Friday, February 19, 2010

Revenue Growth, Recession & Recovery

Using my Compustat data sources, I decided to investigate actual revenue and profit growth in the past seven years.

I totaled revenues for members of the S&P500 from 2003 to now, resulting in slightly more than an actual 500 companies.

As of December, 2003, their reported total annual revenues (the sum of four consecutive quarters) were $23.7T. By the end of 2009, those revenues had risen to $35T.

Calculating annual nominal growth rates in these total revenues, these are the results.

Nominal Total S&P Annual Revenue Growth
2004 10.7%
2005 11.9%
2006 12.3%
2007 9.0%
2008 6.9%
2009 -8.8%

Period Annualized Revenue Growth 2003-09: 6.7%

Isn't this somewhat surprising? Wouldn't you have expected 2008 revenues to have plunged, as the first full year of recession hit? Instead, business revenues grew that year, and only fell, by -9%, last year.

The nearby chart of monthly sampled totals of S&P trailing quarterly revenues does suggest, however, a recent bottoming of revenue loss.

Reinforcing the growth rate analysis, the chart illustrates that revenues peaked in late 2008, then fell, and now have flattened at roughly $8.4 of trailing quarterly revenues for the total S&P500+.

What happened to earnings? I happen to have Net Income After Tax data on the same companies. Here's a table of annual growth in total S&P NIAT for the same period.

Nominal Total S&P Annual NIAT Growth
2004 49.7%
2005 18.6%
2006 17.6%
2007 5.3%
2008 -39.2%
2009 -80.7%

Period Annualized NIAT Growth 2003-09: -20.2%

NIAT fell from $1.3T in 2003 to $333B last year. It appears that earnings behaved more in line with the NBER dating of the recession.

Reinforcing business news of the last two quarters, in which some companies have posted surprising earnings gains, this data illustrates that a broad collection of the US economy's large companies, representing much of the activity of the nation, has experienced a profitability rebound in the last few months. After falling to only tens of millions of dollars for the trailing quarter, NIAT has risen again to a monthly total of trailing quarterly NIAT of $231B for the S&P500+.

It should be noted, however, how much deeper the NIAT decline has been than that of total revenues. The total S&P500+ is a long, long way from its peak running rate of some $800B of total quarterly earnings.

CNBC's Tyler Mathisen Should Go Off-Air

Did you see CNBC's Tyler Mathisen get all cranky and irritable during his stint on the network's noontime program yesterday?

I did. Boy, he needs to get off camera again.

My recollection was that he is the Managing Editor of CNBC, but apparently he's been kicked out of that job, and given the rather empty-sounding post of "Vice President, Strategic Editorial Initiatives."

Here's the official CNBC bio on him:

"Power Lunch" Co-Anchor Vice President, Strategic Editorial Initiatives

Tyler Mathisen co-anchors CNBC's "Power Lunch" (12PM-2PM ET) and is Vice President for Strategic Editorial Initiatives working closely with CNBC's Business Development and Marketing teams on strategic initiatives and alliances. Previously, Mathisen was Managing Editor of CNBC Business News responsible for directing the network’s daily content and coverage. Mathisen also hosted CNBC's "High Net Worth."

He looks a whole lot older and, well, crankier nowadays than in this obviously old, more flattering picture.

The topic that set off the old codger yesterday afternoon was a report on the rise in temporary hiring in the US. As various panel members debated the good or bad implications of such hiring, Mathisen began whining...and I mean whining....that he was so afraid companies would just never hire full-time workers anymore, but only temporary ones, leading to long term lower standards of living of Americans.

Michelle Caruso-Cabrera retorted that with all the government regulatory red tape involving hiring, compensating and firing workers, it's no surprise that many choose to hire temps for as long as possible.

Mathisen shot back, with a grimace and angry tone, something like,

'Go ahead and blame the government for everything.....Companies will hire people when they need them, and government regulations won't matter.'

If nothing else, that retort illustrates how out of touch old Tyler is with today's economy. For example, here's a passage from my January post about the recent BusinessWeek cover story discussing this trend,

"But since the 1930s, government and the unions it has, thanks to a long run of Democrat-controlled Congresses, supported, have cemented into the US economy the notion that employees are entitled to health care, pensions, and vacations, all provided by the companies for whom the employees work.

Within the cocoon of that system, it all seems to make sense, doesn't it? Fair, compassionate minimum standards and lifestyle provisions which, otherwise, workers would never receive?
Here's an alternative view.

For every non-cash benefit, workers receive less cash compensation. Mandatory vacation days means that companies implicitly adjust cash wages and their increase to the number of actual hours worked by employees. More vacation days means less in terms of wage increases.

It's the same thing with employer-paid insurance and pensions.

As my colleague put it so well, they are all simply another variant of the old-style 'defined benefit' compensation system. And every non-cash mandate or demand by unions or government decreases cash compensation to workers."

Old Tyler doesn't seem to understand the global marketplace in labor, does he? More encumbering labor regulations in the US will only lead to more temporary hires here, and more long term employment overseas in more forgiving labor environments. That's just good business and economics.

It's a testament to how liberal CNBC is that Mathisen reflexively dismisses anyone blaming government for anything. And then reflexively insists, categorically, that government regulation has no affect on business hiring decisions.

What sort of fantasyland is this guy living in?

He needs to be shipped off to the rest home for old, out of touch media execs. Maybe replaced with someone better-informed and relevant to today's business climate.

Someone like, oh, Michelle Caruso-Cabrera?

Thursday, February 18, 2010

About That "Resolution Authority"

Two contrasting articles in this week's Wall Street Journal editions beautifully illustrate the wide gap in perception concerning a concept known as a "resolution authority." I wrote this piece earlier this month on the topic.

Former Fed Vice-Chairman Allan Blinder wrote an editorial on Tuesday in which he all but assigned God-like power and omniscience to such an entity. He wrote,

"Here we do need a legislative fix- one that gives regulators a third way, between bankruptcy and bailout, that would either euthanize these institutions peacefully or resuscitate them under new management. That's what "resolution authority" is all about."

The next day, in his editorial revisiting the 2008 TARP, entitled "Rethinking the Bailout," Holman Jenkins, Jr., wrote,

"Another popular fix-it, a resolution regime for big banks, might help in time of calm, but big banks seldom fail in times of calm, and such a regime is no substitute for rolling out an indiscriminate safety net in times of panic. Quite the contrary: If it threatened bank creditors with real losses (as it properly should), invoking resolution authority would only feed the panic.

In a panic, remember, the problem isn't really bank size or interconnectedness- it's behavior, a fear that the public is one headline away from trying to yank its money out of the financial system....But let's face it: The real danger came from incentives that Washington scattered far and wide to much smaller, harder-to-see players that came back to haunt us all, including the biggest banks."

I'm solidly with Jenkins on the resolution authority issue.

Perhaps it's because Blinder was a Fed official for so long. Or a Princeton ivory tower professor. But he seems to simply ignore bankruptcy as if it's an inconvenient detail. Never mind that it was so important as to be included in the Constitution.

Instead, Blinder simply takes on faith that some new entity would be capable of doing what others have not.

Trouble is, it comes down to the people. And the Fed, FDIC and OCC all failed in their oversight roles during the real estate runup and subsequent meltdown. God knows the Fed vastly overstepped its authority, and the FDIC certainly tried its hardest, too.

No, we don't need another entity to invent something that already exists. By that I mean we have bankruptcy, and we have the FDIC to take over insolvent banks.

What Blinder, apparently not well-grounded in the real world, fails to appreciate is the inability for regulatory entities to easily identify the about-to-fail institutions. I wrote this in the prior, linked post,

"As I listened to Volcker and Corker, I heard, instead, a sort of semi-languid tone suggesting that someone from Washington would board a plane to visit the troubled firm and see what was going on.

In the real world, there's just not that much time. The unremarked upon reactions of trading counterparties to ailing and failing institutions is what seems to be unacknowledged by legislators and regulators.

There's a fine line between government seizure, without basis, of an about-to-fail institution, and the closure of an insolvent one. But if the government sends clear signals that no financial institutions that fails will, beyond deposit insurance, be assisted in any way, you can rest assured that counterparties will look after their own risks.

The Constitution specifies bankruptcy for failed firms. For some reason, regulators no longer wish to use that option."

Jenkins understands this. Blinder does not.

Stopping one financial institution's failure from creating a systemic panic is a laudable goal. But as long was we rely on regulatory agencies staffed by human beings to do so, such a process won't function reliably.

It's far more effective and efficient to clearly warn private institutions that they are obligated to look after their own counterparty risks with each other. That nothing will be done by government short of perhaps provide a bankruptcy court with financial services expertise and an understanding of the need for prompt adjudication of claims.

We don't need another regulatory entity or authority. We just have to use the ones we have more effectively.

Wednesday, February 17, 2010

Deere's Surprising Quarterly Results & Forecast

Deere & Co.'s pre-opening earnings announcement sent S&P futures up by about 3 points. The online Wall Street Journal article concerning Deere's results contained these passages,

"Chairman and Chief Executive Samuel Allen said economic conditions "remain stubbornly weak." However, "We are clearly seeing benefit from efforts to win customers with advanced new products while taking cost and asset discipline to an even higher level."

Deere, often viewed as a bellwether of U.S. agriculture, had seen earnings socked as farm-equipment sales dropped by double digits in the U.S. and Canada segment and elsewhere. But the declines mitigated in the latest period, falling 8% in the U.S. and Canada and 6% in the rest of the world. International results were boosted by 12 percentage points from currency changes.

For the quarter ended Jan. 31, the world's biggest farm-equipment producer by sales reported a profit of $243 million, or 57 cents a share, up from $204 million, or 48 cents, a year earlier.

Revenue dropped 6% to $4.84 billion, with net sales down 7.1% to $4.24 billion. Sales were boosted by five percentage points from currency fluctuations.

Analysts polled by Thomson Reuters had most recently forecast earnings of 19 cents on $4.18 billion of net sales."

Essentially, Deere's stunning earnings results were the result of cost-cutting and, to some extent, overseas demand. Not US sales growth.
For some perspective, here's a price chart for the past five years for Deere, Caterpillar and the S&P500 Index.
Both companies, based not far from each other in central Illinois, track the index fairly closely, having crested somewhat higher during the beginning of the recent financial sector troubles in late 2007-08.
Is Deere the bellwether for US economic recovery that so many investors apparently hoped, as today's equity markets opened, retaining the pre-open gain?
Well, Cat, a more diversified earth-moving equipment manufacturer than Deere, despite talk of its order book, remains flat. Deere, primarily an agricultural equipment producer, is benefiting from the constant need of people to eat, and global population growth.
If its recent results are based on overseas demand and internal cost management, that doesn't really seem to bode well for US recovery, does it?
And, in fairness, today's S&P gains are relatively small. Yesterday, the index rose nearly 20 points on, well, who knows exactly what?
In contrast, Deere's unexpected earnings surprise isn't really igniting the broader market.

Tuesday, February 16, 2010

More Curious Omissions From Elizabeth Warren's Rants

Last week I wrote this piece concerning Congressional TARP Oversight Panel chair Elizabeth Warren's flawed editorial in the Wall Street Journal. In a related appearance on CNBC the next day, Warren continued her rant along similar lines.

Back in November of 2007, I wrote this piece discussing what was really occurring as investment committees of various endowments, pension funds, bought debt obligations of a then-hot topic, bank-originated SIVs, or Special Interest Vehicles.

In my fictitious example, I suggest that investment committee members of various entities, with their fiduciary obligations, do a poor job investigating and/or understanding some of the prospective investments they ultimately purchase for the funds of which they are trustees.

Warren goes on rants about allegedly-predatory bankers, but seems to conveniently overlook the members of the investment committees for union pension funds, corporate pension funds, non-profit endowments, municipal funds, and other entities.

How about those buyers of CDOs and other ultimately over-engineered paper? Did anyone put guns to their heads? Hold their children hostage against buying the instruments?

No, not so far as I've been able to discover.

The dirty little secret of the investing world is that these so-called "sophisticated" investors, a technical term of legal consequence in the investing world, are frequently ill-prepared, unqualified people put on investment committees as a sort of plum assignment or favor.

They engage in practices which are supposed to be beneath sophisticated investors. Practices such as: using only S&P, Moodys or Fitch ratings to guide their investment choices, rather than do their own due diligence; succumb to overtures from investment bank sales people without doing objective analysis and asking tough questions; failing to consider, and ask about, the motivations of the selling institutions of various exotic, financially-engineered instruments; believing outsized yields on complex financial instruments can occur without accompanying outsized risks.

Years ago, a colleague introduced me to a middleman for several union pension funds. The person in question was a retired, rather beefy ex-working guy himself. Now wearing a white shirt, tie and suit, he never the less behaved pretty much as he probably did back in the day when he worked beside his fellow union members on a line or dock, etc.

When I met him, however, he was essentially peddling his connections to now-aged union chiefs whose investment committees he could deliver to deserving fund managers. He wasn't too shy about claiming that, either.

At no time did he ever suggest that the investment committee members of the union funds to which he could provide access and to which he would provide endorsement of selected fund managers would ask tough questions, were well-trained in analyzing various fund strategies or instruments, or that there would even be any serious analysis of a manager's approach.

It was pretty much a case of passing muster with the middleman, in order to gain access to relatively easily-provided union pension funds to manage.

I don't recall the person's name, nor the sectors in which he had union connections. But at the time, it was quite clear to me that this was SOP for marketing to some pension funds. Investment committee members were just not very responsible.

I'm sure this was not a rare exception. In fact, in CNBC's 2009 production, House of Cards, David Faber interviews the mayor of, I believe, Narvik, Norway. Unbelievably, the woman seemed aghast that the investment bank vendors of complex financial instruments had apparently hoodwinked her concerning the risks of the CDOs they offered to her municipality. She seemed incredibly naive, never engaging in independent information gathering or analysis of the instruments.

Why doesn't Elizabeth Warren go on a rant- and crusade- to find, identify and punish inept members of investment committees? Why isn't she advocating using existing laws to charge and punish such persons for failing in their fiduciary duty as trustees of the funds on the investment committees of which they sit?

For every flawed, risky asset sold by an investment or commercial bank during the period of financial excess, there was a willing institutional buyer.

Why do we only hear about the sellers, and never the culpable, guilty buyers, as well?