bizzXceleration: Performance, Value and Profit

The last post was a deep dive on how well the Finance Industry was doing and now we need to shift gears and look at the rest of the real world as it struggles to reset for the "New Normal". Just for the record, and to set the table, the Finboys are not only not doing well on adopting new strategies or adapting to the reset but they still struggling to cope with the last two decades of maneuvering. In fact one could fairly summarize their approach as BAU, Denial and Obfuscation. Our buddy Jake over at Econpic explains it all when he borrows from Chris Whalen of Risk Analytics (via BigPicture) to tell us that Almost 1/3 of Banks Rated F . As usual the chart is well worth looking at. Now the question is how is the rest of the business world coping with things ?

The answer is "middlin fair", as they used to say in the sheep business (that's an obscure hint and pun btw). The Readings after the break are a survey of the state of play and cover several industries (Airlines, Retail, CPG, Autos & Manufacturing, Pharma, Technology and Telecom & Telemediatainment), companies (BA, SBUX, WMT, HD, PG, GM, VW, Brailians, Chinese/BYD,BAC, APPL, MSFT, IBM, Lenovo, CSCO, Huawei, iWorld & Smartphones, NOK and GOOG) and we're going to pick on a selection to make our broader points. To be fair each industry and/or company deserves its own in-depth look of the sort we did for Dell, Citi, HD or WMT but that's be many posts and months away. Can we trust you to take the depth as at least implied and carried ? Please ?

PG as Case-in-Point

The real point is that almost every one of these companies was or is a world leader with a track record that puts it in the top tiers of business performance. As such how they're coping seems to us to be a fair test of how others might be doing. If the best of the best are struggling then how are the followers and strugglers fairing ? We'd guess anything but as well. We're going to single out P&G and the CPG industry as a whole, especially since we took an earlier deep dive on PG as being the poster child of innovation and adaptive resilience (Sailing Into the Storm: From Execution to Innovation).

Diving into the PG/CPG situation the upper l.h. sub-chart shows how various brands are doing in the retail space.There's been a surge in store brands, a major shrinkage in other brands, top brands are under pressure as are expensive brands. In other words consumers and retailers are looking for less feel-good differentiation and more value. Reflecting the deep shift in preferences as the result of a new frugality that's likely to be with us for the next decade of doldrums. The u.r. sub-chart shows yoy% changes in Non-durables spending back to 1950 and, as you can see, the drop was a severe as anything previous. Worse it's hanging around at the bottom of the cliff, battered, bleeding and still being kicked around. The only good news is that, like all other indicators, it's still not accelerating downward.

The lower l.h. sub-chart compares PG to the XLY Consumer Discretionary ETF. Obviously it did better the last downturn but has since tracked the Industry almost exactly. Oddly that tells us that Lafley's re-think and re-do was effective, judged by Red Queen standards. It also tells us that top-down macro conditions can swamp anything. The lower r.h. sub-chart shows PG per se back to 1990 and, in some ways, it's a great story of continuing to create value. Notice we built the l.t. trend by filtering out the last bubble (would that we had at the time) and that we built the Fibchart by taking the low as the point where the bubble rice crossed the trend; interestingly the stock hit the 50% correction limit exactly ! Yet, when you check the readings, PG is going thru another huge re-think to take its entire product line down price around the world. It's adapting to the new normal and using, hopefully we think, the agility and resilience that Laffley built into. That also tells us, IOHO, that understanding the "story" (or the "Theory of the Case") for any individual stock is the single most critical thing you can do in the long-run !

Case-Theory: What's the Real Story Behind the Charts ?

In this next chart we apply that theory to some of the other exemplary companies in the readings and find that it's not all that simple; that is, clear technical trends don't automatically pop up and you've got to do a lot more digging. Here's where long, multi-part and involved assessments of each exemplar are required but this is what you get instead. Consider the rest as a take-home test perhaps ?

The upper l.h. chart shows WMT meandering in the early '90s as it's business model aged, riding the boom with everybody else and then meadering again as its BM went from aging to aged to sclerotic. BUT...notice that the new WMT has held up exceptionally well indeed...all things considered. In the upper r.h. corner is BAC, another great company but in an industry that cycles around the boom-n-bust of new aircraft introductions. Each of which represents a bet-the-company risk but one that's unavoidable. The old Boeing was aging badly and didn't ride up with the last boom but then did well as new strategies and leadership along with new planes drove it skyward. The B787 teething troubles are really hurting it now, as they should, but this is not just a new plane but a new manufacturing technology and a new value chain. It was the B777 where BAC revolutionized design and engineering (btw Mulalley was the project leader and then head of Commercial Aircraft this decade). Once they get it fixed and the demand turns, well....

The lower l.h. sub-chart takes us to Technology by comparing CSCO and IBM. The latter was on death's door in the early '90s until Dr. Lou perfored emergency surgery and introduced e-business, which they rode with the boom. Then they went nowhere as Sam tried to find the Next Big Thing (On-demand and Innovation were the two biggies) until giving up and managing earnings while the Software Group saved them. Now everybody believes the "story" but there are not breakthrus here. CSCO is even more interesting. It rode the rocket during the'90s and then went bust badly but has since stayed in a trading range. Businesswise they completely re-thought and re-did the business, leaving a pure dependence on routers and switches and going after the other big telecom markets. Now we have the recent re-structuring which is the first big, large-scale exercise in organizing for innovation on this scale we've seen or heard about in many decades. Whether it will work or not is TBD but that it's necessary seems beyond question to us.

The next big story is APPL and Jobs. Notice they were at death's door until Jobs was brought back in and caught a following wind but also because he built some new sails by re-vamping the Macs and doing a complete refresh. At least on the business as it was. Then they ended up becalmed again. In 2003 Steve took the time he'd bought and resources he'd created plus his experience with innovation and design from Pixar and took us all to iWorld (iPod (music) to iTouch (video) to iPhone) which has revolutionized the cellphone market, jumpstarted the world of smartphones and created a major new sub-industry. But what have they done for us lately ? The new iTablet will be another big deal if it's done right but that won't be the kind of chasm crossing that iWorld was to the MAC. For APPL to keep on keeping on they'll need that next big breakthru. We didn't graph it but the last story, with a longish excerpt, is on Google and how it's beginning to resemble e-Bay five years ago. Lots of churning but no new NBTs despite all the cute experiments. Think about it - at this point we hope you have the toolkit.

Organosclerosis: the Dangers of Putting Internals Ahead of Value

What drags down a good company ? Jim Collins has just come out with his big new book on that topic but it's something we've been covering for a long time now.Business Hilbert Problems: Fundamental Factors of Performance

The blank graphic at right is Collins' recent interview on Charlier Rose. Unfortunately Charlie is moving servers and all you get is this really ugly black screen as a temporary placeholder until/if/when he's back on the good stuff. Either click on the graphic or the highlighting and it should take you to where you can play the temporary file.

In any case he talks about his new Five Stages of how companies are all too prone to creeping sclerosis when the let conviction of their own innate superiorities cause them to loose sight of continuing to create value in the markeplace and innovate. One of his most telling quote is about how you tell when it's in trouble...."when the CEO is all about me and not about the company". We'd generalize that and say when the company spends more time on turf-fights and personal advantage for the power-holders instead of what they can do for the customer they're in deep dodo. Know anybody like that ? How 'bout the entirety of all the failed Finance companies. What you want is the kind of company that Lafley apparantly built at PG where it's not about the players it's about the game !

Here's our checklist of key performance factors for you to use in determing whether a company is a PG or a LEH.

1) Organosclerosis - all organizations that are successful reach a point where they are insulated from external pressures, internal agendi become the dominant decision-making criteria and self-interested political decisions replace a focus on value. What kind of management system is required to correct these historical and innate tendencies - other than Darwinian sortation ?

2) Integration - no single factor determines the success of an enterprise. It needs to integrate the strategy and business model with the operational execution capabilities and establish a management system that holds the responsible parties accountable against realistic operating plans. How do we migrate from our decades-old set of isolated and conflicted functional silos to a more synergistic enterprise ?

3) Execution - most companies are competent or better on a few core disciplines but often neglect developing the full suite of functional capabilities to where they should really be. A growingly classic example is MSFT who's core discipline is Software Development but after the Code Red fiasco delivered an emasculated Longhorn to market based more on market power and coercion than enhancing customer value. How do we ensure, ala Billy Beane's A's, that we get as good a "player" in each position for the "game" we want to play at an affordable and value-effective price ?

4) Innovation - execution is all well and good but once you detox history and transform current capabilities, like a shark, you need to figure out how to swim into the SEE of the future.(Sailing Into the Storm: From Execution to Innovation) What's the best way to go about designing and implementing continuous innovation as a fundamental core competency of the enterprise ?

5) Leadership and Humanity -at the end of the day business is a team sport. And as Red Auerback taught us and the new Celtic have demonstrated you need great players with superb skills who play for the jersey they're wearing. Which requires Leadership which communicates, management systems that measure and reward real contribution and provides an environment that respects, in all senses, the individual as an adult (Aholes, Shirkers and Performance: a Draft People Principles Policy ). What HR, Communication and Leadership development approaches are best suited to the enterprise we're envisioning here ?

 We suggest you apply it to every company you're involved with....or any other organization for that matter.

Business Performance Readings

Grounded BA’s aim is to save the business trip from extinction. It argues that “face-to-face interaction fuels business. In these challenging times, you can keep relationships alive through faceless conference calls or live video conferences, but chances are they won’t grow much without some quality face time.” So far this year the number of business- and first-class passengers on BA’s aircraft has fallen by 15% compared with the same period in 2008 (and an industry-wide decline of 17%). And aggressive price-cutting to try to minimise the fall in passenger numbers means that BA’s revenue from these travellers is down by more than 20%. Clearly, some of this decline is cyclical. The recession has prompted many firms to cut their travel budgets. And even when business trips are still allowed, the prospect of being stuck in economy between a screaming baby and a boring 250lb tourist, rather than stretching out as usual in business class, is deterring executives from trips they might once have made. The finance industry is cutting back on travel more than most, and it was a big user of BA’s business seats. The slump in mergers and acquisitions, and the many other ills afflicting the banking industry, means far fewer Masters of the Universe jetting back and forth between New York and London. But what really worries BA, and other business-oriented airlines, is that the cyclical downturn may be coinciding with a structural decline in business travel because of advances in information technology. Hence BA’s reference to “faceless conference calls or live video conferences.” Predictions of the demise of business travel at the hands of technology have been made before, but this time there is more reason to think they will prove right.

Retail and CPG

Starbucks Aims for 'Lean' Techniques  Starbucks Corp. built its business as the anti-fast-food joint. Now, the recession and growing competition are forcing the coffeehouse giant to see the virtues of behaving more like its streamlined competitors. Under a new initiative being put into practice at its more than 11,000 U.S. stores, there will be no more bending over to scoop coffee from below the counter, no more idle moments waiting for expired coffee to drain and no more dillydallying at the pastry case. Starbucks says the efforts are already helping its bottom line, as shown by quarterly results last month that beat analysts' expectations. Still, some baristas fear the drive will turn them into coffee-making automatons and take away some of the things that made the chain different. Pushing Starbucks's drive is Scott Heydon, the company's "vice president of lean thinking," and a student of the Toyota production system, where lean manufacturing got its start. He and a 10-person "lean team" have been going from region to region armed with a stopwatch and a Mr. Potato Head toy that they challenge managers to put together and re-box in less than 45 seconds. Mr. Heydon says reducing waste will free up time for baristas -- or "partners," as the company calls them -- to interact with customers and improve the Starbucks experience. "Motion and work are two different things. Thirty percent of the partners' time is motion; the walking, reaching, bending," he says. He wants to lower that. If Starbucks can reduce the time each employee spends making a drink, he says, the company could make more drinks with the same number of workers or have fewer workers. Some say lean techniques aren't a panacea. "Those efficiencies only help when people come in the door," says Jeffrey Bernstein, a restaurant-industry analyst at Barclays Capital. "Broader economic pressures need to ease and traffic needs to increase before they can benefit from those efforts." Starbucks's U.S. transactions fell 4% in the most recent quarter. Starbucks's efficiency quest is an example of how even premium brands are re-engineering how they do business amid an economic crisis. Unlike in boom times, offering ever-fancier products and opening new stores is no longer a recipe for growth. The recession has resulted in a new thrift among consumers. In an April poll of 1,500 people, research firm WSL Strategic Retail found 28% said they were putting more money into savings, up from 19% six months earlier.

• Retail Sales in U.S. Unexpectedly Fall on Concern Over Job Losses, Income
• Retailers Brace for Weak School Shopping
• Retailers’ Empty Shelves
• Sortable Chart: From Abercrombie to Zumiez
• Wal-Mart Posts Flat Profit, Lower Sales
• Home Depot, Lowe's still suffering, D.I.Y. Chains Adjust to Smaller Projects
• Sales Continue to Slide at Macy's as Cost Cuts Fuel Improved Outlook
• U.S. Same Store Sales Update [08-06-09] Marty Cej and Linda Sims walk us through the U.S. same store sales figures.
• Same Store Sales [08-06-09]August 6, 2009Seventy percent of all retail purchases made in the U.S. are by women. When are they going to start spending, and on what? A look at same store sales numbers and household budgets with Patti Freeman Evans, research director, ForrestER Research.
• Same-store Sales [08-06-09] BNN speaks to Brian Sozzi, equity research analyst, Wall Street Strategies Inc.

Wal-Mart Thinks Locally to Act Globally  Having powered its way to the top in U.S. retailing, Wal-Mart Stores Inc. has struggled to extend its dominance across the globe. But the world's largest retailer is learning in Brazil and elsewhere that the most successful ideas don't necessarily flow from its headquarters in Bentonville, Ark. That has it tailoring inventories and stores to local tastes -- and exporting ideas and products pioneered outside the U.S. Traffic-choked São Paulo, for instance, proved inhospitable to the kind of vast stores with which Wal-Mart dominates in American suburbs. At the same time, the local-market savvy of Brazilian retailers that Wal-Mart acquired has proved invaluable. "What we have learned in the past couple of years is that one size does not fit all," says Anthony Hucker, a British retail veteran now tasked with taking winning Wal-Mart store formats and expanding them globally. Wal-Mart's challenge abroad is to cater to local tastes for native products that are not popular elsewhere, while still making the most of the global purchasing might that lets its squeeze down its costs.

P&G Turns to 'Basic' to Fight Downturn -- Procter & Gamble Co., under assault by penny-pinching consumers, has quietly rolled out a version of Tide detergent that the company freely admits isn't "new and improved." The product, Tide Basic, is currently for sale in about 100 stores throughout the South. It lacks some of the cleaning capabilities of the iconic brand -- and costs about 20% less. Its very existence is one of the most telling signs to date of how the sour U.S. economy is forcing mass marketers to shift course. On Wednesday, the company reported an 18% plunge in fiscal fourth-quarter profits as sales of its premium-priced brands shrank amid tightened consumer budgets. The decision to develop Tide Basic didn't come easily. For decades, P&G had held fast to a strategy of promoting new features to convince shoppers to pay a premium for detergent, shampoo and other household staples. Then, as cheaper store brands gained traction in the aisles, P&G began offering lower-priced versions of some products -- Charmin toilet paper, Bounty paper towels -- to suit leaner budgets. . Many people for the first time are clipping coupons, trying cheaper brands and buckling down in ways they never had to before. Economists aren't sure how long the trend will last. But a recent report from IRI identified a new class of fiscally cautious consumers. Some 52% of respondents said that in the coming year they plan to buy store brands to save money; 47% plan to eat at restaurants less frequently; and 48% plan to use home beauty treatments rather than visit a salon. The 172-year-old company built its fortunes after World War II on Americans' growing affluence and inclination to equate "better" with a higher price. P&G flooded radio and television with ads promising its products delivered superior performance in everything from teeth cleaning to floor shining. In return, P&G got a superior price. The approach made household staples out of Mr. Clean cleaning liquid, Crest toothpaste and Tide laundry detergent. P&G sold lower-end brands but gave them scant advertising. Now P&G's model is under attack as retailers like Wal-Mart, Target Corp. and supermarket chains nationwide improve the quality and selection of their own brands, tempting penny-pinching consumers to forgo P&G's pricier products and eroding the giant's dominant market-share positions.

• Soap Struggle: Makers Race to Market Low-Suds Detergents For Automatic Washers (May 6, 1954)
• Dental Group Says Crest Toothpaste May Help Curb Cavities (Aug. 1, 1960)
• Marketing Classic: How Procter & Gamble Put the Big Squeeze On Scott Paper Co. (Oct. 20, 1971)
• Report: Warner Chilcott to buy P&G's pharma unit
• P&G Is Seen Likely to Prune Further

The game has changed The recession has spelt disaster for most brands of packaged goods, but not all. Consumer goods were once believed to be as recession-proof as any industry can be. Shoppers might not be able to afford Rolex watches and champagne during a downturn, the theory ran, but everyone still needs staples such as soap and toilet paper. Yet sales have fallen in this downturn, thanks largely to growing competition from stores’ own brands, or “private labels”. Private-label goods tend to cost about a quarter less than branded ones, and so appeal to penny-pinching consumers. Some shoppers are also forgoing altogether items that they used to consider staples, such as air fresheners or special detergents for sensitive skin. The big brands’ recent, ill-timed price hikes of as much as a fifth in response to rising commodity prices have accelerated the trend. Retailers have also been giving more shelf space to their own products, on which they earn better margins, further squeezing the big brands by making them less visible. Jan-Benedict Steenkamp, a marketing expert at the University of North Carolina, estimates that the share of private-label goods is now 20% at Wal-Mart and 35% at Kroger, two huge American retailers. In the past year private-label sales have grown by around 9% in America and 5% in Europe, gaining market share from branded goods in many categories. Middle-market brands, measured by price or sales, are particularly vulnerable to competition from private labels; even in countries like Germany, where private labels now account for almost 40% of sales, the best-selling and most expensive brands have not lost much ground (see chart). Many analysts believe that the flight to private labels will outlast the downturn. Ali Dibadj of Sanford C. Bernstein, a research firm, estimates that about half the people who have recently switched to private labels will never go back. The quality of private-label goods has improved, making it harder for consumers to discern any difference between a store’s brand and a more expensive rival, particularly for commodities such as paper towels or milk.

Autos and Manufacturing

Will anyone mourn Pontiac? The Pontiac brand may be going away, but General Motors (MTLQQ, news, msgs) is hoping its customer base won't. By the end of 2010, GM will have shut down Pontiac while hoping to retain the 83-year-old brand's domestic market share, which was 2% in the first half of this year. Other than GM, "Nobody's going to miss Pontiac," says industry analyst James Harbour, the founder of the Harbour Report and the author of the autobiography "Factory Man." "There was nothing unique about it," Harbour says. "It competed with Saturn, Chevrolet and the low end of the Buick line, and all the cars it had were derivative off a Chevrolet base." Adds Jesse Toprak, market analyst for Edmunds.com: "Pontiac was GM's performance-, sports-oriented brand, but it was never compelling enough, never good enough. For the most part, it was just a redundant brand. It had some exciting products that would come up and create buzz, but then they would go away. "GM can do the math," Toprak said. "They decided they would be better off without it." GM's plan, well-known by now, is to support four core brands -- Chevrolet, Cadillac, Buick and GMC -- and 34 nameplates, down from 48 today. Slimming down narrows the cost and focus for development, manufacturing and marketing. Most experts see that as the sort of strategy GM should have adopted years ago, on the theory that a company with 20% of the market shouldn't try to operate as it did in 1962, when it had 51% of the market. GM had become so ossified that the government had to intervene to enforce this line of thought. For the new GM, the loss of Pontiac is a major adjustment. Pontiac sold 88,794 cars in the first half of 2009, according to Edmunds.com. GM wants to drop Pontiac, Saturn, Hummer and Saab, which combined have 3% of the market, while retaining an 18% to 19% share of the overall vehicle market. "GM has to retain every tenth of a point of market share," says independent auto analyst Tom Libby. "They had 50%, they are now around 19%, and they are on the way to 17%. They have to stop the share decline." As for retaining Pontiac buyers, "I would say there is no way they can retain 100%, but they can retain 40% to 70%," Libby says.

• GM Balks at Selling Opel

• VW Seeks to Turn Nostalgia Into Sales in U.S.
• My other car firm's a Porsche Despite a distracting merger, Germany's biggest carmaker, Volkswagen, is doing well
• Toyota not chasing 15 percent global market share, Toyota Lost Touch, Executive Says
• A question of trust Guiding Peugeot-Citroën through the recession will be hard. Philippe Varin must get along with the owners
• Brazil Car Makers Leave Slump in the Dust
• BYD to Sell Electric Car in U.S. Market Next Year
• Best years of auto industry lie ahead
• Alternative energy powerhouse Brazil finds big oil
• Boeing Halts Dreamliner Plant

Big drugs firms embrace generics  Cost-conscious governments everywhere are bashing pricey patented drugs even as they boost cheap generics. In the past few weeks regulators in America and the European Union have announced separate crackdowns on anti-competitive practices, including “pay-for-delay” deals, whereby big drugmakers pay generics firms to delay the launch of competitors to drugs coming off patent. From Japan to Germany, governments are liberalising drug markets, sweeping away barriers to generics. This pressure from above comes just as the bottom is falling out. A record number of drug patents expire over the next few years, which should lead to stiff competition from generics and a collapse in prices. Evaluate Pharma, an industry consultancy, estimates that about half of the $383 billion-worth of patented drugs to be sold in the world this year will lose patent protection within five years. In 2010 alone the industry will see nearly 15% of its revenue from patented drugs put at risk. Where competition from unbranded generics is fiercest, for instance in America, the price of a given drug falls by more than 85% within a year of patent expiry. Big drug firms used to turn their noses up at the generics business, but the assault on their profits has forced them to think again. In many rich countries and most poor ones, they are managing to avoid calamitous drops in revenue by peddling “branded” (but not patented) versions of their original drugs for higher prices than unbranded generic equivalents. Illogical though it may seem, such is the power of brand loyalty and inertia among doctors and patients that these branded generics often help the firm losing the patent retain half or more of the market, in value terms, even after generic competition is legally permitted (see chart).

• Drugs companies and poor countries
• Something rotten Regulators should put a stop to tactics that delay the introduction of generic drugs

Technology

What's up next for Apple? First, you must recognize that practical products that thoroughly delight consumers are exceedingly rare in our age of instant obsolescence, a time when it has become increasingly hard for companies to raise prices and demand brand loyalty because of the ease with which imitations are created and the speed at which jaded ennui sets in. Companies that cannot demand excess value through useful products paired with imaginative marketing are condemned to bruising battles for market share through price wars that eat up capital, reputation and profits. By creating a software platform in its iTunes App Store on which tens of thousands of profit-incented third parties can essentially create new versions of the device every day, Apple has essentially created alchemy out of aluminum and silicon: The iPhone has become a self-perpetuating machine that changes itself to fit new opportunities and spins off profits with little effort from the home office. It's never been done before, though every company on the planet wishes it could duplicate it. Imagine the margins that Kellogg could achieve if it could find a way to grab a 30% royalty every time someone made Rice Krispie treats. Money is absolutely pouring into the company to the extent that it now has a cash hoard of more than $28 billion and annual free cash flow of nearly $10 billion more. This astonishing profitability -- which competitors ranging from Microsoft to Nokia and Sony have tried but failed to dent -- gives Apple almost unlimited opportunity to invest in developing products. In the meantime, Apple has to keep delivering its current devices at a pace commensurate with the recent pace. Considering that it has not really slowed down in the recession and that the economy is finally heating up again, the company shouldn't have a big problem doing so. I mean, Mac sales in the past quarter were up 4% year over year, versus the negative-3% pace of the industry. Seven percentage points may not sound like much, but it's huge in this business. Plus, there are market-share gains to be made: At present, Apple is only the seventh-largest PC vendor, with a 3% share, and the fourth-largest U.S. vendor, with a 5.8% share. Both of those numbers have risen in the past two years and provide ample room for growth, particularly overseas.

• Jobs Focuses On New Tablet
• Putting lipstick on Microsoft's pig
• Microsoft’s SharePoint Thrives
• Hangover Looms for Lenovo Investors

IBM Defends Its Big Iron The mainframe's fate still matters a lot to IBM. Since their debut in 1964, mainframes have helped send astronauts to the moon, ushered in computerized airline reservations, and crunched numbers for giant banks. Although analysts estimate that sales of the big computers represent less than 4% of IBM's revenues in a good year, the combination of mainframe hardware, storage, software, and services account for nearly half of its profits. To be sure, IBM's mainframe business is slumping. The economic recession has put a damper on demand for computer systems that cost more than $250,000—and sometimes millions of dollars. IBM introduced a new version of the mainframe, called z10, in early 2008, and sales drove mainframe revenue growth of 34% in the second quarter of last year. By now, though, the new models have been installed by the most avid users and demand is trailing off. But this is a slowdown, not a collapse, says Charles King, analyst at market researcher Pund-IT Research. "I wouldn't call it the beginning of the end," he says. That's because the computer design that has shown so much resilience over the decades still has a lot of appeal to corporations. While the initial bill for buying a mainframe is high, customers can process large amounts of data very efficiently. "It's really solid, powerful, reliable, and able to handle the processing needs of large companies," says Jackie Barretta, chief information officer of Con-way (CNW), the large freight shipping company. Con-way leased two new z10s last year, and they provide the transaction processing for most of the company's computing systems. Now, Rosamilia's top priority is making it easier for corporations to run new software applications on mainframes. The company plans to introduce bundles of computers and software the week of Aug. 10, aimed at specific uses such as security monitoring, data warehousing, and disaster recovery. Mainframes are also finding a home with companies hosting "cloud computing" software that's delivered over the Internet as a service. Since customers can run many applications at once in separate partitions, the machines often operate at more than 90% of their total computing capacity, far better than servers based on industry standard chips from Intel (INTC) and Advanced Micro Devices (AMD). "As companies move toward cloud technologies, this is going to be an important option for them," says Rosamilia. Over the past decade, IBM has made it possible to run the open-source Linux operating system and related programs, and has introduced mainframe technology for running applications written with the Java software programming language. Last year, 25% of the mainframe processing power that IBM sold was for use with Linux, which costs customers a lot less than traditional mainframe software.

• IBM Helps Clients Create Smarter Procurement Processes

Telecom and Telemediatainment

Cisco's Profit Slumps  Cisco Systems Inc. posted a 46% drop in quarterly profit as companies continued to pare spending on networking gear. But Chief Executive John Chambers said there are signs the economy likely reached a "tipping point" during the quarter, and stood by a pledge to return Cisco to double-digit growth. Mr. Chambers aims to do that by continuing an expansion push that has seen the company move into more than two dozen new businesses, from consumer camcorders to giant TV screens for stadiums. In order to manage these initiatives, Mr. Chambers has replaced Cisco's top-down decision making with committees of executives from across the company. Some teams provide strategic advice and evaluate the progress of these projects. In total, Cisco now has 59 internal standing committees. Mr. Chambers said in a recent interview the new structure is necessary for the San Jose, Calif., company to avoid the declining growth rates often experienced by large businesses. By expanding into so many new businesses, Cisco can replicate the success of new products it has launched in the past, "just at a much larger scale," he said. But Mr. Chambers's approach flies in the face of the management styles adopted by most companies of Cisco's size, which typically try to streamline operations and focus more narrowly on priorities. "We have gone through the toughest economic time period we've seen in our lifetime," Mr. Chambers said Wednesday during a call with analysts. But he struck a positive note, adding that orders grew sequentially during the quarter for the first time in a year. Cisco's largest business, the Internet switches that pass data between computers, declined 11% to $12 billion in its fiscal year. In addition to the recession, Cisco faced increased competition from rival Hewlett-Packard Co. The company's new management structure has at times slowed its response to rivals' moves, according to people familiar with the matter.In late 2007, for instance, H-P started promoting a warranty for its switches that provides free upgrades and support. Under Cisco's new structure, a decision about how to respond to H-P's offering was delayed as it worked its way through multiple committees, these people said. Cisco didn't match H-P's promotion until this April, and during that period Cisco's market share fell. New Organization Structure Chart

• Cisco suffers 46% profit drop, Parsing Cisco's Results for Tech Spending

• Huawei Sees Gain in European Market Share, `Significant' U.S. Breakthrough
• The Two Sides of Verizon's Deal Making
• Smart Phones Defy Mobile Sales Slump
• AT&T vs. Verizon: Cannibal smackdown
• Friends, family and grandads too BT, a former industry champion battles decline and a huge pension burden
• iPhone market share surged 375%, Apple Highest Grossing Retailer on Fifth Avenue as iPhone Defies Recession
• Apple's Animal Farm
• Microsoft, Nokia Take Aim at BlackBerry
• Nokia's `Slumdog' Slip Puts Market Share at Risk as IPhone Takes Hollywood
• Nokia Rocks the World: The Phone King's Plan to Redefine Its Business

Is Google Sitting on the Clock of eBay? Maybe. There are some worrisome parallels between Google today and eBay in 2005-06, as the online-auction company's growth was faltering. Consider this history: In August 2004, then-Chief Executive Meg Whitman said she didn't believe eBay was approaching anything like saturation. Just six months later the company issued a weaker-than-expected forecast that in hindsight was the end of its red-hot growth phase. EBay's stock is now trading at less than half its December 2004 level.Through 2005-06 some hoped that eBay's PayPal unit, acquired in 2002, and Skype, in 2005, would prove to be new growth engines, along with international markets. As it turned out, of course, after writing off much of the Skype purchase price, eBay now is looking to jettison it. And growth at PayPal and internationally hasn't been enough to stop eBay's top-line growth rate from decelerating.When it comes to Google, there also are hopes for international growth. YouTube has some similarities with Skype, high user traffic but relatively low revenue. Whether YouTube can live up to its promise as a big ad platform is uncertain. Another of Google's potential growth engines is Android. But its ability to help Google expand in the mobile-ad market remains unproved. While investors wait for these new initiatives to prove themselves, growth is slowing in the core paid-search ad business. Google's revenue growth rate has fallen from 93% in 2005 to 31% in 2008. The recession has demonstrated the Internet company isn't immune from pressures other ad-dependent businesses face. Revenue growth dropped to 3% year on year in the second quarter. Moreover, as U.S. revenue growth was only 1.6%, it is possible that Google's core search business actually shrank in the U.S. when contributions from newer businesses like mobile advertising are excluded. Google's revenue growth will certainly accelerate coming out of the recession. The issue is by how much and for how long.

Posted by dblwyo at 10:42 AM | Permalink | Comments (0)

Well we've refreshed ourselves on the economic (here) and market situations (here) with the primary conclusions being we've stopped the cliff-diving but are bumping along at the bottom of the cliff in a very rocky landscape. One that feels better only because it's not so much worse. As for the Markets we referred to them as "euphorilusion" since they ran up with a V-shaped recovery, earnings expectations beats that were really cost cutting with meat-axes and valuations run wild. No matter what happened this last week with the daily runups we still think that's true and without going into a repeat discussion if you want to check out the updated multi-period SP500 chart here it is.

That naturally leads us to the next stage in reality checking - what's the real reality behind earnings. Or, put another way, how are businesses performing and how are they likely to be performing in the future ? Which reminds us to explain that BaU is "Business as Usual" and NN is "New Normal". In other words, on the whole, we find way too many executives just waiting to be saved by the magical miracle recovery so they can revert to BaU (is there a sad parody of Value at Risk here ?) instead of making the reset adjustments required to cope with a NN. Nowhere is this problem more acute than in the Finance Industry, whose surprise earnings drove the market rally but are actually more vaporware and fumes than anything else. Based on various combinations of government money, guarantees, proprietary trading, reduced competition and so on and so forth. And which do not address the continuing threats of over-valued assets, rising bad loans, and long-term shifts in the industry.

More to Come: Bad Loans, Bad Earnings ?

We've organized the readings around several key themes and article collections, starting with the fact that banks are still sick and facing more problems. To quote the first excerpt, "...numerous large banks around the country are still struggling with deteriorating finances. Two dozen banks with at least $5 billion in assets get the lowest one-star rating on Bankrate.com's safety and soundness test...".

On top of which you should recall that all the bad securities are still on the books with grossly unrealistic market values, the CRE market looks to be starting the next wave of boulders rolling into the pond, foreclosures are continuing to grow, including in the prime mortgages and their traditional lines of business aren't doing very well at all. Even if nothing else changes, that is if the sand they're standing on doesn't turn out to be quicksand, they're still very weak and facing years of on-going operating and profit problems. Which explains why the drumbeat of bank failures continues and will keep growing, and the banks biting the dust are big ones. Which is changing the structure of the industry. To quote from another excerpt, "Scores of additional failures are expected in coming years, as the industry works through trillions of dollars worth of residential and commercial real estate problems.". BtW - we traced thru all these cyclical and structural problems in a prior post you might want to look at: Beyond the CRE "Bombshell": Real Stress Testing for Finance. In other words there are no major surprises here other than everybody seems to be surprised at problems that have been visible for a long...long time. That probably illustrates another major problem - one of the biggest - the tendency to subsitute ideology, delusions and wilfull ignorance for analysis and real data. Need to understand how the buzz saw works if you're going to be in a sawmill.

Goldman, Front-running and Bank Performance

In our last post on the Finance Industry (More Darkside Earnings Tales: Banks,Goldman und Unsinn) we covered some of the longer-term ground and asked where all these earnings were coming from so we won't repeat it. If you'll recall we use a "model" of the industry that looks at several key lines of business. In fact that model has three views we re-use: LOB vs Function, LOB vs Drucker Principles, and LOB vs Timeframe. Those Lines of Business are Wealth Management, Consumer Banking, Credit Cards, Business Banking and Securities Management. We include Transaction Services, M&A, Investment Banking, Proprietary Trading and Alternative Investments as sub-sets of the latter, where Alternative Investments include Venture Capital, Hedge Funds and Private Equity. Each and every one of those LOBs is facing major challenges currently, cyclically and structurally. And the Industry is failing, as best we can judge, to do anything about any of them. In an earlier post we even offered up a set of suggestions for strategic initiatives and innovations that would lead to some improvements in industry potential performance. (Firestorms, Finance, Futures: From Sociopathic Dysfunction to Value Creation). The result - da nada !

In the Darkside post what we found was that the only source of profits was proprietary trading, where GS was the exemplar. Or should we say bete noir ? Their, to say the least, highly unusual and unexpected profits all came from proprietary trading and, after the surprise, shock and outrage, a lot more people did a lot more investigating. The bottom line here is that their performance is so aberrational as to be completely incredible - hence the conclusion that seems defensible based on many folks work: GS is a hedge fund in disguise which makes it's money by making markets for clients and front-running them. In other circles that's called a violation of fiduciary trust.

We think the accompanying composite chart tells a terrible and scary story: re-regulation created aberrational finance industry profits which led to two stock bubbles that are still uncorrected and were built on the backs of loading up the rest of the economy with debt. And the primary beneficiaries, speaking of fiduciary problems, were the key players in the industry. How long is that going to continue ?

Alternative Investments: Venture Capital, Hedge Funds, Private Equity

David Swensen of Yale changed the world of institutional and endowment fund management by putting an emphasis on alternative investments. He shifted the portfolios from the traditional and conservation Stocks, Bonds and Funds to a much heavier emphasis on alternative strategies and was very successful for a long time. But the thing to bear in mind is that when he started in the early 1980s those alternatives were under-utilized and under-valued. Investment managers talk about the alpha and beta of investment returns. Beta is the amount of return that's based on market correlations. In other words the proportion of return being driven by the normal up and downs of the market and the economy. Alpha is the return resulting from finding hidden value. Put another way Swensen went after alternative investments when they had a high Alpha, a low Beta and one that was uncorrelated with the rest of the market.

Now as money from institutions, wealthy investors and asset managers flooded into the market you get what you always get - a huge surge in suppliers to meet that demand. In other words thousands more Hedge Funds, PE firms, etc. etc. The last time we saw a flood of hot money was the late '90s boom in Venture Capital chasing dreams of Tech Bubble pots of gold. In the last ten years the VC industry has barely performed as well as the Rusell2000, if that. 

Many firms have gone out of business but what we're looking at now is a huge shakeout, the return of funds and major industry consolidation. We suspect that the same thing for all the other alternative investments. You see Alpha = Anomaly. That is exceptional returns result from finding pockets of value that are under-appreciated and under-priced. Now all the alternatives are just so much BaU, or Beta. Worse yet, implicit in the prior chart, they are just leveraged Beta and the piper wants to be paid for his music.

Dick Bove, Fume Trading and the Last Word

We'll give Dick Bove, the well-known bank industry analysts the last work here because he brings it all home. This is a fairly recent interview on Canada's BNN where he discusses bank earnings, valuations and outlooks. When someone as respected as Bove speaks it'd pay you to listen. When someone that respected has been so right for so long and so contrarian you should really think about it. And when you put what Dick has to say together with our survey on the big picture and structural outlook you should start changing you atttitudes, actions and activities. The Finance Industry of the future will not look anything like the Industry that's evolved in the last thirty years.

But there are three other conclusions that are even more important:

1. On the whole nobody is paying any attention.

2. As a result nobody is doing anything.

3. Society cannnot afford to let the industry keep running around without adult supervision.

Updates, Adds, Refreshes

This morning's headlines are about the re-appointment of Bernanke, a great thing IOHO, and banks starting to raise more capital (Deutsche Bank plans Tier 1 issue, reopens market), on which topic you'll see more as the tide rolls on we suspect. But if our whole theme now is BAU and Denial our theme last year was broken business models, bad practices and malfeasant management. We collected all of last year's major posts on that topic and posted an "essay" on Scribd. Having just read-read it we strongly urge you to download it and at least review. With the caveat that no on is paying attention to:Credit, Leverage, Malfeasance and Broken Business Models.

Finally Simon Johnson and Michael Perino had this interview on Bill Moyer's Journal discussing the Pecoro Hearings in the 1930s which uncovered all the shennanigans that brought about the crash and led to the regulatory infrastructure created under the New Deal. At the time they didn't anticipate new Pecoro II but Congress has since chartered a blue-ribbon panel and, trust us, you need to hear the people singing. As Drucker said, "change the people or change the people". Well, the Industry is refusing to change...what do you think is going to happen ?

Sick Banks

Banks still sick The economy may have pulled out of its plunge, but you'd never know by a look at many big banks. Even after a rousing market rally that spurred new capital into giant institutions such as Wells Fargo (WFC, Fortune 500) and Bank of America (BAC, Fortune 500), numerous large banks around the country are still struggling with deteriorating finances. Two dozen banks with at least $5 billion in assets get the lowest one-star rating on Bankrate.com's safety and soundness test, which is based on an assessment of regulatory filings for the quarter ended March 31. More than half of those banks are ranked "troubled" or worse by research firm Bauer Financial, using the same data. Three of these banks, with a total of $45 billion in assets, have made public statements indicating they could soon collapse. "There are some big ones in fairly dire straits," said Karen Dorway, director of research at Coral Gables, Fla.-based Bauer. "If you see some of these fail, it could add to the stress on local economies." Many banks have had their capital eroded by losses, while their balance sheets remain bloated with billions of dollars in depreciating real estate investments and construction loans. These banks have been setting aside more money for future losses, but in many cases the increases in loan loss reserves haven't kept up with the surge in nonperforming assets. That means profits could be pressured even at stronger institutions. The problems at troubled banks could slow the recovery for their healthier counterparts. So far this year, 69 banks have failed -- the most since 1992. The Federal Deposit Insurance Corp. has already imposed a one-time fee on member banks to shore up its deposit insurance fund and has said it may impose another later this year. The FDIC's so-called problem bank list had 305 institutions -- with $220 billion in assets -- on it at the end of the first quarter. The agency has set aside $22 billion to cover failure-related costs this year. A law enacted this spring gives the FDIC access to up to $500 billion in Treasury credit though 2010. Even so, the scale of the banking problem will surely test the agency's mettle. Veribanc, another bank rating agency, suggested as much this spring when it reported a raft of first-quarter rating downgrades and forecast 97 bank failures for the year. "If the past quarter's trend continues, more than half of all banks could be downgraded during the remainder of 2009," Veribanc said.

• Watchdog says bad assets still threaten banks
• Bank bailouts: Never ending
• Next Bubble to Burst Is Banks' Big Loan Values:
• Banks May Reach Point of No Return as Toxic Loans Exceed 5% of Holdings
• New Phase of Crisis: Securities Sink Banks
• Souring Loans Compound Mortgage Woes
• Issuers Surprise Cardholders at the Register
• Don’t begrudge the banks their overdraft fees. Poor things, it’s all that’s keeping them afloat
• Bankers Craving Bonuses Fudge Loan-Loss Reality
• Trading on Fumes [08-11-09] There's been a shift in the psychology of how American bank stocks are valued and although Dick Bove remains bullish on U.S. financials in the long-run, he sees this as an opportune time to sell.

Failures and Consequences

Who wins when banks fail Shares of BB&T Corp. shot higher Friday after reports that it might be scooping up the remains of Colonial BancGroup. It's no wonder: Such purchases give healthier banks a chance to grow on the cheap. That's valuable at a time when many institutions have been shrinking in response to the recession. More than 70 banks have failed this year. Scores of additional failures are expected in coming years, as the industry works through trillions of dollars worth of residential and commercial real estate problems. While most of the biggest recent bank failures have been resolved via sales to major institutions or investor groups, regional banks have been bulking up as well. Since the banking crisis started last year, six regional banks have bought at least two failed banks from the FDIC. The leader has been Zions Bancorp (ZION), a Salt Lake City-based institution that has acquired four banks from the FDIC. Other buyers of multiple troubled banks include U.S. Bancorp (USB, Fortune 500), the Minneapolis-based bank that last year bought the remains of troubled thrifts Downey Savings and PFF, which failed on the same day. The joint purchase of Downey and PFF wound up being the third largest deal by assets for failed banks last year, after the WaMu and IndyMac sales. In addition to BB&T (BBT, Fortune 500), analysts have pointed to Cincinnati's Fifth Third (FITB, Fortune 500) and Atlanta's SunTrust (STI, Fortune 500) as regional banks that might be chosen to participate in future deals. Some bankers have downplayed questions about buying failed institutions. Such deals "really are off our radar," Fifth Third chief executive officer Kevin Kabat told investors last month, noting that there have been relatively few bank failures in the Midwest. But given the advantageous terms, no one is ruling FDIC-assisted deals out, either. U.S. Bancorp chief executive officer Richard Davis said in a conference call with analysts and investors last months that the bank "will always be available" for any "opportunities that come along" on the FDIC failed bank list, though it is keeping an eye out for bigger ones.

• Colonial failure could make mortgages scarce
• BB&T Takes Over Failing Colonial BancGroup
• BB&T buys Colonial bank; 4 other banks fail
• Biggest bust of '09; 5 more banks fail
• Problem Bank List (Unofficial) Aug 21, 2009
• Meredith Whitney: 300 Banks to Fail
• Failed Banks and the Deposit Insurance Fund

Re-visiting Goldman

Goldman facing compensation, derivative inquiries Goldman Sachs Group Inc., one of the banking industry's top performers, said Wednesday that government agencies have asked about its compensation practices and use of credit derivatives. been among the most hot-button topics in the financial services industry since the credit crisis peaked last fall. In a filing with the Securities and Exchange Commission, Goldman said it is cooperating with the requests from undisclosed regulators. A spokesman from Goldman declined to provide further details about the inquiries. Politicians have recently questioned the methods big banks use to determine compensation packages, especially in the wake the government's bailout last fall of the banking sector, known as the Troubled Asset Relief Program. Banks have also faced criticism for use of risky derivatives contracts, which have been partly blamed for the collapse of Goldman's competitor Lehman Brothers Holdings Inc. and the near-collapse of insurer American International Group Inc. Fearing more fallout after Lehman and AIG's problems, the government launched the bank bailout program. Goldman, however, has been quickly able to rebound from last fall's sector-wide troubles to return to its perch as a highly profitable Wall Street trading giant. During the second quarter, Goldman ramped back up its aggressive trading practices as markets began to stabilize and posted a profit of more than $2.7 billion. Profits were strengthened by fixed income, currency and commodities trading.

• Despite Bailouts, Business as Usual at Goldman
• Goldman: Is Its Trading Performance Statistically Reasonable?
• Goldman Sachs' 97% Win Percentage Possible but Not Probable
• Goldman’s 42 $100MM+ Trading Days In Q2 - An Absolute, Unprecedented Record; Just Two Days Of Trading Losses
• Goldman Sachs's Barry Bonds Complex
• The 8-point 'Goldman Socialist Manifesto'
• Don’t Dismiss Taibbi
• Goldman Sachs may be bad, but it’s far from the worst
• Goldman Toaster Alone Can't Reheat Global Economy

Alternative Investments: Venture Capital, Hedge Funds, Private Equity

Coming venture capital shakeout a good thing Before the dot-com boom and bust, the world of venture capital was much different.Venture firms invested in technology companies for the long haul. They didn't look at the initial public offering as their "exit.""A public offering early in my career wasn't an exit," said Andy Rappaport, a partner at August Capital, a 25-year-old VC firm near Silicon Valley. "Most of the money that we created for our limited partners was created after they went public. That was because most of the companies you would take public had their growth ahead of them." But the dot-com bubble changed everything. In 1999-2000, in came the fast money, with some firms hiring freshly minted MBAs -- the young, get-rich-quick kids who could make sense of the Internet boom and whose buddies from business school were fledgling entrepreneurs. The venture capital lemming thrived, with investors throwing money at copycat ideas, and hoping their investment went public first. Now, 10 years since the formation of many of those fat funds during the boom, a reckoning is coming. And it won't be pretty. But it will be good for the bloated industry, which still has too much money sloshing around and not enough big hits. Many VCs still invest in companies that don't have enough growth yet to go public, and shouldn't try. The recent slower pace of the first and second quarters of 2009, where $3.2 billion and $3.7 billion were invested, respectively, indicates VC is getting back to 1997-98 levels. Now, it looks like $15 billion to $20 billion will become the new investment norm for the entire venture-capital industry. "Some of you have seen the VC numbers for the first and second quarter," said Fred Wang, general partner at Trinity Ventures, at the AlwaysOn Summit at Stanford University last week. "People are waiting for venture to come back." But he added that is unlikely to happen. "These numbers are the new norm. Venture capital is going to see a big shift," he said. How will that play out for investors, start-up companies and technology innovation? Returns have not been as stunning as you might expect. The big payoffs come from only a few winners a year, if that, such as Internet giants Amazon.com Inc. in 1997 and Google Inc. in 2004. Those major triumphs have to compensate for otherwise mediocre performance across a portfolio."The venture industry's current returns are unsatisfactory," according to a recent report called "Right-Sizing the U.S. Venture Capital Industry." The report was written by Paul Kedrosky, a senior fellow at the Kauffman Foundation in Kansas City, Mo., which focuses on entrepreneurship. The study says that the venture industry leads the Russell 2000 small-cap index on a five-year and 10-year investing horizon in annualized returns, while lagging slightly on 10-year total returns. The Russell had a total 10-year return of 18%, while venture capital had a total 10-year return of 16%, according to data in the Kauffman study.

• Hedge Funds Rally as Cash Flows Back In, Hedge Funds are "en Fuego"
• Distressed Takeovers Soar
• Business of Buyouts Sees Signs of Rebound
• For Private Equity, a Very Public Disaster, Cerberus Investors Exit Funds
• Wall Street's B-List Firms Trade on Bigger Rivals' Woes
• Small Banks Gain Cachet in Talent-Poaching Game

Credit Markets, Credit and Policy

Commercial Credit Crunch Means We May Not Be Out of This Yet Commercial property values have fallen an average of 35 percent, with further declines expected as the recession drives more tenants out of business or puts them behind in their rent payments. The process of securitizing new loans has ground to a complete halt, and the limited financing that's available now comes from banks and insurance companies on much tougher terms. Loans now are typically for no more than 60 percent of a property's current value, with an interest rate four percentage points above the Treasury rate. Borrowers must also repay principal, which is like adding another two percentage points to an interest-only loan. All of this has been wrenching for the industry -- particularly for some of the biggest names, such as General Growth Properties, Maguire Properties and Tishman Speyer, which bought at the top of the market. Not only has their equity been pretty much wiped out, but those who financed their bubble purchases have lost anywhere from 35 cents to 100 cents on every dollar lent. Unfortunately, this isn't just a tragedy for rich developers, bankers and investors. It's also a problem for the rest of us. For starters, local and regional banks have so many souring commercial real estate loans that they have begun to fail at a rate not seen since . . . well, you know. The latest was Colonial Bank of Alabama, which was rescued last week at a cost to the Federal Deposit Insurance Corp. of about $2.8 billion, the sixth-largest bank failure in history. And over the coming year, it will be a rare Friday afternoon that the FDIC doesn't announce the takeover of some bank that lent too much to local builders and commercial real estate developers despite abundant evidence that a bubble had developed. It's a good bet the agency will have to replenish its coffers by drawing on its line of credit from the U.S. Treasury. Then there's the matter of half a trillion dollars in securitized loans that were made during the bubble and will be coming due over the next few years. These will need to be refinanced. Unless the securitization machine can be cranked up again, there's simply not enough lending capacity at the banks and insurance companies to fill the gap. Moreover, there can be no refinancing until the current owners of the buildings come up with billions of dollars in fresh equity to make up for what has already been lost.

Posted by dblwyo at 02:38 AM | Permalink | Comments (0)

If we'd put up this post over the weekend Monday's "bump" would have us temporarily claiming prescience again but the naysayers would point to yesterday and today as proving our senescence instead. The fundamental problem the Markets face right now is just that - they're pricing in beyond perfection to Nirvana in earnings and valuations and the economic data flatly contradict it. All the facts on the ground about earnings coming from continuing cost costing while revenues continue to show y-o-y declines combined with every single econ datapoint lying painfully at the bottom of the cliff tell us so. Our last market post (Brown Shoots, Weak Markets, Resilient Business ?) said it was time to take money off the table and we repeat, reiterate and reinforce that recommendation now. Even though if you'd acted on our advice you'd have lost something in the last several weeks that something was based on as airey a set of finance earnings as was ever fabricated that trigered the recent runup. (More Darkside Earnings Tales: Banks,Goldman und Unsinn). And all that's before we accurately price in the longer-term economic outlook. Remember investment returns result from buying at low prices and right now markets are weigh over-valued IOHO ! Again we've got an extensive reading section to back all this in addition to our own analysis but if you read nothing else read (****) IS THE RECESSION REALLY OVER?.

What's Really Going On ?

 Let's start with this composite SP500 chart which shows YtD daily and since Jan07 weekly along with some indicators. On the daily chart you can see where the economic realities dawned on people as the Q1 data flowed in leading to the huge panic drop (NB: we published our quarterly newsletter in Feb. warning about that and whammo...something that's happend with every edition so be warned...just sayin). That was followed by the widespread discovery that the Armageddon Panic was overdone and the world wasn't coming to an end. Strangely enough though the Mar. lows actually brought the markets back to the long-run market and economic trends since 1990 (actually 1950 ! as we've discussed). Now we called for a correction in late June/early July and it looked like we were getting it until GS and the rest of the Wall St. crowd took us all up again on the backs on public money and proprietary front-running trading (can anyone spell fiduciary ?). Markets are now over-valued and way...way ahead of the economic data, for the next several years in fact. At minimum now is NOT the time to buy in unless you're holding period is ten years !

The bottom chart is even more interesting. The market corrected backup to one of the natural boundaries between the Oct07 high and the Mar09 lows to about 38%, or 1018. That's all in the context of course of this last two years and not looking for limits on the longer-term. The technical indicators would tend to support all this. Here's where all this is important - if the market corrects as it should will it hold and what resistence levels of on the upper chart ? Notice that in the May-Jun-Jul period it was bouncing off 875 prepatory to the "real" correction. Holding at 875 would be encouraging but based on all these whacky interpretations of the outlook. Which means that a correction back to the 800-825 levels would make more short-term sense. In other words a better than 15% correction should be, on the facts, well in order and setting aside our conviction that the Mar lows were more realistic in the long-run. If you'll continue on to the readings you'll find some backup charts on sectors and world markets; pay especial attention to Shanghai which led up and is leading down.

Let's Talk Earnings

Central to all this is what are realistic expectations for earnings (again there's another chart we've used before in the readings) which we set out hear. That starts with what do we mean by earnings ? S&P reports operating earnings - what the companies tell us ignoring "1-time" events, as reported - what they tell us also including those events and estimates including screwups done top-down. There have been so many "adjustments" for the last several years we're much more inclined to take the center column as closer to the truth, which makes a huge difference. In Dec10 it's the difference between $20.10, $9.14 and $12.50. On the data the latter two are much more indicative IOHO. Then what PE do you use ? As David Rosenberg points out even in Mar. PE's only got down to 12.4, not the 6-9 that would have been appropriate for a real downturn. We'll let you read this chart results (HT: Macroman) and the charts in the readings which show what an outlier the going forward fantasies are, for yourselves. But at reasonably optimistic PE's and earnings an 800 on the SPX is right in line while a 400 is not out of line on realistic assessments based on appropriate economic growth estimates and multiples. Keep in mind - we have yet to correct for the Tech Bubble !!!

If that happens look out below.

Which leads us to the fundamental fundamental questions.

Where's the Beef?

Keep in mind that a) this whole last decade has seen essentially flat to negative investment returns and two major bubbles that are NOT corrected for. In other words the markets have yet to adjust to the new normal and reset their expectations accordingly. The other thing to keep in mind is that the new normal will be a nation of consumers rebuilding their balance sheets, i.e. forced savers. Beyond, and all of these are point we've been repeating almost ad nauseum, there are likely to be fundamental value changes. So a nation of frugal shoppers who have learned that they can't borrow their way to happiness is a far cry from the nation of spendthrifts who borrowed our way into trouble. Our buddy Jake over at Econpic captures the history as well as anyone with this cute little chart. We're coming off a period of almost three decades where per capita net worth climbed steadily. People have had no other expectations for better than a generation. Grasshoppers indeed. Now, in a certain sense, all the net worth gains since 1968 have been wiped out.

Certainly we know a lot of folks who talk and act like that's how it's going to be. Who knows when a more stable new normal will appear and how they'll adapt ? We suspect it's never going to be what it was. At a minimum that means a slower growing economy, at least until repaired balance sheets support new investment and new growth a decade from now. It also means lower valuations.This all leads us to a straightforward conclusion, especially when coupled with our previous discussion(s) on the longer-term economic outlook.

We are looking at a low-growth doldrums for the next decade.

And nobody is adjusting, adapting or acting to prepare.

Current Market Situation

Words from the (investment) wise for the week that was (August 10 – 16, 2009) During the week marking the second anniversary of the start of the credit crunch, stocks, copper, nickel, zinc and sugar recorded fresh 2009 highs. But the celebrations came to an abrupt end as caution crept back into investors’ vocabulary on Friday when it dawned upon pundits that markets were running away from economic reality. On top of that, Chinese equities - a leading stock market on the way up - saw a reversal of fortune and declined to a five-week low. This is where the Ecclesiastes-based lyrics of the Byrds’s classic, Turn, Turn, Turn, started resounding in my head: “To everything (turn, turn, turn), There is a season (turn, turn, turn), And a time for every purpose, under heaven, A time to gain, a time to lose …” 

The Case for More Upside: Performance Anxiety and Surprising Growth Stocks were weak midday Wednesday, which may be the beginning of a correction some say is long overdue, given the S&P 500 entered the session up more than 50% from its March lows.But don't confuse a near-term setback with the end of the rally, says Mark Dow, fund manager at Pharo Management, a global macro hedge fund with about $2 billion of assets. Dow believes the market can "continue to grind higher for a while" for a number of reasons: - - Performance anxiety: Market psychology moves in three phases Dow says, denial, migration and capitulation. After having "denied" the rally in its early phase, many institutional investors are now "migrating" back into stocks, he says, mainly out of fear of missing more upside. "They're buying not because they want to but because they have to," he says. In other words, big money is only just starting to come off the sidelines. - Upside surprise: While not a believer in the V-shaped recovery story, the former IMF and Treasury staff economist believes the market still has a "bearish bias" when it comes to the economy, which he thinks will prove better than consensus. - Weak Dollar: In case you haven't noticed, the dollar has fallen as stocks, emerging markets and commodities have rallied. Dow believes this trend will continue and doesn't believe a weak dollar is a sign of impending doom (as we'll discuss further in an upcoming segment).

• S&P 500, Nasdaq party like it's 1998
• What makes the market tick
• What do PG and AXP Tell Us About the Economy?
• A Time to Let Go Of Overvalued Stock
• Earnings Growth Forecasts May Require a Robust Economic Recovery
• Canadian Equities [08-10-09]Pierre Bernard, VP Canadian equities, Industrial Alliance Fund Management, talks to BNN about the early Canadian market movers.

Debt Burden to Weigh on Stocks Economists are boosting growth forecasts. Employment numbers are improving. Manufacturing activity is bottoming. Housing demand is strengthening. Business leaders are starting to say the worst may be over. Markets are celebrating, hoping the good news will keep on coming. But there is a smudge on the picture. A surprisingly large number of money managers and economists are warning that, despite the hopeful signs, the economy is still deep in the woods, not strong enough to support a long-running stock and bond recovery. The Dow Jones Industrial Average now has jumped 43% from the 12-year low hit March 9. It finished Friday at 9370.07, its highest close since Nov. 4. Risky credit investments, such as junk bonds and even mortgage-backed securities, also have been recovering. "The question now is, 'Where do we go from here?' " John Osterweis, chief investment officer of Osterweis Capital Management, told clients in a recent report. "The simple answer is probably, 'Nowhere fast.' " According to this view, the market surge of the past five months has been a celebration of the government's success in staving off financial doom. Stocks deserved to rise from panic lows. To keep rising in the future, the market needs a sign of real economic recovery, and that requires a surge in consumer spending, business investment and home buying. That is what is in doubt, and one word explains why: debt. Despite an uptick in consumer saving, debt levels have only barely begun to come down. Even after the recession ends, economists expect the gradual reduction of the nation's massive consumer debt to take years. In the meantime, they are warning that the economic-growth surge expected for the second half of this year could be followed by slower growth and a softer stock market in 2010. A survey of six leading Wall Street stock strategists, ordinarily a bullish bunch, shows them on average forecasting the Standard & Poor's 500-stock index at about 1033 by year's end. Their forecasts range from 930 to 1100. The S&P 500 finished Friday at 1010.48, already nearly at the average forecast. On Wednesday, in the wake of encouraging manufacturing and auto-sales data, economists at Goldman Sachs Group tripled their forecast for inflation-adjusted economic growth to a 3% annual rate for the second half of this year. And after that? They see the growth rate steadily declining to 2% in the first half of 2010 and 1.5% in the second half.

• Long view: bears will hold sway

Fantasies vs Realities

Profiting from the Tooth Fairy Although the stock market's advance since March is taken as evidence that the economy is on the mend, the extent of that advance represents just over one-third of the prior bear market loss, which is somewhat standard (if not reliable or predictable) for bear market rallies. Interestingly, the advance since March has almost exactly matched the size and duration of the rally that followed the initial market plunge in 1929, just before the stocks and the economy suffered fresh deterioration. That's not to say that we are assuming that stocks are still in a bear market. Nor do we assume that they are in a bull market. I don't think we can rule out a further advance, nor should we rule out a fresh loss from these levels of over 40%, extending well into next year, before this adjustment is durably behind us. We aren't investing on either as an expectation. As I've noted before, the bull/bear distinction is not a useful concept except in hindsight. The prevailing status is not observable in real time, so we rely instead on variables that are continuously measurable, focusing on full-cycle performance, and accepting that hindsight will only sometimes be kind to our assessment, and will sometimes be utterly cruel.

• Hussman: Today's Crazy Market Can Stay Nuts for Longer Than We Can Remain Solvent
• Post-crash dynamics

Why are company insiders selling? A few tidbits of good economic data and generally better-than-expected profit reports have heated up the market once again on speculation the worst is really over. Company insiders may be telling us the opposite. While investors have lifted stocks even higher off the March lows, insiders have been quietly selling lots of shares of their own companies into the strength in the past month. Ominously, insider sales now stand at levels not seen since late 2007, right before the current bear market began. And history shows that insiders are worth paying attention to, because they're the ones on the front lines. The good news is that inside selling hasn't yet reached levels that portend a prolonged bear market. Instead, they could be signaling pullbacks that give you a chance to put money into stocks at lower prices. But several sectors do appear destined for serious trouble, including consumer-oriented stocks and technology. Specifically, negative trends combined with insider selling suggest to me that First Solar (FSLR, news, msgs), J.M. Smucker (SJM, news, msgs), Moody's (MCO, news, msgs), Pulte Homes (PHM, news, msgs), Riverbed Technology (RVBD, news, msgs), CKE Restaurants (CKR, news, msgs) and Texas Roadhouse (TXRH, news, msgs) are particularly vulnerable. First, here's the big picture: An insider gauge tracked by Market Profile Theorems, a Seattle research shop, moved into bearish territory July 31 for the first time since November 2007. An insider sell-buy ratio tracked by Thomson Reuters has been hovering around bearish levels not seen since November 2006. It recently registered 53, meaning insiders pulled $53 out of the market for every $1 in stock they purchased. Another insider sell-buy ratio, tracked by Vickers Stock Research, is now "well within the bearish range," says David Coleman, who analyzes insider activity for Vickers. It hasn't been so high since November 2007.

Mobius Says Global Stocks May Drop as Much as 30% in Correction This Year  Mark Mobius said global stocks will drop as much as 30 percent following their recovery from last year’s rout as companies take advantage of the rebound to sell more shares. “When you have these rapid increases, almost without correction, you will definitely have a correction at some point, so we can expect a lot of volatility,” Mobius, the executive chairman of Templeton Asset Management Ltd. said in an interview in Kuala Lumpur today. “Increases of 70 percent will be followed by decreases of 20 to 30 percent.”  The MSCI World Index has climbed 54 percent from a 13-year low on March 9, boosting valuations as governments worldwide spent more than $2 trillion to end the global recession. The rebound prompted a revival in share sales. China State Construction Engineering Corp. and Visa Inc.’s Brazilian affiliate VisaNet raised about $11.9 billion in the world’s largest initial public offerings this year. The biggest risk for global stocks is the increase in initial share sales and bond issues, Mobius said today. Investors will be “selling to take up new stocks, that will impact the prices,” he said. Mobius, who oversees about $25 billion, on July 29 said he plans to double Templeton Asset Management’s emerging-market assets within two years. The so-called correction “can happen anytime, probably this year,” Mobius said. “It may not be all at once, you may not see a decrease of 20 percent suddenly, it could be 10 percent here, and a rise of 5 percent then another 10 percent, you’ll see this kind of volatility in the markets.” He added that he was referring to shares “globally.”

Resetting the New Normals

The New Bond Equation  As the financial crisis heads into its third year, investors in bond funds are facing some difficult choices. Investors usually turn to these funds for safety. But bond funds are facing a host of pressures that are driving down returns, raising long-term risk—and making it tougher to settle on the right investment strategy. Take funds that focus on long-term Treasurys. These have often been an easy choice for a safe haven. But after frenzied buying of Treasurys last fall when the financial crisis became acute, prices have fallen as broader fears have eased and some of that money has come back out of the government-bond market. There’s also concern about the huge amount of debt the Treasury Department must sell to finance higher federal spending. The result? Funds focused on these bonds are down 13% this year, according to Morningstar Inc. “Treasurys, which are considered the risk-free asset class, probably are the riskiest asset class right now’’ among fixed-income options, says Robert Gahagan, team leader for U.S. taxable bond investments at American Century Investment Management Inc. As for municipal-bond funds, lots of states and localities are strapped for cash, which raises the specter of defaults—and makes their bonds a riskier investment. Likewise, corporate-bond defaults are high and still rising. Even money-market funds are under pressure these days. The older securities that such funds bought when rates were higher are maturing, and those available now pay paltry yields because the Federal Reserve is keeping short-term rates low to spur economic growth. So, even the highest-yielding funds have annualized yields of less than 1%. In this tough environment, many investors are steering for the middle of the road. Instead of looking for long-term-bond funds—which could get slammed if rates rise in the near term—they’re buying vehicles that invest in intermediate-maturity bonds. These funds also typically hold a mix of government, mortgage and investment-grade corporate bonds, which spreads risk around. Even cautious intermediate-bond funds yield about 4%, handily beating rates available on money-market funds. If you head into a bond fund, pay close attention to the types of bonds it holds. Some of the most popular choices—corporate bonds and munis—carry greater risks these days. With corporate bonds, it’s probably better to avoid funds that have loaded up on speculative-grade, or “junk,” issues—those rated at or below Ba1 by Moody’s or double-B-plus by Standard & Poor’s. Last year, some intermediate-bond funds that owned a lot of riskier securities were down 25% or more on panic selling. And now? Moody’s Investors Service says by the end of June, 11% of some 1,500 U.S. speculative-grade corporate issuers it tracks had defaulted on debt during the previous 12 months, up from 8% at the end of March. Moody’s expects that rate to reach about 13% by year-end and then to start dropping.

Households Start to Rival the Chinese in Treasury Market China is center stage when it comes to fears that buyers will one day spurn U.S. Treasurys. The bond market has been the source of much political theater between the U.S. and China in recent months, with Chinese officials passing up few chances to lecture the U.S. on its profligacy. But that has obscured an important change: The market for Treasury bonds is now more reliant on U.S. buyers -- including the Federal Reserve after its recent buying spree -- than the Chinese. The rising budget deficit, which has led to record issuance in recent months, doesn't necessarily mean the government is becoming more indebted to foreigners. While the U.S. government is borrowing furiously, the current account deficit has actually halved from an annualized $829 billion in mid-2005 to an annualized $409.5 billion in the first quarter of 2009. That shows the U.S. is now less dependent on external financing, because it is saving more domestically. The U.S. government may be in hock, but it is increasingly to its own citizens. China's monthly purchases of Treasury bonds have actually picked up since 2008, but by much less than the government has expanded sales of bonds. And U.S. households stepped in to purchase 86% of all new Treasury issues in the first quarter, according to flow-of-funds data. The next snapshot of household appetite will come in September.

• The USG doesn’t need foreigners to finance the US fiscal deficit? Who knew?
• Treasurys Attract Foreigners

Good News! The Dollar Is Falling Like a lot of money managers, Mark Dow of Pharo Management is bearish on the dollar and the global macro hedge fund has positioned its $2 billion of assets accordingly, as detailed here. As a result of continued dollar weakness, Dow remains bullish on emerging markets and commodities, and believes the stock market has more upside, as detailed here.But unlike so many others, Dow does not believe the dollar's decline - the Dollar Index hit its lowest level since September this week - is a sign of impending doom, or even the end of the greenback's role as the world's reserve currency. Instead, he believes the greenback's most recent bout of weakness is a positive development, and "a sign of risk appetite returning" to the global markets after the paralysis of 2008. A former staff economist at IMF and Treasury, Dow notes the dollar rallied last year when the Fed was rapidly expanding its balance sheet, but has been falling lately as the Fed has drained liquidity. In other words, the dollar isn't falling because the Fed is "printing money like crazy," as many dollar-bears contend. "The world is not awash with dollars because of low interest rates," Dow says. "The world is awash in dollars because it was the only game in town for the last 60 yrs -- a store of value, medium of exchange -- it was everything." Today, more foreigners have more faith in their local currencies, meaning the "de-dollarization" process will continue, he says, but not at the expense of the dollar's reserve status.

• Nothing brings out buyers like higher prices, and other short stories
• China Purchasing U.S. Treasuries Proves That Dollar's Demise Exaggerated
• Dollar Gains Broadly in Flight to Safety; U.K. Pound Pulls Back

Commodity Rally Lacks Underpinning  Funds, not fundamentals, are driving commodities prices higher. But with regulators keen to rein in speculators, recent gains might not bode well. Rises have been across the board, from copper and gold to oil, as "green shoots" optimism pervades the markets. Still, many brokers have attributed the rise to bullishness of hedge funds and investment banks, rather than to underlying factors. "It's a tricky business for certain investment banks because nobody really wants to admit too strongly that these price moves are down to money, because money is speculation and speculation is something that is out of fashion," said Stephen Briggs, an analyst at RBS Sempra in London. Traders say that, despite an improved longer-term outlook, the gains can't be justified right now, pointing to still weak demand and high levels of inventories in many of the commodities markets. Corporate earnings confirm the negative picture, with a slew of miners and oil companies reporting losses for the first half of the year and an uninspiring outlook for the rest. No one can determine for sure how much of the rise comes from real-world factors and how much from speculators' interest in the market. Barclays Capital recently estimated that around $209 billion was directly invested in commodity markets as of the end of June through index swaps, structured products and exchange-traded products. This figure excludes hedge-fund activity and new money flowing into the asset class in July.

• Prices Fall in Flight From Risk
• China Opts for Plan B on Iron Ore
• China's Iron-Ore Discount Hinges on Granting Loans

Real Realities: Earnings, Valuations and Outlooks

Whoops: Stocks Now 10%-15% Overvalued Stocks have jumped 45% from the March lows.  They have also blasted past fair value, which is about 900 on the S&P 500 on a cyclically-adjusted price-earnings ratio (see professor Robert Shiller's chart below).  So they're now about 10%-15% overvalued. (Jeremy Grantham puts fair value at 880 on the S&P 500.  That seems a bit precise.  Let's call it 900). Of course, today's overvaluation doesn't tell you much about what stocks will do next week, next year, or even the next 5-10 years.  Before the 2007 market crash, stocks were overvalued for the better part of 20 years, and observing that didn't help you make money.  On the contrary, it usually got you fired. What today's valuation does suggest is that stocks are priced to return a bit less than average over the next decade, perhaps 4%-5% real per year, as compared to the 6%-7% they have returned over the past century. Today's valuations also suggest that stocks may have gotten way ahead of themselves, especially in light of the structural problems that will continue to bog down the economy. As the chart above illustrates, every one of the prior mega-busts in the past century has been followed by a "trough" in which the cyclically adjusted PE ratio hit the high single-digits.  We didn't quite make it there in March (the P/E bottomed around 12X). This, combined with what is likely to be a decade of deleveraging, consumer retrenchment, and sluggish growth as we work off our debt binge, suggests that we still yet might hit that single-digit low before we take off on another secular bull market again.  This could be achieved either through another market crash, or a prolonged period of backing and filling as earnings growth gradually reduces the long-term PE ratio (this is what happened in the 1970s). Long-term Shiller PE Chart

• After Dow's 42% Run, Roadblocks Looming Stocks have roared back from March lows, but some observers suggest that they will be stuck in a holding pattern until 2011.

• What's the Real P/E Ratio?
• Industrial Stocks Living in the Past
• Why the 'Carry Trade' Is Back

(****) IS THE RECESSION REALLY OVER? We have never before witnessed a stock market rally of this magnitude over such a short time frame; and absent anything more than tentative signs of economic improvement. The only rally of this magnitude was the wild bear market rally ride in 1930, which was followed by a resumption of the decline that finally bottomed 82% lower in 1932. As we said last week, the equity market right now is priced for 40% profit growth and 4.0% real GDP growth in the coming year. At the lows back in March, we estimate that the equity market was pricing in flat earnings growth for the coming year (since that time, the S&P 500, by our reckoning, has gone from discounting $50 on operating EPS to just over $70). We’re not sure if pricing in $50 on earnings is truly an Armageddon scenario seeing as we were at that level in 2003, but let’s say that a really bad backdrop, especially for the financials, was priced out four months ago; by the same token, nirvana began to get priced in with this last leg up in the equity market that began just about a month ago. At best, the truth is somewhere in between, but it is not at 1,000+ on the S&P 500. Not at this juncture. This goes down as the mother of all ‘show me’ situations.

Pension Funds Paring Stocks Globally as Calstrs Ignores Economic Rebound  The world’s biggest pension funds lost confidence in stocks as the best long-term investment, cutting holdings or leaving them unchanged during the steepest rally since the 1930s.

Funds overseeing money for California teachers and public workers, Dutch government retirees and South Korean private- sector employees reduced their target weightings for equities this year, data compiled by Bloomberg show. The rest of the 10 largest kept them the same. U.K. pensions have cut stock allocations to the lowest since 1974, according to Citigroup Inc. Managers handling Oxford and Cambridge University professors’ assets have been selling shares as the MSCI World Index posted a five-month, 51 percent rally. “Given the storm in financial markets that we have seen, the name of the game is risk management,” said Dirk Popielas, head of the Pension Advisory Group at JPMorgan Chase & Co. in Frankfurt. “The majority of pension funds have not finished taking risk off their portfolios. Some have not even started.” Losses suffered in the worst decade for stocks versus bonds since at least 1900 drove pension funds to pour more money into fixed income, commodities and derivatives just as signs the global recession is easing helped equities rebound from the MSCI World’s biggest annual drop on record. The average return for U.S. stocks has trailed government bonds by about 8.6 percentage points annually since 1999, after outperforming by 8.2 points last century, based on data compiled by the London Business School and Zurich-based Credit Suisse Group AG. Equities appreciated an average 12.91 percent a year from 1900 to 1999, while bonds returned 4.69 percent annually, according to the data from the London Business School and Credit Suisse. Since the start of the new century, bonds gained 6.36 percent, compared with a loss of 2.27 percent for shares.

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

The immediate prior post actually covered the ground we're going to re-cover with this one. The difference then is that we pivoted around the new and revised GDP numbers to hang everything else on while this time we'll focus a bit on employment and retail sales. While we put up this longish posts that cover some ground and attach excerpted readings to go with them this time we've outdone ourselves on the readings. In fact normal blog practice would have had almost 20 separate posts on just the first item - the hot, recent econ news, alone. This way though you don't get machine-gunned with a bunch of data that doesn't fit into a larger picture. Instead we're going to drop a round of artillery with many big guns to try and link it all together. We start with the recent economic news (employment, output & consumption and real estate) then we hop to some big picture topics on the longer-term consequences of the new new thing...FRUGALITY ! Then we segue to the international consequences with particular attention to China, move on to talking about oil and the dollar and conclude with a few readings on policy. Which, btw, was extensively covered in the last post (Interrupting Your Reported Data Distortions: More Darkside for the Economy).

Employment and Outlook

 Amazingly enough a loss of only 270K jobs had everybody dancing in the streets, completely unjustifiably so in our opinion. The basic chart on YoY Employment is shuttled off to the readings. The only number that showed any "improvement" was unemployment, which was down "only" -60% instead of the prior '-80% ! Jobs and hours continued to deteriorate. Consumer spending is NOT going to come back until we see significant long-term job creation, which will be a long time coming. Based on this prior chart of job re-creation (HT CalculatedRisk of course and not the NYT, et.al. who ripped him off w/o attribution) this is already longer and deeper with more to come; ioho we're not going to see significant job creation for a long time indeed. To breakeven we need to create 150K jobs/month, otherwise it's the Red Queen falling farther behind. We entered this recession ~3million in the hole and are now about 12 million jobs in the hole. It'll take a long period (five years ?) to make that up and required we hit 4-5% GDP growth (3%+ real growth ?). The Fed's looking for 2.5% growth in real GDP at best !

Consumer Behavior

Some folks outlook is pretty sanguine but some have a more realistic view, as you can see in this chart on consumer spending recovery. More importantly we funded the growth in consumption in the '90s on the wealth effects of the Tech Bubble and during this decade by leveraging the housing ATM. Those are both going away, consumer are converting to savers, faced with years of having to re-build their balance sheets AND we're seeing some fundamental re-thinkings about what we actually need. So for many years at least credit availability restrictions will constrain spending, followed by balance sheet constraints and then we might reach a new normal. But that new normal will be at alower set point. The best depiction of all that we've seen is (HT !) from our buddy Jake over at Econpic where he looks at 10yr annualized change vs. net worth. Read a certain way the last four decades of consumer wealth creation has just been destroyed. And people are pricing the market for a quick-hit V-shaped recovery ? We don't think so.

The China Syndrome and Consequences

China's performance so far has been miraculous while India and Brazil's have been excellent. But Russia is sliding over the lip of a black hole. We want to talk about China mostly but a few words on the others as well. First off, China's recovery has resulted from massive public spending and money injections. But unlike in the states where the new money disappeared into the banks balance sheets China's sloshed on thru to spending. The question is how much of that went to productive investments that will pay off in the long-run. Not a lot. Aside from severe data reporting problems where there kumquats are not either our apples or oranges (cf. the Jim Jubak URL in the readings on China's realities) the real problem is their continued dependence on exporting. If the US and the other developed countries become net savers and reduce consumption the demand for Chinese exports will drop dramatically. That in turn will lower the demand for commodities over what the speculative fantasists are currently imagining. When you look at the long-term prospects China has to keep running faster and faster to stay ahead of its population's needs for jobs but is facing some major barriers. So, of the BRICS, we'd have to say that Russia is a basket case headed for worse, India will face many challenges and China is storing up serious problems for the not to far future. On the whole the best of the four is Brazil which has pursued careful monetary and fiscal policies, has a more robust and balanced economy and has a shot at growing domestic consumption enough to be self-sustaining.

China may eventually get there (certainly they are aware of the problem) but it won't be easy, will take longer than expected and be at a lower growth rate than we've seen. So for everybody expecting commodities and gold to shoot off think again. The one major caveat, which we've discussed before, is that folks like Russia, Mexico, Venezuela and Nigeria have been over-exploiting their existing oil fields and not investing in new ones. So, even with reduced Chinese growth, we're likely to be back at a D>S imbalance.(Oil Industry II(Analysis): LT Supply-Demand, Outlook and Disruptions)

Note: this will also impact the dollar. The dollar rose in the last several months as a flight to quality play when everybody was piling into US Treasuries (so much for the "replace the $" theory) and is since dropping as people are becoming more comfortable that worldwide Armageddon has been averted. What drove it down secularly, over a period of years, was that we were exporting borrowed dollars to buy oil, goods and other stuff from China and the ME. As we shift to a Savings > Investment world net exports will tend to get more positive. And fewer dollars will be flowing abroad; the net result will be the reduction, if not elimination, of the structural down pressures.

Welcome to the Brave New World of the New Normal.

But bear in mind lots of folks think we're kidding so you may want to play them !

US Economic Data 

Surprisingly strong jobs data signal turning point It's the clearest sign yet the recession is finally ending: U.S. employers laid off far fewer workers in July, the jobless rate dipped for the first time in 15 months and workers' hours and pay edged upward. Those are the kind of figures that could give Americans the psychological boost necessary for recovery to take root after the worst recession since World War II. A net total of 247,000 jobs were lost last month, the fewest in a year and a drastic improvement from the 443,000 that vanished in June. The Labor Department's report Friday showed that the unemployment rate dropped a notch to 9.4 percent in July, from 9.5 percent the previous month. Together with slight increases in the average workweek and wages, the new figures suggested the economy is in a transition from recession to recovery. "The worst may be behind us," President Barack Obama declared. "Today, we're pointed in the right direction." Still, the job market remains shaky. A quarter-million lost jobs are a far cry from the employment growth needed to put the national economy on solid footing. When the economy is healthy, employers need to add a net total of around 125,000 jobs a month just to keep the unemployment rate stable. And to push the jobless rate down to a more normal 5 percent range, it would take much stronger growth -- at least 200,000 new jobs a month. Economists say it might take until 2013 to drive down the unemployment rate to 5 percent. Analysts say companies will keep cutting jobs probably through the rest of this year, though the pace of layoffs should continue to taper off. The beginnings of recovery could actually push the unemployment rate higher, since far more people would be energized to look for work again. In fact, the main reason the unemployment rate declined last month was not an inspiring one: Hundreds of thousands of people, some discouraged by their failed job searches, left the labor force. The labor force includes only those who are either employed or are looking for work. If laid-off workers who have given up looking for new jobs or have settled for part-time work are included the unemployment rate would have been 16.3 percent in July. All told, 14.5 million were out of work in July.

Employment

• Job Growth Lacking in the Private Sector FOR the first time since the Depression, the American economy has added virtually no jobs in the private sector over a 10-year period. The total number of jobs has grown a bit, but that is only because of government hiring. Private Sector Employment Growth
• Planned layoffs accelerate again in July
• Private sector loses 371,00 jobs in July
• Weekly Unemployment Claims Fall to 550 Thousand
• New Jobless Claims Rise Unexpectedly to 558,000
• Unemployment Rate Drop = Decline in Labor Force, NILF Chart
• Unemployment: Stress Tests, Unemployed over 26 Weeks, Diffusion Index
• Employment-Population Ratio, Part Time Workers, Average Workweek
• Taking a Closer Look at NFP

 Output, Production, Consumption

• ISM service sector index dips unexpectedly in July
• Real GDP per Capita Redux
• Income Down, Savings Up = Consumption Down = Stalled Economy
• Consumption Stabilizing... Now What
• Retailers See Back-to-School Sales Slowing

 Real Estate

• About half of U.S. mortgages seen underwater by 2011
• Department chain sales results for July
• Sluggish July Sales Show Tight-Fisted U.S. Consumers
• Foreclosures: One Giant Wave, Still Building
• Zillow: Underwater Mortgages May Reach 30%
• Barry Gosin: State of Commercial Real Estate

Savings and Change

Signs of economic cheer: The sun also rises The clutch of data now available for July has strengthened expectations that GDP will rise in the current quarter by as much as 3%. An index of manufacturing activity rose to its highest level since last August, and manufacturers reported that new orders were growing briskly, the best in over two years. Car sales jumped 15% to an annualised 11.2m and manufacturers are ramping up production. Sales of existing houses have risen. Even battered Elkhart got some good news: on August 4th Dometic, a supplier of recreational-vehicle parts, said that with some help from local incentives it would add 240 jobs to its operation in the town. Mr Obama and his aides have wasted no time in crediting the $787 billion fiscal stimulus for spurring this recovery. In fact the stimulus’s contribution so far has been relatively modest. More important was last autumn’s massive injection of public capital, loans and loan guarantees into the financial system, and this spring’s bank stress tests. These stopped the spiral of declining asset prices, credit withdrawals and bank failures that had threatened to turn a recession into a depression. One of the most encouraging bits of news is that the S&P/Case-Shiller 20-city index of house prices fell just 0.2% between April and May, the smallest fall in two years. Stable house prices would do wonders in reducing loan delinquencies, shoring up the banks’ balance-sheets and restoring the flow of credit. Despite the good news, Mr Obama’s approval ratings, though high, are slipping. This, in part, is because the single most important economic benchmark, employment, remains grim, surprisingly so. Unemployment usually responds to economic growth in a relationship that was captured by an economist, Arthur Okun, in the 1960s. But it has risen more during this recession than most formulations of Okun’s Law would suggest. The publication last week of revisions to earlier GDP data explains some of the discrepancy. The revisions show that GDP has declined a cumulative 3.7% since the end of 2007, thus tying with 1957-58 as the deepest recession since the Depression (before these revisions, the decline was shown to be 2.5%). Even so, Michael Feroli, an economist at JPMorgan Chase, says that Okun’s Law would have predicted an unemployment rate of just 8.6% during the second quarter, whereas it actually averaged 9.3%.

Savings Are Good, but May Slow Recovery The stock market is clearly pricing in an end to recession. What remains to be seen is the strength of the recovery, and savings accounts could have a lot to do with that. The Bureau of Economic Analysis is due Tuesday morning to report June personal-income and personal-spending data, which will include the latest figures on personal saving. Economists, on average, think income fell 1.2%, reversing May's 1.4% spurt, which was driven mainly by a one-time stimulus windfall for Social Security recipients. Economists think spending rose 0.3%, thanks mostly to more-expensive gasoline. Inflation-adjusted spending was likely flat. If this expected combination of falling incomes and higher spending comes true, then the percentage of consumers' disposable income socked away into savings will likely fall after surging to 6.9% in May. But the long-term path for savings is inevitably higher. The ratio of household net worth to disposable income is at its lowest level since 1992, according to the latest Federal Reserve data. Lower net worth usually inspires people to squirrel away more of their income. Current net-worth figures are consistent historically with savings rates of between 6% and 10%, according to Goldman Sachs economists. If savings merely rise to the low end of that range -- 6% of disposable income -- then that could keep some $700 billion in consumer income out of GDP next year, assuming growth in disposable income gets back to normal. A 10% savings rate, which often prevailed in the decades before those stock and housing bubbles inflated, could put nearly $1.2 trillion on the sidelines. A recent San Francisco Fed paper estimated that getting to such a savings rate between now and 2018 would shave three-quarters of a percentage point from consumption growth each year. This savings boom isn't all bad for the economy. By spurring demand for Treasury bonds and short-term corporate debt, it could keep interest rates low. It will help households work off debt loads that are still far too high. The economy can recover even as savings rise -- but the recovery won't be as robust.

• When Will Consumers Start Spending Again?
• Kellner: Economists argue over how to spell recovery
• Americans No Longer Seduced By Shopping: The Case Against a 'V' Shaped Recovery

Building a Recovery, Factory by Factory If a V-shaped recovery is in store, it will be built in U.S. factories. The Institute for Supply Management reports its July manufacturing index on Monday morning. Economists think it rose to 46.5 from 44.8 in June. That still would indicate a shrinking factory sector, but it would be the best reading since last August and would signal the latest step toward recovery. There is a small cadre of forecasters who expect a far better outcome than mere recovery, soon. They see not only the end of recession but also a classic, V-shaped recovery brewing. In their view, global manufacturing is rebounding to refill inventories that were depleted in the recession. Juiced by government stimulus, this factory renaissance will kick a new business cycle into gear, leading to hiring, rising incomes and a rebound in consumer spending. One of the first gauges to register such an event would be the cyclically sensitive ISM. An ISM bounce certainly seems due. The government's "cash for clunkers" program generated an estimated 250,000 new auto sales in about a week, a far more concentrated boost than many economists expected. The program likely won't show in the July ISM report, but signs of its impact could come Monday, when car makers report July sales. Already, U.S. steelmakers have recalled workers and restarted plants, thanks partly to rising auto demand, notes Wells Fargo senior economist Mark Vitner. Some economists have estimated this program could boost third-quarter gross domestic product by 0.5 percentage point. More broadly, given the near-empty shelves, a slower pace of inventory liquidation is likely. More-stable inventory figures should further bolster third-quarter GDP, giving ammo to the V-shapers. But when these effects fade, the recovery's strength will fade, too, unless U.S. consumers resume their spending habits. Considering their still-heavy debt load and vanished wealth, both unprecedented relative to other recessions, it might take more than an inventory-rebuilding spurt to make that happen. "The stock market is betting on a full recovery, and it may occur in the short term," says Miller Tabak strategist Dan Greenhaus. "But you have to be apprehensive because this isn't an ordinary recovery."

Stiglitz: America at "Serious Risk of Extended Malaise" Day by day, the "the recession is over" crowd continues to get larger and louder. But the U.S. faces "serious risk of an extended malaise" after the bursting of the credit bubble, says Nobel Prize-winning economist Joseph Stiglitz of Columbia University. Today's optimistic policymakers (current and former) and economists risk confusing the technical end of recession with a robust recovery, he says. "It would be a mistake to say ‘because we're out of a sense of freefall and may have turned a corner [that] we're on the road to recovery.'" In the short term, there is a "very remote likelihood" the job market will turn around anytime soon, the famed economist says. Therefore, it will still feel like a recession for many Americans even if GDP does produce positive readings. Stiglitz also cited a number of potential negative speed bumps the recovery may hit, including: Weakness in commercial real estate. Huge deficits at the state level, leading to more job losses. Many Americans at risk of having unemployment benefits expire. Weakness in our major trading partners, and overall lack of final demand. In fact, Stiglitz says the next few years may be characterized by weak growth and false starts on the road to recovery, not unlike Japan in the past 20 years or America during the Great Depression. As a result, he says the government should plan on additional stimulus packages focused on improving technology, education and infrastructure. While lamenting "there's no appetite" for additional government spending, he says these investments provide a better long-term return than tax cuts or rebates. Best to get these plans ready to go for when the current stimulus package, which Stiglitz called "too small and badly designed" last spring, starts to wane. In sum, Stiglitz believes we should hope for the best, but plan for the worse.

• Krugman: World avoided second Great Depression

International Outlook: Not What You Here !

Which Countries Are Surviving Downturn? This week, I take a look at which countries have best weathered the global recession and credit crunch. All economies have been affected by the crisis, but a combination of policy responses and strong fundamentals has given some countries, especially some emerging market economies, a relative edge. These same strengths could lead the countries I highlight below to perform better as the global recovery begins, even if their growth rates remain well below 2003-07 trends. What do these countries have in common? One major theme is that they tended to have lower financial vulnerabilities due to more restrictive regulation and less developed financial markets, as well as larger and stronger domestic markets that sustained domestic demand. Moreover, they had the resources to engage in countercyclical fiscal and monetary policies, actions that were not possible in past crises. In contrast, countries that borrowed heavily to finance domestic consumption in the days of easy money are now facing sharp economic contractions. Despite the relative strength of these countries, however, their ability to return to sustained growth will depend on structural reforms that support consumption.

• Unbalanced Germany Europe’s champion is justly proud of its exporters. It also needs to worry about markets closer to home
• Japan's Future: "It's Going to Be Scary" After two decades of economic doldrums the Japanese economy is ready to hit the wall.
• The Recession in Europe
• The Recession in Central Europe, Part 1: Armageddon Averted?
• The Recession in Central Europe, Part 2: Country by Country
• The Russians Are Coming! The Russians Are Coming! Long-term, this will hollow out the Russian economy, which will put more pressure on Russia's leaders.
• Ruble Falls in Longest Slump Since February on Record Drop in Russian GDP
• Russian Economy Contracted by Record 10.9% Last Quarter as Slump Deepened
• Hints of a Rebound in Global Trade

China's Discombobulations

What should have been discussed during the SED meetings (Part 2) So what does all this have to do with the SED?  It means that the best hope for the two countries, I think, is a well coordinated set of policies acknowledging that the US savings rate must rise, and with it the Chinese must decline, but also recognizing that if this happens too quickly, or is accompanied by a collapse in trade, it will be bad for the US and terrible for China.  These coordinated policies must also acknowledge – and this becomes much more difficult – that the current Chinese stimulus may be making the adjustment more difficult, and much of it will have to reversed at the same time as the “appropriate” measures aimed at spurring consumption may cause a short-term rise in unemployment. Finally, the while the US commits to keep fiscal spending high, to turn a blind eye to trade disputes, and to run large trade deficits for several years more, China must commit to the financial sector and currency liberalization that will effectively reduce subsidies to producers and constraints on consumption.  The SED might also discuss the ability of workers to demand and enforce wage increases, since there is a wide consensus in China and abroad that among the main reasons for low household consumption in China is that wages are rising too slowly relative to GDP, and household savings are “taxed’ too heavily via interest rate policies.  Of course discussing workers right in a bilateral context is politically difficult, even without the irony of this particular discussion, so it will probably not happen.

• China's recovery: Is it for real? The country's economy seems to have quickly responded to government stimulus -- much more quickly than the US economy has -- but appearances can deceive.
• China’s savings problem and the consumption constraint
• What should have been discussed during the SED meetings (Part 1)
• The China Bubble's Coming -- But Not the One You Think
• China's Exports, Lending Fall, Adding Pressure to Maintain Stimulus Effort

Get Out the Wallets If I were told by the economic gods that I could have the answer to one question about the fate of the global economy, I know what I would ask. "When will the American consumer start spending again?" I know that doesn't sound as sophisticated as a question about industrial production, interest-rate fluctuations, or the Chinese stimulus plan, but it's the key to understanding when we will get out of this recession—and what the recovery is likely to look like. The rise of emerging powers like China, India, and Brazil is real. But for now, there is still just one 800-pound gorilla. The American consumer is the single largest factor at play in the global economy. Our spending is currently equal to the entire economies of China and India added together and then doubled. But this is not a usual recession. The United States entered this downturn with the average American deeply in debt. In 2007, total household debt was $13.8 trillion. Household debt per person nearly doubled between 1997 and 2007, from about $25,000 to $46,000. That means people might spend the next few years rebuilding their personal balance sheets, spending less, saving more. In fact, they're already doing that. The savings rate has shot up to almost 7 percent, the highest rate in 15 years. But many experts think that it will have to get up to 8 or 9 percent—the historical average in the pre-credit-bubble years—before Americans start spending again. That would mean either a longer recession or a much weaker recovery than most expect. The Chinese government is spending pots of money building bridges right now, German industries are retooling, but eventually they will all need to be able to export to Americans again.

Commodities & Exchange Rates

Bitter Cost of Replacing Oil Reserves Imagine an urn filled with good, strong coffee. As you pour cup after cup from the tap at the bottom, you simultaneously refill it at the top with weak, watery stuff. After a while, your supply is as full as ever, but it just doesn't deliver quite the same kick. The oil majors face a similar problem, underlined by talk of more cost-cutting from the likes of Royal Dutch Shell amid dreadful quarterly results. Overall, the sector has struggled over the past decade to replace crude-oil and natural-gas reserves depleted by production. Shareholders were prepared to overlook this as long as high energy prices funded big cash distributions. The added twist, says Neil McMahon of Sanford Bernstein, is that not all barrels in the ground are the same. Overall, the majors have been pumping out high-margin oil from mature fields in areas like the North Sea. The majority of those barrels have been replaced with expensive, highly taxed reserves in regions like Russia. Average cash flow per barrel divided by finding and development costs -- a ratio measuring whether oil companies can cover the cost of replacing reserves organically -- has dropped from about 200% at the start of the decade to about 150%. That cash flow also has to fund big dividends. Some companies also have relied too heavily on acquisitions, where the risk of overpaying is high. Less than one-third of BP's and ConocoPhillips's reserves added over the past five years have come from finding new fields themselves, says Mr. McMahon. Cutting costs helps. But weaker reserves portfolios will leave a bad taste in investors' mouths for years to come.

• Oil Prices Retreat After Rally
• Oil May Climb to $95 in Early 2010 as Demand Recovers: Technical Analysis
• EA Bumps Oil-Demand Forecast Higher
• Oil Outlook [08-11-09] BNN talks to Earl Sweet, economist, BMO Capital Markets
• Oil Industry I (Readings): Prices, Fundamentals, and Big Oil Futures
• Oil Industry II(Analysis): LT Supply-Demand, Outlook and Disruptions
• New (Old ?) Frontiers in the Oil Markets: the Return of Geo-Politics
• Hurtin Worldwide:Outlook, Countries, Commodities & Geo-politics

Big Mac Says All About World After Lehman's Fall The U.S. Treasury secretary is spending more and more time placating fears about the dollar in Asia. Yet concerns that Asian policy makers would pull the plug on U.S. debt haven’t been realized. The reason says more about Asia’s weaknesses than its strengths. Many believe Asia’s vast savings give it considerable leverage over the biggest economy. In reality, Asia’s Treasuries fetish is more about weakness than strength. Asia has gotten itself into an arrangement from which it can’t escape. If it dumps its Treasuries, it loses billions of state money and wrecks any chance of a U.S. recovery. Political will is lacking to retool economies away from exports toward domestic demand. China, for example, is throwing nearly $600 billion at its economy and the result is an astonishing 7.9 growth rate. It’s doing little to boost domestic demand, though. The unbalanced nature of China’s pump priming may be setting the stage for a Japan-like bad-loan crisis. Japan’s plight isn’t much brighter. The hundreds of billions of dollars it’s spending offer merely a short-term fix. The money won’t get Japan any closer to dealing with a steady loss of competitiveness amid the rise of China and India or an aging population. It will only increase an already daunting debt load for Asia’s biggest economy. And so, policy makers are sticking to a formula that’s worked wonders for over a decade: Holding down exchange rates. That’s good for the U.S. at the moment. Washington needs Asia’s money to finance its historic borrowing spurt. That’s why Asia’s dollar-buying has a powerful inertia to it. The question, of course, is whether the phenomenon can continue indefinitely.

• Dollar Holds Gains in New Paradigm

Strategic Outlook and Policy

`Lost Couple of Decades' Looming for U.S. Economy: Chart of the Day The U.S. economy may be just as sluggish during the next 20 years as Japan’s economy was in the last 20, according to Comstock Partners, a money manager founded and run by Charles Minter. Stimulus programs and a surging money supply aren’t likely to “solve a problem of excess debt generation that resulted from greed and living way beyond our means,” the firm wrote yesterday in an unsigned report on its Web site. “We could wind up with a lost couple of decades.” The CHART OF THE DAY shows U.S. total debt and gross domestic product since 1952, along with the ratio between them, based on data compiled by Bloomberg. The ratio rose in the first quarter to 372 percent even as household borrowing dropped for a second straight quarter, an unprecedented streak. The U.S. is headed for “a deleveraging period” in which the amount of so-called private debt, including consumer borrowing, collapses as government borrowing explodes, Comstock wrote. Assuming that private borrowers pay down debt at the same pace as they did in Japan after its 1980s economic bubble burst, the savings rate will climb to about 10 percent in 2018, the report said. The estimate was made in a study by the Federal Reserve Bank of San Francisco that Comstock cited. It’s more than double the 4.6 percent rate for June. Citing the study in addition to its own research, Comstock wrote that reduced borrowing may curtail growth in U.S. consumer spending by 0.75 percentage point annually on average during the next nine years.

• Deleveraging the U.S. Economy
• U.S. Household Deleveraging and Future Consumption Growth

Fed Focusing on Commercial Real-Estate Recession as Bernanke Convenes FOMC The collapse in commercial real estate is preventing Federal Reserve Chairman Ben S. Bernanke from declaring the economy and financial markets are healed. Property values have fallen 35 percent since October 2007, according to Moody’s Investors Service. That’s making it tough for owners to refinance almost $165 billion of mortgages for skyscrapers, shopping malls and hotels this year, pressuring companies such as Maguire Properties Inc., the largest office landlord in downtown Los Angeles, to put buildings up for sale. The industry is likely to be high on the agenda when Bernanke and his colleagues sit down in Washington tomorrow for the Federal Open Market Committee meeting on monetary policy. Lawmakers including Barney Frank and Carolyn Maloney are pushing the central bank to extend an aid program designed to restore the flow of credit. If nonresidential real estate remains in the doldrums, the Fed may be forced to leave emergency-lending programs in place and keep its benchmark interest rate close to zero for longer than some investors expect, given positive signs elsewhere in the economy. Commercial property is “certainly going to be a significant drag” on growth, said Dean Maki, a former Fed researcher who is now chief U.S. economist in New York at Barclays Capital Inc., the investment-banking division of London-based Barclays Plc. “The bigger risk from it would be if it causes unexpected losses to financial firms that lead to another financial crisis.”

Policymakers "Got It Right": Why Free Market Ideology Is Wrong Just like the market's mood, economic orthodoxy moves on a pendulum - only the swings come far less frequently. Generally speaking, from the 1940s to the 1970s, the prevailing wisdom in economic circles was that government was a force for good. Then came the Reagan Revolution of the 1980s, which steadily led to the dominance of free market ideology until the present day. After the credit crunch of 2007-08, even free market stalwarts like Alan Greenspan admitted the ability of markets to self-regulate was a "flaw" in the prevailing view of capitalism. But even after the implosion of Wall Street, a "high degree of residual [free market] ideology" remains, says Mark Dow, fund manager at Pharo Management, a global macro hedge fund with about $2 billion of assets. This view that government isn't the solution, it's the problem is "impeding progress" and limiting policymakers' abilities to bring about necessary reforms to reduce the odds of another systemic crisis, Dow says. Being a former staff economist at IMF and Treasury, it's not surprising Dow believes government has a role in keeping the market's "animal spirits" in check; but he's not advocating socialism -- far from it. Nor does he believe the Obama administration wants to maintain such a high degree of government involvement as currently exists, noting Tim Geithner and Larry Summers (particularly) are big believers in free market capitalism. Whether the government and the Fed can get the "exit strategy" right is to be determined, but Dow has faith in policymakers and believes they've mainly "got it right" so far. It may not be perfect but he says actions taken to date "saved the system" - arguably from itself.

Turning on a Paradigm In my experience there is little room for ideology in economics. No set of rules or principles can fit all of reality for all points in time. The world to too complex and moves too quickly for this. The ‘perfect’ mix of markets and government is not a static concept. It is dynamic, and highly contextual. Again this post is not ideological. It is more a cautionary tale about human nature and the way we follow trends. We are trendy by nature. We stick with our old ideas for too long after the facts on the ground change. We then begrudgingly migrate to what appears to work, and, inevitably, take things too far. No amount of regulation can fix this; it can only mitigate the consequences from it. Let’s just hope that the amplitude of the next pendular swing is less extreme—but I suspect we are years, if not decades, away from worrying about it.

Averting the Worst A few months ago the possibility of falling into the abyss seemed all too real. The financial panic of late 2008 was as severe, in some ways, as the banking panic of the early 1930s, and for a while key economic indicators — world trade, world industrial production, even stock prices — were falling as fast as or faster than they did in 1929-30. But in the 1930s the trend lines just kept heading down. This time, the plunge appears to be ending after just one terrible year. So what saved us from a full replay of the Great Depression? The answer, almost surely, lies in the very different role played by government. Probably the most important aspect of the government’s role in this crisis isn’t what it has done, but what it hasn’t done: unlike the private sector, the federal government hasn’t slashed spending as its income has fallen. (State and local governments are a different story.) Tax receipts are way down, but Social Security checks are still going out; Medicare is still covering hospital bills; federal employees, from judges to park rangers to soldiers, are still being paid.

As Economy Turns, Washington Looks Better What if, amid all their missteps and all the harsh criticism, the people in charge of battling the worst financial crisis since the Great Depression — Ben Bernanke, Timothy Geithner, Lawrence Summers, Henry Paulson and the rest — basically succeeded? It is clearly too soon to know for sure. But the evidence is now pointing pretty strongly in one direction: history books may conclude that the financial crisis of 2008 turned out to be far less bad than it could have been and that Washington deserved much of the credit. Washington’s early responses to the bubbles in real estate and stocks, and then to the crisis that followed, were full of mistakes. But since the collapse of Lehman Brothers, the record has started to change. The government has undertaken one extraordinary effort after another to revive the economy, and the economy has seemed to respond.

As Wall Street fix slips, a reminder from Enron Yet only seven years after Enron went down in a flaming pile of management hubris and false accounting -- taking corporate America's reputation with it -- small investors and savers found themselves again at the mercy of a Wall Street-induced scandal, this time one that would take down the world economy. No wonder Timothy "Come on, guys" Geithner, our usually placid Treasury Secretary, exploded in a profanity-laced tirade recently at a meeting with financial regulators. Now that the major bleeding has stopped in New York, banks and bankers want to get back to business. And regulators of those banks and bankers want to keep their turf. So the old battles have started up again in Washington and the prospect of major financial overhaul grows dimmer by the day. Perhaps sometime after the health-care issue gets addressed, right? There have been a lot of batty ideas coming out of Washington in the first few months of the Obama Administration with regards to Wall Street. The idea of taxing bonuses at 90% comes to mind. But the core idea that something must be done to rein in abusive trading and risk-taking, and the compensation impetus behind them, is still something that must get done. The time to push through some sort of overhaul is still now, while the administration is young and can wield influence. FDR pulled it off during the Great Depression, and it changed Wall Street for 70 years. Nothing of that magnitude appears headed anywhere now.

• Pay and politics So far, Congress is taking a surprisingly sensible approach to the problem of pay
• Restraints on executive pay
• Executive pay in America
• Regulating executive compensation
• Urgency' Drives SEC Crackdown

Posted by dblwyo at 01:18 PM | Permalink | Comments (0)

We're interrupting your regularly scheduled data dumps of economic data, and our planned posting schedule, to bring you this special bulletin about what yesterday's GDP numbers really said. First off there were not just huge revisions but a complete re-factoring of the data. This is not, and for the record, some nefarious government plot (though it will again be taken that way) which resulted from better data and revisions stretching back decades. Which made, among other things, the '01 downturn much milder and this one must worse. More importantly our recurrent theme of needing to really look into things needs re-emphasizing because the reported headlines are based on QtQ data instead of YoY and when you look at properly are much worse than anybody is telling you. The fact that mis-interpretations and resulting distortions are beyond widespread, beyond endemic and would appear to be innate is another critical factor.

This morning's WSJ put it all very nicely in historical context though by comparing the decline in GDP to previous downturns since the end of WW2 with this nice chartporn. We'll dig into all this graphically because it's critically important but what you need to know is the headlines reported QtQ changes over the last three quarters in real GDP of -5.4, -6.4 and -1.0%. Which gives great weight to the fantasies of a V-shaped recovery. In actual fact, on a YoY basis, the last three quarters were -1.9, -3.3 and -3.9%. Let me repeat that - REAL GDP WAS DOWN IN Q209 BY ABOUT -4% !!! If you take out the effects of trade (exports were down -15.7% while imports dropped further by -18.6% and net exports as a whole were -28.7% YoY. That last number is a slight improvement over the previous -29.8%) GDP x-Trade was down the last four quarters by -1.1, -2.5, -4.4 and -4.7%. Let's try that again too...DOMESTIC GDP WAS DOWN ALMOST -5% !!!!!. No way, shape or form that one can read those as good numbers. Nor can one argue that they show much flattening of the rate of decline, or bottoming out. The QtQ numbers do tell us that we're in the process of crossing that cusp point though and we'd expect to see better numbers in the next few quarters, at least in the sense that the rate of declines drops. Positive GDP improvements are a ways off, significant positive GDP improvements farther, growth in employment and investment and the return of a naturally growing economy is much...much...much farther off. In fact the Fed expects that after a bump up the long-term outlook is for an average growth rate of 2.4% - that's barely breakeven on required new job creation and means we're going to have an organically weak economy - thru 2015 and beyond.

Letting the Real Economy Stand Up

Let's put all that in context with this graphic so you can what the data really says and how it looks in comparison to the last two decades plus (we'd go back farther but the structural revisions of the data are a work in progress and it'll be some time before it's completed and we can rebuild all our spreadsheets). There's a pernicious meme in wide circulation, mostly driven by deliberate distortions for political purposes, that the stimulus program isn't working. In actual fact about $300B of tax cuts and transfer payments have already gone out the door and have been what's kept state and local disasters from turning into catastrophes. A very rough cut of GDP, with and without Federal spending, shows the downturn would have been significantly worse. NB: that initial $300B is about all that could be shoved out the door and actually work. NB2: and the pace, timing and structure of the program thru the rest of this year and thruout next, on which continuing to keep the wolves at bay depends, is beyond what the operational capabilities of the federal departments can handle; in other words about all that can be done is being done. (Realities vs Rhetorics: Economy, Policy, Real Data). Understanding the real data is critically important but it would appear that understanding how it's being mis-reported and deliberately mis-represented is even more so. Without Federal spending YoY GDP growth would have been -0.6, -2.7, -4.0 and -4.7% the last four quarters. In other words the economy was almost a full percentage better than it would have been otherwise in Q2.

The Real Outlook: Consumption, Investment and Implications

Current consumption tells you how the engine of the economy is doing, investment (real estate and business) tells you how it's likely to be doing and the combination of wages and employment tell you how the future is likely to evolve. The second chart above shows us that Consumption is still bad but it leveled off somewhat, instead of following over the cliff with GDP as it usually does. For the last four quarters real Consumtion was -0.7, -1.8, -1.5 and -1.8%, so it's bumping along a bottom for now. That is its not getting better but it's stopped getting worse - in some significant part because of stimulus. Employment on the other hand is dropping like cliff-diving lemming, along with GDP.

Consumption drives future business expectations which in turn drive hiring and investment decisions; which, in turn, feedback on consumption decisions. With consumption still very weak and employment dropping we'll be lucky if demand holds up which means investment and hiring will be constrained for a long time. Take a careful look at investment in this second composite - it sharply peaked in early '04 and began declining immediately. The first thing that tells you is one of the major reasons we had a very weak and jobless recovery - the organic feedback loop never caught and the engine was just sputtering along with poor capex spending and hiring. Then it started falling rapidly until it went cliff-diving very early in '08. The last four quarters were -8.1, -12.5, -25.2 and -27.4% YoY ! Investment dropped by almost 30% in Q2 !! Residential investment generally leads the business cycle and this last time housing price bubbles led to sustaining Consumption on the back of the Housing ATM. That's created a long-term structural problem where excess inventory will have to be worked off, where Housing won't recover as it normally does and where the ATM is never coming back. Business spending fell -6.0, -17.4 and -19.6% the last three quarters. Again the start of a bottoming process but -20% is a LONG way down in our book.

Investment and Future Demand

In this third composite the top part breaks down Investment into its two major components so you can the RI and Business pieces separately. (Again the revisions to the reported data and the on-going updates make the earlier data a little squirrely, technically speaking, but the recent data appears reliable.). In the top of this graphic you can see how the cliff-diving real estate drop preceded the overall downturn and then how business spending has followed it off a cliff. With all this in mind (the worst downturn, preceded by a jobless "recovery", VERY poor business spending prospects) we can probably say that getting back to 2.4% growth would be an optimistic outcome.

The next question is how is the Consumer going to react, now and in the future. Remember no more stock market or housing bubbles to subsidize consumption. Then there's the re-balancing and de-leveraging of consumer balance sheets - the fuel that drove the engine the consumption engine for three decades is being taken away. Now at this moment in time consumption depends, and will depend, on incomes and nothing else. The best indicator of that is the combination of real wages and employment. In the second sub-graphic here you can see where real wages have jumped up as inflation has dropped. But you can also see where job market pressures are beginning to impact wages. Meanwhile of course Employment is in terrible shape, and given normal business cycle behaviors in combination with terrible job creation prospects, will worsen significantly (at least 10% Unemployment and likely worse) and will be followed by a really terribly jobless non-recovery. At 2.4% growth businesses will NOT be hiring nor investing much.

What's Really Going On

This rather large and complex composite puts together four different graphics we've put up several times and like to re-use because they tell the complete story. One of the advantages of ideographic languages like Chinese is that the characters also tell a story because they are pictures. Think of this graphic as four ideograms that also form a fifth, master, picture of how the major currents are playing out all together inter-actively. First you have the business cycle where Consumption drives business spending and hiring but both Consumers and Business decide based on income, prospects and funding/borrowing. As we cycle around this feedback loop, which can be either virtuous or vicious (and we're in a vicious one indeed), the economy oscillates like a wave pattern.

But we have some deep-seated structural feedback problems where Credit Markets sustain or constrain how the economy does. They are self-repairing in the sense that collapse is no long immanent (make no mistake last Fall and this Winter that was NOT a given - Bernanke, Paulson and Geithner saved Western Civilization). So Credit and Housing are still in trouble but the US Economy is, as we've just been pounding away at, in deeper trouble. As it happens, not matter what you here in the headlines, the International Economy is much worse. Partly because Japan and Europe are in the deepest dodo but also because China's reported growth is still not good enough to breakeven on job creation requirements. It's not an accident that so many serious civil disturbances have been breaking out, getting bigger, more serious and widespread. And also because China acted fast and well but has created terrible problems for the future by pumping too much money that moved out of their credit system into bad loans.

The bottom left-hand chart pulls all this together and tells you where we think we're at in the cycle and what the alternative paths were and are. A shallow V-recovery is out of the question. Depression 2.0 has been avoided, so far ! Judging by GDP one could estimate we're at the beginnings of a bottoming process. But, especially with poor future growth prospects, the continued deterioration and poor future prospects for Employment - which is IOHO the best gauge of overall economic health - has not begun that process yet.

There's a log of pain to come and our long-term condition will be chronically poor for a longer-time, even if we manage to start putting together positive growth on a sustainable basis.

U.S. Economy Pulls Out of Tailspin  The U.S. economy came out of its tailspin in the second quarter and may be poised to resume growing, even as new signs of economic strain showed up in Europe. U.S. gross domestic product -- a broad measure of the value of goods and services produced -- contracted at a 1% annual rate last quarter, its slowest pace in a year. That was a marked improvement from the first-quarter contraction of 6.4% and the fourth quarter's 5.4% pullback. Mr. Maki expects the economy to grow at a 2.5% annual rate in the third quarter and a 3% rate in the fourth quarter. Several economists raised their forecasts after the most recent report; JPMorgan Chase, for example, revised its projection for the third-quarter growth rate up to 3% from 2.5%, citing the fall in inventories. The White House wasn't predicting clear sailing ahead, however. "As far as I'm concerned, we won't have a recovery as long as we keep losing jobs," President Barack Obama said Friday. Though the U.S. trade position has improved and buffered the recession, new signs of stress emerged among key U.S. trading partners. Unemployment in the euro-zone economies rose to the highest level in a decade and consumer prices there fell, a worrisome sign of deflation that emerges when demand is so weak that businesses can't raise prices. New government revisions to U.S. growth data showed what most Americans already suspected: The current recession is the worst since World War II. Since economic output peaked in the second quarter of last year, it has fallen by 3.9% -- the steepest decline since the government began keeping quarterly figures in 1947.

Revised Data Soften View of '01 Slump  The current recession turns out to be worse than previously thought, while the 2001 recession was milder than earlier reported. Those were two conclusions from wide-ranging data revisions released Friday by the Commerce Department's Bureau of Economic Analysis. Data for the 2001 recession had shown that the nation's gross domestic product declined 0.2% from the fourth quarter of 2000 to the third quarter of 2001. On Friday, the government said GDP actually grew 0.1% during the recession. The current downturn is much different. Revisions show that from the fourth quarter of 2007 to the first quarter of 2009, inflation-adjusted GDP dropped at a 2.8% annual rate, compared with the 1.8% drop reported previously. The decline continued in this year's second quarter, producing the worst recession since World War II. The government initially reports the nation's GDP a month after a quarter's end. That makes the figure a rough estimate. It updates the estimates in the following months, and conducts comprehensive revisions every five years as new data arrive. Many economists consider a recession to be two straight quarters of declining GDP, but that didn't happen in 2001. Economic activity bounced around in the first nine months of 2001, with a 1.3% decline in the first quarter, a 2.6% rebound in the second quarter and then a 1.1% decline again in the third quarter.

Falling Imports versus Falling Exports (GDP = -2.38%) I noted earlier that the oddity of imports versus exports calculation would produce a positive contribution to GDP. Let’s look at the details of this, and find a way to understand what this means. First, off conceptualize the difference between what imports and exports are. At the most basic level, Imports represent our consumption of overseas production, i.e., We buy what they make. Exports are where overseas consumers purchase our production, i.e., They buy what we make. What were the specifics of the GDP data regarding import/export? -Real imports of goods and services decreased 15.1% -Real exports of goods and services decreased 7.0% So in Q2, both consumption by us of overseas goods and services and by them of US made goods and serivces declined significantly. The Differential between imports and exports — who dropped fastest — was the key to this quarter’s GDP data. According to Bloomberg, Decreasing Exports subtracted 0.76% from GDP. At the same time, falling Imports added 2.14%.  Net contribution of the fact that Imports are free falling twice as fast as Exports are = 1.38%. If they were both falling at the same rate — if Europe and Asia’s consumers were hurting as much as ours –  GDP would have been -2.38%.

If it seems weird to you that the ratio of domestic and overseas shrinking economies and their reduced consumption somehow turned into a positive GDP contributor, well, welcome to the wonderful world of government statistics.

Revisionist History, by the Numbers Tomorrow, we get two big changes. The first is the granddaddy of revisions. Using better data than was available before, the Bureau of Economic Analysis will revise the growth figures going back to 1998. That will let us know if this recession began more severely than we thought. We may learn that growth was negative in some periods when we thought it was positive, or vice versa. The second change will be in a lot of definitions. The way they divide up personal consumption expenditures will change significantly, going back decades. That change will not change the total expenditures — at least before inflation adjustments are applied — but it will change the way the figures are split up.

Deeper Than We Thought The recession was worse than we had thought, or at least worse than the previous G.D.P. numbers seemed to indicate. From the fourth quarter of 2007 through the first quarter of 2009, we had been told the G.D.P. fell at an annual rate of 2.8 percent. The new number is 4.3 percent. What made the difference? In general, the things we thought were bad turn out to have been worse. Personal consumption spending was lower than we thought, falling at a rate of 2.1 percent rather than 1.5 percent as previously reported. That was largely due to the decline in spending on durable goods — such as cars and furniture. Instead of falling at a rate of 11.5 percent for the period, we are now told the rate was minus 13.5 percent. Every type of investment — from housing to equipment — was also worse. We thought residential investment fell at a rate of 34.5 percent. Make that 35.9 percent. We thought spending on nonresidential structures fell at a rate of 9.4 percent. Make that 13.1 percent. On the other side, foreign trade was better than previously reported, and the federal government’s military spending rose more rapidly than we thought. But nonmilitary spending rose a little less than previously reported, and state and local government spending declined faster than previously reported. To balance that off, at least a little bit, we are now told that from the third quarter of 2001, when the G.D.P. reached its lowest level in the 2001 recession, through the fourth quarter of 2007, the economy grew 18.1 percent, rather than the previously reported 17.7 percent. On an annual basis, that raises the growth rate in the last last up cycle from 2.645 percent to 2.696 percent. And in case you are wondering, the revisions for all the previous years added up to a small net positive. On an annualized basis, the real growth of the American economy from the first quarter of 1947 to the first quarter of 2009 was 3.257 percent, not the 3.243 percent previously reported.

Three in a Row For the first time since 1954, nominal G.D.P. has fallen for three consecutive quarters.

GDP Revisions: Deeper 2008-09 Contraction, Milder 2001 Recession The latest recession, it turns out, is even worse than previously reported. And the 2001 downturn that plagued the job market for years? It now barely registers as a sustained contraction in economic output. Alongside the second-quarter report on gross domestic product, the Commerce Department’s Bureau of Economic Analysis today released revised estimates of economic data going back to 1929. The BEA’s comprehensive revision to its National Income and Product Accounts shows an average annual growth rate of 3.4%, 0.1 percentage point higher than previously published estimates. From 1997 to 2008, the economy is shown growing at a 2.8% rate, also 0.1 percentage point above its earlier figure. The update moves the current recession past the late-1950s downturn as the worst (in GDP terms) since the Great Depression. (Of course, the 2009 data could be revised next summer so you can’t say for sure.) The BEA now says inflation-adjusted GDP increased just 0.4% in 2008. Earlier estimates had put the growth at 1.1%. GDP is now shown dropping in last year’s first quarter (reported earlier as a gain), posting a smaller gain in the second quarter than shown earlier, a larger drop in the third quarter and a slightly-less-large tumble in the fourth quarter. From the fourth quarter of 2007 to fourth quarter of 2008, real GDP is shown dropping at a 1.9% annual rate compared with the earlier estimate of 0.8%. The first quarter of 2009, which last month had been estimated as declining at a 5.5% annual rate, now shows an even worse 6.4% decline due to the benchmark revisions. That matches the first-quarter 1982 decline, but is still slightly better than the 7.9% drop in the second quarter of 1980. The government’s comprehensive revisions are carried out every five years to update the NIPA accounts with new data from government agencies (such as the Census Bureau and IRS) and outside sources. This year, as we told you earlier, the BEA is changing some of its definitions and moving items around on the NIPA tables The 2001 recession registers as even less of a contraction when measured over the full course of the downturn. From the fourth quarter of 2000 to the third quarter of 2001, real GDP increased by 0.1% under the revised figures due to a smaller contraction in investment spending. The earlier estimate showed it dropping 0.2%. Both are essentially flat, but the new figures should renew debate about the conventional GDP measure of a recession (versus the broader look at other data by the National Bureau of Economic Research). The first quarter of 2001 declined at a 1.3% annual rate, followed by a 2.6% gain in the second quarter, a 1.1% decline in the third quarter and a 1.4% gain in the fourth quarter. The BEA says earlier business cycles show little revision.

Economists React to G.D.P. Report Here is what economists had to say about this morning’s report about a less-than-expected decline in the nation’s gross domestic product in the most recent quarter:

 “The path to recovery remains a long haul, with more disappointments likely in the months to come. The contraction — though less severe than most forecasts — offers no sign of a V-shaped recovery. Consumer spending came out worse than expected and is likely to remain weak into the third quarter because of ongoing clogging in income and credit channels. The very rapid decline in inventories raises hopes for a recovery in industrial production, but also increases chances of a pushback later in the year as domestic and global markets remain weak. With capital spending still falling and unemployment rising, neither investors nor workers are likely to see strong rewards anytime soon.” — Bart Van Ark, chief economist, The Conference Board

“Three components account for virtually all of the relative improvement in the second quarter. A surge in exports narrowed the trade deficit and added 1.38% to the second-quarter report. A spike in government spending added 1.12% to April-June real G.D.P. And a decidedly slower pace of inventory liquidation reduced the drag from this key G.D.P. category. The second-quarter report did, however, mark the first time in the postwar period that real G.D.P. has declined for four consecutive quarters. The composition of the second quarter real G.D.P. report supports our call that the business cycle will not bottom until later this year.” — Steven Ricchiuto, chief economist, Mizuho Securities USA

 “The downward revision helped explain the severity of job losses in the economy but I don’t think the G.D.P. report tells us anything different about the outlook from here — mainly that inventory adjustments are very far along which should mean that factories will be starting back up. In fact there’s evidence of exactly that all around the world. We’ve had much better manufacturing data in Japan, in Germany, in non-Japan Asia, and just this morning in the U.S. ticking back up just as the market expected. I view the G.D.P. report as confirmation of the severity of the downturn but I don’t think it changes the story going forward.” — Stuart Schweitzer, global market strategist, JPMorgan Private Bank

“Unlike those analysts arguing that we will see a robust ‘V-shaped’ recovery, however, we believe the boost to real GDP during Q3 will be fueled more by transitory factors, and that the longer-term outlook is for a fairly tame recovery.” — Richard F. Moody, chief economist, Forward Capital LLC

The Great Recession: A Downturn Sized Up What makes the current recession so bad? Other downturns have been more painful by some measures, but none since World War II has delivered so many severe blows to the economy at the same time. Already it is the longest. The nonprofit National Bureau of Economic Research, which determines when the U.S. economy slips into recession, says the downturn began in December 2007, 19 months ago. That makes it longer than the wrenching, 16-month recessions of 1973-75 and 1981-82. The unemployment rate is approaching the peak seen in the 1981-82 recession and the scope of job losses is the worst since the 1948-49 recession. The decline in gross domestic product is the deepest since the 1957-58 downturn, and Americans haven't seen so much of their wealth evaporate since the Great Depression. With a dwindling number of people who remember the Great Depression, the 1981-82 recession is many Americans' high-water mark for economic pain. To tame the era's rampant inflation, the Federal Reserve pushed short-term interest rates above 20%, slamming the brakes on the economy. Millions lost their jobs, lifting the jobless rate to 10.8%. Last month, the unemployment rate hit 9.5%. But most economists forecast it will keep climbing even after the recession ends because businesses will remain cautious about hiring. Making matters worse, the economy needs to add some 100,000 jobs a month to keep pace with population growth. While the unemployment rate isn't yet as high as in the early 1980s, the job losses associated with this recession already have been deeper because the downturn started with a lower unemployment rate than in the 1981-82 slump. Last month, there were 6.7 million fewer Americans working than in December 2007, when employment peaked -- a 4.7% decline, compared with 3.1% in 1981-82. "In terms of employment, we're now way past 1982 and we're just about to cross the worst postwar recession, which was 1948," says Stanford University economist Bob Hall, who heads the NBER's recession-dating group.

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Help Wanted for Market Recovery Are markets taking too rosy a view of unemployment? Joblessness is usually seen as a lagging rather than a leading economic indicator. In the last two U.S. downturns, firms continued shedding jobs for months after the recession was officially over. Typically, companies only start hiring in earnest once a recovery is clearly under way. But this time, unemployment may play a bigger role in determining the timing and shape of recovery. Markets are betting the old orthodoxy still holds sway. Unemployment has climbed quickly. The U.S. rate hit 9.5% in June. That is higher than at any point since 1983 and, up from 5.6% a year earlier, represents one of the steepest annual increases on record. In the euro zone, May's 9.5% rate was the highest in 10 years. The Organization for Economic Cooperation and Development forecasts rates of 10% in the U.S. and more than 12% in the euro zone in 2010. But that hasn't stopped equity markets rallying strongly, amid growing hopes of an economic recovery this year. That is partly because job losses and other cost cuts have provided a cushion for corporate profits. According to Deutsche Bank's calculations, 82% of the S&P 500 companies to report so far have beaten second-quarter earnings expectations. The snag is that only 50% have beaten sales targets. For the moment, earnings are only being held up by costs shrinking fast alongside revenue. For a true recovery, sales need to start growing, too. Rising unemployment may make that harder to achieve. First, the flip side of better-than-expected corporate profits is real financial and consumer pain. U.S. credit-card bad debt, for example, is rising faster than unemployment. Annualized write-offs of securitized credit-card debt hit a record 10.8% in June, according to Moody's. The agency expects that to rise to 12% to 13% in mid-2010. That leaves the risk of a nasty feedback loop: Continued downward pressure on sales provides further impetus for companies to cut jobs, leading to more losses on consumer debt -- and more economic pain.

Squeeze on Pay, Benefits May Crimp Recovery The economy may be on the cusp of a recovery, but workers may not be anxious to step up spending, in part because employers are keeping a lid on salaries and benefits. The Labor Department's Employment Cost Index -- a broad measure of worker compensation ranging from health benefits and 401(k) contributions to hourly pay -- was up 1.8% in the second quarter from a year earlier for civilian U.S. workers. For private-sector workers, the index was up 1.5%, the smallest annual increase since the government began tracking the data in 1980. Public-sector workers have fared much better. State and local government workers saw their compensation increase 3.2% in June versus 3.5% a year earlier. The increase in benefits actually accelerated, to 3.6% from 3.5% in June 2008. The compensation changes calculated by the Labor Department aren't adjusted for inflation, which moderated over the past year and cushioned the wage impact on workers. The squeeze on benefits has been especially stark, according to the federal government statistics. After registering a year-over-year increase of 7% in 2004, benefits for private-sector workers were up just 1.3% in the second quarter from a year earlier. They have grown at an annual rate of less than 1% during the first six months of the year.

Skeptics Continue to Abound As the stock market consolidates its recent gains, lots of professional commentators continue to toss brickbats at the notion of a decent economic recovery or a sustained bull run in stock prices. Here are some recent samples:

Harm Bandholz of UniCredit says: “Are we facing a double-dip recession?” He trots out comparisons to the brutal double-dip recession of the early 1980s. He notes that the oil prices and inventory draw down and rebuilds mimic what happened back then. He does note, however, that a double-dip recession is not his base case, but rather a “W” shaped recovery that won’t be particularly fun. Ian Shepherdson at High Frequency Economics notes that consumer confidence is rising and home sales may be turning, but that’s nothing to get terribly excited about. The consumer, key to any real recovery, still faces horrific debt problems and won’t be spending anytime soon. “Don’t be seduced by rising consumer confidence,” he writes. “People need cash as well as confidence if they are to go shopping, and cash will be in very short supply for much longer than in a normal economic cycle.” MF Global extols the recent decent earnings and notes the many positive surprises. But at the same time, it warns that “earnings expectations may rise too quickly and exceed reality.”

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