Friday, February 18, 2011

Kelly Evans Gets It Right On US Standards of Living vs. Inflation

Kelly Evans' Ahead Of The Tape column in yesterday's Wall Street Journal contained a concise, distilled read on the US economy over the past 25+ years.

Evans began,

"The threat of inflation is real. It is just a different threat than many realize."

She then reminded readers that much of the price pressure on commodities comes from smaller, faster-growing economies. It's a demand-push phenomenon.

Then she noted that "median income for men was actually higher, in real terms, in 1973 than in 2009."

But the best, punchiest passage was,

"The globalization of the labor force, meanwhile, continues to exert pressure on the U.S. job market even as it pushes up commodity prices by expanding the middle class world-wide.

This vulnerability was highlighted in mid-2008 when oil prices soared and consumer spending promptly tanked. That was before the worst of the recession. Households are hardly better able to handle such a run-up now."

Thus, the more we look backward, protect union jobs at defunct auto makers and such, the more we pour scarce economic resources into the wrong opportunities. And you wonder why the US is a slowing economic power, relative to some other nations?

Evans then delivers an apolitical shot of truth in her last sentence,

"The real risk is that the U.S. faces a poverty cycle rather than an inflationary one."

That word, poverty, should rivet you. It did me. But that's what happens when your economy no longer focuses on ever higher value-adding opportunities, seeking, instead, to subsidize less robust value-adding economic situations.

Thursday, February 17, 2011

Kyle Bass On CNBC Yesterday

Occasionally David Faber has a worthwhile guest on his noontime CNBC program, Strategy Session. Yesterday was one such occasion.

Kyle Bass, a hedge fund manager who scored big by correctly betting against the residential finance boom in its latter years, was on to give his opinions on a variety of market topics.

You can probably find his appearance in a video on the CNBC website. But here, in brief, is what he said.

On municipal defaults, he agrees with Meredith Whitney.

On equity markets, he's swearing off of them, because he believes what we are now seeing is mostly just a result of QE2 and too easy money. He believes it's a global phenomenon which will end very badly. I don't recall his measure of choice, but he mentioned a particular rate which one could watch to discern when the top in equities had been reached, and the fall would begin.

One interesting anecdote he told was being at a conference of alleged observers of credit markets or some such relevant group. He asked how many of the several hundred people in the room in which he was speaking new the weighted average cost of the Greek government's debt? Nobody did. Bass said it was about 4.3%. He expressed shock and amazement at the faulty, shoddy, poor quality of basic analysis by people whose job it was to know that type of data.

The lesson, of course, is that, like the anecdotes he told in the CNBC House of Cards documentary, about Wall Street mortgage finance desks, you can't really trust the so-called experts and analysts to know what they are doing, or to have proper incentives to know it and tell you.

Bass has become recently well-known for being right on US mortgage finance markets. His comments and manner convey a sensible, thorough, reasonable approach to what he does. Very credible.

On The NYSE-Deutsche Borse Merger

I saw an interesting take on the NYSE-Deutsche Borse merger from a floor broker the other day on CNBC.

A periodic guest/contributor named, I think, Peter Costas, he was livid about the merger. It shows you how far the NYSE has come from its once-cozy specialists world. The world of legal front-running, inefficient personal involvement in trades, and an avoidance of acknowledging the reality and capabilities of modern technology. For all his faults taking the Merrill Lynch CEO job and botching it, NYSE ex-CEO John Thain probably saved the place.

Yet, Costas mentioned some risks on which the Germans and current NYSE CEO Ducan Niederauer are silent. Think of it as a rerun of the Daimler-Chrysler merger.

Costas wondered aloud what would happen to the New York trading floor, should profits drop or costs rise? How committed would the merged, Germany-headquartered company really be to maintaining the current physical presences in the US?

Since so many pundits characterize the deal as really all about derivatives and other non-equity products, I suspect Costas' fears are not trivial. Nor totally misplaced.

On the other hand, also on CNBC earlier this week, Jim Chanos expressed no interest nor concern about the NYSE-Deutsche merger. But Chanos doesn't really seem all that emotional about that sort of issue to begin with. He didn't say he thought the concerns people had about the NYSE being controlled by overseas management/ownership was misplaced. He simply said he didn't really care.

Niederaur is taking pains to stress how current ownership of the NYSE and Deutsche Borse is predominantly American, by shareholders. A situation which is both fluid and uncontrollable. But his temper came out when CNBC co-anchor Mark Haines accused him of selling out Americans and repeatedly invoked the "buttonwood tree." In retaliation, Niederauer said, in a close paraphrase, while punching Haines on the arm,

'That's what I get for giving CNBC the first interview about this deal.'

Niederauer looked like he feels he needs to do all he can to convince investors, regulators and politicians to allow this merger.

Perhaps the real issues here aren't even being spotted yet. For example, listing standards. If the NYSE becomes controlled by European owners, who is to say that listing standards for what was America's largest equity market won't be controlled by Europeans?

That would indicate, however, truly global equity markets.

One thing that does make sense to me, however, is the comments of pundits regarding derivatives. Exchanges tell customers that they provide efficiency and best execution. But the truth is, profits for these entities come primarily, in a margin sense, from newer, less-well-understood, complex instruments. Like, well, derivatives.

That's why, over time, human floor specialists have declined in value. The instruments of which they allegedly facilitate the buying and selling have simply grown less profitable to intermediate.

Pepsi Joins Companies Which See Inflation Coming

My latest post concerning companies behaving differently in light of the inflation they see coming was earlier this month.

In last Friday's Wall Street Journal, Pepsi CEO Indra Nooyi defended her company's projections for lower earnings in the future,

"We have no idea what the commodity markets are going to look like in 2012 and beyond."

While one analyst was quoted in the article as chiding Nooyi and Pepsi for citing commodity price pressures, claiming that "everybody else" is facing these, as well, I think he is missing the point.

The article contends,

"At the same time, consumers are still holding back and so it will be difficult to raise prices on drinks and snacks enough to offset the higher costs."

And Nooyi is quoted, again, as saying,

"Had we not had the continued macroeconomic sluggishness and this commodity inflation, we are a solid, double-digit [percentage] player."

Simply put, commodity price inflation, at least partially induced by US monetary-policy, is affecting yet another, very large US company.

Despite Fed officials', current and former, claims to the contrary, US businesses continue to talk and behave as if inflation is coming and will affect their operations and financial results materially.

Wednesday, February 16, 2011

Borders' Bankruptcy & William Ackman

Back in early December- could it be that long ago?- I wrote this post regarding William Ackman's Pershing Square's attempt to have Barnes & Noble merge with Borders, one of his firm's holdings. I wrote, in part,

"It's unclear to me why Ackman has so diligently and doggedly pursued either physical book retailer over the past few years. With Amazon and Google targeting the space, and Apple's recent iPad adding to the mix, it wouldn't seem to be an easy product/market in which to earn substantial gains by maneuvering with the remaining two, damaged retailers, would it?

Ackman has a track record as a smart investor. But, then, so did Ed Lampert before his plunge into owning retailers K-Mart and Sears.

Why on earth would anyone have bought into these turkeys even as long as three years ago? Their underperformance has only increased since then.

I suppose Ackman has a very short-term, 'turnaround' sort of mentality that seeks a quick, abrupt rise in share price from an unexpected reorganization, followed by a hasty exit from his positions.

I'm just not seeing the logic to this situation for Ackman, other than desperation to rescue some value from his 1/3+ ownership of the worse-performing, lesser-sized turkey in the sector."

Perhaps I was more prophetic than I knew. This past weekend's edition of the Wall Street Journal carried the news of Borders' Chapter 11 filing. According to the article,

"Mr. LeBow, who became CEO of Borders Group last year, invested $25 million last May as Borders tried to rework its finances. Mr. Ackman's Pershiing Square Capital Management LP is expected to lose at least $125 million in its investment."

Since I don't follow Borders, I had no idea Ben LeBow had become involved. Seeing LeBow and Ackman lose at least $130MM in this turkey is surprising. Especially since LeBow's investment was so recent. Ackman's investors can't be happy to have read about this over the weekend, can they?

Why do these investors with such great reputations get involved with one of the worst companies in a market segment? Ackman is also involved with Penney's, hardly a leading retailer, either.

The Journal piece catalogued Borders' decline and fall, amidst a general shrinking of the sector. Considering its ills, I really can't comprehend why these two marquee investors got involved with the firm.

I haven't followed LeBow's moves for years, but Ackman makes generous use of CNBC, so he's much more visible.

Let's see...the failed Target deal, then Borders, now Penneys. Is he losing his touch?

Eddie Lampert & Gap

News of Ed Lampert's sizable investment in Gap, Inc sent shares of the latter up sharply yesterday.

Shares of Gap Inc. (GPS) climbed Tuesday as hedge fund billionaire and Sears Holding Corp. (SHLD) Chairman Edward Lampert reported holding a 5.8% stake in the retailer.

At midday yesterday, the Wall Street Journal reported,

"Lampert, known for large, concentrated bets on the stocks of a small number of companies, reported the stake in a 13G filing, or a filing for passive investors, with the Securities and Exchange Commission late Monday.
Lampert's ESL Partners, along with affiliates, reported beneficially holding 35 million common shares as of Monday.
Gap shares were recently trading 5.8% higher at $22.72.
Investors are "excited that he may see some value in a retailer that has been struggling with its merchandising," said Wedbush Securities analyst Betty Chen."

Looking at the price chart for Sears Holdings, Gap, Inc. and the S&P500 Index since late 2003, it's difficult to see why Gap shareholders would cheer Lampert's control over the struggling retailer. Granted, anyone buying into it would be cause to celebrate- after dumping your shares.
But look at the price curve for Sears after Lampert's early-2005 takeover. It's worse than the S&P and Gap,  which tracked together over the period.
Just how is it that Lampert will do for Gap what he hasn't managed to do at Sears/KMart?
Beats me.
Has Lampert lost his touch, too, as I muse about William Ackman in today's next post?

Tuesday, February 15, 2011

Will Services Truly Go Global?

Mr. Joseph Sternberg edits the Wall Street Journal Asia's Business Asia column and recently wrote an editorial entitled Now Comes the Global Revolution in Services.

Of course this has been a feared development by many in the US economy, since our services sector is so large. The first such globally competitive service which probably comes to mind is call centers.

Sternberg wrote,

"Asia has been a big winner from the development of global manufacturing supply chains. Japan and the four tigers—Hong Kong, Singapore, South Korea and Taiwan—showed how cheaper shipping could create opportunities for factories far from the intended market. As supply chains have grown more complex, the benefits have spread. Components now travel from Thailand, the Philippines, Malaysia and Taiwan to a factory in China, where they're assembled before hitting the shelves of an Apple store in New York as a finished iPhone.

Even as the manufacturing supply chains continue their evolution, a new question confronts Asia: How to profit from increasingly sophisticated supply chains in services? Despite all the political hype in the West about the ills of outsourcing and the perceived ubiquity of overseas customer-service call centers, services supply chains are still in their infancy."

It's thought-provoking to realize how the economics of various manufactured and assembled parts of goods such as an iPhone make it affordable to ship the incomplete item around so much of the world simply to take advantage of lower labor costs. Sternberg then contends,

"We're heading for a day when a Malaysian architect will sketch out a new office tower for London, a Philippine architect will prepare detailed renderings, and a Chinese engineer will assess the structural soundness of the designs. Or a specialist firm in Bangalore will administer health benefits for a Kansas company. Indeed, such things already are happening on a modest scale.

That's particularly apparent on the infrastructure front. Ask experts what a government needs to do to develop a services- outsourcing industry, and the first answer is usually "provide more reliable electricity" or "lay fiber-optic cable." True, but more important will be the human intangibles. Educating a sufficiently skilled work force—no small task in itself—is only the start."

Sternberg's example sounds simple enough. But will it really occur? Are language barriers really so easy to overcome that complex building design will be piece-parted out as he describes?

He concluded with this passage,
"Manufacturing supply chains applied modern transportation technologies to a millennia-old principle that if someone in a neighboring village can make a good more efficiently than you can, you should buy it from him. Service supply chains derive a new principle—that you no longer need to be geographically near the person providing you a business service—from modern communications technologies. Now countries need to figure out how they fit into this trend, and how to profit from it."

Personally, I believe Sternberg is far too optimistic about the globalization of high value-added services. Especially services involving high levels of complexity.


Well, for one, globalization of product manufacture and assembly has a simple test. Does the resulting product function at a competitive price? The proof is easy to see.

Services aren't so simple. The success of a globally-designed building or other complex system using services provided in so many countries and languages might not be apparent for years. And they tend to be one-off projects, rather than, like products, things of which millions are sold and used.

Even the lowly call center has seen a reversal of outsourcing overseas from the US. Too many problems with language and basic service quality levels has resulted in some firms regaining an edge by relocating their call centers back in the US.

Then there's the recent comments of Boeing CEO Jim McNerney on CNBC. In answer to questions concerning the Dreamliner's continuing delays, McNerney confessed that the firm had overreached with its design outsourcing. He said that they won't be doing that again, focusing instead on more onshore engineering and design.

If one of the most sophisticated engineered systems we have, a modern jetliner, has failed to be reliably designed and produced globally on time, what are the prospects for equally-sophisticated systems? At least the Dreamliner results in a testable product on which quality control may be performed before it actually goes live in its initial commercial flights. And Boeing has been building such systems for decades.

I think it says a lot that they got the mix and management of global design of the various parts and subsystems of their newest jet fouled up, and are planning to move back to more centrally-sourced services in the future.

Thus, it's my guess that Sternberg's concerns and visions are very premature. And a big chunk of US exports in the service-based sector remains somewhat safe for a while.

Monday, February 14, 2011

Cisco's Continuing Woes

I recently exchanged some email missives with an old friend who escaped the collapsing financial sector for the decidedly greener fields of the California technology sector. He was glum over that day's equity price performance of his new firm, Cisco.

I didn't think much of it, until I read, later that day, of Cisco CEO John Chambers' downbeat outlook and the lackluster quarterly earnings report.

I wrote this post last November, on the occasion of the company's and Chamber's last sobering, disappointing quarterly outlook and earnings report.

"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."

The price chart for Cisco, Dell, Intel, Microsoft and the S&P500 Index which appears at the beginning of this post bears out my contention.
More surprisingly, Thursday, on CNBC, one pundit was actually arguing that it's time for Chambers to find a new job. And whereas Microsoft is usually given a magical pass for its lost decade, Cisco doesn't seem to merit the same kid glove treatment.
A Wall Street Journal article in the Heard On The Street column matter of factly notes that the switch market, which Cisco rode to success a decade ago, has matured and become much more competitive. Revenues and margins are down. Like so many other technology firms have experienced, it appears that Cisco's main engine of profitable growth has flamed out, or settled down to a constant, slow burn, with no similar product/market to replace its earlier performance.
John Chambers and Cisco, meet Joseph Schumpeter's world of competitive, dynamic capitalism. Cisco hasn't been selected for my equity portfolios in at least a decade. Like the other firms I included in the price chart- Dell, Intel and Microsoft- all were once profitable contributors to earlier portfolios. But, once growth ebbed and returns came back down to earth, they were jettisoned, never to reappear.