Friday, January 14, 2011

US Drops A Rank to 9 On 2011 Index of Economic Freedom

Wednesday's Wall Street Journal contained an editorial by Terry Miller, director of the Center for International Trade and Economics at the Heritage Foundation.

The Index of Economic Freedom, jointly published by the Heritage Foundation and WSJ, recorded the lowest US rank in a decade. The UK dropped from 11th to 16th place. Leading the list of 179 countries are Hong Kong, Singapore, Australia, New Zealand and Switzerland. Canada is now 6th. Denmark is just ahead of the US.


What does it take for our state and federal governments to wake up to the risk of US economic atrophication? Our country's historic global diplomatic and military power have always been based upon our vibrant, leading economic power.

Now our tax rates are high by global standards, we've borrowed too much and misspent most of it. Our politicians have voted for the biggest lurch leftward toward a European social state since Medicare and Medicaid passed Congress in the late 1960s.

Even S&P and Moodys warned this week that continued US profligacy will result in debt rating downgrades.

These rankings and credit warnings will eventually serve to harm US businesses, too, after our government has lost its ability to borrow at preferential rates. The dollar, too, after decades of hollow warnings, may finally begin to lose its role as an unquestioned global reserve currency.

This recent Economic Freedom slip in rank is a warning we should all take seriously, especially when we view which countries are now outperforming the US.

Thursday, January 13, 2011

Trade Wars & Economic Statistics

Tuesday's Wall Street Journal's lead staff editorial revealed some very troubling information regarding international trade data.

Labeling the current flap over China's currency "a distraction the economy can't afford," the editorial continues,

"How much of a distraction is suggested by a paper out last month from the Asian Development Bank Institute. Economists Yuqing Xing and Neal Detert examined the supply chain of the iPhone to reach a surprising conclusion: Technically, the iPhone contributes to America's trade deficit with China.

The basic explanation is that data on bilateral trade are calculated assuming that the entire value of a traded good is created in the exporting country. If that ever made sense, it certainly doesn't in a global economy marked by increasingly complex supply chains.
In the case of the iPhone, Messrs. Xing and Detert note that the device was invented in America by an American company, Apple. The components are manufactured, either inside or out of China, by companies based in several other countries. The only part of the process that is unambiguously "Chinese" is the final assembly—a process that, in the estimation of Messrs. Xing and Detert, adds only $6.50 to the $178.96 wholesale value of an iPhone.
Yet that entire $178.96 value ends up attributed to China in official trade statistics. As a consequence, the iPhone contributed nearly $1 billion to China's bilateral trade surplus with America in 2008, and nearly $2 billion in 2009, the authors conclude. If the trade data had been based solely on the $6.50 cost of assembling each unit, the iPhone would have added only $34 million and $73 million in those years to China's surplus.

The ADBI study ought to be required reading on Capitol Hill. Most importantly, it raises the question of how much anyone really knows about what America's trade with China is. Critics of trade data, including us, have long argued that bilateral statistics are misleading. As the bilateral deficit with China grew, deficits with South Korea, Taiwan and Singapore declined, confirming that China's comparative advantage lies in the assembly into finished products of components manufactured around the region, due to its low-wage, low-skilled labor."

How about that last paragraph? Is that not insane?

For years we've been wringing our hands over trade imbalances with other nations, only to now learn that, sorry, ooops.....we don't actually account for specific value-addeds on an incremental basis.

So we really have no idea what any country's bilateral trade is with any other country? Why, because keeping track at the component or assembly level is too much trouble?

How can we realistically conduct trade policy or even correctly model the US economy if our fundamental data on international trade flows is basically wrong?

For me, this puts a huge hole in the econometric models predicting quarterly GDP growth. Back when I was in college and grad school, international trade wasn't a major component of GDP. Now, it is. Or so we think. Maybe we really don't know exactly how big it is, if we are crediting other countries with the entire cost basis of an assembled product which passes through that nation for one stage of production.

This valuable information buried in the Journal's editorial provides a big wake-up call regarding the quality of international economic trade data, does it not?

Wednesday, January 12, 2011

Mike Jackson Flacks For US Automakers

Autonation's CEO, Mike Jackson, a guest host on CNBC yesterday morning, spent his time flacking for the US auto sector.

It's exasperating to me to listen to Jackson recount a history that never was as he extols US automakers to the detriment of those overseas. What one has to remember is that Jackson, whose company is in the business of selling cars, is a ceaseless promoter of all things automotive.

Thus, to hear Jackson's version of history, the only way America's automakers could be saved was by government rescue. And that was necessary to preserve jobs and technology.

Well, as I've written in several prior posts, a conventional Chapter 11 filing by GM and Chrysler would have provided both with the time and opportunity to reorganize, group healthy units together and refloat them independently, or sell them to bidders. Further, neither company had to cease operations to do this.

Why Jackson seems ignorant of this fact is beyond me. I guess he's either not creative or simply not well-versed in the very real and frequent occurrence of business death or dismemberment.

So, to hear Jackson sing the praises of GM and Ford and the coming high volume vehicle unit sales years is to listen to someone tell half of a story. Give any business free government help to an extreme and you'll get the same happy ending. Jackson failed to discuss government-mandated purchases of hybrids and other unholy consequences of the excessive intervention.

The one- and only- thing which Jackson got right in this morning's auto fairy tale is that Alan Mulally rescued Ford by better leadership, focus and management, not wholesale reinvention- yet. Because it's way too soon, despite the views of many sector cheerleaders with agendas, to declare Ford a medium- to long-term shareholder winner.

The chart above displays the lone US automaker with a continuous price history, Ford, and, for good measure, Jackson's Autonation, along with the S&P500 Index.

If you have a technical inclination, you might notice that both firms' recent rapid price gains don't have long term sustainable precedents. In Ford's case, it's pretty clearly just a function of the rebound from the nadir of the 2008-2009 market bottom. Of the three series, anemic as its last decade has been, the S&P is the least volatile, ending with a much better performance than either company.

Of perhaps more import is how both Ford and Autonation have current share prices below their 1990s-era tops. Autonation peaked a few years before Ford, but both had either a flattening or multi-year decline for most of the past 12+ years. Jackson became CEO of Autonation in 1999, so he owns most of that performance.

What Jackson chooses not to explain, or perhaps genuinely doesn't realize, is that automaking is, for the most part, an unattractive commodity business over the long term. He railed about how China is the real 'Government Motors,' but, if true, this simply proves my point. It's hardly the sort of industry in which you'd invest a billion dollar fortune, if you had one to invest.

For what it's worth, you don't hear this analysis on CNBC during the day, either, when they prominently showcase all those analysts singing GM's praise. There wouldn't be any agenda there, either, would there? Say, for pieces of future underwriting?

Holman Jenkins, Jr., of the Wall Street Journal, has written many times how US auto manufacturing, especially of small cars, has been legislated onshore to appease unions, thus hurting profitability of the assemblers. When you consider where most of the so-called innovations in vehicles originate, it's typically with vendor-supplied assemblies or devices, e.g., anti-lock brakes, airbags, and, now, so famously touted by Ford's Mulally, all manner of wireless communications devices. Thus, most of the profit for the automakers would seem to be sourced in design, rather than manufacture. Otherwise, the smart, value-adding components are available from sector vendors to any assembler.

Doesn't sound very attractive as an investible sector to me. Rather, it sounds more like a case of advanced Schumpeterian dynamics, wherein the value-added growth has long since left the sector's auto assemblers. The entry of Korean and Chinese automakers, and near-exits of GM and Chrysler fits the description of an industry with low barriers to entry and exit.

Hardly your choicest sector for long term investing.

Tuesday, January 11, 2011

Another Perspective On Facebook's non-IPO

I recently wrote this post in light of the publicity surrounding Facebook's recent private equity offering, ending with this passage,

"Facebook continues to confound. Is global social networking truly a value-added proposition and business model on a par with Google's search and related ad businesses? Is online gaming via social networking really so novel and profitable?

Or is Zuckerberg merely enjoying the latest, most profitable round of social networking hype?
One thing may be a positive, however. That is, Facebook, Twitter and Groupon, at present, are not public. So any frothiness that subsequently deflates, with concomitant value destruction, will be absorbed by wealthy, so-called 'sophisticated' investors, rather than the general public."
Then there's another side, presented in a Wall Street Journal editorial in Monday's edition. Gordon Crovitz asks if the real issue is that wealthy private investors who are clients of Goldman Sachs are getting the benefit of early price appreciation in Facebook, while the average investor has to wait for an IPO that will enrich those early private investors?

What Crovitz contends is that my last sentence needn't even be true, and, at least each investor should determine the suitability of a Facebook-like equity for her/himself.

On further reflection, I agree with him. Mostly because the current system results in the wealthy having access to so many issues which the average retail investor never sees. An example comes to mind: then-vibrant Microsoft.

And I suppose one can contend that retail investors don't need hot IPOs to lose money. They can do that in individual brokerage accounts already. But as Crovitz notes, issues like Facebook, regardless of their long term viability, tend to have short term gains which now belong exclusively to sophisticated, already-wealthy investors.

So I guess I don't mind that retail investors would be exposed to risks from investing in a less-mature Facebook's IPO. Because at least that company would have audited financial statements allowing investors to easily assess, for themselves, the wisdom of buying and/or holding the shares. But on the positive side, average investors would have the opportunity to participate in some of the genuinely value-adding investing successes much earlier, thus sharing much more of the early gains.

To be clear, I'm not advocating investing in Facebook, Groupon or Twitter. Certainly not Twitter. But I am in favor of the SEC putting these into public markets earlier, allowing for public availability of their financials in real time at a much earlier phase of their corporate life.

Monday, January 10, 2011

Investing In US Financial Companies

I continue to find remarks on CNBC regarding investing in the equities of US banks to be suspect.

Consider, for example, the nearby price chart for BankAmerica, Chase, Citi, Wells Fargo, Goldman Sachs, Morgan Stanley and the S&P500 Index.

Despite what you may believe from the daily cheerleading by CNBC equities reporter Bob Pisani, simply holding a basket of these largest six (surviving) equities for the past five years was worse than holding the anemic S&P index.

Yes, Pisani is largely valueless as a reporter, because he's really just an equity markets shill. But it's a deeper issue than that.

First, as I noted, there's the survivor bias. Wachovia acquired itself out of business, while Bear Stearns just imploded. Merrill Lynch and Countrywide are gone, now part of BofA.

Even if you knew in advance which large financial institutions would survive, you'd have to be pretty fortunate to randomly pick the winner- Goldman Sachs. Chase and Wells Fargo basically tied the S&P with no price appreciation over the period. It's difficult to credit those latter two CEOs with being paid handsomely for simply tying the index. If they were hedge fund managers, they'd be pilloried on Capitol Hill.

Citi and BofA remain, of course, unholy messes. The former should have been allowed to fail, so that better management could have gained access to that large asset base. Morgan Stanley continues to limp along, performing like a badly-managed commercial bank, but with the business mix of Goldman Sachs.

If you look back just about a year, you see that, in general, prices have either flattened or actually dropped. So timing didn't really get you much in a year when the S&P rose 15%.

Then there's the sector's prospects for 2011. Here, Goldman is again probably the best-advantaged of a mediocre bunch. With no asset base like a true commercial bank, it doesn't own mortgage portfolio valuation risks and, if it behaves as it has in the past, may even bet on further declines in related assets. For the commercial banks, recent housing price weakness, noted recently in posts here and here, portend another round of punishing valuation plunges reminiscent of late 2007.

Between that imminent risk, and the uncertainty of rebuilding fee income in the wake of the Dodd-Frank bill, commercial bank revenues are not so, well, bankable. Plus there's the reality that bank profitability historically rises with rates...which are ultra-low and show no particular sign of rising.

Unless you feel lucky about timing financial equities, there's not really much positive in the outlook for financial equities.

All of which leaves me critical of CNBC's ceaseless pumping of financial equities. At least Kelly Evan's recent Journal piece on the upcoming earnings season cautions on financial sector equities.