarter to a U.S. Zillow Home Value Index (HVI) of $206,919(2), according to the Q2 Zillow Real Estate Market Reports(3) released today. The median U.S. home value has not been this low since the fourth quarter of 2004, leaving nearly one-third (29.1%) of homeowners who purchased since 2003 with negative equity(4). The significant majority of MSAs (140) lost value since the second quarter of 2007 and those in some of the hardest hit markets have seen more than one-third of their home's value lost in the past year. For example, the Zillow Home Value Index in Stockton, Calif. fell 38.2 percent from the year-ago quarter while the Las Vegas, Los Angeles and Miami areas have fallen 27.4 percent, 21.4 percent and 20.8 percent respectively. Nationwide, nearly one in four (23.7%) homes sold during the past year sold for a loss while nearly 15 percent of sales were foreclosures(5). In parts of California, more than 60 percent of homes sold in the past year were for a loss while homes sold in foreclosure exceeded 50 percent. In New York- Northern New Jersey-Long Island MSA, which has the lowest rates of foreclosure among the markets monitored by Zillow, the percentage of homes sold for a loss since the second quarter 2007 is 8.8 percent and the percent of homes that sold in foreclosure is 3 percent. In many markets, the rate of these Distress Signals is two to three times what was reported just a year ago. For example, 32.7 percent of homes sold in the second quarter were sold for a loss and 18.6 percent were foreclosure sales compared to the year-ago quarter when the rates were 12.2 percent and 7 percent respectively. Interestingly, homeowners seem to be oblivious to the reality of the housing market as it pertains to their individual home. As reported last week through the Q2 Zillow Homeowner Confidence Survey(6), 62 percent of homeowners think their home value increased or stayed the same in the past year and 75 percent expect their home value to increase or stay the same in the next six months. Based on the Q2 Real Estate Market Reports, 77 percent of homes actually declined in value over the past year, a slight increase from the 75 percent that declined year-over-year in the first quarter.

Fraud in Real Estate, Mortgages & Homebuilders Anyone who follows the real estate market long enough will eventually become familiar with various forms of fraud that at times lurks in the industry. Any industry where large sums of money are involved invites unsavory characters.  With median home prices well over $200,000, housing was no different. I do not believe Real Estate related fraud, under most circumstances,  is all that widespread or common. One of the many things that made the 2002-2006 housing boom so unusual, however, was that fraud had become pandemic. What might start out as a minor conflicts of interest slips over time into something more nefarious. When False statements get made to counter- or third parties who in good faith rely on those statements to their detriment, you have the makings of fraud.  And what these types of undisclosed misleading statements become the norm, you have systemic fraud. The most recent cycle saw many different types of fraud perpetrated by various industry players. All together, these various fraudulent actions contributed in a large way to the extent of the housing boom. Here are what I see as the most common forms of fraud during the 2002 - 06 cycle:

• FBI Probes Unusual Incentives for Home Buyers

 Weak rules cripple appraiser oversight As soaring home prices set the stage for America's great housing meltdown, a critical step in making sure those home sales were a fair deal -- the real estate appraisal -- was undermined from within. After the nation's last major banking disaster, Congress set up a system to catch rogue appraisers. Their game: inflating the value of homes at the direction of equally unscrupulous real estate agents and mortgage brokers, whose commissions are determined by the size of the deals. But a six-month Associated Press investigation found that the system is crippled by both the bumbling of its policemen and their inability to effectively punish those caught committing fraud. And despite ample evidence appraisers are pressured into inflating home values -- sometimes to prices in support of loans that are more than buyers can afford -- the federal regulators charged with protecting consumers have thus far made a conscious choice not to act.

• Nonfeasance in Financial Oversight

On-going Financial  Crisis & Consequences

Bernanke: Financial Crisis Taking Toll on Economy Federal Reserve Chairman Ben Bernanke said Friday the financial crisis that has pounded the country -- coupled with higher inflation -- is taking a toll on the economy and poses a major challenge to Fed policymakers as they try to restore stability. "Although we have seen some improved functioning in some markets, the financial storm that reached gale force" around this time last year "has not yet subsided, and its effects on the broader economy are becoming apparent in the form of softening economic activity and rising unemployment," Bernanke said in a speech to a high-profile economics conference here. Although Bernanke welcomed the recent drops in prices for oil and other commodities, and believes inflation will moderate this year and next, the Fed chief said the inflation outlook remains highly uncertain. The Fed, he said, would monitor the situation closely and will "act as necessary" to make sure that inflation doesn't get out of hand. The current financial and economic environment is one of the most challenging to Fed policymakers "in memory," he acknowledged. Given those dueling economic cross-currents-- weak economic growth and higher inflation -- many economists believe the Fed will leave rates where they are at its next meeting on Sept 16 and probably through the rest of this year. The bulk of Bernanke's speech dealt with the need to bolster oversight of the nation's financial system to make it better able in the future to withstand future shocks. To that end, Bernanke recommended that regulators work on ways to assess the health of the entire financial system, rather than the condition of individual banks, Wall Street investment firms or other financial companies -- as is currently the focus. "Such an approach would appear well justified as our financial system has become less bank centered," he said. "Some caution is in order, however, as this more comprehensive approach would be technically demanding and possibly very costly both for the regulators and the firms they supervise," he added. He also said that "stress tests" for a range of financial firms might also be helpful.

Financial Crisis Expected to Bring More Big Shocks The year-old financial crisis is not only far from over but could actually get much worse, bringing more big shocks to the US economy and stock market, a host of experts said Monday. Among the predictions: the failure of some of the country's biggest financial institutions, the collapse of 1,000 banks and a possible government bailout of mortgage giants Fannie Mae (NYSE:FNM - News) and Freddie Mac (NYSE:FRE - News). "I think the financial problem is halfway through the cycle," David Kotok, chairman and chief investment officer from Cumberland Advisors, told CNBC. "There's another shoe to drop ahead of us and it could be more severe." Kotok thinks Merrill Lynch (NYSE:MER - News), Wachovia (NYSE:WB - News) and other financial companies are at risk of failure as the cost of raising capital soars at a time when the banks need to pay settlements over auction rate securities. The cash companies need to shore up bad investments, "is up to about $50 billion and will probably top $100 billion before it's over," he added. Meanwhile, billionaire investor Wilbur Ross told "Squawk Box" that a thousand banks could fail before the financial crisis is over. "Not very big ones necessarily," he said. "But a thousand banks is going to be a lot." And the impact on the credit crunch could be severe, he added. "Each dollar of bank equity that gets lost takes out about 12 or 13 dollars of loans so there's a tremendous magnifier effect of small changes in bank equity." His comments were echoed by Morgan Stanley co-President Walid Chammah, who told a German newspaper that the financial crisis will probably not end until next year or even 2010.

Bond market jitters return -- Don't look now, but the markets could be headed for another stomach-churning drop. U.S. stocks have rallied over the past month, as the price of crude oil has tumbled after a long run-up and the dollar has rebounded from a long decline. The dollar's bounce and oil's fall have delivered some badly-needed good news to consumers pinched by a weak job market and to companies squeezed by soaring materials and transport costs. But if the past month's developments in the stock, currency and commodities markets have been welcome, there are other signs that the good feelings could be short-lived. Take a look at the credit markets, where borrowing costs are rising for all sorts of companies as spreads between safe Treasury securities and riskier corporate bonds expand. These trends suggest that bond investors don't share the rosy view being exhibited lately by shareholders - a divergence that, given the bond market's past success in predicting stock market action, may point to a coming pullback in stocks. But even before Monday's raft of bad news, there were worrisome signs in the financial sector. Financial giants such as American Express Citi and AIG have lately paid big premiums to raise billions of new cash in the bond market. Last week, AIG offered investors an 8.25% yield for $3.25 billion of 10-year notes, and Citi offered 6.5% for $3 billion of five-year notes. Those yields are substantially above the rates the companies paid earlier this year, reflecting continued uncertainty about the firms' finances after tens of billions of dollars in writedowns. Financial fears are visible elsewhere in the bond market as well. Rosenberg notes that the spread between the yields of the 10-year Treasury note and lower-rated corporate bonds, dubbed the 10-year Baa spread, recently hit 326 basis points, or 3.26 percentage points.

The next credit crunch We made it through the bursting of the Internet bubble and now the bursting of the real estate bubble. Next we may be approaching the end of the most worrisome bubble of all: the standard-of-living bubble. That conclusion comes from the latest data on credit card debt. It's growing fast, but the problem is bigger than that - and to understand what it means, we have to take a few steps back. For the past several years, the average inflation-adjusted total pay of American workers hasn't been increasing. That means we haven't been building a foundation for increases in our living standard. You might be tempted to say that by definition our living standard couldn't have increased, but that's not quite right. Even with stagnant real incomes, we can always live a little better every year through borrowing and pretending that our living standard is still rising, just as it was for decades. So the Great Bull Market made us feel rich, and we felt justified in saving less and borrowing - and spending - more. After stocks collapsed, home prices took off, making us feel rich all over again. So we continued saving less and spending more, creating the illusion that our living standard was still rising. In 2005 our personal savings rate went negative, but even that didn't slow us down, because our homes were still appreciating - and rising home values meant that household net worths weren't declining. Of course, we don't hear those assurances anymore. Stocks are back where they were eight years ago, and home prices are where they were five years ago. But personal debt is much higher than ever before, and average pay is still going nowhere in real terms. So now how do we live as if our living standard is still rising? That's where the credit card reports come in. Last year, just as the subprime crisis happened, credit card debt took off. The home-equity ATM had been shut down, so people turned to the last source of easy money they had left, the most expensive debt on the menu, credit card borrowing. Since credit card debt has been growing much faster than the economy - more than 8% in last year's third and fourth quarters and over 7% in May (the most recent month reported)- people are apparently using it as a substitute for income. Thus, for the past year or so we have still maintained the standard-of-living illusion. But a big crunch is coming - and here's why.

Debt & Borrowing  Today’s New York Times  carried an article calling attention to Americans’ diminished infatuation with debt and borrowing, and expressed the hope that Americans may begin to save once more. That of, course, implies reduced spending. Here are some excerpts from the article: “For more than half a century, Americans have proved staggeringly resourceful at finding new ways to spend money……“But now the freewheeling days of credit and risk may have run their course — at least for a while and perhaps much longer — as a period of involuntary thrift unfolds in many households. With the number of jobs shrinking, housing prices falling and debt levels swelling, the same nation that pioneered the no-money-down mortgage suddenly confronts an unfamiliar imperative: more Americans must live within their means…….“The long collapse in the United States savings rate is over,” said Ethan S. Harris, chief United States economist for Lehman Brothers. “People are going to start saving the old-fashioned way, rather than letting the stock market and rising home values do it for them.” The binge may be done, but get ready for the hangover. The economy has become dependent upon rising borrowing (and therefore indebtedness) to support the increased demand that is key to production’s and employment’s healthy growth. When borrowing slows, however, so does spending. (Note the residential-construction collapse.) And that has always brought recession. This time is no exception. The following chart captures households’ and businesses’ borrowing binge.

Investment-Grade Yield Spreads Rise to Record on Concern About Bank Losses The extra yield investors demand to own U.S. investment-grade bonds over Treasuries rose to a record for a third straight day amid concern that financial companies may take more writedowns and losses. The gap climbed 3 basis points to a record 311 basis points today, according to Merrill Lynch & Co.'s U.S. Corporate Master index. It was the third time the spread reached a new high this week, surpassing the gap of 305 basis points set March 20, just after the government brokered a takeover of Bear Stearns Cos. Investors are commanding greater concessions from banks and brokerages, which have logged $504 billion in asset writedowns and credit losses since the start of 2007. Investment-grade spreads will keep climbing until investors are assured that financial companies are well capitalized, said Matthew Eagan, a vice president at Loomis Sayles & Co. in Boston.

Corporate Bonds Feel Pain The gap between the yields of corporate bonds and those of ultrasafe Treasury securities has grown to a multidecade high as financial institutions have struggled to raise money. The credit markets are treacherous ground for financial institutions, and their recent struggles raising money are dragging down the corporate bond markets. In recent days, price declines among investment-grade bonds have pushed their spreads -- the gap between their yields and those of ultrasafe Treasury securities -- to a multidecade high, according to Merrill Lynch data. These bonds now yield 3.11 percentage points more than Treasurys on average, exceeding their recent March peak at 3.05 points. That erases the improvement that took place from April to June, after investors were heartened that Bear Stearns's problems didn't topple the financial system. Junk-bond spreads are also growing, but at 8.3 percentage points, the gap over risk-free Treasurys remains below March's high of 8.6 points. The current junk spread is still well under multidecade highs at 11 percentage points hit November 2002 -- the bottom of the tech-driven downturn that included large bankruptcies such as Enron and WorldCom. The investment-grade bonds of banks, brokerage firms and other financial companies have suffered the most pronounced decline. Spreads on their debt have reached new highs as well, at 3.78 percentage points over Treasury bonds, significantly higher than the 3.62 point peak in March. Investors and analysts are concerned about the ability of financial institutions to withstand the now yearlong pressures on their balance sheets from illiquid assets and deteriorating loans, a weakening economy and a mountain of debt coming due in coming quarters. Fears about the future of housing-finance companies Fannie Mae and Freddie Mac are also weighing on the market for corporate debt.

• Worry About Stretched Firms, Consumers Hits Debt Markets

Posted by dblwyo at 09:31 AM | Permalink | Comments (0)

Well diving back into the on-going trials and tribulations of the Finance Industry wasn't today's strategic objective but with the industry ETF (XLF) up 3.3% and LEH closing up 7.4%, after being up over 11% on rumors of some sort of buyout, injection, something it seemed necessary. In a perverse way it pairs perfectly with the prior discussion of the dismal and deteriorating Retail outlook. The Finance outlook is much worse and the causes are linked - there's still more write-offs, the economic downturn will worsen loan losses and credit continues to tighten. In fact the spreads on some corporate bonds, discussed in the readings, are getting so bad that the credit markets are clearly anticipating a wave of bankruptcies in both the Finance industry and the general economy as the result of all this.

After the break you'll find the usual collection of readings. We want to couple those readings with an analytic review of the economy, monetary situation, the credit markets and the industry outlook. Which is far too much for one post so we're putting up this part with the readings and a few kickstart graphics and will plan to follow-up with the analytical dissection later. The readings are broken up into three clusters: some general stuff and examples, including some excellent BNN interviews which we've annotated a tad, some specifics on the disaster children (LEH, FNM, FRE) and some other exemplars (MER, AIG). The excerpts for the later, especially AIG, illustrate the pit fall trying to apply traditional analysis to companies facing these perfect storms of problems AND broken business models. On the other hand Dennis Berman's dissection of MER's stock float and the implications for the future is an excellent example of the kind of thinking that should go on. As is the BNN interview with Dick Bove where, among other bon mot gems, he points out that Dick Fuld of LEH has three days to pull the trigger or get bought in a hostile takeover. If not in so many words. The other thing that folks are missing, for all practical purposes, is that the Fannie and Freddie are effectively bankrupt with stock prices as close to zero as makes no never mind. What's going to happen when they have to be salvaged we wonder ? Talk about the collapse of Western Civilization if BSC was a threat this is the 8,000lb pre-historic ape in the parlor. We'll pick up the graphic with the next post but it shows a shrinking money basis as credit tightens and a rising yield spread between Fed Funds and 10Yr Treasuries. Most likely due to worries over the dollar and interest rates as the result of all this mess. Think about it in this context.

The Lehman Disaster 

And then consider the accompanying LEH stock chart, which shows today's bump true enough. But also shows the implosion over the last year as all these problems eat away at it. Today's little bump up in this context doesn't mean so much does it ? Wonder how it managed to take the markets up with it ? The story is that all the folks approached by Fuld have been balking because he wants 20% over book value, i.e. a ~ $40 price. Instead he'll be lucky to get $15-20 and has destroyed his company by not dealing with these problems. As Bove points out.

The Fannie/Freddie Catastrophe

But whatever has been going on at LEH is nothing compared to FNM and FRE - which are central not just to the Housing market but to our economy. Talk about too big to fail ! The "funny" thing is that when you dig back thru it, like MER and Citi, most of the really bad crap they engineered for themselves was done in '06 and '07. In other words after the crisis in Housing was generally visible and should have been crystal clear to companies who's entire existence depended on understanding those markets and mechanics. Talk about your boiled frogs being flayed and displayed. 

We dissected all that at great length in a prior post which you may want to review:

Bad Times, Really Bad Behavior, Bad Trouble: Fannie/Freddie and Perdition Road

Finance's Dismal Future

Wall Street, meet small street Storm-tossed financial firms are throwing their treasures overboard just to stay afloat. After years of rapid growth, the big players on Wall Street are downsizing. Stung by billions of dollars of losses and impoverished by plunging stock prices, firms from AIG and Citi to Goldman Sachs and UBS have been selling assets, laying off workers and mulling over possible split-ups. But with credit markets sending distress signals again, even a measured scaling-back may not be enough to see some firms through the next tempest. That's why, like Merrill Lynch before it, Lehman Brothers) is now considering jettisoning a prize asset in the name of raising cash. Indeed, investors have been consumed this year by uncertainty over the value of financial firms and their mortgage-heavy portfolios. One measure of that opacity lies in how much of a firm's asset base it designates as Level 3, signifying that the values have been assigned without any market input because none was available. Over the past four quarters, assets designated Level 3 by the eight biggest commercial and investment banks rose to $612 billion from $461 billion, according to investment strategist Ed Yardeni. While many of those assets no doubt have substantial value, the fact that no market exists to readily set a price suggests firms wouldn't be able to sell them to raise ready cash except at a steep discount. Beyond that, the sheer size of these illiquid asset stores is startling. Recent data show that both Lehman and Goldman Sachs have more Level 3 assets than they do tangible equity, a measure of the firm's value to shareholders.

• Market Lookahead BNN sets you up for your trading day with Bill Strazzullo, partner and chief markets strategist, Bell Curve Trading. [Worthwhile for the distinction between balanc sheet and income statement problems. Too optimistics on credit markets IOHO]

National City Bond Trades Show Looming Defaults KeyCorp Yields Can't Deny Never have regional banks been so disrespected by bondholders. National City Corp. Chief Executive Officer Peter Raskind says Ohio's biggest lender is the ``best capitalized of all major U.S. banks'' after raising $7 billion this year, yet its bonds show it's at risk of default. Cleveland-based National City's bonds have plummeted as much as 17 cents on the dollar since June and yield more than 10 percentage points above Treasuries, similar to Ford Motor Co. debt. KeyCorp, Comerica Inc. and Fifth Third Bancorp have also tumbled, falling as much as 14 cents. The declines underscore growing speculation among investors that the more than $500 billion of credit losses and asset writedowns sparked by the collapse of the housing market are nowhere near ending, and there is little Federal Reserve Chairman Ben S. Bernanke or Treasury Secretary Henry Paulson can do. ``It's like catching a falling knife and I'm not real interested in that,'' said Eric Johnson, president of Carmel, Indiana-based 40/86 Advisors Inc., which manages $25 billion in fixed-income assets. Until yields on corporate credit and mortgages stabilize, ``it's still going to be too early to buy.'' More than a dozen regional banks have been closed by state or federal regulators since 2007. The number of lenders on the Federal Deposit Insurance Corp.'s ``problem'' list climbed to 90 in the first quarter from 76 in the fourth quarter, the agency said in May, without naming the firms.

Bond yields hint at corporate bankruptcies AS RECESSION FEARS loom for the world's leading economies, analysts say a rise in corporate bankruptcies is inevitable over the next 12 to 18 months, and the banking sector could provide a larger-than-expected chunk of the proportion of companies that fail. According to the Merrill Lynch Corporate Master index, which tracks the performance of dollar-denominated, investment grade-rated corporate bonds, there are 72 bonds trading in distressed territory, 28 of which have been issued by banks. We are forecasting 110 banks with $850 billion in assets to fail by next July. That's eight times the FDIC's total reserves," says Chris Whalen, managing director of Institutional Risk Analytics. "The next president of the U.S. is going to have to create a vehicle to buy banks that we can't sell after they fail." The fallout from IndyMac has hit the broader banking sector hard, as evidenced in the option-adjusted spreads -- a measure of a security's extra yield over the yield of a comparable treasury security after accounting for any options or sinking funds -- on outstanding bank bonds.

The Evolution of Private Equity Despite the credit crunch some deals are getting done - but the amount of leverage is significantly less. BNN discusses the evolution of private equity with Howard Johnson, president, Veracap Corporate Finance.

Ron Insana's Hedge Fund Closure a Cautionary Tale Hedge funds used to be seen as a license to print money, but 2008 is shaping up to be the year the bubble burst. Earlier this month, former CNBC anchor Ron Insana folded Insana Capital Partners, the hedge fund he launched in 2006, while superstar investor Dan Benton announced that he's shuttering his $2 billion hedge fund Andor Capital Management in October. Our guest, New York Times M&A reporter Andrew Ross Sorkin, detailed Insana's travails on his DealBook blog, and goes into the finer points of the rash of hedge fund failures in the accompanying video.

 Key Player Problems: LEH, FRE, FNM

Lehman On The Bubble  Richard Fuld seems to be putting himself and Lehman Brothers into a corner. The embattled chief executive can't find willing investors, even overseas--perhaps because Lehman Brothers shares have tanked 61% since the last time the company raised capital. The $4 billion of common stock sold in June as part of the $6 billion total capital raised is now worth $1.8 billion. On Thursday, the Financial Times reported Fuld tried to convince the Korean Development Fund to buy 50% of his company last month and was turned down. The inability to raise cash, even from sovereign investment funds that have eagerly embraced U.S. investments since the credit crisis began, speaks to the difficult straits Fuld finds himself in. It's clear he puts Lehman's value well above where the rest of the market thinks it should be. Lehman's book value is $34 per share, but its stock trades at $13. Lehman's market capitalization of $9 billion as of Thursday is equal to the low end of the value attached to its Neuberger Berman asset management division alone. That implies the market values Lehman's remaining operations at zero. Richard Bove, an analyst at Ladenburg Thalmann, says this disconnect makes Lehman ripe for a hostile takeover. "It is possible that negotiations to sell a portion of the company to outsiders broke down because management was demanding to be paid book value or a premium to book value," Bove said Thursday. "So the market is at a standoff." Lehman is heading into another quarterly loss, according to analysts, whose views of the company's financial performance this summer grow increasingly pessimistic. That would be the second-straight loss for the bank, including an estimated $4 billion of additional write-downs.

• Pitfalls of a Lehman Sale Looking to sell its asset-management business sounds like a last-ditch move for Lehman Brothers, and any deal needs to be bold to clear the clouds hanging over the firm.
• Lehman Jumps After Korea Development Bank Says It's Considering Investment
• Lehman's Korean Suitor BNN speaks to Dick Bove, analyst, Ladenburg Thalmann. [This is the best discussion with insightful context from the anchor that we've heard]

Freddie Hunts for Cash Freddie Mac executives are talking to private-equity firms and other investors about the possibility of buying new common or preferred shares, but many investors fear their money will be lost if the Treasury bails out the companies. But that effort is running up against what may be an insurmountable hurdle: Many investors fear any money they invest now in Freddie or its main rival, Fannie Mae, will be lost later if the U.S. Treasury bails out the companies through a purchase of equity in them. Investors believe such a purchase would likely involve terms that would wipe out the value of previously issued shares.

Fate of Fannie and Freddie Hinges On $225 Billion  Mortgage companies Fannie Mae and Freddie Mac are facing a $225 billion question. That is the amount of debt the companies need to refinance by the end of September. Thus far, they have had little trouble persuading investors to buy debt with maturities of a year or less. But investors say the mood could change as long as details of any potential government bailout remain murky. Shares of both companies have been hammered for weeks by fears they would no longer be able to function, a problem that would likely cripple the U.S. housing market. Last month, Congress gave the Treasury Department the authority to lend money to the firms or take an equity stake. Because investors have little idea how Treasury would intervene, they have become less enthusiastic about adding Fannie or Freddie debt to their portfolios, creating a potentially self-fulfilling spiral. For Treasury, which is mulling how to structure a rescue of the two mortgage companies, if necessary, the ability of the pair to keep turning over their debt is paramount. Treasury Secretary Henry Paulson has said the government has no plans to use its authority. But Treasury is developing a series of options that it could use to shore up the companies if a market seizure forced them to intervene, according to people familiar with the matter. The steps they take will depend on market conditions at the time and the needs of the firms, these people said. Among the options at Treasury's disposal is to make a large capital injection that would essentially result in a takeover by the U.S. government. Such a move wouldn't be undertaken lightly, these people said, and would be done as part of a broader plan to remake the companies. Among the issues being debated is whether to oust management and whether to treat both companies equally or devise a rescue for one and not the other. Treasury has no imminent plans to intervene, but a deterioration in the housing sector could force its hand if either company can no longer fund itself.

Other Examples: MER, AIG 

Slim Pickings at Merrill Lynch What if you woke up one morning and had 615 million more mouths to feed? And your fridge? It's half-empty. This is the dilemma for Merrill Lynch Chairman and Chief Executive John Thain, who last week unveiled an $8.55 billion sale of new Merrill common stock. Coupled with other share offerings, previous Merrill holders will be diluted by 615 million shares, or roughly 38%. The market seemed to overlook this dilutive donnybrook, instead focusing on Merrill's other plan, to dump $30.6 billion in crummy derivatives. Mr. Thain tinkered with the timing of his problems: trading today's derivatives-pricing mess for tomorrow's earnings shortfalls. All this wheeling and dealing will soon leave Merrill with 1.6 billion shares outstanding. To return to an earnings-per-share level of $4.40 each, Merrill will have to produce annual net income of a little more than $7 billion. Right now, Street analysts are predicting median per-share earnings of $2.65 for 2009, or net earnings of $4.2 billion, according to Thomson Reuters. In other words, Merrill needs to come up with $2.8 billion in new profit -- not sales -- to get back to its 2004 per-share earnings levels. That's $43,000 in new profit for each of Merrill's 65,000 employees. Oh, and don't forget Merrill's dividend. Merrill continues to pay out 35 cents a share per quarter. Layer on 615 million more shares, and that's an additional $861 million out the door each year. That's precisely the problem. All those businesses have largely disappeared. That puts most of the earnings burden on Merrill's old-line businesses -- brokerage, asset management and investment banking. Mr. Thain embraces these units as Merrill's future, as well he should. But those new mouths are hungry. And the fridge is indeed sparse. Amid a flagging general economy, that leaves few options for Mr. Thain: Cut costs even deeper, hoping that the franchise can stay intact with ever-fewer employees. Somehow grab market share from other Street houses. Or, gradually, start to take on more risk on Merrill's trading desks, which produced the bulk of the $30 billion in losses over the past 12 months.

The Lessons of AIG From a high of $72 in early 2007, AIG has now collapsed to just $24.40. That follows an eye-watering plunge today, following dismal second-quarter results and some fears about the balance sheet. Mr. Greenberg, of course, retains a very large stake in the company. The shares he kept have, of course, plummeted along with everyone else's. But his sales still saved him, and his family, hundreds of millions in further losses. The unhappy investors who bought his shares aren't the only ones crying. AIG raised $20 billion in new money in May to shore up its balance sheet. That included selling new shares for $7.5 billion. Those who invested have already lost $2.7 billion, or more than a third of that, due to the collapse in the stock price. AIG has become blotting paper, soaking up investors' money. Over 10 years, they have actually lost half their stake. This is not a minor financial story. In sense, everyone in America is a loser. AIG is one of the most valuable companies in the world. If you have a pension plan or money in any stock mutual funds, the odds are strong that you have lost money on this stock. The question remains whether the latest plunge is the time to buy, or whether, in that unhappy Wall Street phrase, things are going to get worse… before they get even worse. And there's some reason to think shares have already baked a lot of further bad news into the cake. The latest plunge wasn't just about the dismal second-quarter earnings, and the further deep write-offs in the company's pile of bad mortgage-related investments. AIG management also added to the alarm with a PowerPoint slide suggesting future losses from its subprime and mortgage-related paper could reach another $8.5 billion. But if you listened to the conference call, that figure was based upon some very gloomy assumptions about write-downs and defaults.

Is Your Insurance Safe With AIG? For anyone who holds an annuity or other policy with insurance giant AIG, the current turmoil is surely both unnerving and frustrating. On the one hand, the news has been dreadful. The company has lost billions on bad investments due to the credit crunch. So far it has booked post-tax losses of more than $18 billion in the last three quarters, including $5.4 billion in red ink in just the last quarter. Wall Street has responded with alarm. AIG's stock price has collapsed by about two-thirds in a year, wiping more than $100 billion off the company's value. A former chief executive has already walked the plank. Meanwhile, the talk on has focused on the stockholders more than on policyholders. So is your policy, or annuity, safe with AIG? The good news is that there is no reason to be concerned, at least for now.

Posted by dblwyo at 02:58 PM | Permalink | Comments (0)

The prior post (LT Business Cycle De-construction: Time to Pay the Piper), which we've left up for your browsing pleasure for a bit to let it really sink in, covered the long-term structural and secular trends in the economy as well as the current cyclic outlook. To re-iterate we think we're crossing a "tipping point" where a normal cyclic downturn is beginning, or has begun as a matter of fact. And that we'll see increasing economic weakness in the months ahead. A good bellweather of this is retail sales and retailers performance, which is what we'll focus on here. And take the opportunity to correct an early data manipulation error we made.

Real Retail Sales Re-visited

If you look at the accompanying chart it contrasts real retail sales in the updated, or revised, version verses the old one. In both cases we tried to estimate real retail sales ex-gasoline, which requires an estimate of real gasoline station sales which is NOT available. We found the "scissors-blade" where real sales dropped and gas sales rose to be extraordinarily surprising. Some of that surprise remains but the new data isn't as anomalous. Nonetheless the fundamental result remains. Originally the overal CPI was used but this time we found a specific, or at least more specific CPI, index to apply. Now Gas sales follow a more rational pattern but are still absorbing a lot of the consumers budget. In any case there's been a severe drop in real gas sales. And overall real sales turned down in the Fall and negative around Jan08. Last month it was down ~ 2% ! And gas is dropping like a rock. That's as good an indicator of "look out below" for Consumer Discretionary and Staples stocks as anything we've seen. As well as an indicator, at least IOHO, that a recession began during the holidays and is accelerating. From the general economic situation to real retail sales takes us from 500K to 100K feet of analytical altitude. Let's drop lower.

Retail Stock Performance

 The next graphic is a Yahoo Finance tracking portfolio of key Retailer stocks which tells us whether or not that outlook is reflected in the market veiws. After the break you'll find a decent-sized collection of stories on earnings and outlooks which would strongly suggest that it does NOT. The other thing we'd suggest looking at is not just the daily changes, which are interesting for very short-term sentiment, but where those stocks sit in relation to their 50-day MA's and highs and lows for the year. TGT for example is above its' 50da and significantly below the year high while WMT, on the strength of its' relative performance (entirely earned IOHO again) is barely below it's high. LOW's is doing well and HD surprisingly so. Yet if our economic analysis is correct there are going to be some unpleasant surprises in store for all of these companies and their investors. The trick will be to sort thru them and find the good performers. Which in many cases means those who have re-thought their operations, strategies and execution. As WMT did and as HD is beginning to do, very well, when you dig into it. On the whole, however, we don't see that a reasonable view of the economic future is reflected in these prices. So if that takes us from 100K to 10K feet of altitude the next step is to get down as close to the ground as we can manage. Which requires examining each retailer in some detail - which is for some other time. Sears on the other hand has seen the penalities of substituting financial engineering for operational acument come full circle. Now that's a stock we'd steer well clear of for a long time to come !

Down on the Ground: Home Depot Example

But we can throw up one example in quick summary form. This next graphic is a composite from HD's last annual analyst presentation in which they outlined how they see the world, what they're doing about it and where they intend to go. Judging the whole (which you can collect from their web site btw) their grasp on the Housing market is enormously more realistic, the realize where they're broke and where they need to fix things and have a very good grasp on some key details, strategic initiatives and operational execution requirements. In other words we're very impressed, though now we all will see whether the charts are translated into store-level realities across the system. 

This chart is a composite drawn from the CEO and CFO's presentations and shows, starting in the UL corner  and moving clockwise, their outlook for Housing, and then their monumental re-think in how they invest their monies. Which represents as good a translation of business strategies and operational changes into financial strategies as we've seen. A major cultural change for HD in particular and American businesses in general. Think of it as a major indicator of sound corporate business practice. Followed then by store-level metrics that derive from their strategic and operational re-thinks but are translated into financial metrics. And finally overall strategic control metrics for major operating areas (and therefore initiatives).

The one metric we'd question is matching capital spending to depreciation. While financially sensible in the short-run, and likely dictated by conditions, this would be a time to invest judiciously in training, hiring, technology, logistics and all the other areas we outlined as strategic requirements. BtW - if you compare to our earlier assessment they hold up very well indeed (Six Steps to Prosperity: HD Initiatives to Consider,Performance Re-visited: Another Trip to HD's Woodshed). And compared to last summer have made a huge turn-around in their worldviews, which is vital.

The jury is of course out. And a huge amount of pain lies ahead because of the next two years of Housing problems as well as the general economic situation. Nonetheless keep your eye on HD ! And also think of this whole process as a way to approach business investment and performance analysis by linking top-down economic to bottom-up business analysis. In other words think of it as a model for the kind of analysis that Warren would be proud to see you do. 

Strategic Outlook 

Skies Darken For Retailing As Spree Fades  A number of retailers expect same-store sales, or those at stores open at least a year, to begin decelerating. That could disappoint investors who were hoping for easy comparisons against last year's weak sales.Throw into this mix July retail-sales data, which the Commerce Department reports Wednesday morning. Economists on average estimate a decline of 0.4% after rising a meager 0.1% in June. Excluding the grim automobile sector brightens the picture considerably. Adjusting for inflation, however, turns it dark again. Retreating energy prices may help. But J.P. Morgan Chase's Charles Grom notes that consumer spending is correlated more with unemployment, which is rising.Moreover, a new Federal Reserve survey shows about two-thirds of the country's loan officers reported tightening standards for credit-card and other consumer loans in the past three months, the highest in the 12 years the Fed has kept track and far higher than in the 2001 recession. That could mean less spending of cash at the malls. Retailers are managing inventory better, which helps preserve profits, "but the back half of the year, and well into 2009 still look troubled," said Adrianne Shapira at Goldman Sachs. The trends will play out differently for various retailers, several of which report this week, including Macy's on Wednesday, and Wal-Mart, Urban Outfitters, Kohl's and Nordstrom Thursday. Warehouse clubs and discounters should do OK. Still, product mix is shifting to lower-margin goods, and, as Costco Wholesale recently noted, inflationary pressures are pinching profits even for low-cost leaders. Department stores didn't benefit much from the rebate checks and likely will continue hurting, analysts said. Specialty retailers that aim to stay in touch with ever-changing trends, such as Urban Outfitters, are expected to benefit from shoppers' continued inclination to splurge on occasion. But up to what point? Urban trades at a rich 33 times trailing earnings.

• Wal-Mart Earnings: Wal-Mart reports second quarter earnings. BNN speaks to Burt Flickinger III, managing director, Strategic Resources.
• Home Depot and Target earnings Markets will get a gauge of the resilience of the U.S. consumer when Home Depot and Target release earnings. David Abella, portfolio manager and senior equity analyst, Rochdale Investment Management, talks retail with BNN.

Key Retailers

Housing malaise eats into Lowe's net Lowe's Cos. said Monday that its second-quarter profit fell 7.9%, hurt by the housing market downturn, which cut into demand for cabinets, countertops and other big-ticket purchases. Results, however, exceeded analysts' estimates, thanks to strength in seasonal sales as homeowners restored lawns and outdoor landscaping after last year's drought in much of the country. The No. 2 home-improvement retailer also benefited from the U.S. government's stimulus checks, which aided its comparable sales by as much as 1.5 percentage points, more than it projected. It also gained unit market share at its fastest pace in eight quarters as many independent operators closed shops, Chief Executive Robert Niblock said on a conference call with analysts.Despite better-than-expected results, Lowe's third-quarter profit forecast missed analysts' estimates as the retailer expected a continued challenging housing market into 2009, especially in regions such as California, Florida and the Gulf Coast. It also said it is evaluating the number of stores it plans to open for next year in light of the current sales environment. It said it will announce the final number next month. Sales rose 2.4% to $14.5 billion as the company opened in more locations. Same-store sales, or sales at stores open at least a year, dropped 5.3%.

• Lowe's beats 2Q estimates, despite profit drop

Home Depot's 2Q Profit Drops 24 Percent The Home Depot Inc., the nation's largest home improvement retailer, reported a 24 percent drop in second-quarter profit on Tuesday and reiterated its downbeat outlook for the year amid a weak housing market that shows no signs of recovery. The Atlanta-based company said net income fell to $1.2 billion, or 71 cents per share, in the three months ended Aug. 3, from $1.59 billion, or 81 cents per share, a year earlier. Sales fell 5.4 percent to $21 billion from $22.2 billion in the year-ago period. Same-store sales, or sales at stores opened at least a year, fell 7.9 percent. Same-store sales are considered a key indicator of a retailer's health. The results did beat the expectations of Wall Street analysts surveyed by Thomson Reuters, who projected earnings per share of 61 cents on revenue of $20.58 billion. "We continue to see pressure on our market and the consumer, generally," Home Depot's Chairman and CEO Frank Blake said in a statement. Despite the weak economic climate, he noted that the company saw improved execution in its merchandising and operations initiatives during the past quarter. Home Depot's business has been hurt by the sluggish economy and the housing slowdown, that's also battering its competitors such as Lowe's Cos. Inc. Lowe's reported Monday that its second-quarter profit fell nearly 8 percent, but managed to top Wall Street expectations as the nation's second-biggest home improvement retailer benefited from customers' efforts to repair last year's drought-stricken gardens, tight expense controls and better-than-expected sales. Lowe's offered a weaker-than-expected outlook for the third quarter, but raised its guidance for the full year.

• The Street :Home Depot Earnings & The Home Improvement How badly will Home Depot's earnings be hurt by the slump in U.S. housing? BNN speaks with Maureen Atkinson, senior partner, JC Williams Group.

Target Quarterly Profit Drops Target Corp (NYSE:TGT - News) reported a nearly 8 percent drop in quarterly profit on Tuesday as shoppers passed over trendy clothes and home decor in favor of everyday necessities, hurting its margins. The No 2 U.S. discount chain behind Wal-Mart Stores Inc (NYSE:WMT - News) said profit was $634 million for its second quarter that ended August 2, down from $686 million a year ago. Earnings per share rose to 82 cents from 80 cents, boosted by fewer shares outstanding in the quarter. Analysts, on average, had been expecting it to earn 76 cents per share, according to Reuters Estimates. The second quarter marked the fourth straight quarterly profit decline for Target as its shoppers, who once splurged on its cheap but chic cashmere sweaters or metallic handbags, pulled back on spending. Last week, Wal-Mart reported a 17 percent jump in second-quarter profit as bargain-hunting consumers scoured its stores for food, medicine and electronics. "Wal-Mart has staked out the position with its 'Save Money. Live Better' tagline ... that they are the king of low prices," said Craig Johnson, president of retail consulting firm Customer Growth Partners. To compete, Target needs to go beyond advertising its stylish merchandise and incorporate the message that "we'll save you money and we'll help your family make it through these economic times," he said. To improve results, Target has focused more on items such as food or medicine that bring shoppers in more frequently. It is also putting a bigger emphasis on the "Pay Less" side of its "Expect More. Pay Less." tagline. But Target has said it does not intend to significantly change its strategy due to the current economic climate. Target also said it saw soft sales trends in the quarter. Its retail sales, excluding credit-card revenue, rose almost 6 percent to $14.97 billion from $14.17 billion. Sales at stores open at least a year, a key retail gauge known as same-store sales, slipped 0.4 percent. Its second-quarter gross margin rate declined from last year, driven by faster sales growth in lower-margin merchandise, the company said.

Staples Warns on 2Q Earnings, Shares Lower Staples Inc. warned Tuesday that its second-quarter results, excluding its acquisition of Corporate Express, would be weaker than anticipated as American consumers pulled back on spending. The Framingham, Mass.-based office supply company said revenue rose about 3 percent and earnings per share fell about 15 percent in the quarter, compared to a year ago. At the end of the first quarter, Staples executives predicted that earnings per share would be flat in the second quarter. Staples said sales in North America were hurt by lower customer traffic and smaller orders, leading to a revenue drop of 1 percent as comparable store sales fell about 7 percent over 2007. International sales rose 17 percent, with a big boost from a weak dollar, and rose 6 percent when measured in local currency.

Saks Reports Wider 2Q Loss, Shares Tumble Luxury goods retailer Saks Inc. reported a wider-than-expected loss for the second quarter on Tuesday and delivered a downbeat forecast for the year as its affluent customers cut back on apparel amid a slowing economy. The New York-based retailer said it lost $31.7 million, or 23 cents per share, for the three-month period ended Aug. 2. That compares with a net loss of $24.6 million, or 17 cents per share, in the year-ago period. Revenue fell 3.5 percent to $669.2 million from $694.1 million a year ago.Thomson Reuters says that analysts it surveyed expected a smaller loss of 19 cents a share on higher revenue of $679.2 million. Saks said it expects its 2008 operating margins, excluding certain items, to decline from 2007 levels. It also expects same-store sales, or sales at stores open at least a year, to be anywhere from unchanged to down by low-single digit percentages for the second half of the year.

Strategic Re-thinkings

Engineering a Change at Wal-Mart  Eduardo Castro-Wright took over as chief executive of Wal-Mart Stores Inc.'s U.S. stores division in 2005. The economy was relatively robust, but sales growth at the $240 billion unit was slowing as its rivals' surged. One solution the Bentonville, Ark., discounter tried -- luring higher-income shoppers with trendier fashions -- had flopped, eroding profit. Mr. Castro-Wright, an engineer trained at Texas A&M University, devised a three-year plan to overhaul stores marred by cluttered aisles and slow checkout lines. As Wal-Mart prepares to report fiscal second-quarter earnings on Thursday, the changes appear to be paying off. Its U.S. stores have beat or hit sales targets for the last six months, besting most of its competitors. Sales slowed somewhat in July, though, as the last of the federal tax-rebate checks were spent, and Mr. Castro-Wright noted that consumers are growing more cautious. The company's return to its low-price roots has been seen as a boon to consumers. But recent efforts to warn its work force about proposed legislation that could make it easier to unionize companies have given Wal-Mart's opponents new ammunition. Wal-Mart: $1 billion expansion in Brazil, Wal-Mart Earnings Analysis: Analysis of Wal-Mart's earnings, with John Lawrence, of Morgan Keegan

Tesco Sets Sights on India Tesco PLC, one of the world's largest retailers by sales, is joining forces with India's Tata Group to target the emerging Indian middle-class consumer market. U.K.-based Tesco announced plans Tuesday to invest about £60 million, or about $115 million, during the next two years to become the latest global giant to set up wholesale "cash-and-carry" stores in India. Current Indian regulations allow foreign retailers to invest here only through such wholesale outlets -- which sell to other businesses such as hospitals, hotels or other stores -- or through franchise and licensing agreements. Tesco has also agreed to put its expertise and technology behind the Tata Group's expansion into hypermarkets. For a fee, Tesco will teach Tata Group's retail arm, Trent Ltd., how to set up large retail stores and streamline its supply chain. Tesco has been expanding globally in recent years in an effort to diversify away from its home market in the U.K. The Tesco-Tata move comes at a time when many retailers are discovering that it isn't as easy as they hoped to make money in India. Some are scaling back expansion plans, and Indian consumers haven't been spending enough to sustain all the newcomers. Still, Trent has ambitious plans for its hypermarkets, which are called Star Bazaar. The company already has four outlets and plans to open 46 more stores in the next five years. "Through the wholesale agreement, Trent will gain access to the supply-chain infrastructure, which Tesco will set up in coming years," Trent Managing Director Noel Tata told reporters.

Posted by dblwyo at 01:44 PM | Permalink | Comments (0)

Well in case you hadn't noticed today was a bit bad in the markets, led down by the financials as the realities of the dreaded credighetti monster re-surfacing, with more bad news from LEH, FNM and FRE. The latter were down 22% and 25% respectively. As were Financials (-3.6%) and Consumer Discretionary (-1.7%) in general. Not surprising in light of our thinking but the really interesting headlines were on Lowe's, which closed up slightly (.16%) on better than expected earnings. Consider the following headlines (from Marketwatch, AP) and especially the emphasized line:

Housing malaise eats into Lowe's net Lowe's Cos. said Monday that its second-quarter profit fell 7.9%, hurt by the housing market downturn, which cut into demand for cabinets, countertops and other big-ticket purchases.  Results, however, exceeded analysts' estimates, thanks to strength in seasonal sales as homeowners restored lawns and outdoor landscaping after last year's drought in much of the country. The No. 2 home-improvement retailer also benefited from the U.S. government's stimulus checks, which aided its comparable sales by as much as 1.5 percentage points, more than it projected. It also gained unit market share at its fastest pace in eight quarters as many independent operators closed shops, Chief Executive Robert Niblock said on a conference call with analysts.Despite better-than-expected results, Lowe's third-quarter profit forecast missed analysts' estimates as the retailer expected a continued challenging housing market into 2009, especially in regions such as California, Florida and the Gulf Coast. It also said it is evaluating the number of stores it plans to open for next year in light of the current sales environment. It said it will announce the final number next month. Sales rose 2.4% to $14.5 billion as the company opened in more locations. Same-store sales, or sales at stores open at least a year, dropped 5.3%.

• Lowe's beats 2Q estimates, despite profit drop

 Along with a lowered outlook you'd think that would hardly be a reason to bid up the stock. As usual what we think is going on is that the lack of grasp on the nature, timing, structure and lags in the business cycle completely escape everyone in general. For example the new meme is that while the world is headed in the tank the US is potentially headed back up. BtW - that differential explains the dollar bounce along with interest rate gaps...watch out. But other than that one line nobody gave the most important retail statistic much attention.

Let us offer up another stat that will be completely ignored - no coverage whatsoever. Real weekly wages were updated by the BLS after the CPI release. Guess what...they were down -3.1%. In fact for the last six months the figures are: -1.4, -.8, -.9, -.7, -1.1,-2.5 and -3.1% ! Remember our "Tipping Point" discussion - well it certainly looks like it's here IOHO. We're going to spend the rest of this post digging thru some big picture economic data to try and read ourselves into a more realistic, data-grounded context. Hopefully in such a way that you can reach your own conclusions. 

GDP vs Consumption

Let's start with a comparison of GDP and Consumption (PCE) back to 1980. Take a gander at this little chart which shows the YOY% change in the two. If there's any doubt about this being cyclic speak now. We'll draw your attention to the teeny little tail where both, but especially consumption, have dropped below the trendline. Now ask yourselves - what recent data you've seen, or read here, would indicate that's going to turn around ? We think the more relevant question is what will the downturn look like - '01, '91 or earlier ?

Recession vs Growth Recession

You might recall that the Fed's current published forecast calls for growth thru 2010 of less than 2% - in fact they're counting on it to reduce inflationary pressures. When the economy grows at less than its' full employment potential think of that as a "growth recession". More importantly translate that out of geekspeak and into pain indicators. That means lost jobs, lowered spending, bad earnings pressures, you name it. Just to put that in context we ran back to 1960 or so and ranked downturns as Recessions (<0%), Week Growth Recessions (0-1%) and Growth Recessions (1-2%). And ended up with this fascinating chart. Note: if you believe our measures we almost experienced a growth recession at the end of '06 but were saved by the oil price drop and saw one again this last couple of quarters. But we are, in fact, now in a growth recession !!

If you'd really like to dig a little more into what's going on we put together some more economic cycle charts running back to 1960 where possible so you can see how the economy (GDP), Consumption and Investment relate and what links to what in the lag structure. We also - and this is especially important - look at the key drivers of future consumption demand. Which are growth in employment and real wages. Like we said at the start that news is getting worse fast. See what it means and keep reading (and of course click to enlarge the charts). 

BtW - the most interesting and potentially useful chart on Wages, Employment and future demand is the last one :) ! 

Consumption and Employment

Here's a composite chart that takes GDP, Consumption and Employment back to 1960. If that doesn't look like your perfect theoretical business cycle then we give up. We think it's beautiful - though scary. Notice that, in general, Consumption tends to trigger an economic downturn though not always. And go down proportionately as far - which it did not do because of the Housing ATM. The piper is playing and we avoided a major downturn with his music after the Tech Bubble. But now he's coming to get paid. When you look at Employment though you can see he already collected part of his fees. Employment dropped relatively farther during our "mild" '01 downturn than in previous ones and never recovered as well. And we wonder why people have been "whining" for the last few years - makes sense now doesn't it ?

Investment

If Consumption is the engine of the economy the accelerator that speeds it up or slows it down is Investment. And for almost every period and cycle since the end of WW2 there's been a regular and predictable relationship between the economy and Investment. Unfortunately that afore-mentioned Housing ATM was part and parcel of a Housing Bubble unlike anything we've seen. In fact anything I've heard about forever. And we're in the process of an unprecedented bust that'll stretch out for at least another couple of years. So, congratulations. We're all the proud parents of two back-to-back bubbles that are going to burst with unfortunate consequences. Notice that Investment follows along quite nicely with GDP thru this whole period - except for the last few quarters when it's pulling down and away much more rapidly than you'd expect. When we breakdown investment into its' Capex and Real Estate components you can see why. RI is tanking big time. But here's the real rub - that we know about. If the Economy tips over what happens to Capex ? And Tech Spending ? And.....tech company revenues, profits, earnings and stock prices ? Now there's an interesting question. 

Wages, Employment & Consumption

The critical question is what's going to happen to consumption ? Will the engine get starved of fuel ? Well, judging by the changes in real wages it's already beginning to be. If employment tips over, as one would expect, you can count on it. Take a look at this composite which shows the key indicator - W+E vs Consumption on the bottom and the pieces (Real Wages, Employment) on top, since 1960. W+E looks to be dropping like a rock - or more importantly like it has in other previous, serious downturns. When you look just at Wages that's the primary current reason. Though we will point out that YoY Employment went negative with the last month's payroll data. And bear in mind the Birth-Death adjustment is still adding in more "virtual" jobs than the actual data. When some real data gets collected and the model's parameters get refreshed we're all likely to be in for some very unpleasant surprises.

Posted by dblwyo at 03:23 PM | Permalink | Comments (0)

After the break you'll find the week's collection of readings on the general worldwide outlook, plus some specifics on Dubai and China, trade and currencies, particularly the role of exports in keeping the US up and the rise in the dollar and a particularly interesting discussion of long-running trade imbalances. That may be all besides the point. Make no mistake about the world's in the process of a tectonic shift in the underlying geo-political structure. The rise of inflation with the accompanying pressures on food and energy prices were an initial trigger. The collapse of the Doha round into domestic agricultural protectionism was a major warning shot. One we might have worked around in time. Russia's unprovoked invasion of Georgia puts it in the position of controlling Europe's energy supplies as well as mediating access to Central Asia and, to some extent, the Middle East. All the assumptions we've all made about how the world will work in terms of stability, security, globalization and worldwide growth are now up for grabs. (Marching thru Georgia: the World Just Changed and We Can't Get Off) We'll try and pursue that line of inquiry at some future date - particularly in conjunction with a discussion of worldwide Oil markets - but do keep it in mind. Especially since the markets and the prognosticators aren't...yet.

Meanwhile we'll focus back on the worldwide economic news - which is almost uniformly bad. BtW - in the readings you'll find the URL's for the Economists free on-line tables for economic and financial information. A worthwhile resources. In the meantime let's consider the state of play of some key worldwide economies, largely courtesy of the Northern Trust econ team who continues to do such thorough and excellent work.

Europe and Japan

 The most recent economic numbers from Japan and Europe are not encouraging, to say the least. As you can both had pretty severe QtQ dives with the latest reports after holding up more than well thru the end of last year and the first quarter of this. Unfortunately the expectations are for rapidly deteriorating conditions in the future. Below you'll find the OECD's outlook for the G-7 which are "set to slow more sharply in the months ahead." That looks pretty sharp so far to us. In fact Friday the WSJ had a major front-page story on the "Global Economic Picture Darkens (WSJ)", which tells you how seriously this is beginning to be taken. Too bad nobody was paying attention back in Jan. or thereabouts when some pre-positioning was possible, instead of ex-post scrambling. Live and learn I guess.

Europe's Big Three

 The European big three, or continental big three (Germany, France, Italy) were the driving engines for those abysmal overall numbers and judging from the outlooks the rest of the continent is following. Associated with the OECD clipping are headlines for the UK, France, Japan, India, Hong Kong, and China. Guess what - you won't like any of them. After all our domestic sturm und drang it would appear that the rest of the world is deteriorating much faster than we are. But the re-coupling thesis will start running painfully in reverse when exports start drying up as these charts tell us will happen.

European Inflation

 As it happens we may enjoy another slight advantage. While our CPI numbers were also as bad as they've been the future outlook is for inflation to start dropping as energy prices come down. In contrast Europe appears to have a more structural inflation problem setting in. Which courtesy of the 1rst Guards Tank Regiment just got a whole lot worse. Europe, along with the rest of the world, appears to be moving into the worst combination of rising inflation and slowing growth. We'll have to see how that all plays out for them. But irrespective of the geo-politics none of this was good news.

Oil, Dollar and Emerging Markets 

Just to end on a cheerful note - NOT. Sorry just kidding. We're going to leave you with a single ginormous chart that shows the dollar, oil prices and the Russian and Brazilian markets. Not coincidently oil prices are down with the growing consequences of a worldwide slowdown. At the same time the downdraft in the dollar with our slowing economy and the growing European ones is reversing. That and the expectations of fewer oil imports, a smaller interest rate differential and so on and so on. The rest of the chart couples in the Russian and Brazilian stock markets. With oil down Russia would be in trouble anyway. Add in Georgia and you'd expect them to do terribly - and they are. But this isn't solely a Russian phenomenon as the Brazilian chart makes clear. Bear in mind Brazil is a commodity export driven economy and when the world imports fewere commodities, well....was it only 2-3 weeks ago that Brazil was the one emerging market you should keep investing in ? 

World Economic Outlook 

OECD Forecasts Sharper Slowdown for G-7 The world's leading developed economies are set to slow more sharply in the months ahead, according to the OECD's indicators of future activity. The world's leading developed economies are set to slow more sharply in the months ahead, according to the Organization for Economic Cooperation and Development's indicators of future activity. The OECD Friday said its composite leading indicator fell to 96.8 in June from 97.4 in May and was down five points from June 2007. The leading indicators for six economies of the Group of Seven leading developed nations fell from a month earlier; Japan's was unchanged. From a year earlier, indicators for all seven were down sharply. "OECD composite leading indicators...for June 2008 indicate a continued weakening outlook for all the major seven economies," the Paris-based think tank said.Over the rest of this year and into 2009, the OECD said, its leading indicators point to slowdowns in the U.S., Japan, Germany, the U.K. and Canada. They point to "strong" slowdowns in France and Italy. Italy Friday became the first big euro-zone country to report its economy contracted in the second quarter, raising expectations that Germany or France, and perhaps the euro zone as a whole, could follow when they report gross domestic product Thursday. Istat, the Italian statistics agency, said Italian GDP fell 0.3% in the second quarter, worse than expected, returning the country to the brink of recession after a narrow escape earlier this year. A recession is usually defined as a contraction of GDP for two or more successive quarters. Italy's GDP contracted 0.4% in the fourth quarter of last year, followed by a 0.5% rise in the next quarter. With at least two of the three big euro-zone economies set to slow sharply, the OECD said leading indicators also point to a strong slowdown in the currency area as a whole. That will help cement investors' expectations that the European Central Bank won't raise its key interest rate again. The ECB Thursday left its key rate unchanged at 4.25%, having raised it from 4% in July.

• U.K. July Producer Prices Increase at the Fastest Pace Since at Least 1986
• French Industrial Output Unexpectedly Fell in June, Led by Car Production
• Japan's Economy Shrank 2.4% in Second Quarter as Exports, Spending Dropped
• Soft industrial output dims euro-zone outlook
• Indian government sees growth approaching 8%
• Slower Growth Is Seen in Hong Kong
• Bank of England Says Economy Is Likely to Stagnate
• German, French economies contract in second quarter
• China's Industrial-Output Growth Slows on Olympic Closures, Weaker Exports

Global Economic Picture Darkens (WSJ) The global economy -- which had long remained resilient despite U.S. weakness -- is now slowing significantly, with Europe offering the latest evidence of trouble. On Thursday, the European Union's statistics agency said gross domestic product in the euro zone contracted 0.2% in the second quarter, the equivalent of a 0.8% annual rate of decline. It marked the first time since the early 1990s that GDP has fallen overall in the 15 countries that use the euro. In a fresh sign of the pressures facing the American economy, the Labor Department said Thursday that U.S. consumer-price inflation hit a 17-year high in July, rising 5.6% from a year earlier. With the European growth report, four of the world's five biggest economies -- the U.S., the euro zone, Japan and the U.K. -- are now flirting with recession. China, the world's fourth-largest economy, is still expanding strongly, as are India and other large developing economies. Still, weak growth elsewhere in the world is tempering the torrid rise in prices of commodities such as oil, copper and corn, giving relief to consumers from high gasoline and food costs and cutting manufacturers' raw-materials bills. U.S. benchmark crude on Thursday closed at $115.01, down roughly 20% from its July 3 peak of $145.29 a barrel. Easing inflation pressures could also make it easier for the world's central banks to lower rates in an attempt to fan flagging growth.

The global weakness marks a sharp reversal of expectations for many corporations and investors, who at the year's outset had predicted that major economies would remain largely insulated from America's woes. For the U.S., economic sluggishness abroad is both a blessing and a curse. Lower commodity prices are giving welcome relief. In addition, the dollar has strengthened as other economies lose steam -- which benefits U.S. consumers by cutting the cost, in dollar terms, of imports ranging from flatware to flat-screen TVs. Yet at the same time, weaker foreign economies also undercut one of the few remaining bright spots in the U.S. economy: exports. Indeed, in a sign the world is dialing back its shopping spree of the past few years, the Baltic Dry Index, a measure of demand for shipping services, has fallen 37% since hitting a record on May 20, including a stretch of 23-straight down days. Dollar strength could also hurt U.S. exports by making U.S.-made goods pricier abroad. The dollar rose against the euro Thursday to levels unseen since February.

Economist World Data Tables:

·          Output, prices and jobs 

·          Trade, exchange rates, budget balances and interest rates 

Countries and  Cases

Cracks surface in Dubai Cracks are starting to show in Dubai's well-crafted and glitzy property-marketing machine. Flipping properties has reached such a feverish pace, driving up prices, that Dubai's Real Estate Regulatory Authority, or RERA, is looking at measures to crack down on the practice, which involves quickly reselling property at a profit. Meantime, a series of legal tussles and property-related scandals have rocked investor confidence, and analysts are forecasting that property prices, which have risen sharply in a matter of months, could tumble by as much as 10%, hurt by oversupply. Fitch says speculative real-estate investment, fueled by fast price rises, adds to the risks of the bubble inflating. Similar bubbles popped in the U.S., Spain and the U.K. after rampant flipping and other trends similar to those in Dubai. Lacking the huge oil reserves of neighbor Abu Dhabi, Dubai has worked hard to turn itself into the region's tourist, business and transport hub. Real-estate development has been at the heart of this effort. But the global economic slowdown has all kinds of markets teetering on an edge -- and while the cash-rich Emirates are considered havens for investors, they too may be vulnerable to slowing global growth. In the worst-case scenario, Morgan Stanley says, property prices could follow those of Singapore in the late 1990s, when real-estate prices plunged 80% in 18 months. The market also has recently been rocked by a series of scandals involving some of the emirate's biggest real-estate players. So far, a robust economy and favorable regional economic conditions have deferred any slowdown and extended the period of rising prices. But the number of real-estate projects facing delays or cancellations is rising as developers face soaring construction costs and rampant inflation.

China shares hit 19-month low on economic fears- China's benchmark Shanghai Composite Index fell 5.2 percent Monday following the release of economic data showing wholesale price inflation jumped to its highest level in 12 years in July. China's benchmark Shanghai Composite Index fell 5.2 percent Monday following the release of economic data showing wholesale price inflation jumped to its highest level in 12 years in July. The Shanghai index closed at 2,470.07 on Monday, down 135.65 points. That was its lowest close in more than a year and a half. The Shenzhen Composite Index of China's smaller, second market plunged 6.6 percent to 698.37. Airlines, textile exporters and refiners led the decline. Two of three major publicly traded airlines dropped by the daily maximum 10 percent. The government reported Monday that the producer price index rose 10 percent in July over a year earlier, its highest rate of increase since 1996 and a jump over June's 8.8 percent rate. Such increases, fueled by rising energy and raw materials costs, add to pressure on consumer prices, complicating Beijing's effort to rein in politically sensitive inflation. Chinese investors have become increasingly jittery over the economic outlook amid signs that the malaise afflicting the U.S. and Europe might be spreading to Asia, with corporate earnings bound to suffer. Analysts said the start of the Beijing Olympics last week had quashed any lingering hopes for a games-related rally.

The search for the new China Dongguan City is the the shoe capital of the world: more footwear is made there than anywhere else on the globe. From 2001 to 2007, the value of footwear exports from its province of Guangdong doubled from $4.3 billion to $9.2 billion, according to China's state-run news agency. But in the past year, hundreds of factories have left town, driven out by the rapidly rising cost of doing business in China. That story is being repeated throughout China's provinces as manufacturers confront sharp price shocks, sparked by stricter environmental and labor controls, higher land and commodity prices, and the Chinese government's moves to curb its trade surplus by reducing the tax incentives that helped the country become the world's low-cost production epicenter. "In my research of multinational companies, 17% of manufacturers are moving investments out of China," said Ron Haddock, the Shanghai-based vice president of consulting firm Booz Allen Hamilton. "The majority go to Vietnam and India."

Rising yuan crunches outsourcers' bottom line

Trade and Currencies 

Over There, U.S. Goods Ride a Weak-Dollar Wave AMERICAN exports are rising at the most rapid rate in decades, helped by a weaker dollar and by rising prices of food sent overseas. The trade figures for June, released this week, showed that the dollar value of total exports was running at a pace 19.2 percent higher than it was last year. Not since 1988, another year when exports were helped by a falling dollar, have exports grown so quickly. Those figures are not adjusted for inflation, and the real increase is undoubtedly smaller given the rapid rise in the price of grains. But the increase is nonetheless substantial, as is shown in the accompanying chart. Imports are also growing, however, despite expectations that the weakening American economy would slow them down. Expressed in dollars, imports in the three months through June were 14.1 percent higher than in the same period of 2007, and the trade deficit was 6.6 percent higher. Nonetheless, there are signs of a slowing economy in the figures. Imports of oil and petroleum products soared 57.3 percent when measured in dollars. But imports of crude oil, measured in barrels of oil rather than in dollars, were 5.8 percent lower than in the same period of 2007. Change in U.S. Exports

Dollar Bottom Against Yuan Gets Louder as Traders Discount China's Economy Just as the Bush administration prepares to take a bow for persuading China to let the yuan strengthen 18 percent against the dollar over the past three years, the gains are grinding to a halt. The yuan retreated in the last two weeks after government officials said supporting growth is as important as fighting inflation. That raised speculation that currency policy will be adjusted to bolster exports as the trade surplus shrinks. Legg Mason Inc.'s Western Asset Management Co. is trimming bets on the yuan after it rose in July by the smallest amount in a year. China is reining in yuan appreciation to help exporters weather a global slowdown and deter so-called hot money, speculative funds attracted by anticipated gains in the currency. The yuan recovered from earlier losses today after a government report showed export growth unexpectedly gathered pace in July and the trade surplus widened for the first time in four months. China's economy, the world's fourth largest, expanded 10.1 percent in the second quarter from a year earlier. While that is the slowest pace since 2005, it's still the fastest among the world's 20 biggest economies. The yuan is likely to strengthen 3.4 percent to 6.63 in the second half of the year, according to the median estimate of 25 analysts surveyed by Bloomberg. So-called non-deliverable forward contracts indicate investors have been scaling back bets on currency gains. They suggest the yuan will reach 6.6060 per dollar in the next 12 months, an advance of 3.8 percent from the current exchange rate. Two weeks ago the contracts, which allow traders to bet on the future value of China's currency, predicted an advance of 5.3 percent. At the start of last month, they priced in a 6 percent rise. Forwards are agreements to buy and sell assets at current prices for delivery at a specified time and date. Non- deliverable contracts are used for currencies that can't be freely converted and are settled in dollars. China let the yuan strengthen against the dollar for the first time in a decade after mounting criticism from the U.S. and Europe that the nation had an unfair trade advantage. The U.S. trade deficit with China ballooned to a record $256 billion last year, equivalent to about a 10th of the Asian nation's gross domestic product. Yuan's Recent Retreats Spur Diminished Forecast

Why the Dollar Rally Ends Here The dollar has sprung off its deathbed, but a swift return to ruddy good health looks like a long shot. After years of steady depreciation, the U.S. currency has rallied strongly this month. The surge in the dollar's purchasing power - a euro now fetches $1.50, down from $1.57 near the end of July and $1.60 in April - is good news for U.S. consumers, because a stronger currency makes imported goods cheaper and helps to hold down inflation. And inflation, of course, can use some holding down: even after recent declines, the prices of commodities from crude oil to corn remain sharply above year-ago levels. Unfortunately, the dollar may not be much help there in coming months, because its run may be coming to an end. Big Funds Embrace Dollar

The riddle of the impossible surpluses One of the long-running riddles of the world economy is that international current account balances do not balance. During the last three years, the world has shown an arithmetical impossibility: ever-larger overall surpluses. Evidently a considerable amount of double-counting is going on, among both oil- and commodity-rich exporters and also other large surplus nations such as China, Japan and Germany. But, in lots of ways, the surpluses are real. Despite the credit crisis, signs of capital over-supply abound, seen for example in the almost daily news of sovereign wealth funds from Asia or the Middle East taking part in private equity transactions. The booming surpluses are mainly the result of climbing energy and commodity prices. They also reflect severe misalignments in international exchange rates, for instance between the Euro, renmimbi and dollar. Particularly among oil exporting states, the surpluses encourage profligacy. Plainly, far more money is being spent than is being earned. . In "normal" years over the last three decades, the total current account positions of the 181 members of the International Monetary Fund world added up to overall annual deficits, mainly ranging between $50 billion and $150 billion. Individual countries were plainly over-recording imports and other payments (for transfers and services) and understating exports and other receivables. In 2005, the world's current account balances - exceptionally - did actually balance. Since then, the surpluses have gained the upper hand. According to the IMF's latest estimates, the world will show an overall combined surplus of $265 billion this year. Large surpluses in China ($385 billion), Japan ($193 billion), Germany ($191 billion), Saudi Arabia ($145 billion) Russia ($99 billion), Kuwait and the United Arab Emirates (each $66 billion) more than compensate for the red ink in the deficit countries, led by the US ($614 billion), Spain ($171 billion), UK ($137 billion), France ($67 billion), and Italy ($56 billion). The world has never seen such a profusion of imbalances - a potent source of international liquidity as well as of potential financial instability. No one is sure how, when or why, but sooner or later these figures will have to come into better balance. If we are lucky, the correction will take place without too much damage to the global economy

Geo-Politics

Days of G-7 Running The Show Are Over  As the collapse of the trade talks in Geneva in July made clear, there is no longer any meaningful trade negotiation without the main nations from the emerging world. The year 2008 may go down in history as the one in which rich countries discovered that this applies to macroeconomic policies, too. In January it looked as if the opposite lessons could be drawn from events. For a while, Ben Bernanke at the US Federal Reserve and Jean-Claude Trichet at the European Central Bank seemed to be the only relevant policymakers in the world – and they were, as far as liquidity strains were concerned, if only because the US and Europe account for about two-thirds of the global supply of financial assets. But as months went by, it became clear that countries affected by the shock represented merely a half of world gross domestic product, two-fifths of global energy demand and not even a third of world cereal consumption. Furthermore, rich countries have significantly less weight at the margin: their contribution to world growth is about half their share of world GDP, so one-quarter of the total, and the same rule of thumb applies even more to the demand for oil and foodstuffs. So in the market for scarce commodities, the effects of the slowdown in the US and Europe were offset by domestic booms in the emerging world. By the end of spring, policymakers in the Group of Seven leading nations had awoken to an uncomfortable reality that focusing on a regional financial shock had led them to ignore a global commodity shock. Worse, thanks to the fact that most emerging and developing countries in Asia and the Gulf were part of a de facto dollar zone, actions taken by the Fed to address financial stress in fact compounded runaway domestic demand in those countries and fuelled global hunger for commodities. In spite of rising inflation, real interest rates in the main emerging countries are still inappropriately low or even negative. Stagflation is not here to stay. East Asia is unlikely to remain immune from current near-zero growth in Europe (to where it exports about 5 per cent of its GDP) or, even more, from forthcoming deterioration in the US (to where it exports almost 7 per cent of its GDP). Commodity prices have started to decline. However, the underlying issue will not go away, for two reasons.

Vladimir Putin makes Robert Maxwell look small-fry One of the curious trends of recent years has been the Western business community’s enduring love affair with the unlovely Russia. With every passing week, it becomes clearer that this is a country run by and for people little different from gangsters. The tanks rolling into Georgia have reminded us that they are gangsters with keys to a big arsenal. The largest Western companies, Shell and BP included, have been bullied, intimidated and forced into concessions by the Kremlin and its cronies. This week a Moscow court joined in the harassment, targeting the head of BP’s troubled joint venture in Russia. This is a country that defaulted on its overseas debts less than ten years ago; a country that, after its journey from feudalism to kleptocracy via totalitarian communism, has little truck with Western-style capitalism; a country alive with corruption and not averse, it has been suggested, to the occasional state-sponsored murder. Hardly the ideal recipient of Western capital, you might think. But Western companies have rushed to throw money at Russia, both in direct and indirect investment. But the idea that Russia can be seen as just another economy, and its businesses assessed purely in terms of dry p/e ratios, is folly. Western investors are mistaken if they think that Vladimir Putin would hesitate to expropriate their assets if it suited him.

• Georgia on the oil market's mind [08-15-2008 10:10PM]Friday The military conflict between Russia and Georgia has oil markets on the edge. Greg Priddy, global energy analyst, Eurasia Group tells BNN if supply concerns are well founded.

Posted by dblwyo at 04:15 PM | Permalink | Comments (0)

After the break you'll find this week's collection of readings in three categories: General Economy, Housing, and Credit Conditions. We've sampled some of the first group's headlines to kickstart our explorations of the tipping point and the consequences for market outlooks. But the bottom line is this - there is a widespread consensus developing that there's no second half recovery and '09 is looking worse. There's also a bit of better reporting on some of the data, and some not. In Housing what's started to dawn on folks is that the sub-prime mess is moving into Alt-A and Prime, or as the Great Tanta has it, "we're all sub-prime now". The number of homeowners under-water and the new wave of defaults lead to CR's discussion of strategic themes for Housing for '09 - which is a must read. And all that naturally leads us to tightening credit conditions, more bank writeoffs and even the best banks (JPM of all people) hiding more surprise write-offs and losses in obscure reports. Read away - we urge you. In the meantime we want to take a deeper dive into some of today's data to set the stage - having already covered Retail Sales (Dismal Headlines, Worse Realities: Retail Sales and Economic Outlook).

 But just for fun let's quote you two different headlines on Industrial Production - both reporting on the same data and both given entirely opposite impressions.

Industrial Output Growth Slows U.S. industrial production slowed in July, pulled back by a drop in output at utilities as the weather turned fairer. Industrial production increased 0.2%, following a revised 0.4% climb in June, the Federal Reserve said Friday. Previously, June output was seen rising 0.5%.

Industrial output up 0.2 percent in July Industrial output rose in July at a slightly better pace than expected as a further rebound in the auto industry offset a big plunge in output at the nation's utilities.

Fascinatingly the markets are up today, led by Financials of all things. Will wonders and delusions never cease ? This despite the fact that, other than WMT earnings, all the economic news was unremittingly bad: foreclosures are up 55%, new house prices dropped -7.3%, continuing jobless claims accelerated and new claims were unexpectedly high and consumer inflation jumped 0.8% MtM, a 17-year high ! None of that sounds like the outlook is sanguine in the sense of good. Anyway, as threatened, we're going to revisit the outlook and consequences for corporate earnings and what it means for the market. Tracking which posts get the most attention, equally strangely if not more so, the diagnosis of a schizoid market attracted more attention then the careful dissection of the profits outlook (Talkin Profits: Economic Outlook, Earnings, Business Performance ?) and what the rapidly deteriorating economic outlook means. To put a point on it if we are indeed crossing a tipping point and starting into a consumer-driven downturn, as is now being widely recognized, ignoring profits and the current market valuations is dangerous to your financial health. On the grounds that perhaps we haven't made it entirely clear why you really care we're going to build a longish post walking thru various aspects of profits, earnings, PE's and the outlook. Just as one example most of the downturn so far in the S&P is due to Financials. If the economy turns over, as we expect, none of that is priced in.

Economy vs Markets

Just to set the stage let's start by considering the long-run relationship between the economy and the Markets. The meme is that markets are forward-looking though the WSJ noted that hasn't been true recently - as in the last decade ! Actually it's never been true. This multi-part chart shows the YoY% changes in GDP and the SP500 on top and the % growth in both since 1951. To our eyes the markets are still far ahead of where the state of the economy would justify their current levels.

Earnings Outlooks

Hopefully the prior post put enough evidence on the table about the structural relationships between the economy and profits that we can take it as given. And the translation between Profits and Earnings will also be taken as understood. That being the case the fundamental valuation equation we like is Graham-Dodd's: PE = (8.5 + 2*Growth)* 4.4/AAA-Yield. We'll dig into that a little later but taking it as a starting point the question becomes what are earnings expectations. And, much more importantly, do they make sense in view of our economic outlook. Take a look at the following chart which reproduces S&P's bottoms-up collection of analysts earnings prognostications and take a careful look at a) the revisions by sector and b) whether or not you believe the outlooks. And to put another point on it the two sectors that are up today and driving the market are Financials and Consumer Discretionary - with the big debate about a bottom in Financials raging onward (Riding the Storm - NOT: Breakdowns, Culture & Malfeasance in Finance).

 Now if you're readers of this blog and these two sets of earnings estimates hang together for you you can probably stop reading. But if thinking that the Financials (in read) and the Discretionary and Technology outlooks (in yellow) have some questions that should be asked below we walk thru some valuable issues of PE and valuation that should be reflected. And aren't IOHO.

PE Valuation vs Long-term Investment Performance

Let's start by looking at the longer-term investment return verses PE Ratios with the accompanying chart (courtesy of John Mauldin). Here you can see total return vs initial PE Ratios. Currently the PE on the SP500 is running about 16, which according to this chart is pretty ambitious. Even if you think earnings will hold up what's your return likely to be ? According to this any reasonable increase in earnings is more than fully priced into the markets at this point. In fact according to this, in the best possible case, a 3-6% return over the next twenty years is the best outcome. Buying corporate bonds would be better, aside from some of their risks of course. :)

Return vs PE: the Margins of Safety

Ben Graham talks about a concept called "Margin of Safety", which can be translated as buy low and sell high. Or better, don't buy until you know that you're paying a fair value and KNOW when and how you'll get a reasonable return with a very high probability. Again via Mauldin but actually from Prieur du Pleiss of Plexus Asset Management we have this interesting little chart that looks at forward returns over certain time horizons vs PE Ratios. When you make value-investing, as opposed to speculative, decisions that margin of safety depends on getting into investments far below the current PE prices. In fact there's a real distribution of returns. And unless you think we're looking at the beginnings of another long-term bull market this ain't it.

PE Reversion to Mean and Value

Over time PE ratios tend to average out but the cycles around that mean can be very long indeed. As you may know by now real returns for the SP500 over the last ten years are negative, yet PEs are still above the long-term. And judging from this chart still have quite a ways to go. And there's the other little tidbit that the tend to settle below the long-run mean as well over 10-year and 1-year periods. 

Not to mention the fact that we're still coming off the biggest investment driven boom in stock valuations in the post WW2 era. We would appear to be a long way from a fair, safety margined, PE in general. And that's before asking about the likely drop in earnings with a downturn in the economy.

Earnings, Outlooks, PE's and Reasonableness

Now let's take a look at one ginormous chart without dissecting every component. What it does is reproduce and compare actual and estimated earnings by major S&P sector over four different time periods. It's built from the quarterly S&P tables which are based on bottom-up analyst estimates. We've highlighted some of the total market (SP500) numbers in red just to make our points but you want to look at each sector. And ask yourself - are the estimates reasonable ? Bearing in mind what you've read here about the economic outlook in general and the specific comments we've made on various major GDP components ? And also bearing in mind that the analysts don't tend to make top-down assessments. Rather they talk to the executives at individual companies - always with the assumption that "my company is different and the exception". Maybe - but the collective result flies in the face of common sense, analysis and the recent headlines. A final observation - take a careful look at how earnings are being revised by sector. Pick one, say technology, and work thru whether the earnings, growth rates and PEs make any senses whatsoever. We'd argue that by and large they're still incredibly optimistic - which tends to be confirmed by the slow downward revision you can see in the numbers as reality overcomes optimism.

 Graham-Dodd Re-visited

And one final chart that translates the G-D Valuation formula we promised to return to into a couple of tables and a chart so you can answer that last set of questions by quick inspection.

Posted by dblwyo at 10:54 AM | Permalink | Comments (0)

After the break we provide a couple of excerpts from our accumulating weekly readings on the economic news - and can we just say reality is slowly creeping in. We tried to make that point with the prior post and translate the implications of a rapidly slowing economy into the earnings outlook. Since that argument didn't fly very well we'll pick it up again later and concentrate on today's headlines. Not un-representative of which would be:Retail Sales Drop for First Time in 5 Months. Or these:Economic Slide to Extend Into 2009: Blue Chip, Economy Seen Slowing More Sharply: Philly Fed.

 Fortunately, or not, we consider the MSM reporting to be improving but still not quite there yet. Sadly for our market positions the markets got it right the first half of the day but schizophrenia returned in the second, as they recovered. But if Mr. Market is listening let us correct your mis-apprehensions. They are indeed out to get you and here's the proof.

As always  if you'll click on a chart  you'll get an enlarged version in a seperate window.

Retail Sales

 The headlines have it that Retail sales dropped after an upward revision for last month, not mentioning the downward revision for May :). More interestingly our preferred YoY change was 2.9%, 5.8% x-Autos. Which sounds good until you look at the chart and realize it's downtrending. MUCH more important though is real retail sales which was -1.9%, negative for the eight month in a row and at an increasing rate. Let's zoom in and get a little more granular so you can see the more recent data.

Real Retail Zoom-In

I'm afraid the headlines and MSM reporting still hasn't absorbed the power of YoY reporting or of looking at the inflation-adjusted data but at least they're improving a little. When you get more granular, as in this chart, you can that we turned negative in Dec07. In other words when energy prices started going crazy people did the rational thing. CalculatedRisk's continued emphasis, supported by minor analysts like Marty Feldstein, that we most likely enterred a recession in then is looking better and better. 

 Real Sales Energy-Adjusted

Thought if you just looked at retail sales x-Autos you'd think things weren't really that bad. As a big picture sidebar observation we urge you to recall our comments from a while back that the GDP numbers and component breakdowns tell us that indeed we crossed, or are crossing the tipping point into a more serious downturn. (Tipping Points, Blindsides, Ouches: Tough Times Getting Tougher) An observation obviously NOT absorbed into the markets as yet. Where you can see this is by netting out gas station sales - a statistic you can get nowhere else since it's a painful manipulation of the data, at least so far.

 When you do that it turns out real retail sales turned negative in Oct07 ! And of course that's the same month when real (estimated) gasoline sales jumped and have kept climbing. In other words real retail sales has been negative for 10 months. And the rate of decrease is increasing. Tipping points indeed. And nobody is factoring that into their pricing, valuations or business planning that we can tell. There are some very unpleasant surprises lurking in the wood work for a lot of people as the normal cyclic lags start to work themselves into view.

Just put another big picture point on it what we've seen is the air going out of the leveraged financial bubble over the last three quarters. In other words the consequences of the credit bubble bursting and destroying the Housing market and sucking out the "vital bodily fluids" from the markets. What we have not seen is the consequences of a downturn in the business cycle. But IOHO we're about to. (News Alert: Vicious Credit, Economy, Market Cycle Spotted, Markets Drivers 2 (Buyouts): the Carry to Cash Economy, Market Drivers: Liquidity, Liquidity(Buyouts) and Buyouts (Buybacks)

Economists Expect 2008's Second Half To Be Worse Than First The U.S. economy is poised for an unpleasant finish to 2008, amid a consumer-spending slowdown and a weakening global economy. The emerging pattern is the reverse of what most forecasts showed at the beginning of the year. The U.S. economy, facing a consumer-spending slowdown and a weakening global economy, is poised for an unpleasant finish to 2008. The pattern of growth that is emerging this year -- a mediocre first half followed by a weaker second half -- is the reverse of what most forecasts showed at the beginning of the year. Economists have downgraded growth forecasts in recent weeks. "We are on the cusp of a renewed deceleration in growth," Goldman Sachs economists said, noting that a contraction in consumer spending is likely over the second half of this year and that "the risk that foreign-demand weakness will wash back onto U.S. shores is clearly growing." Households are grappling with layoffs, stagnant wages, falling home values and tighter credit. The U.S. government's economic-stimulus program, which was intended to give households a boost in the middle of the year, may not have done enough to stave off recession. The payments coincided with a run-up in fuel prices, so a portion of the checks were gobbled up at the gas pump. So far, most of the money appears to have gone to savings and debt rather than to immediate spending in stores.

"The air is coming out of the balloon pretty quickly here," said Brian Bethune, a senior economist with Global Insight, a Lexington, Mass., forecasting firm. "Consumers are just throwing in the towel." Retail sales in July were weaker than expected at many chain stores, suggesting the May and June sales boost from the stimulus checks is quickly fading. Talbots Inc., Kohl's Corp. and Gap Inc. were among those retailers reporting double-digit sales declines last month. Discounters, including Wal-Mart Stores Inc. and Costco Wholesale Corp., fared better, but Wal-Mart U.S. President Eduardo Castro-Wright warned that spending could slow: "With the end of the stimulus checks, we know consumers are spending more cautiously," he said. Consumer spending is poised to weaken just as foreign growth -- a vital offset to sluggish domestic demand -- also shows signs of slowing. Surging export growth, coupled with falling demand for imports, added 2.4 percentage points to second-quarter growth in U.S. gross domestic product -- marking the largest contribution in nearly three decades. Without that contribution, GDP would have slipped 0.5%. WSJ Vidclip Review

·          Economic Slump in U.S. to Worsen as Consumers Get `Squeezed' After Rebates [Kaufman Says U.S. Economy `About to Approach Recession']

·          Economic Slide to Extend Into 2009: Blue Chip, Economy Seen Slowing More Sharply: Philly Fed

U.S. Retail Sales Drop as Record Gasoline, Credit Squeeze Hurt Auto Sales Sales at U.S. retailers dropped in July for the first time in five months as record gasoline prices and tighter credit reduced automobile purchases. The 0.1 percent drop followed a 0.3 percent gain the prior month that was larger than previously reported, the Commerce Department said today in Washington. Sales excluding automobiles rose 0.4 percent, less than anticipated. The sales drop came even as the Treasury distributed tax rebates as part of the government's fiscal stimulus plan. Consumer spending, which accounts for more than two-thirds of the economy, is likely to keep fading, hurt by rising unemployment, falling property values and elevated fuel costs. Retail sales excluding gasoline fell 0.2 percent, the Commerce Department said. Spending, which has grown every quarter since 1992, may stall in the last three months of this year after growing at a 0.6 percent annual pace from July to September, according to the median estimate of economists surveyed by Bloomberg from Aug. 1 to Aug. 8. Figures from Commerce on July 31 showed spending grew at a 1.5 percent pace in the second quarter. The world's largest economy will expand at an average 0.7 percent annual pace from July through December, half the gain in the first six months of the year, according to economists surveyed.

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

Now we're going to shift the focus back onto business performance but come at it top-down by starting with the macro-issues of profitability and asking what the economic outlook means for business performance and earnings outlooks. After the page-break you'll find some readings on those topics, general business conditions and some specific players (WMT, SBUX, Kraft, Whole Foods) that illustrate many of the points. Before we get into the meat however we'd like to share some of the morning's headlines which reinforce the arguments about a slowing economy and the deteriorating earnings outlooks. MUCH more importantly however these are the headlines from places like the WSJ and Bloomberg. Here's the first central question: what happens when it dawns on businesses and investors that the V-shaped recovery is history ? And that '09 is not looking much better ?

1.       Economists Expect 2008's Second Half To Be Worse Than First The U.S. economy is poised for an unpleasant finish to 2008, amid a consumer-spending slowdown and a weakening global economy. The emerging pattern is the reverse of what most forecasts showed at the beginning of the year.

2.       OECD Forecasts Sharper Slowdown for G-7 The world's leading developed economies are set to slow more sharply in the months ahead, according to the OECD's indicators of future activity.

3.       Predicting What's Next Gets Harder Investors often expect the stock market to behave like a crystal ball. Lately it has made a better rearview mirror. For decades, turns in the stock market typically led earnings by roughly six months. But during the past decade or so, stocks have moved roughly in tandem with, and occasionally lagged, the trajectory of profits…

4.       Is the Market Still a Future Indicator? At this point, you would have thought the Efficient Market Hypothesis would have died a quite death. The most fascinating aspect of this is the opportunity for anyone in the market to identify inefficiencies. Discover where the market has a non random error -- we've called it Variant Perception over the years -- and you have a potentially enormous money making opportunity.

 Those headlines pretty well capture the arguments we've been making for some time, are based on similar analysis and point to a lot of other folks seeing the tipping point being crossed. And as Barry Ritholz points out in his post on the Deficient Market Hypothesis "you have an ....opportunity" ....if you make the right choices of course :) ! Speaking of which the next central question is what happens when the analysts figure out that their earnings outlooks need to go in the trash ? And the markets absorb those revisions ? How long will all that take to percolate ? Somewhere in there may lie some of Barry's opportunities.

We'll leave you to skim thru the readings which beef up these arguments but will note that the blue-highlighted titles are URL's - in other words you can click thru to get to the underlying story or post if you like. Now let's jump into parsing out the profit analysis

 Corporate Profits: First Pass

Let's start with a fairly simple look by using the St. Louis Fed's FREDII data graphing tool to look back at YoY changes in corporate profits to 1980. Part of the point here is that you aren't reliant on the MSM but courtesy of the Fed can take some pretty deep dives yourself.  It may take a bit to learn the tool and data sources, and maybe a bit more to learn what the data's telling you, but generating current analysis eventually takes a few minutes. Also btw just clicking on any graphic or chart will bring up an enlarged version for closer examination.

Take a careful look here and there are several things to notice. First off the timing, patterns and business cycle relationships are exactly what one would expect. The economy drives profits, no if, ands or buts. With some aberrations  that are important.  The blue line is  "real company"  after-tax profits on the right scale and it's volatile. But that scale wouldn't be so distorted except for the huge jump since '00. Before that those profits were cycling around a trend, which turned down in the '90s. Notice also that the drop in this decade is steep, now near-zero and below and appears headed lower.

Corporate Profits: Pass II

Let's take another pass at the data courtesy of Northern Trust's econ department and zoom in a bit, albeit with slightly different data on profits coupled with some inflation data.

 First off notice that QtQ profits have been negative and dropping since Q406. Wonder where those buybacks and earnings reports are coming from ? You should. We do know it certainly didn't go into hiring or capex. And therefore won't either !

What about margins ? Well when the ratio between the good CPI and the finished consumer goods PPI is dropping like a rock that tells us there's no pricing power whatsoever. It also tells us that profits have been under enormous and growing pressures for some time. And when it accelerates those pressures worsen. Now what do you think about future profit prospects ? Worse and worse we hope ! :)

Corporate Profits: Pass III 

Now let's take final pass at the big picture so you can get the full "slowly-boiling-frog" environment. The rather busy chart below shows corporate profits from 1979 from the national accounts. The UL shows the absolute number stacked up and if it looks like the Finance industry has been wallowing at the trough you'd be right. The UR shows profits as a % of GDP. We see three major structural trends that will govern things in the future. First off profits for non-financial companies were steady until this decade when they started liquidating their futures. Second, it looks like Financial companies went thru a major structural jump-shift and grabbed off more of GDP and, in the LR chart which shows % share of total profits, that's confirmed. And we now know what that was based on and how solid it was. Hm.....not promising. Remember the broken business models and wonder how that'll play out. And third, it looks like foreign profits (Rest-of-World or ROW) showed a steady rise until later in this decade when they took a big jump. That's born out in the LL chart which shows YoY% chanages, which btw, are both steady and pretty much mirror the business cycle. Note that very recently ROW profits are showing a non-cyclic jump. Brave new world indeed.

Business Readings

U.S. Economic & Interest Rate Outlook: Base Case vs Checkmate (NT): On a year-over-year basis, U.S. nonfinancial corporation profits generated from domestic operations have been contracting since the fourth quarter of 2006 (see Chart 19). With our forecast of contracting real GDP growth in the second half of this year followed by a muted recovery in 2009, unit sales growth for nonfinancial corporations is likely to be weak. Because of soft final demand, we believe that profit margins also will be squeezed as businesses find it difficult to pass on their higher commodity prices to consumers. This has been the case so far as the ratio of the Consumer Price Index (CPI) for goods to the Producer Price Index (PPI) for finished consumer goods has been falling (see Chart 20).

• Misery Index: 10 CEOs in the hot seat

And the Winner, er, Loser Is... Portfolio.com readers speak: Who is the least trustworthy C.E.O. on Wall Street? John Thain has been thumped recently for having apparently reversed course on some initially reassuring comments he made about Merrill Lynch's capital position. But he's hardly alone in having been overly optimistic amid the mortgage meltdown, as Portfolio.com writer Megan Barnett recently documented. That raised the question of which financial-services C.E.O. is saddled with the widest credibility gap these days. So we asked our readers to vote. By that measure Thain came out fairly well, perhaps because Merrill is still in business and Thain still has his job. Readers said the least trustworthy executive is Alan Schwartz, who was unfortunate enough to be in the corner office at Bear Stearns when the C.D.O.'s hit the fan there in March. Close behind: Martin Sullivan, formerly chief executive of American International Group, who famously calculated the chances of AIG posting a loss as "close to zero" -- a few months before AIG posted losses of $13 billion. Thain came in sixth place of our nine nominees, a few basis points behind Dick Fuld at Lehman Brothers.

Big Differences In Earnings and Analysts' Estimates What's the value of analyst estimates? Look at the enormous differences between actual earnings and analyst estimates for a couple of recent companies: GM (NYSE: gm) loss: $11.21 Estimate loss:: $2.62 Merrill (NYSE: mer) loss: $4.97 Estimate loss: $1.91 These aren't the only ones: there are dozens of other examples in financials, autos, airlines and home builders where we have seen misses not of a few pennies, but of orders of magnitude. The problems: 1) poor visibility: these industries are seeing business deteriorate on almost a daily basis 2) poor communication and data sharing: many companies provide little if any guidance and share a little information as possible, leaving analysts to either develop their own sources or remain at the mercy of the company 3) poor quality of analysts: the best analysts have left the sell side and now work for the buy side. The remaining sellside analysts, as a group, are of lesser quality.

Shipping Costs Start to Crimp Globalization The world economy has become so integrated that shoppers find relatively few T-shirts and sneakers in Wal-Mart and Target carrying a “Made in the U.S.A.” label. But globalization may be losing some of the inexorable economic power it had for much of the past quarter-century, even as it faces fresh challenges as a political ideology. Cheap oil, the lubricant of quick, inexpensive transportation links across the world, may not return anytime soon, upsetting the logic of diffuse global supply chains that treat geography as a footnote in the pursuit of lower wages. Rising concern about global warming, the reaction against lost jobs in rich countries, worries about food safety and security, and the collapse of world trade talks in Geneva last week also signal that political and environmental concerns may make the calculus of globalization far more complex.

Commodity costs crimp Kodak turnaround Surging commodity prices are complicating Kodak’s (EK) recovery plan. The Rochester, N.Y., photo company posted a second-quarter profit that missed Wall Street’s estimates, as profit margins narrowed under the pressure of year-over-year increases in silver, aluminum, petroleum-based and other raw material costs. Kodak also said it expects its full-year profit to come in at the low end of its earlier forecast, and reduced its 2008 cash generation target.

Players

Las Vegas's Gambling Slump Shows How Starbucks Expansion Bubble Lost Air The Starbucks index is pointing down in Las Vegas. The Nevada city's gambling-driven growth in the 1990s proved irresistible to Starbucks Corp., the world's largest coffee-shop chain. Las Vegas, which had no Starbucks outlets before 1995, has about 155 now, according to the store locator on the company's Web site. Starbucks, stung by a slowdown in sales as strapped consumers shy away from $4 lattes, is staging the biggest retreat in its 37-year history, closing 600 of 11,168 U.S. company-owned and licensed stores. Las Vegas is taking the biggest hit, losing 16 of the once-trendy cafes, including in North Las Vegas, or 10 percent of its total. Los Angeles will lose just two of about 56 and New York City 10 of more than 200. The closings ordered by Chief Executive Officer Howard Schultz, 55, will cost as many as 12,000 jobs in the U.S. The company had 172,000 jobs as of last September. Rising gasoline and food prices, increased unemployment and the housing slump have shackled Starbucks. The company said in April that U.S. sales in stores open at least 13 months, a standard retail industry measure of performance, declined for the third straight quarter. Starbucks swings to loss on store closure costs

Why Starbucks lost its mojo Pundits and analysts blamed stock prices, the mortgage crisis, competition from McDonald's and Dunkin Donuts, along with real estate blunders, like putting stores on opposite corners of the same intersection. But they had it mostly wrong. This economic logic was too narrow and not culturally informed enough to explain Starbucks' fall. The company thrived throughout the past 15 years by giving middle-class Americans exactly what they thought they wanted – and this wasn't really about coffee. It was about creating a product that allowed doctors and lawyers, IT specialists and travel writers, and then their imitators, to portray themselves as they wanted to be seen. That's how products work in the world we live in. We buy things to announce something about ourselves. For the most part, the products that sell the best are the ones that communicate most effectively. That's what Starbucks did with their coffee. Really, then, they sold not coffee but elevated status. Just by buying the coffee and speaking the company's made-up lingua franca, you became a cup-carrying member of the upper class. And that made Starbucks, overpriced as it was, an affordable form of statusmaking.

Whole Foods Looks for a Fresh Image in Lean Times Whole Foods Market is on a mission to revise its gold-plated image as consumers pull back on discretionary spending in a troubled economy. The company was once a Wall Street darling, but its sales growth was cooling even before the economy turned. Since peaking at the beginning of 2006, its stock has dropped more than 70 percent. Now, in a sign of the times, the company is offering deeper discounts, adding lower-priced store brands and emphasizing value in its advertising. It is even inviting customers to show up for budget- focused store tours like those led by Mr. Hebb, a Whole Foods employee. But the budget claims are no easy sell at a store that long ago earned the nickname Whole Paycheck. Told of the company’s budget pitch by a reporter, some Whole Foods customers said they had not noticed cheaper prices; a few laughed.

Walter Robb, the company’s co-president, acknowledged that Whole Foods was fighting strong consumer perceptions about the chain’s prices, and he added that some of that was deserved. But he said the company had made a strong effort to challenge its competitors on price. Whole Foods’ makeover comes amid a tumultuous time in the grocery industry, as customers struggling to pay for higher-priced fuel and food are trading down to lesser products and discount-oriented stores. A July survey by TNS Retail Forward, of Columbus, Ohio, found that 20 percent of shoppers have changed where they buy groceries and household essentials because of the economy. The biggest beneficiaries have been dollar stores and discount grocers like Aldi and Save-a-Lot, which offer a limited selection at extreme discounts.

Wal-Mart Stores Inc.'s run as this year's best-performing Dow Jones Industrial Average company may end after the world's largest retailer said sales growth will slow this month. Wal-Mart declined 6.3 percent yesterday, the steepest drop since 2002, after it said sales in stores open at least a year may rise as little as 1 percent, which would be the smallest gain in five months. The company said most shoppers had spent the U.S. tax rebates that spurred sales. Wal-Mart had climbed 28 percent this year before yesterday, compared with the 30-company Dow's 14 percent drop. After yesterday's decline, Bentonville, Arkansas-based Wal-Mart had a gain of 20 percent, just ahead of International Business Machines Corp.'s 19 percent increase. Spending of tax rebate checks, part of the government's attempt to rejuvenate the economy, helped produce Wal-Mart's biggest same-store sales gains of the year in May, with a 3.9 percent increase, and June, with a 5.8 percent jump. The company lured shoppers battered by soaring gasoline and food costs with $4 prescriptions and discounts on groceries and flat-screen televisions as steep as 30 percent. Total sales in the first half of the fiscal year that started Feb. 1 climbed 9.6 percent. Total sales in July increased 9.4 percent. ``We are seeing the end of a catalyst,'' Lauri Brunner, a Minneapolis-based analyst for Thrivent Asset Management, said yesterday in a Bloomberg Radio interview. Thrivent manages $73.2 billion in assets, with 1.5 million Wal-Mart shares through June.

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

If they really are out to get you are you paranoid, or security conscious or both ? Well those of us who have had a general bearish tenor to our thinking might be excused for viewing a week with a couple of 300 point or so days as "out to get us". Especially when the last one was triggered by a huge drop in oil prices and a rise in the dollar. And both in turn resulted from a rapidly slowing world economy, demand destruction and weakening of foreign currencies. In other words because the last prop that was holding up the economy got kicked out from under the Markets rallied ? Sheesh ! The saving grace in all this (H/T Big Pic btw) is that 300-pt days occur during Bear Markets, not bull ones.

Since markets can demonstratively stay irrational longer then we can manage solvency we can at least have the pride and consolation of knowing they're NUTs. That is, they are paranoid and don't know which way the fundamentals are going and trust none of them. And schizophrenic since this week also saw 200 pt. drops - all on rather weak volume relatively speaking. After the break you'll find the usual collection of relevant readings for reflection - which we urge. And you should also consider this post as part of series, almost a hat trick or better (News Alert: Vicious Credit, Economy, Market Cycle Spotted,It's a Long Way to Tipperary: the Foreign Economic News,Take No Prisoners: Real Econ Data vs MSM Reporting) of prior posts. Not that repeating ourselves appears to be influencing the madmen in power to any extent. Nonetheless let's go into the breach another time with the following Chart sets.

UPDATE (tomorrow's WSJ): Signs Suggest Recovery  For U.S. Hasn't Arrived  (WSJ) Dead-end rallies often pervade bear markets, and while some negatives for stocks have turned positive, a laundry list of challenges still needs to be overcome. {well, well, welll...extened excerpt after the break...amazing !}

Basic Market Charts

Below are the basic comparison charts between the SP500 and the NDX showing daily back to Oct07 and weekly back three years. As you can see both are "rallying" in what we think is a bear market rally, somewhat milder than March's. Also notice that while the SPX has given up most of its' gains since '06 the tech index is clinging to everything almost thru last Fall. On the presumption of course that tech earnings will not experience any down pressures from a slowing economy and declining capex spending - despite the fact that the letter has already started tipping over ! 

 Inter-Market Comparisons

Speaking of widespread schizophrenia and paranoia how 'bout those foreign markets ? The chart set below shows daily back a year and weekly back three for selected ETFs: EEM (emerging markets), EWJ (Japan), IEV (Europe), EEB (BRICs), FNI (Chindia), GXC (China), EWZ (Brazil) and EPI (India). Didn't find a Russian specific one but in addition to their minor domestic political corruptions problems they've just started a war with Georgia. Be interesting to see how that plays out if you're not there. Meanwhile we'd say the bloom is definitely off the foreign, emerging and BRIC markets, a point we've been "chicken-littling" about for some time. With the possible exception of Brazil, which looks like a great speculative trading opportunity though, not an investment opp. At least until/if it joins its' breathen.

 Inter-Sector Comparisons

Even more interesting by our lights is how the different sectors have been doing since it appears that the runup in this little BM Rally is concentrated in Financials ! [You're kidding me, right ? (Riding the Storm - NOT: Breakdowns, Culture & Malfeasance in Finance, Cramer's Anniversary: Continuing Credit Metastasis and Economic Outlook)]. And Consumer related stocks - ditto, cf. the prior posts on the economy. Below you'll find another composite chart using ETFs again to compare the sector performances. With six-month daily charts on top and 1-year weeklies on bottom. Where the sectors are Finance(XLF), Consumers: Discretionary (XLY) and Staples (XLP), Healthcare (XLV) and Industrials (XLI) are the left. And Energy (XLE), Materials (XLB), Tech (XLK) and Telecom (IXP) on the right. Which neatly divides them - Links vs Rechts - into better and worse than the SP500. The worst of course being Finance but Discretionary not too far behind. And both doing nicely in the BM Rally. Interestingly Industrials are weakening. Energy has really taken a hit as the global slowdown advances which has also impacted Materials. But unless our assessment of the economy is completely off base those gyrations are not well-grounded. In fact, a striking point we want to re-emphasize (Bad Times, Bad Companies, Bad Markets), is that except for Finance and perhaps XLY none of these have shown a serious decline. Somethings not right here....which may make us the paranoid but not the schizoid.

Market Situation

Shares Rally as Oil Continues to Fall  In what has become a familiar pattern on Wall Street, stocks surged Friday, a day after falling sharply. The immediate impetus for the rally appeared to be a big drop in commodity prices, including a 4.1 percent fall in crude oil, which settled below $116 a barrel for the first time since early May. The dollar also continued to gain strength, rising 1.7 percent against a basket of six major world currencies. The Standard & Poor’s 500-stock index rose 30.25 points, or 2.39 percent, to 1,296.32, its biggest one-day gain since April. The Dow Jones industrial average was up 302.89 points, or 2.65 percent, to 11,734.32; the Nasdaq composite jumped 58.37 points, or 2.48 percent, to 2,414,10. In recent weeks, the stock market has swung between strong rallies and steep drops. The S.& P. 500 has moved by at least 2 percentage points on 6 of the last 25 trading days since July 4. By contrast, there were only two days with 2 percent changes from the end of 2003 to the end of 2006. Despite all the sharp moves, the S.& P. 500 index rose just 0.3 percent from July 4 to Thursday’s close. Friday’s jump increased that gain to 2.7 percent. Some analysts say the volatility indicates that investors are increasingly uncertain about the economy. While they are encouraged that oil prices have fallen more than 20 percent from a high of $145.29 in early July, the housing market and the economy over all are still showing significant weakness. Earlier on Friday, Fannie Mae, the government-chartered mortgage giant, slashed its dividend after reporting a $2.3 billion quarterly loss. “Strictly from a psychological standpoint, it tells you that there is not a lot of conviction,” said Barry L. Ritholtz, chief executive of FusionIQ, an investment firm in New York. “Fund managers that are hot to buy one day, turn around and sell the next.” But others see reason to hope the market may have bottomed in mid-July and is starting a slow and hesitant rebound. These analysts note, for instance, that recent economic and housing reports may be bleak but the data is often better than expected.

The Stars Have Yet to Align for Stocks CONDITIONS are most ripe for a bear market to end and a new bull market to begin when investor sentiment and fundamental and technical factors are all in alignment. Unfortunately, the rally that began three weeks ago is fully supported by investor sentiment alone, suggesting that the bottom of this bear market has not yet been reached. First, consider the technical evidence. Compared with the initial rallies after previous bear-market bottoms, the rally that began in mid-July has been disturbingly weak. In fact, during the first days of the climb, a relatively large number of stocks actually fell. That has led many analysts to conclude that the upward trend is likely to fizzle.Take note of one particular indicator — based on the proportion of shares trading on the New York Stock Exchange that rise in price in a given session. If July 15 were the bear-market low, according to many technical analysts, there should have been at least one trading session in the subsequent rally in which at least 90 percent of total trading volume was from shares rising in price. Now consider the stock market’s fundamental foundation: stocks are still not cheap, at least in relation to corporate earnings. On the contrary, the market remains more expensive than it has been at most other times in recent decades. This is well illustrated by the price-to-earnings ratio for stocks in the Standard & Poor’s 500 index. It is now at 20.0 when calculated on the basis of trailing 12-month earnings…The Larry Kudlow Recession Summer Rally, 300 Point Dow Gains? During Bear Markets ONLY,

• 300 Point Rally follow up Let's consider Bespoke's Analysis on the subject: They note that average returns three months after all 300+ point moves has been 0.06%, with positive returns 50% of the time. Buying the 1997 and 1998 300+ days made you money (if you held on long enough). But as my marked up version of their chart (below) shows, every subsequent 300+ day led to an eventual lower low. Marked Up Chart (you need to look at this !!)

Investors, taking long view toward recovery, lift stocks Oil prices are touching three-month lows, the latest milestone in a steep reversal for commodity prices that is supporting stocks around the globe and easing inflation concerns among investors and policy makers. Markets rallied across Asia and Europe on Wednesday after sharp gains on Tuesday on Wall Street, even though the falling prices reflect, at least in part, a slowing global economy. Investors, however, seem to be looking further down the road, believing that the weakness is likely to be short-lived - with the promise of stronger growth and corporate earnings down the road. U.S. shares were narrowly mixed Wednesday afternoon, held back by a report of a steep loss at Freddie Mac, the mortgage-finance company. "The market wants to be bullish. It's sick of being bearish," said Paul Mortimer-Lee, head of market economics at the London office of BNP Paribas. "Is the glass moving from half empty to half full? We're not out of the woods yet, but there are a few rays of hope." The surge in the past year in prices of raw materials, driven by demand from growth in developing economies, had threatened to anchor higher inflation and severely curtail the purchasing power of consumers in the West. Now, however, with inflation fears receding, policy makers should be free to focus on trying to stimulate faltering demand rather than fighting price pressures.

Credit and Currencies 

Money Markets `Plagued' by Libor, TED Spread That Fed, ECB Fail to Reduce A year after central banks started to pump trillions of dollars into the financial system to end a seizure in credit markets caused by subprime mortgages, cash is about as tight as it's ever been. The U.S. market for commercial paper, or short-term IOUs, backed by assets such as mortgages has shrunk 40 percent from its peak in July 2007. The amount borrowed in pounds between banks in the U.K. fell by 70 percent in June from a record in February 2007. The European Central Bank received $100 billion of bids for the $25 billion it offered to financial institutions on July 29, the most since the sales began in December. Efforts by the Federal Reserve, ECB and Swiss National Bank to shore up the world's biggest banks and promote lending have had limited success. The London interbank offered rate, the basis for at least $150 trillion of financial products, is within 0.06 percent of the highest since November 1999 compared with the Fed's benchmark interest rate. The largest financial companies have lost almost $500 billion from subprime-linked securities. Credit markets seized up a year ago as banks suddenly became wary of lending to each other because BNP Paribas SA halted withdrawals from three investment funds on Aug. 9 after the French bank couldn't value their holdings of securities linked to U.S. subprime mortgages. That same day the ECB made the unprecedented move of offering unlimited cash as losses spread. Securities firms are only now realizing how little the securities are worth. Last week, New York-based Merrill Lynch & Co. said it sold collateralized debt obligations with a face value of $30.6 billion for 22 cents on the dollar. Three-month dollar Libor rose to 2.40 percentage points above yields on Treasury bills on Aug. 20, the widest margin since December 1987. While the so-called TED spread, which measures the difference between the rate banks pay to borrow and the U.S. government's costs, declined to 1.15 percentage points, it averaged 0.5 percentage point over the previous five years. ``The money markets have ceased to function as they should, as nothing has been resolved with regards to the lack of trust between banks,'' said Marius Daheim, a senior bond strategist in Munich at Bayerische Landesbank, Germany's second-biggest state- owned bank. ``This is why you're seeing such demand for central bank money 12 months on from the start of the crunch. These measures were only supposed to be temporary, and they're looking increasingly permanent.''

Copper, Oil Lead Decline in Commodities as Global Economic Growth Weakens Copper and crude oil led a decline in commodities on concern that slower global economic growth will curb demand for raw materials. Copper headed for its biggest weekly drop since March, crude oil fell to the lowest compared with closing prices since May and silver reached its cheapest since January. Italy's second-quarter gross domestic product unexpectedly shrank, the statistics office in Rome said today. Japan's economy probably contracted in the three months ended June, according to the median estimate of 25 economists surveyed by Bloomberg News. ``People understand that we might face a difficult two or three quarters ahead of us,'' said Christoph Eibl, who helps manage more than $1 billion of commodities at Tiberius Asset Management AG in Zug, Switzerland. ``Industrial-related commodities will not outperform.''  Commodities, as measured by the UBS Bloomberg CMCI Index of 26 raw materials, have advanced for six consecutive years, bolstered by demand from China, the world's largest consumer of metals. The Reuters/Jefferies CRB Index of 19 commodities jumped 29 percent in the first half, the most since 1973. Crude oil fell $2.60, or 2.2 percent, to $117.42 a barrel on the New York Mercantile Exchange, as of 12:26 p.m. in London. That's the lowest compared with closing prices since May 2. Oil is trading 20 percent below the record $147.27 reached July 11. A stronger dollar reduced the appeal of commodities as a currency hedge. The euro slumped to a five-month low against the dollar as traders pared bets the European Central Bank will raise interest rates as the economy slows.

Oil and the Dollar Oil continues to sell off, and is now below $114 per barrel (Brent Crude Oil nearest futures). Meanwhile the dollar is rallying. These are two important stories. As I noted late last year, the dollar had fallen enough to make a significant dent in the ex-petroleum trade deficit. Unfortunately for the trade deficit, oil prices were surging. This graph shows the U.S. trade deficit through May. The blue line is the total deficit, and the black line is the petroleum deficit, and the red line is the trade deficit ex-petroleum products. The current probable recession is marked on the graph. The oil deficits in June, July and probably August will be ugly, but it now looks like the oil deficit will decline sharply later this year. Although there are other factors that impact exchange rates, this decline in oil prices will have a significant impact on the overall deficit, and might mean the dollar has finally bottomed (heresy to some I know!).

Euro Falls the Most in Four Years on Reduced Bets for Higher Interest Rate The euro slumped the most in more than four years against the dollar as traders pared bets the European Central Bank will raise interest rates as the economy slows. The euro also fell to a three-week low versus the yen after ECB President Jean-Claude Trichet said economic growth will be ``particularly weak'' through the third quarter and policy makers kept the benchmark rate unchanged yesterday. The South African rand led losses among the most-traded currencies on speculation the central bank will cut borrowing costs. Crude oil fell, heading for its fourth decline in five weeks. ``This is the beginning of a new chapter for the dollar as Trichet and other central banks are paying more attention to the downside risk to growth,'' said Dustin Reid, a senior currency strategist at ABN Amro Bank NV in Chicago. ``The decline of oil prices is a significant driver behind this dollar rally because it enables other central banks to turn their eyes away from inflation and focus on growth. It's tough to stand in the way of this dollar rally.''

Signs Suggest Recovery  For U.S. Hasn't Arrived  (WSJ) Dead-end rallies often pervade bear markets, and while some negatives for stocks have turned positive, a laundry list of challenges still needs to be overcome. It hasn't been a smooth ride, but the stock market's ability to hold onto gains posted since mid-July once again is raising hopes that a bottom finally is in place. Not so fast. The problem is that bear markets are chockablock with dead-end rallies, and while some negatives for stocks have turned positive, a laundry list of challenges needs to be overcome. Strains continue in the credit markets, banks and brokerages may need to raise large sums of additional cash to stabilize balance sheets, home prices keep falling, and consumers are pulling back on spending as Washington's stimulus checks are used up. For now, though, a drop in oil prices and a rebound by the dollar, both of which bolster the spending power of consumers, are fueling a surge in stocks. The Dow Jones Industrial Average's 3.6% jump to 11734.32 last week, capped by a 2.6% rise Friday, put the index 7% above its July 15 close. The Dow is down more than 12% this year and 11% in the past 12 months. Among the signs that suggest a genuine recovery isn't here yet, the most daunting are lingering problems from the collapse of the real-estate market and credit crunch. Clarity and stability in corporate earnings are needed for a sustained rally. The picture continues to worsen. Operating earnings on companies in the Standard & Poor's 500-stock index are on track to post a 22% decline in the second quarter, according to Thomson Reuters. That is nearly double the loss expected at the start of July. Third-quarter earnings forecasts, meanwhile, have been cut in half in recent weeks. Analysts expect just a 6.4% increase. David Kostin, equity strategist at Goldman Sachs, says attention is turning to 2009 earnings, but the outlook will be muddied for months by the tapering off of the fiscal stimulus that propped up consumer spending in the second quarter. Mr. Kostin, who had been bearish on stocks, has turned modestly constructive with the market down sharply from where it started the year. He is encouraged by the resiliency of earnings outside of financials. Given the unknowns about the economy and earnings, "it's not like we're pounding the table."

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We interrupt our regularly scheduled posting to warn you that our early storm warning system has detected more early signs of bad credit weather. Over the weekend our alert news monitors found a new wave of back-on-balance sheet adjustments, Fannie Mae issued worse than expected news, both GSE's (FNM, FRE) announced that they would be restricting new mortgage loans and guarantees. And (H/T CalculatedRisk) Fannie's conference call tells us that the books closed in June but there were significant deteriorations in July MORE THAN THEY ANTICIPATED when putting together their books. As you can see from the early warning reserve dashboard Fannie has both upped its' reserves and doesn't begin to cover its' risks. Making a huge Treasury equity investment increasingly likely, indeed mandatory to keep them from sliding into major default (dare one say the BK-word ?) and at least threatening to follow Merrill in throwing existing stockholders to the wolves of insolvency.

What's It All Mean: the Vicious Circle Grinds On 

 

READINGS 

UBS Agrees to Auction-Rate Pact  UBS has agreed to buy back nearly $19 billion in auction-rate securities, in a settlement with the New York Attorney General, the SEC and regulators from Massachusetts and other states. A once-obscure corner of the bond market is triggering one of the messiest Wall Street scandals in years -- and potentially the largest mass bailout of American individual investors ever. On Friday, facing allegations of wrongdoing over its sales of so-called auction-rate securities, UBS AG agreed to buy back from investors nearly $19 billion of the investments as part of a settlement with federal and a group of state regulators. It will start buying from individuals and charities in October and from institutional clients in mid-2010. UBS was the third major firm this week to vow to buy back the securities, which allegedly were improperly sold as higher-rate equivalents for super-safe money-market funds. UBS, Merrill Lynch & Co. and Citigroup Inc. have committed to taking back a total of more than $36 billion of the instruments. Other financial firms are expected to follow suit. Auction-rate securities are a kind of debt that soared in popularity in recent years. They let issuers such as municipalities and student-loan organizations borrow for the long term, but at lower, short-term interest rates. The rates reset at periodic auctions, hence the name. Wall Street sold more than $330 billion of these securities to more than 100,000 individuals and other investors. State regulators from Massachusetts and New York have sued Merrill Lynch and UBS for civil fraud, with the UBS case now settled. Regulators from several states have also shown up on Wachovia Corp.'s doorstep demanding documents; the bank says it is cooperating. A New York state official has accused Citigroup of destroying documents, a charge Citi has denied. Federal prosecutors are preparing to file criminal charges against two former Credit Suisse Group brokers who allegedly lied to investors about auction-rate securities. It's rare that Wall Street firms make good on client losses, and the size of the auction-rate payments is unprecedented. But a review of several recent regulatory cases reveals the legal pressure facing Wall Street, and shows that some authorities believe the auction-rate market, which was created in the mid-1980s, got out of control. Regulators say that financial firms, at various times, secretly propped up failed auctions; misled investors on the safety of the securities; pressed brokers and research analysts to sell the very securities executives were trying to unload; and resisted client demands for relief. WSJ Auction Rate Security Graphic

Fannie Mae Loss of $2.3 Billion Exceeds Forecasts Fannie Mae reported a wider-than-expected second-quarter loss of $2.3 billion and said it expects more heavy losses from the surge in home-mortgage defaults. Mounting losses at both Fannie and Freddie Mac, the two main providers of money for home mortgages, are limiting their ability to buy and guarantee home loans. That may mean higher interest costs for consumers.

"What are losses going to be? Where is credit going to go? Where are home prices going to bottom? How long is that going to last? What's the overall impact of the macroeconomy? What is funding liquidity in the capital markets? All of these scenarios that everybody has are highly, highly sensitive to the variables and the assumptions that you make. And none, in my view, are conclusory enough to have full visibility into where they wind up in '09" -- Dan Mudd, Fannie president and CEO.

Fannie chopped its quarterly dividend to five cents per common share from 35 cents but said it still may need to raise more capital, beyond the $7.4 billion in proceeds from share offerings in May. Congress last month gave the Treasury authority to make loans to Fannie or Freddie or buy shares in them, and some analysts say they think the Treasury eventually will have to shore the pair up by acquiring sizable equity stakes. Losses are turning out worse than generally forecast largely because home prices have fallen more steeply than expected, particularly in such states as California, Florida, Arizona and Nevada, Fannie executives said on a conference call with investors. That means Fannie and Freddie recoup less money from sales of foreclosed homes. Prices for single-family, detached homes in July were down 28% from a year earlier in California and down 17% in Florida, according to data to be released Monday by First American LoanPerformance. For the U.S. as a whole, the decline was 11%. WSJ Reserve Impacts Graphic

Mortgage Giants to Buy Fewer Risky Home Loans Gaping losses at Fannie Mae and Freddie Mac are causing the two mortgage giants to slow their purchases of home loans at a time when the government is counting on them to help prop up the housing market. The reductions and associated measures that the companies are taking are likely to drive up home mortgage rates, which are near their highest levels in a year. Concern over the companies’ financial health was heightened on Friday when Fannie Mae reported a second-quarter loss of $2.3 billion. The deficit was three times what analysts had forecast and was the company’s fourth consecutive quarter in the red. This week, Freddie Mac reported a $821 million loss for the quarter. Although Fannie Mae’s revenue was up slightly — to $4 billion, an increase of $200 million from the previous quarter — its expenses related to foreclosures and other credit losses soared to $5.3 billion, up from $3.2 billion in the previous three months. In light of their losses, both companies have indicated they will slow the number and types of loans they are purchasing. Fannie Mae executives, in a conference call with analysts on Friday, said they intended to reduce the growth of the company’s loan portfolio and stop buying riskier so-called Alt-A mortgages by the end of the year. Fannie Mae will also begin charging more to guarantee loan repayments, a step that is likely to push mortgage rate higher. “Fannie and Freddie’s decision to curtail support of the mortgage market is going to make mortgages more expensive for potential home buyers, which is going to hurt the overall economy,” said Howard Shapiro, an analyst at Fox-Pitt, Kelton. “They’re the only real buyers in this market, and they’re going to buy less. That’s really bad news.”

Posted by dblwyo at 11:28 AM | Permalink | Comments (0)