Friday, June 27, 2008

GM vs. Toyota

Nearly three years ago, I wrote this post as one of my first on this blog.

Entitled "Queens of Denial," the post contained this passage,

"I’ve done quite a bit of research on drivers of consistently superior company performances, looking over long timeframes among many large-cap companies. The very best companies consistently grow revenues at high rates. This typically involves both repurchases by customers, as well as an ability to sustain price levels. This type of customer behavior, repurchasing and paying full price, is usually seen when a company adapts its offerings to evolving customer needs over time in a competitively-advantaged manner.

GM and Ford don’t appear to be able to do either one. That’s their real problem. Failure to solve this problem will overwhelm the resolution of any of their other apparent problems, including those involving workforce healthcare.

Judging from where GM and Ford appear to be putting much of their energies these days, I’d say we’re going to be shy at least one major US-based car manufacturer before the decade is out."

Tuesday's Wall Street Journal article concerning Toyota's imminent dethroning of the once-vaunted GM as the largest vehicle seller in the US merely adds more evidence to my point.

But the really stunning information in the article which caught the attention of both my partner and me was this: GM's market value now stands at about $8B, while Toyota's is $154B.

That's nearly a 20x difference.

The nearby Yahoo-sourced price chart for Toyota, Ford, GM and the S&P500 Index tell a pretty clear story.

Since 1993, when, I'm guessing, Toyota was traded publicly in the US, the Japanese-based automaker has never really underperformed its American counterparts.

Since as far back as the late 1990s both Ford and GM have been on a downward drift, first flattening before gently sliding below their initial value early in the decade.

For an automaker, Toyota has actually done well, matching the S&P over nearly the entire period.

Looking more closely at the last two years, the same information shows that all three companies tracked the index closely until late last year. After a brief rise, GM began to slide severely, while Ford maintained its momentum with the index until its recent surprise announcement of unexpectedly low sales.

Zooming in on the last year, however, we see that GM really has deteriorated more rapidly and severely than Ford, while Toyota, while underperforming the S&P, has had a much milder decline of only -20%.

By contrast, Ford lost 40% of its market value in the last twelve months, while GM has now plunged by more than 60% in market value.

No wonder a recent stock price chart for GM on CNBC showed the current price below that of the late 1950s.
The Yahoo equivalent chart only goes back to 1962, but that is, sadly, sufficient time to show the same picture.
GM CEO Rick Wagoner has now taken shareholders back to a time when John Kennedy was still alive. All of the value (less dividends) created in the intervening 40+ years has been wiped out by Wagoner and his team of inept executives.
It's no wonder, with an eight-year decline in stock price, that the forward value ascribed by investors to GM is only 5% of that of Toyota.
That's a startling expression of the same information which I cited earlier from the Journal article. But that's what the numbers mean.
A stunning commentary on the total failure of the management of America's largest automaker in under a decade.
Is it any wonder that I believe GM is finally on the edge of death? Even my foreign exchange trading friend whom I mentioned in this recent post agreed that while Ford might survive, GM is likely to die before the economy recovers, barring some stupid political intervention.

Thursday, June 26, 2008

GE's Continuing Woes

Judging by this morning's Wall Street Journal article, Jeff Immelt and GE just can't catch a break these days.
It's not enough that Bill O'Reilly's Fox News Factor program bashed Immelt and GE yet again last night. It's become an almost twice-monthly event now, since he first did it in April, when I appeared as O'Reilly's guest to discuss Immelt's awful performance leading GE since late 2001.
The nearby Yahoo-sourced five year performance chart of GE and the S&P500 Index continues to show the diversified industrial giant struggling to even match the market index. And it's only gotten worse in the past two months.

Now it appears that Immelt can't even sell GE's private label credit card business.

It seems, believe it or not, that when you want to unload a turkey, other people actually notice and shy away.

Imagine that! Didn't Immelt and his minions figure other business people can do the math, too, on GE's card portfolio's weak returns?

According to the Journal article, GE, which does a lot of card issuance and processing for so-called private label accounts, runs a card business which is riskier and less profitable than the average major bankcard- Visa and Mastercard- business at a large commercial bank.

These days, your local department store or big box chain's credit card is, in all probability, actually outsourced to GE for the operation of the program.

What I find, well, arrogant, is that the senior guys at GE, including Immelt, think that they can just nonchalantly dump their mediocre card business onto some other company- preferably a bank- and the buyer won't notice the portfolio's problems.

The Journal article notes that Chase and other commercial banks have now retreated from considering the purchase of GE's business.

It's one thing when you have a rare crown jewel in your company, or a well-performing misfit with the rest of your business portfolio, and you expect to get some interest from prospective buyers when you want to sell the business.

In this case, however, GE is trying to peddle an also-ran credit card business as the whole sector is experiencing rising chargeoffs.

These guys at GE just don't get it, do they? Not only are they not the smartest guys in the room. Everyone else is not just stupid, either.

How much longer will GE's board put up with Immelt's follies? Probably a long time. But shareholders can sell now, and contribute to a further slide in the company's stock price and total returns.

Wednesday, June 25, 2008

George Soros' World-Class Ego

This past weekend's Wall Street Journal edition carried a piece on George Soros' latest warning- an asset 'superbubble.'

Like Julian Robertson and Michael Steinhardt, George Soros seems to get lavish attention long after his period of successful trading, or investing, if you prefer, has ended.

The Journal article notes that Soros made large fortunes in 1992 and 1997 by betting, respectively, against the pound and the bhat. While never proven, rumors have always swirled around Soros concerning whether or not he was the recipient of insider leaks about the British financial authority's intentions regarding the pound.

Now, writes Greg Ip, Soros,

"wants to be remembered most as a philosopher. Since he was a student in 1952, he has been promoting his economic theory, which he calls 'reflexivity.'

In essence, he argues that markets don't simply reflect fundamental determinants but can change those determinants in a way that causes asset prices to go to extremes. In his latest book, "The New Paradigm for Financial Markets," he argues a "superbubble" has developed in the past 25 years and it is now collapsing."

Ip notes that Soros' predictions have routinely falled wide of the mark. He prematurely sounded the death of the US dollar in 1987, yet neither the world-wide depression, nor global conflict of which he warned have arrived. In 1998, he claimed that

"The global capitalist coming apart at the seams."

Actually, it would seem that in the decade since Soros wrote that somber prediction, global capitalism has contributed to more trade, wealth creation and freedom than ever before in man's history.

Believe it or not, Soros actually alleges that, because in the story about 'the boy who cried wolf,' the wolf really arrived after three warnings, his three most recent books warning of global economic catastrophe mean he is now probably correct.

I'm serious. Greg Ip's piece quotes that comparison by Soros. You cannot make up stories this silly.

To prove how important his ideas are, Soros notes,

"The most popular reaction to my philosophy is....success has gone to his head and he wants to be more than what he is....But I would like my ideas to be judged on their own merit. I think I'm on the verge. For the first time, this book is a best seller. I was asked to testify (before the Senate Commerce Committee) because a staff member read the book."

Well, if I told George Soros that I happened to see a copy of his book in the garbage, would he promptly declare it to be garbage, too?

If he seriously believes that because some no-name staffer to some Senatorial windbag read his book, it now is important, his long-ago success has gone to his head.

I laughed when I read the next passage, where Soros answers Ip's question about whether policy or academic heavyweights are noticing his ideas,

"It has certainly not penetrated academia, and not policy makers, either. I wish I could engage in a discussion with (the Federal Reserve). I'm waiting for a phone call. I'm (meeting with) Alan Greenspan."

These days, I don't think Greenspan's such a hot economic ticket, George.

At the end of Ip's piece, he quotes Soros actually saying something interesting,

"This is, of course, [Joseph] Schumpeter's creative destruction idea. However ... going overboard in generating change is not necessarily a good thing. Financial innovation may not be an unmixed blessing because it really prevents proper regulation.

If you look at the 19th century, you had creative destruction going on, one financial crisis after another. But each time you had a crisis, you had an examination of what went wrong, and you put in some instrument or some institution to prevent it from happening.

I'm not advocating ... central planning because that's worse than markets. But the regulators need to learn from the mistakes that they have made. I think it's pretty clear that you've got to accept responsibility for moderating asset bubbles. ... That involves regulating credit as well as [interest rates]."

It's not clear what Soros is actually saying here beyond the existing awareness that some regulation of financial services is a beneficial activity. He does not speak to the perennial difficulty of staffing such governmental entities with employees who are as motivated and intelligent as those whom they would regulate.

Perhaps what would satisfy Soros, and it would satisfy me, is to regulate certain classes of financial services activities, such as insured deposit-taking, residential mortgage, consumer and conventional business lending, and transactions processing, very strictly and heavily, so as to safeguard these core economic activities.

Non-commercial banking practices involving riskier investments will always be subject to loss of capital and liquidity risks, to name just two. It's unclear how much regulation can function effectively, other than to try to herd over the counter markets, such as swaps, into exchanges. The Treasury, under Paulson, is already headed that way.

As I wrote here a while ago, in response to Henry Kaufman's tirade against financial innovation, I think, over time, we've been far better served by the phenomenon than we've been hurt by it.

I think Soros' thinking here is muddled, if it's anything relevant at all.

Why does anyone pay attention to him? Because, I guess, like Robertson and Steinhardt, once, years ago, in different market conditions, George Soros made a lot of money. And even he confirms it was due in no small measure to luck.

So on this basis, we should all listen to his personal crackpot theory of 'reflexivity?'

God help us if that's what we've sunk to in the US.

Current Market Signals

Things sure have changed in the equity markets since March.

Back in the final weeks of that month, as the Fed opened the discount window to investment banks and assisted in the retention of trades on the books of the failing Bear Stearns, my partner and I saw signals that the worst of the equity and options markets for long positions was over. The Fed, as my partner put it, was not going to allow money to be made on the short side anymore.

At that time, the risk was to the financial services sector and, it was believed, the credit markets in general.

We carefully monitored our new signaling/risk management tools and bought calls in April and May. By June, we again bought calls, but with a sense that maybe we should have straddled.

We were right.

In just two months' time, we sold call options with returns of over 150%, and roughly 50% on the April portfolios. May's options were less profitable, but still returned positive results, with one call exercised for a very significant return.

Now our signals look very similar to those of both December and March. Our S&P-based volatility measure has risen significantly to levels near that of mid-March, while the S&P returns in trailing months has been dropping.

Without divulging our specific proprietary measures, this combination is a lethal one for equities.

What has stunned my partner and me is that we don't really think there has been much in the way of new, fresh, bad economic news. But the business media and political machines of both parties seem to be dwelling on the worst economic and sentiment measures they can find.

Housing is compared to the Great Depression, as is joblessness, though both are wrong.

Energy producers are maligned, as are derivatives markets investors who provide liquidity and price discovery services to energy futures markets.

Now, they are labelled 'profiteers' and 'speculators.' Talk of windfall profit taxes and stiffer regulation or prohibition of 'speculation' is rampant among our King Canutes in Congress.

In fact, I don't think economic measures have declined as precipitously as the S&P and its futures have. Perhaps the one new development is more awareness of higher, if not crippling, inflation, and a potential rise in the Fed rate sometime in the next few months.

But these two factors alone seem to be offsetting the less-than-catastrophic business and economic news occurring recently.

Back in April, I thought we had a good 4-5 months of call options portfolios before we had to worry about weakening markets.

Instead, in only six weeks, we're somewhere between neutral and short in our evolving outlook for equity allocations in the next month.

Tuesday, June 24, 2008

You Read It Hear First...... Reuniting Commercial & Investment Banks

Late in March, I wrote this post concerning the ultimate result of the Fed's decision to open the discount window to investment banks. In that post, I wrote,

"Looking beyond simply Bear Stearns, can anyone truly justify the existence of all four of Goldman Sachs, Merrill, Lehman and Morgan Stanley? Especially in the modern world of large private equity firms and hedge funds? The former provide additional underwriting, M&A advisory and asset management, while the latter focus on providing trading capacity and investment management.

Other than emotional reaction of former employees seeing their old firm's name vanish, what would be different if one or more of those names were bought by or merged with a commercial bank?

Contrary to Andy Kessler's view, in the Wall Street Journal this past January, about which I wrote here, it's unlikely now that an investment bank will do the buying. With their high leverage and dependence upon commercial banks for funding, I suspect the investment banks are the more vulnerable. Now having access to the Fed discount window, it's only a matter of time before the regulators get around to levying a new regulatory framework on the investment banks."

In today's Wall Street Journal, Dennis Berman writes, in an article entitled, "Maybe It's Time To Put the Banks And Wall Street Dealers Back Together,"

"Speculation has in recent weeks mounted that one of the Street's brokers may even buy a commercial bank. Whether true, the rumors speak to three deep changes under way.
First, looming Federal Reserve assistance and regulation could force brokers to keep reserve ratios similar to that of deposit-taking banks. Second, short-term bank funding now is regarded with suspicion. It is capable of being yanked at a moment's notice, sending a bank such as Bear Stearns to the brink of bankruptcy (it is now part of
J.P. Morgan Chase). Third, the securitization markets also have contracted, which is in turn forcing the investment banks to shrink their balance sheets.

In theory, these problems are all solved by putting a large, plodding typical bank -- with stable deposits and returns -- next to the more-speculative realms of investment banking and trading.
Citigroup, the prime "universal bank" sounded good in theory, too. It has performed miserably since its creation after Congress rolled back the Depression-era limits a decade ago. That misses the relative success of J.P. Morgan Chase and Bank of America, the country's two other big universals."

I'd disagree with Berman's evaluation of Chase's and BofA's 'relative success,' as I described the entire publicly-held financial sector's woeful performance in yesterday's post.

But Berman has finally arrived at the same conclusion I did last three months ago. He further observes,

"Three or four years out, the investment-banking model is coming to an end," says Brian J. Sterling, co-head of investment banking for boutique adviser Sandler O'Neill & Partners. "If it walks like a bank and quacks like a bank, it's going to have capital ratios like a bank." "

No argument from me. In fact, I concluded that March post with these thoughts,

"A natural consequence to this will probably be even more smart financial services people migrating back to the privately-financed arena. Just like consumer goods merchandising has the 'wheel of retailing,' whereby new entrants compete at the low-cost end of the market, as existing players migrate upwards in terms of quality, service, selection and price, so, too, it seems, will financial services now have its own version of this 'wheel.'

Only in financial services, the 'wheel' is between publicly- and privately-held concentrations of capital and risk management. Again, viewed from afar over decades, the story of commercial and investment banking for the past forty years has been a gradual selling of transactions, asset and risk management businesses at their 'tops,' as formerly-private banks of both stripes went public, followed by managerial ineptitude, decline in risk management, and excesses in pursuit of growth via more risk.

Now that the public is absorbing the brunt of the losses, via equity ownership of these firms, the logical next step is for the better executives to join the early-adopters in forming new, or joining existing private equity and hedge fund shops."

It seems nearly everybody missed the real event of late March. It wasn't helping Bear Stearns avoid the unraveling of its entire book of credit default positions. It was the opening of the Fed window to investment banks, and the inevitable changes in regulation and/or capitalization requirements that will follow.

Yes, you read it here first. Three months ago.

Monday, June 23, 2008

On The US Financial Service Sector

I ran into an old friend this weekend who works as a senior foreign exchange trader at one of the larger NYC commercial banks.

This particular trader is very common-sensible and experienced, both in trading and banking. Conversations with him are always a pleasure.

After discussing the volatility in the currency and energy equity markets, he asked what I thought about financial service equities.

When I related the opinions contained in these recent posts about commercial and investment banks- here, here, here and here- he readily agreed.

Furthermore, he concurred with me that among investment banks, there only seems to be sufficient talent and cultural maturity to staff one successful publicly-held investment bank, i.e., Goldman Sachs. Other than that, he agreed that private equity and hedge funds employ the next-best non-commercial bankers, with the other, smaller three investment banks- Merrill, Lehman and Morgan Stanley- now populated by also-rans.
The nearby Yahoo-sourced price chart for Goldman, Merrill, Morgan Stanley and Lehman clearly shows that only the first one has outperformed the S&P500 Index over the past five years. And even Goldman hasn't done that consistently.

On the commercial banking side, my friend prophesied dismal prospects for growth on the order of perhaps 5% per annum, like a bond return. In this, he shares the view of my friend B and me that the largest US commercial banks are now so large as to prohibit effective management of both risk and growth.

Again, the nearby five year Yahoo-sourced price chart shows that Chase, BofA, Wachovia and Citi have all underperformed the Index for the past five year period.
As I told my friend, I wouldn't hold any financial services equity right now. Or, perhaps better put, I don't see my quantitative equity selection process producing any financial service equities anytime soon. I suppose it's technically possible, but, given these charts, barely.
I sure hope so.

Robert Mundell's Nobel-Quality Economic Insights

Economic Nobel Laureate Robert Mundell's interview with Kyle Wingfield of the Wall Street Journal appeared in the weekend edition of that publication.

What ought to concentrate the mind of any business person wonderfully is Mundell's clear, explicit assertion that the failure to make the Bush tax cuts permanent will push the US "into a big recession, a nosedive."

Mundell continued,

"This would be devastating to the world economy, to the United States, and it would be, I think, political suicide."

The economist opined that his own view of the best corporate tax rate is that it be set at 25%.

On the seemingly-endlessly debated topic of whether we are currently at risk of a new round of serious stagflation, Wingfield relates,

"With prices again rising as growth slows, some economists are worried that stagflation could be making a comeback. Not Mr. Mundell- not yet.

He draws a comparison with the situation in 1979-1980. Start with the dollar price of oil, which he calls "one of the two most important prices in the world" (the other being the dollar-euro exchange rate).

"If you look at the price level since 1980," he begins, "oil prices would naturally double by the year 2000. So from $34 a barrel in 1980 to $68 a barrel. And then...because the inflation rate's about 3.5%, it would double again by 2020. So the natural price...would be something like $136 in2020.

"Now, we already got to $130-something, but...I really think the price is going to settle down, probably below $100, if not below $90. What I'm saying is we're not so far off track."

"The price of gold in 1980 was $850 an ounce. And the price of gold today is about the same. It's astonishing," he says. "It's true, gold did go up" to more than $1,000 an ounce earlier this year, "but the public doesn't believe that there is inflation. If there was big inflation coming, then you'd see the price of gold going up to $1,500 an ounce very quickly, and that hasn't happened."

I found Mundell's opinions to be both reassuring and troubling. Reassuring that gold prices indicate we are not necessarily in for a serious, long-term bout of inflation.

Troubling about the absolute necessity of making Bush's tax cuts permanent. McCain wants to do so, but doesn't really prostyletize that convincingly. We know Obama wants to run the other way and raise taxes everywhere possible.

At least I can take comfort in the likelihood, per Brian Wesbury's observations about political gaffes being punished in internet time now, in this post, that if Obama is elected, and he conspires with Congress to raise taxes, that mistake should be rectified at the ballot box in, first, two years, then four.

It took a Carter to bring us Reagan. We may have to suffer through Obama to revitalize our economy, in terms of lower tax rates and government spending, with another fiscally conservative President, regardless of his party.