Friday, September 04, 2009

Today's Employment Report

This morning's employment report information provided the headline news that unemployment has now risen to 9.7%.

A little over a month ago, I wrote this piece, comparing the economic outlooks of several well-known pundits. In particular, I focused on Mort Zuckerman's views, which I happen to share,

"Then we have a very detailed, persuasive editorial in last Tuesday's Journal, written by Mort Zuckerman. In his piece, the chairman of US News & World Report, and head of Boston Properties, dwells almost exclusively on the under-representative current unemployment rate of 9.5%.

Zuckerman lists 10 separate, but related points, all of which provide evidence that the demand side of the economy, via consumer spending, will almost certainly be much lower in the next few years than most pundits, analysts and economists realize.

Among his points, Zuckerman cites: underemployed, those no longer even looking for work, workers 'employed' but on unpaid leave, part-time workers who were once full-time, shorter work weeks among the employed, a 65% capacity utilization at US factories, and, finally, the longest average length of official unemployment- 24.5 weeks- since this data item has been tracked back in 1948.

For good measure, Zuckerman adds that low consumer confidence and high debt levels have increased the savings rate which will, of course, dampen any subsequent recovery, as the consumer's 'marginal propensity to consume' will be much lower than in recent years. He laments that now, when a truly job-creating, infrastructure-building federal spending bill would help, it's too late. That's because $787B was allocated for what has been, to date, largely increases in Medicare and other state-based transfer payment programs.

In effect, Zuckerman would conclude that people like Bank of New York's Hoey mistakenly believe that there will be sufficient consumer demand to justify rebuilding inventories, building new cars and houses."

This morning, with the release of the unemployment numbers, CNBC had a brief 'discussion' among some pundits and their usual non-pundit, senior economic idiot Steve Liesman.

Bob Barberra was actually bullish, believing that some rather innocuous elements of the data indicated a recovery was already well underway. Mark Zandi, an economist with S&P, disagreed, but in a manner so subtle that one really had to pay close attention to catch it.

Zandi closed his remarks by noting that, with such high unemployment, some of the hopeful signs others noted, such as hours worked or weekly income, weren't all that significant. Instead, Zandi expressed the view that the still-increasing unemployment rate was going to overwhelm those modest signs of some added consumer spending power.

Rick Santelli closed his own comments by noting that the 9.7% topline unemployment rate would be the headline news for the day and weekend.

I went back to my post concerning Zuckerman's piece to remind myself of something I've only seen him illuminate. That is, much of the continuing unemployment data simply defines away, or omits, the fact that the report's perspective excludes certain classes of the unemployed who no longer look for work, and miscounts or under-represents those effectively now on part-time schedules.

One thing is sure, though. The immensely expensive "stimulus" bill passed early this year has done nothing to mitigate the continued rise in unemployment. We don't yet know for certain whether an economic recovery is underway, but there are collateral signs that it is not.

For example, in today's Wall Street Journal, there is an article detailing the unexpected deterioration of the financial condition of consumer borrowers once rated as prime. Their mortgage and credit card debt is growing delinquent at a faster pace now than subprime loans are continuing to deteriorate.

It doesn't take much logic to see this hitting bank earnings and capital, causing another round of private-sector financial shrinkage. Not to mention dampening consumer demand and affecting consumer sentiment.

I personally believe, as I've written in a prior post, that many economists are using inappropriate models and assumptions from over 25 years ago. Models and assumptions which are tied to a different type of economy and workforce than we now have. As such, I don't think they are correctly accounting for today's business IT allowing for previously-unimagined control of overheads and inventories.

If economic recovery is based upon expectations of inventory rebuilds, I just think that's overly optimistic for the next few quarters.

Thursday, September 03, 2009

What Does The FDIC's Need For Backstopping Imply For America's Financial Power?

Dennis Berman wrote an interesting piece in Tuesday's Wall Street Journal concerning the current cries abroad- yet again- for an end to the role of the US dollar as the international reserve currency.

I've read these pieces for over 20 years now, and, until now, I have always considered them wishful thinking on the part of foreign economic wannabes.

Berman even included the comments of one academic who continues to label this desire wishful thinking.

But there are developments in the US domestic economic and financial situation which could well herald the final coming to feasibility of these calls for an end to US 'economic hegemony.'

For me, they became more thought-provoking and sobering with the recent spate of articles calling attention to, of all things, the FDIC insurance fund's near depletion.

Of all the FDR-era New Deal programs, the FDIC may well be the first to officially crater. And this marks, I believe, a very differential milestone of a very troubling sort for US economic power.

Why? Why this one somewhat innocuous program, rather than, say, Medicare, Social Security or Medicaid?

Precisely because, while those latter three are explicit social wealth transfer payment schemes, the FDIC program was designed to be a private business-funded insurance program to prevent a repeat of the 1930's era bank collapses which caused depositors' funds to simply evaporate.

That Sheila Bair may have to call on Treasury to write a check to replenish this bank sector-financed program is deeply worrying to me. It means that federal regulatory ineptitude has caused the bank deposits insurance program obligations to have outrun its resources, making this promise essentially empty.

Since the US has an outstanding deficit, any funds lent to the FDIC from Treasury must, given money's fungibility, be borrowed from the financial markets. Thus, the promise to safeguard consumer bank deposits- and money market balances, too- is being financed with borrowing.

There is nothing "there" anymore. The deposit insurance promise will now simply be dependent upon market funding appetites.

This was always supposed to be a federally-designed and -managed scheme whereby private commercial banks paid insurance premiums to be used to guarantee the consumer deposits of banks which were declared bankrupt and seized.

Now, the premiums and their income have been overwhelmed by bank failures. The program hasn't worked, although it took some 70 years to occur. Whether the rate was too low, or FDIC bank closures too lenient, poor design and/or mismanagement has resulted in this program failing.

If a privately-financed, government-run scheme from the New Deal era has failed, what is one to imagine has occurred with government-financed, government-run schemes? Because government-financed is now just another term for borrowed funding.

I suspect the longer term implications for the looming FDIC fund insolvency is going to be skyrocketing interest rates on US debt and a consequent impoverishment of Americans due to the gradual, practical, if long term aversion to dollar-denominated obligations by the rest of the world.

Everyone understands government borrowing for impractical social schemes. But when a US private sector-funded program is seen to become unaffordable, it has to call into question the soundness, creativity, ingenuity and superiority of the now-crippled American capitalistic system for wealth creation.

What once was the envy of the world as an economic wealth-creation engine has been severely damaged over the past several years. Perhaps, now, we are seeing, sufficiently seriously to make the rest of the world's investors finally doubt the once-accepted truism that America is the best country for wealth creation on the globe.

Wednesday, September 02, 2009

Daniel Yergin On The Future of Oil

Daniel Yergin, the esteemed oil analyst, wrote a wonderful editorial in Monday's Wall Street Journal. In it, he reminded us why oil, for all its problems, will still be with us as the world's dominant energy source, for some time to come. Meaning decades.

He noted, in his piece,

"Why this debate about the single most important source of energy—and a very convenient one—that provides 40% of the world's total energy? There are the traditional concerns—energy security, diversification, political risk, and the potential for conflict among nations over resources. The huge shifts in global income flows raise anxieties about the possible impact on the global balance of power. Some worry that physical supply will run out, although examination of the world's resource base—including a new analysis of over 800 oil fields—shows ample physical resources below ground. The politics above ground is a separate question.

But two new factors are now fueling the debate. One is the way in which oil has taken on a second identity. It is no longer only a physical commodity. It has also become a financial asset, along with stocks, bonds, currencies and the rest of the world's financial portfolio. The resulting price volatility—from less than $40 in 2004, to as high as $147.27 in July 2008, back down to $32.40 in December 2008, and now back over $70—has enormous consequences, and not only at the gas station and in terms of public anger. It makes it much more difficult to plan future energy investments, whether in oil and gas or in renewable and alternative fuels. And it can have enormous economic impact; Detroit was sent reeling by what happened at the gas pump in 2007 and 2008 even before the credit crisis. Such volatility can fuel future recessions and inflation."

So much for two key reasons why Americans might wish for oil to be less important than it is. But then Yergin goes on to analyze the likelihood of such change,

"But are big cuts in world oil usage possible? Both the U.S. Department of Energy and the International Energy Agency project that global energy use will increase almost 50% between 2006 and 2030—with oil still providing 30% or more of the world's energy.

The reason is something else that is new—the globalization of demand. No longer are the growth markets for petroleum to be found in North America, Western Europe and Japan. The United States has already hit "peak gasoline demand."

The demand growth has now shifted, massively, to the fast-growing emerging markets—China, India and the Middle East. Between 2000 and 2007, 85% of the growth in world oil demand was in the developing world. This shift continues: This year, more new cars have been sold in China than in the United States. When economic recovery takes hold, what happens in emerging countries will be the defining factor in the path for overall consumption.

There are two obvious ways to temper demand growth—either roll back economic growth, or find new technologies. The former is not acceptable. Thus, the answer has to lie in technology. The challenge is to find alternatives to oil that can be economically competitive—and convenient and reliable—at the massive scale required."

Mr. Yergin has basically alerted us to the fact that the marginal uses of oil will now be determined by other countries, not the US. Our own management of demand no longer will determine world prices.

Zeroing in on oil's role in energy even further, Yergin observes,

"For oil, the focus is on transportation. After all, only 2% of America's electricity is generated by oil. Until recently, it appeared that the race between the electric car and the gasoline-powered car had been decided a century ago, with a decisive win by the gasoline-powered car on the basis of cost and performance. But the race is clearly on again.

Yet, whatever the breakthroughs, the actual impact on fuel use for the next 20 years will be incremental due to the time it takes to get large-scale mass production up and running and the massive scale of the global auto industry.

My firm, IHS CERA, projects that with aggressive sales volumes and no major bumps in the road (unusual for new technologies), plug-in hybrids and pure electric vehicles could constitute 25% of new car sales by 2030. But because of the slow turn-over of the overall fleet, gasoline consumption would be reduced only modestly below what it would otherwise be. Thereafter, of course, the impact could grow, perhaps very substantially.

But, in the U.S., at least for the next two decades, greater efficiency in the internal combustion engine, advanced diesels, and regular hybrids, combined with second-generation biofuels and new lighter materials, would have a bigger impact sooner. There is, however, a global twist. If small, low-cost electric vehicles really catch on in the auto growth markets in Asia, that would certainly lower the global growth curve for future oil demand."

Again, Yergin points out that developments in, well, the developing countries, e.g., India and China, will have more impact on oil demand than will what happens onshore in America. Precisely because of our mature demand for automobiles, any new, rapid incursion by electrically-powered vehicles won't likely happen in the US. I am presuming that Yergin believes that any draconian federal action to mandate against new gasoline-powered cars will simply result in Americans holding on to the ones they already have for longer, thus further increasing average vehicle life, and reducing turnover. Especially at current prices for electric vehicles, and the non-existent infrastructure for recharging them.

He closes with this passage,

"As to the next 150 years of petroleum, we can hardly even begin to guess. For the next 20 years at least, the unfolding economic saga in emerging markets will continue to make oil a global growth business."

Daniel Yergin doesn't write in the Journal very often, but he never disappoints with the quality and focus of his insights. In this editorial, he reminds us, with factual support, why oil will be powering American vehicles for the next several decades. And why, regardless of our energy policies for the next few years, other countries will have greater impact on the larger issues of vehicular power sources than will Americans for the future.

It puts the current federal government preoccupation with energy policy, cap-and-tax, and other related matters in a whole new light, doesn't it?

If you thought those initiatives were misguided and pointless before, you probably are even more convinced of that position after reading Yergin's thoughts.

Tuesday, September 01, 2009

Earnings vs. Revenues

Sometimes I have difficulty believing how simple and shallow business writers can be. Even at the Wall Street Journal.

Monday's edition carried a Money & Investing Section lead article seriously discussing whether the recent equity market rally, founded upon the belief of an economic recovery, can be sustained on profit increases without concomitant revenue growth.


There's no discussion here. The answer is a resounding, absolute "NO."

In my proprietary research on large-cap equities over several decades, I discovered that there is a large and clear-cut fault line between those companies which can grow revenues, and those which cannot.

The latter exist, and some can actually consistently outperform the S&P500 Index for several years at a time. In the past, Colgate's Ruben Mark did this for about a decade- the longest of any slow/no-growth company which I observed.

But, due to the lack of revenue growth, Colgate's margin of total return over the S&P was only a few percentage points per annum. Far, far below the average total return that the most consistent high revenue-growth companies achieved.

It's a stunningly simple theoretical argument which is borne out in empirical results.

While revenue growth allows all of the rest of the income statement, and, thus, balance sheet, to grow at a rapid clip, revenue stagnation or shrinkage does the reverse.

You can't cut 100% of operating expenses. Neither overhead, nor direct labor or materials. It's a long walk on a short pier.

Thus, without steady growth in consumer demand, low-/no-growth companies will quickly reach the end of what gains are feasible using only cost-cutting. After that, margins are pretty much purely a function of volume.

It's pretty simple. There's no need for a long article or hopeful conjecture.
No, the equity rally of the past few months will not survive another quarter of no revenue growth.

Monday, August 31, 2009

Cerberus Restructures

It took a few years, but private equity group Cerberus' investments in Chrysler and GMAC have finally come home to roost in a big way.

So big that the group was forced to offer its investors an option to exit the their Cerberus positions. According to the weekend edition of the Wall Street Journal, slightly over 70% of investor assets, some $5.5B, are being redeemed.

I wrote two posts, here and here, back in May of 2007 and January of 2008, concerning Cerberus' purchase of Chrysler, then some early performance signs after the buyout. Even that far back, I was sceptical that Cerberus could refine gold out of the dross that had and has become the third-ranked US-based car maker.

As one would have guessed, Cerberus' investments in the two entities were zeroed out when the private equity group went to the federal government for a rescue.

Looks like I was correct in my belief that Chrysler was just too far gone to be viable, even if my expectation that high interest rates would eventually be the firm's undoing. Cerberus didn't choke on high interest rates for its highly-leveraged play for Chrysler and GMAC but, instead, failed due to an inability to simply raise private capital for them.

As I mentioned in the May, 2007 post, there's something decidedly ironic and telling about the Schumpeterian aspect of Cerberus' failures. Just because something is cheap doesn't mean it's attractive.

The industry structure of automobile manufacturing has been problematic for at least a decade. Barriers to entry are low, wages in foreign countries require extremely productive US operations if those costs are to be offset, and increasing numbers of subsystems have become outsourced, making auto "manufacturing" more a case of auto "assembly."

Cerberus' senior managers do seem to have become overly-confident and foolishly optimistic. Now, they and their investors are paying a heavy price.

It's pretty eye-opening that more than 2/3 of their investors are going to beat a path out of Cerberus, assuming the private equity group goes ahead with its restructuring plans. That surely is a vote of no confidence whatsoever in the group's ability to both rescue its current slate of investments, and do a better job choosing future ones.

I can't say that I blame those investors. Cerberus has shown an appallingly-bad habit recently of buying mediocre, or worse, properties and being unable to handle them as market conditions deteriorated. This is supposed to be the strong suit of private equity, and, in that, Cerberus has failed.