Friday, November 12, 2010

Cisco's Troubles- Are They Really Surprising?

Today's Wall Street Journal has a piece calling attention- apparently in surprise- to Cisco's latest earnings disappointment. The article cites slowing revenue growth at the networking gear giant.

 Frankly, like a procession of formerly-consistently superior performing technology icons before it, including JDS Uniphase, Cognizant Technologies, Dell, Microsoft, and Intel, Cisco has been a total return has-been for quite some time.
The nearby five-year price chart for Cisco and the S&P500 Index show the firm has outperformed the latter over the period. But, upon close inspection, it's evident that the outperformance has really been in the brief period of the equity market crash between late 2008 and early 2009. Before and after, the performance patterns were similar, with Cisco declining to nearly the index's level by fall of 2009.

However, a much more revealing chart is the next one, spanning the public life of the firm. It produced shareholder value so fast in its early years that comparisons with the index are really pointless. But it's easy to see that, like Microsoft, Cisco has really 'enjoyed,' or, more pointedly, its shareholders have not, a lost decade. From its peak at the peak of the technology bubble in 2000, Cisco slid dramatically and really never substantially recovered.

I have checked my own records, and do not find evidence of the firm in any of my portfolios after early 2000. Between its dismal total return performance, relative to better-performing firms, and, I expect, slowed revenue growth, the firm joined the list I mentioned earlier in the post. Those technology firms whose charmed life of meteoric total return and revenue growth has slipped into history, almost certainly never to return.

Thus my amazement that pundits still put so much emphasis on the firm's every move. The information is clearly available for all to see- Cisco hasn't been a consistently superior performer worthy of long term holding for a decade. You'd have to be a market timer to have earned significant gains by owning the firm during that period. And if you simply bought and held, you'd be a big loser.

But, I guess analysts have to create interest and drama in order to be noticed and, well, get paid. As for me, I won't be expecting Cisco to be returning to its former, attractive performance profile of the 1990s, when it hasn't managed to do so in the intervening decade.

Thursday, November 11, 2010

How Did We Return To The Brink of 1970s Stagflation?

You sit up and take notice when people as diverse as economist Alan Reynolds, former Reagan Treasury official Bob Zoellick, and former Alaskan Governor Sarah Palin decry, the latter two in the same edition of the Wall Street Journal, the Fed's QE2 policies for stoking inflation.

Palin's remarks demonstrated a surprisingly firm and clear understanding that Helicopter Ben's recent QE2 monetization of Treasury debt is weakening the dollar, thus driving dollar-denominated prices of commodities skyward.

Add to this Alan Meltzer's Journal editorial a week ago, entitled Milton Friedman vs. the Fed, and you should really be worried. Meltzer began his piece,

"Some people, including this newspaper's David Wessel in a column last week, believe the great Nobel laureate would favor this inflationary program. I am certain he would not.

Friedman's main message for central banks was to maintain a monetary rule that kept the growth of the money supply constant. In his Newsweek column, "Inflation and Jobs" (Nov. 12, 1979), for example, Friedman emphasized that "unemployment is . . . a side effect of the cure for inflation," so that if a central bank "cured" unemployment by inflating, it "will have unemployment later." In other words, don't try it."

That's what I recall from my undergraduate economics courses, as well. Friedman was famous for eschewing any active currency creation, instead, legislating some constant rate of growth of the currency, perhaps related to population or GDP growth rates.

On the subject of inflation measurement and expectations, Meltzer helpfully wrote,

"In the late 1980s, former Fed Chairman Alan Greenspan encouraged everyone to watch the core deflator for personal consumption expenditure—the PCE deflator. Since then, the Fed has used that measure as its inflation target. Recently, without much publicity, the Fed switched to the consumer price index (CPI). The reason? From 2003 to 2009, the two measures moved together. In 2010, they diverged—and the CPI shows substantially less inflation than the PCE.

Even so, the most recent PCE deflator shows inflation running at around 1.2% annually, about where the Fed says it wants to hold the inflation rate. And it has been between 1.5% and 1.8% for a year. There is no sign of deflation.

The two measures diverged because they give different weights to their components, especially housing prices. The CPI gives almost double the weight to housing prices, especially the rental value of owner-occupied houses. This is not a number that government statisticians sample in the market. They make an estimate. The new long-term bond purchase program puts a lot of weight on a weak foundation.

Paul Volcker and Alan Greenspan restored much of the credibility that the Fed lost in the great inflation of the 1970s. The Fed's plan to increase inflation puts this credibility at risk and is a large step away from the policy that Milton Friedman favored."

So we see that the Fed has been playing fast and loose with measured inflation, while somewhat unbelievably declaring that the current risk to the economy is deflation. I distinctly read of Bernanke's recent comments about how slack labor markets virtually guarantee no imminent inflation. This while commodity prices such as copper, corn and oil spike to new highs, thanks to global perceptions of the administration's and Fed's weak dollar policy.

Can anybody say "stagflation?" Art Laffer wrote a Journal editorial just over a year ago, on which I wrote this post. He rather eerily foresaw what is now occurring. A few years ago, I dismissed some pundits' fears of stagflation, because, then, monetary policy-induced inflation wasn't yet evident. It is now.

I well recall, though young at the time, the decade of monetary policy incompetence delivered by Fed Chairmen Arthur Burns and G. William Miller. They presided over the monetary half of US stagflation, while LBJ's Great Society spending, combined with the Vietnam war, provided the fiscal half.

Is it really that possible that we've learned nothing from that era, as well as, per Laffer's editorial, the 1930s? What more evidence is needed for the Fed and Congress to understand where their joint policies are headed?

Only, this time, global interests and ubiquitous information make reactions near-immediate and much more damaging. As significant as our deficits and foreign-held debt were in the 1970s, they are far larger now. And today's global economy is much more multi-lateral than it was forty years ago.

Reynolds notes this in his recent Journal editorial, Ben Bernanke's Impossible Dream, in which he uses an EFT which ultra-shorts Treasuries, TBT, as a barometer of market reaction to Fed moves,

"Producer prices rose at an annual rate of 5.5% in September and 4.8% in August. The broad price index for GDP rose at an annual rate of 2.3% in the third quarter, up from 1.9% in the second quarter and 1% in the first.

Mr. Bernanke is unconcerned, however, because he believes (contrary to our past experience with stagflation) that inflation is no danger thanks to economic slack (high unemployment). He reasons that if people can nonetheless be persuaded to expect higher inflation, regardless of the slack, that means interest rates will appear even lower in real terms. If that worked as planned, lower real interest rates would supposedly fix our hangover from the last Fed-financed borrowing binge by encouraging more borrowing.

This whole scheme raises nagging questions. Why would domestic investors accept a lower yield on bonds if they expect higher inflation? And why would foreign investors accept a lower yield on U.S. bonds if they expect exchange rate losses on dollar-denominated securities? Why wouldn't intelligent people shift their investments toward commodities or related stocks (such as mining and related machinery) and either shun, or sell short, long-term Treasurys? And if they did that, how could it possibly help the economy?

On Oct. 15, Mr. Bernanke gave another speech, at the Boston Fed, saying, "Inflation is running at rates that are too low . . . and the risk of deflation is higher than desirable." TBT rose again to 34.17, up from 33.34. On Nov. 3, when the scope of the Fed's long-term Treasury purchase plan was revealed, TBT jumped from 32.69 at 2:12 p.m. (EST), just before the news was released, to 34.99 by 3:34 p.m. (TBT closed Monday at 34.99.) If the Fed's plan really portends a sustainable reduction in long-term rates ahead, TBT should have moved in the opposite direction. When technocrats and markets disagree, it is rarely wise to bet against the markets.
There is ample evidence from commodity and foreign-exchange markets that world investors are indeed confident the Fed will raise inflation. However, the growing interest in shorting long-term Treasury bonds shows that the market does not believe higher inflation is consistent with lower long-term interest rates.

In other words, Mr. Bernanke and his FOMC allies are risking higher interest rates and inflated commodity costs in the pursuit of the contradictory objectives of higher inflation and lower bond yields, seemingly oblivious to all the evidence that they are pursuing an impossible dream."

Why is it a collection of notable economists are observing, across a variety of media, that the Fed is pursuing a foolish goal which will lead to sharply increased inflation, and, yet, the Fed and Bernanke seem largely unmoved?

Now, more than any other time in history, large numbers of investors, economists and various pundits have access to historical evidence and current data to make the case that US policy makers, both monetary and fiscal, are retracing steps down a painfully familiar road to stagflation.

Yet the Fed continues on this dangerous and foolish path.

Elizabeth Warren's Suspect Research On Personal Bankruptcies

Back at the end of September, Todd Zywicki wrote a lengthy article concerning Consumer Financial Protection Bureau head Elizabeth Warren. He focused on her rather checkered history researching alleged consumer financial bankruptcies. Zywicki teaches contract and bankruptcy law, as well as editing the University of Chicago's Supreme Court Economic Review, so he would seem to be familiar with some of the data Warren used in her studies.

Here are some of the passages from Zywicki's editorial,

"By appointing another White House czar to avoid Senate confirmation, the administration politicized the powerful new bureaucracy from its birth. And by appointing an individual with a track record of using questionable research to advance policy ends, it has jeopardized the second goal as well.

Consider Ms. Warren's much-ballyhooed study on the alleged link among health problems, medical expenses and personal bankruptcy filings. Published in the February 2005 issue of Health Affairs, the report was timed to head off bipartisan bankruptcy legislation that was enacted later that year. Ms. Warren and her co-authors claimed that "at least" 46% of personal bankruptcy filings in 2001 (the year from they collected the data) were the result of "medical causes," and that this represented a 23-fold increase over 20 years.

Both conclusions are extremely suspect. First, the study provided an implausibly broad definition of "medical bankruptcy"—including any filer who reported uncontrolled gambling, drug or alcohol addiction, or the birth or adoption of a child.

Equally dubious, the authors classified a bankruptcy as having a "major medical cause" if the individual had accumulated more than $1,000 in out-of-pocket medical expenses (uncovered by insurance) over the course of two years prior to filing—regardless of income, and even if the debtor did not cite illness or injury among the reasons for bankruptcy.

In 2001, average per capita out-of-pocket medical expenses were $683. During the two-year period Ms. Warren and her co-authors studied, in other words, Americans spent an average of $1,366 on uninsured medical expenses, or 30% more than their threshold definition of a "major medical cause." There was no larger context for their threshold figure: A debtor with $1,001 in uncovered medical expenses and $50,000 on a Saks card would constitute a "medical bankruptcy" in their study.

The claim of a 23-fold increase in medical bankruptcies was based on a comparison of their 2001 data with Ms. Warren's research in a 1981 study—which appears to count only those who self-reported as having filed bankruptcy for medical reasons. This is a completely different and much narrower definition of "medical bankruptcy" than the one she used 20 years later, and obviously inflates the increase.

In contrast to Ms. Warren's studies, a battery of analysis, including research done by the Department of Justice's Executive Office of the United States Trustee (which oversees the administration of bankruptcy cases), and by David Dranove and Michael Millenson of Northwestern University, concluded that fewer than 20% of bankruptcies are caused by health problems or medical expenses."

This is pretty troubling, isn't it? Just what is Warren's claim to expertise in this area, if her research is demonstrably flawed, poorly designed, and seemingly deliberately misleading. Warren comes across as having her conclusion in mind, and jamming the data into whatever classifications were required to support those a priori conclusions.

Zywicki further wrote,

"Last year Ms. Warren and her co-authors were back with an even more dramatic study, in the American Journal of Medicine, timed to promote President Obama's health-care reform law. Drawing on 2007 filings, the authors concluded that 62% of bankruptcy filings were the result of medical issues and that the odds that a bankruptcy had a medical cause had doubled between just 2001 and 2007. This study was also flawed.

After Congress made it harder for people to skip out on their debts in 2005, the number of bankruptcy filings plummeted. In 2001, the year Ms. Warren used for the first study, there were 1,452,030 personal bankruptcy filings; in 2007 there were 822,590. Even if we are to accept the methodologies of the two studies for the sake of argument, there were 670,838 "medical bankruptcies" in 2001 and 510,828 medical bankruptcies in 2007—a drop of 160,000 per year. Yet Ms. Warren's article nowhere acknowledges that the absolute number of bankruptcies and purported medical bankruptcies declined.

Concerns about Ms. Warren's presentation and interpretation of data have been longstanding. As I wrote in these pages in August 2007, her book "The Two-Income Trap" willfully ignores the obvious in her own data: that spiraling taxes—and not living expenses—were a major cause of middle class financial woes.

Similarly, reports of the Congressional Oversight Panel of the Troubled Asset Relief Program (TARP)—a panel of which she was chair—uniformly treated home foreclosures as the result of bank fraud and the bullying of helpless homeowners. Fraud and bullying there was, but her panel consistently ignored the many foreclosures that have resulted from a homeowner's strategic decision to walk away from a house whose value has fallen below the amount still owed on the mortgage. Economists and housing analysts widely agree that a substantial number of defaults occur for this reason. That reality is largely absent from the TARP panel's reports."

It's quite distressing to learn that Warren, a darling of Washington's liberals, has basically twisted facts and done shoddy research, published just in time to affect some key legislation which will continue to cause unintended consequences for years to come.

Wednesday, November 10, 2010

CNBC Stumps For Ford

CNBC is pushing its special program on what it calls Ford's "turnaround," which apparently airs on the network this evening. In support of the documentary, the morning program orchestrated an on-air debate/discussion involving the network's auto reporter, Phil LeBeau, ex-every US auto company senior exec, Bob Lutz, former Wall Street Journal senior exec and Pulitzer Prize winning author Paul Ingrassia, and one or two other pundits.

As I've contended in many prior posts, as well as Alan Mulally has run Ford since his arrival, it hardly constitutes an enduring turnaround.

Bob Lutz, amidst his usual gushing, pointed out that GM, Chrysler and Ford all nose-dived, in terms of share price, during the financial crisis of two years ago. Echoing Holman Jenkins' recent WSJ editorials, on which I wrote here and here, Lutz contended that Ford's survival and subsequent greater prosperity was a matter of luck.

As he said this, Paul Ingrassia grew increasingly agitated, shaking his head. Given the "last word" in the debate, Paul quickly cited some capital management facts regarding GMAC and Ford's borrowing pre-crash that he felt demonstrated Ford to be the better-managed of the two companies.

I would have loved to have seen an on-air debate between just Ingrassia and Jenkins on the subject of GM vs. Ford for the past five years.

My last Ford-centric post was in March of this year, on the occasion of Mulally's interview in the Journal. I won't quote extensively from it, but merely observe that Ford has, for decades, experienced a sort of boom-and-bust pattern.

It's not hard to see why CNBC wants to do a big Ford special, is it? They showcase an advertiser, ensure continuing, and better access to Mulally and various Ford debuts, and, in my opinion, prematurely anoint the company as a turnaround wonder.

The problem is, as I've written before, one of timeframes and measurements. Holman Jenkins, in his second editorial defending Rick Wagoner, lamented the focus of so many observers, and probably investors, too, on share price performance. However, like it or not, that's what investors get. Whether a company is hiring more people, doing good works, etc., is, to public shareholders, really beside the point, unless those activities result in better-than-average total returns over time.

In that regard, I hardly think Ford's post-crisis share price snap-back constitutes a long term return to solid, consistently superior total return performance. What I wrote in that March post I believe still holds true,

"Thanks to global government support of various auto producers, industry over-capacity remains. Ford has to grapple with a government-owned and -subsidized competitor, GM, and a Congress and administration willing to and capable of attacking that failing auto maker's competitors, e.g., Toyota

Political expediency drives Ford to hybrids and alternative fuel sources for its cars, while end-user demand isn't necessarily there for the longer term. Nor is the economy healed, portending a potential slump in demand in the next few years.

Unless Mulally continues to pull more very sizable rabbits out of his hat at Ford, the pace of revenue growth, cost reductions, and, thus, total return performance, is likely to slow. Ford still competes in a business with too much capacity, a government-owned competitor, capital intensity and fairly volatile demand over time.

For all of the adulation given to someone like Warren Buffett
Perhaps demand for cars and trucks won't soften in the year ahead. But this sector is still one in which pricing power is very hard to achieve. Regardless of Mulally's great job in preparing Ford for the 2008 crisis, and managing to bring it out of that crisis in good shape, it's far from home free. It remains a firm with many competitors, a challenge to differentiate its products when much of the value-added of cars comes from vendor subsystems, and a unionized workforce.
I'd hardly say Ford's recent survival without resorting to Chapter 11 equates with it having turned around for good. Right now, it appears to be simply another upward move in a cycle the company has repeated for decades.

Tuesday, November 09, 2010

Fed Governor Kevin Warsh's Straight Talk In The WSJ

Yesterday's Wall Street Journal editorial by Fed Governor Kevin Warsh seemed, at least to me, to be an unusual one for a sitting Fed Board member.

Unlike the double-speak and evasions we've grown used to in testimony on Capitol Hill by Greenspan and Bernanke when asked about fiscal policy, Warsh clearly states,

"Given what ails the economy, additional monetary policy measures are poor substitutes for more powerful pro-growth policies."

Warsh goes further, criticizing the last few years of temporary stimulus measures, culminating with this passage,

"Fiscal authorities should resist the temptation to increase government expenditures continually in order to compensate for shortfalls of private consumption and investment. A strict economic diet of fiscal austerity has greater appeal, a kind of penance owed for the excesses of the past. But root-canal economics also does not constitute optimal economic policy.

The U.S. would be better off with a third way: pro-growth economic policy. The U.S. and world economies urgently need stronger growth, and the adoption of pro-growth economic policies would strengthen incentives to invest in capital and labor over the horizon, paving the way for robust job-creation and higher living standards."

This is, to my knowledge, fairly unprecedented talk by a Fed Governor. In today's environment, it borders on political speech, given the very wide distance between Democrats and Republicans on so many fiscal policies. Warsh clearly sides with the latter.

Toward the end of his piece, he cautiously acknowledges that QE2 is making the Fed a Treasuries price setter, not taker. Something CNBC's Rick Santelli bemoaned on air late last week. Warsh rather carefully shares that concern with these words,

"As the Fed's balance sheet expands, it becomes more of a price maker than a price taker in the Treasury market. If market participants come to doubt these prices- or their reliance on these prices proves fleeting- risk premiums across asset classes and geographies could move unexpectedly."

Volumes are implied in those last two words.

Warsh ends his editorial with a nod to the growing currency wars, triggered by the Fed's own depreciation policy. But he doesn't suggest any solution. Instead, he refers vaguely to FOMC "tools and conviction to adjust policies appropriately."

Trouble is, he began his piece by pointing out that monetary policy can't substitute for good fiscal policies. And can't overcome bad fiscal policies.

So, except for the last line of Fed-style happy talk, Warsh seems to depart from the usual institutional silence or vagueness on macroeconomic fiscal policies.

If you connect the dots in his editorial with rising anger by other central banks and conservative American politicians over US monetary policy, it should cause significant concern. Because what Warsh is really saying is that the Fed is going to be unable to fix the problems caused by reckless US fiscal policies, new, exorbitant debt levels, and rising international anger at both US fiscal and monetary policies.

Monday, November 08, 2010

Scott Adams On Bad Management

Scott Adams, the creator of the comic strip Dilbert, wrote a hilarious piece in this past weekend's Wall Street Journal. He traced his own career from first part-time jobs to the one he held at Pacific Telephone, before finally relying on his published comics for financial independence.

What really struck me about his story was that, twice, he was told he could not be promoted because he was a white male, and his company's management(s) could not afford the risk of media criticism for more such promotions.

One of those companies was Pac Tel. I, too, was victimized in that fashion early in my career. At AT&T, of which Pac Tel was a subsidiary.

Adams writes that when informed of his second non-promotion, for reasons of race and gender,

"that was the day the "Dilbert" comic strip was born, although I had not yet drawn one. Let's call it a tipping point."

He then spends the rest of the piece discussing how those sorts of experiences create entrepreneurial motivations in otherwise-ordinary employees.

I'm just surprised that firms in back in that era couldn't comprehend the effects on morale, motivations and loyalty by simply notifying middle-management white males that they could forget being promoted.

There may not be as many EEOC lawsuits and as much interference in the promotion policies of corporate America, but I think management is, on balance, as deaf and blind as ever to what motivates their employees.

Holman Jenkins' Defends Rick Wagoner As GM's True Savior- Part Two

Last Friday, I wrote about Holman Jenkin's piece in the weekend Wall Street Journal of the end of October defending Rick Wagoner's CEO tenure at GM. Inexplicably, at least to me, Jenkins wrote another defense of Wagoner in this past weekend's edition of the Journal.

He began the column,

"Of all the responses to a piece defending GM's Rick Wagoner, most irritating were those folding their arms, pointing to GM's stock price and harrumphing, "Case closed."

A stock price may be all a stockholder cares about, just as a movie studio may only care if a movie is profitable. But there are other things to be said about a CEO, who is dealt a certain hand."

I must say I'm shocked to see Jenkins using this language and perspective, even in GM's case. Using Cisco's wild valuation ride under John Chambers since 1999 doesn't, in my view, excuse what Wagoner did, and did not do, at GM. Mind you, I'm not agreeing with Steve Rattner that GM's 'rescue' is to be credited to the current administration. In my prior post, I clearly stated that I think it's premature to declare GM to be fixed at all at this point in time.

But back to Jenkins' second piece defending Wagoner. Jenkins pounds away on his most prominent theme in the latter's defense- negotiating with the UAW to remove certain benefit costs from GM, via a one-time payment, and getting various concessions to reduce costs and improve productivity.

According to Holman,

"The only difference between the companies (GM and Ford- my note) by then was a quirk of history- the kind that makes history interesting and CEO tenure worth examining through more lenses than one."

To make his point more forcefully, Jenkins describes Ford as having,

"mortgaged everything in sight, giving it a $23 billion safety net just in time to ride out the subprime disaster. This was not management genius or clairvoyance, and it was not shareholder-optimal at the time. It was a decision by the Ford family (owner of just 2% of the shares) that the company would survive or fail with the Fords in charge rather than accept a dominant foreign partner that way Chrysler, Nissan and others had."

Jenkins essentially attempts to build a case for Wagoner having done all the right things, then getting blindsided by the 2007-2008 financial crisis, which seized up the economy, choked car-buying credit, and led to GM's bankruptcy just as it was turning around. While Ford benefited from luck and GM's government bailout, which preserved the very same vendors on which Ford, too, depended, at not cost and with no public shame to Ford from taking a government handout.

Jenkins combines so many complicating themes and events that it becomes next to impossible to untangle the mess so that one can anoint Wagoner as GM's true savior, Ford's Alan Mulally as a lucky bum, and totally remove the financial meltdown as having any bearing on either CEO's performance.

My prior posts explains some of my reasoning for believing that Wagoner had continued to lead GM toward bankruptcy. I just don't think that GM was headed for any sort of consistently superior total return performances in the years ahead. I don't think Ford is, either, by the way.

Further, I continue to believe that, had GM and Chrysler been processed through conventional bankrupty processes, the vendors supplying them, and Ford, would have remained intact, as neither firm would have been shut down, but, rather, allowed to operate under temporary court supervision. If necessary, government money could have provided some short-term financing while viable divisions and operations were either sold or spun-off. The units destined for closure would have eventually been eliminated, or should have been. Any resulting share loss would have been made up by other brands, thus providing demand for the vendors so many pundits, including Jenkins, continues to believe would have failed.

It seems to me to be a very tall order to try, in two brief editorials, to rehabilitate the image of Wagoner as CEO of GM. Wagoner was named GM CEO in 2000, while Alan Mulally took over at Ford in late 2006. How is it that Mulally's quick actions which ultimately resulted in Ford's independent survival pale next to Wagoner's comparative inaction for most of his decade-long tenure at the helm of GM?

How is it that one excuses Wagoner for so many years of inaction, then, as Jenkins does, gives him superlative reviews for the last few years, excusing the ultimate outcome due to uncontrollable economic factors? Didn't Wagoner's GM continue to own and expand GMAC, which plunged deeply into housing finance, thus worsening GM's problems?

There are simply too many confounding factors, too much time in which Wagoner was responsible for GM's fortunes, and too little hard analysis in Jenkins' editorials for me to be convinced of any of his salient points. And certainly not convinced of his conclusion that Wagoner not only performed well, but should be seen as a viable future government resource.