Boone Pickens On Oil Prices & US Energy Policy

Yesterday morning on CNBC's Squawkbox program, T. Boone Pickens made some major waves.

First, in the course of opening comments and questions, the co-anchors pressed Pickens on his views for oil and other energy prices in the coming year. Noting that he had correctly predicted $100+/bbl oil, Boone gave a rough forecast of softening prices from now until mid-year, followed by higher prices after that. He said the same for natural gas.

The CNBC staff immediately asked if he was now short oil and natural gas. After a moment's thought, in which he obviously considered being coy, Boone said "yes" to each question.

Within moments, futures on both commodities were trading down. It was reported that the major newswires immediately published Boone's remarks on his pricing views and short positions.

But that's not what this post is about. Instead, it's about a topic related to this post of a few days ago.

Pickens remarked that he had lain awake in bed the night before thinking about the topic, it was so important. He reinforced that, saying it was bigger than being long or short oil, or making money in his fund by his prescient energy price calls.

What Boone Pickens worries about is the $500B per year that the US now pays foreign oil producers to import the precious commodity. Half a trillion dollars. That's how Boone put it.

More than $1B per day.

This morning on CNBC, AutoNation CEO Mike Jackson reiterated Boone's concerns, citing the need for higher oil and gasoline prices, if the US is ever to reverse this trend.

Boone went on to extol the benefits and practicality, feasibility, of wind power across the Midwest and Southwest US, and solar energy development in the latter region, mentioning Sweetwater, Texas by name as a model for economic redevelopment in concert with clean, domestically-produced energy.

Boone went on to cite, as I noted in that prior post, the continuing trend toward nationalization of oil reserves. He pointed out that Exxon pumps only 3% of the world's current 85B bbls pumped per day. He then cited a statistic that the US has 5% of the world's population, but consumes 25% of its oil production. That this "isn't fair."

Maybe, maybe not.

What Boone didn't note is that the US produces 25% of world GDP, using 25% of oil, but only 5% of population. Doesn't that make us a productivity wunderkind?

So here's my question: what if Boone, though well-intentioned, is wrong?


Could he be overlooking Ricardian economics?

How much do we export? Is our oil usage for our 300MM population, or our 25% of global GDP? on the latter basis, it seems actually fair.


Don't we effectively produce for export, as well? Can you actually align US oil consumption purely with domestic consumption, or is it, in a value-added-chain manner, an input into GDP, too? Don't our exports of intellectual property-based value-added goods and services represent a usage of imported oil? Just like we import aluminum, steel, titanium, diamonds, and a dozen other important, necessary commodities for manufacture of US-sourced goods?

I'm reminded of the pre-Ricardian economic comments of one of the men we honor on President's Day. It's the wrong one for today, unfortunately, it being the birthday of our country's first President, George Washington. But Abraham Lincoln is remembered, and occasionally quoted, a la Boone Pickens' remarks yesterday, for this quote, contained in remarks by former Fed Bank President Bob McTeer, in this piece,

"For example, Abraham Lincoln was a very good amateur economist, as I will show later. But he wasn't good enough to get international trade right. Here's what he is supposed to have said about tariffs: "I don't know much about the tariff, but I know this. If I buy a coat in England, I get the coat and England gets the money. If I buy a coat in America, I get the coat and America gets the money." "

That's how I remember the quote as well. And I was born in Illinois- does that count?

By extension, Pickens' and Lincoln's views become one of zero trade. Anything that sends our currency overseas, creating external liabilities, is to be shunned.

But where do you draw the line? Can Boone, or any of us, really know just how much of the $500B annually that we send overseas for oil is 'too much,' given that we use that energy, rather than other, assumedly less efficient domestic sources, to create value?

If we could stop buying foreign oil tomorrow, and, instead, use the $500B to buy onshore energy, would we accidentally reduce our resource productivity, make our exports more expensive, lower our domestic standard of living and, in the end, actually damage our long term economic prospects?

So long as we create value with the imported oil, and the dollars we pay for it are not being used with malicious intent toward us, what's the problem?

I think it's that second clause that is the issue. It was in the prior post, where I noted that the desire of other, oil reserve-owning nations to effectively withdraw from tradeable energy spot markets, makes the whole game different.

But it's not about trade balances, per se. It's about the motives of our putative trading partners, isn't it?

In effect, it's less about economics and productivity than it is about long term national security. And again, as I wrote in this post,

"Rather than global warming or clean air, I think the Journal piece reveals what's really going to drive new energy technologies in the West."

And that was the Saudi plans to consume more of their own oil, eventually changing the economics of many things- aluminum and other basic materials' production economics, oil pricing and supply.

That said, I think Boone is right to simply call attention to the outflow of half a trillion dollars annually for oil. But while he's at it, why don't we tote up the bill for various other commodities, in order to understand just how much we pay, and for what, in order to drive our current economy?

In the end, it's not about oil, is it? It's about creating dollar liabilities in the hands of those who don't wish to merely use them to trade, but, potentially, use them for purposes calculated to undermine our country's long term welfare.

And that's a different issue entirely.

More On Bond Insurance

This morning's guests on CNBC provided some truly interesting and valuable insights on several topics.

One guest was T. Boone Pickens, opining on oil and natural gas prices, as well as longer term energy concerns. I'll be writing about his comments in my next post.

The other guest was one who I have seen once or twice before on Squawkbox- Doug Dachille. Mr. Dachille, from his title and the name of his firm, seems to be head of a not-large investment management firm. As I searched my prior posts, I found this post, dated exactly two weeks ago, in which Dachille's prior appearance (with Jim Cramer) is described.

I was, for the most part, impressed by Dachille. His grasp of macroeconomics left something to be desired, but his logic and comments on fixed income issues were refreshing and provocative.

This morning's appearance was no different, in terms of the quality and value of Dachille's remarks.

His focus was on the very hot topic of what is to become of AMBAC, MBIA, FGIC and other so-called financial instrument insurers.

The discussion began with remarks about noted short-seller William Ackman's proposed 'good insurer/bad insurer' plan, as well as NY State AG Dinallo's similar idea, both of which have put pressure on the insurers to do something prior to a rating agency re-evaluation of their credit ratings next week.

Dachille did an admirable job of cutting the Gordian knot surrounding the business of these bond insurers.

In essence, Dachille argued that their business is superfluous. Period. That their existence is now the result of some hoary old legislation or internal investment rules by various pension or government funds regarding the minimum rating which a security must have to be held in their portfolio.

Dachille noted that the insurers cost approximately 10-15bp for their function. In comparison, according to Dachille, fixed income managers are paid roughly 35bp.

Both fees are not necessary, according to Dachille, because only one 'due diligence' need be performed. If the insurers are truly taking the risk, via insurance, then at least a commensurate amount of fee should be removed from the managers, because their work is made easier, and risk removed for their customers.

Dachille questioned why an insurer whose financial resources are obviously inadequate to serve their obligations, whose stock price has fallen so much in the past year, and whose ratings are about to be changed to a level below many of their customers, should have any material affect on, or benefit to, a bond issuance?

Santelli agreed wholeheartedly. Both engaged in a brief dialogue suggesting that the bond insurers no longer serve an economic purpose, because they confer a sort of average risk rating, by virtue of their coverage, when buyers should really do their homework to more accurately price individually-issued municipal securities for risk.

Thus, Dachille's overall view is that there isn't really a crisis because these firms don't really add economic value now anyway.

Granted, he admits that banks holding suspect, effectively under- or soon-to-be-uninsured CDOs, will have to take further writedowns. On this note, he observed the parallel between the insurers' "crisis" and the super-SIV plans last fall.

Those plans, he noted, came to naught as banks began to just write down their losses. He feels the same should occur now, because, one way or another, the holders of these insured, but ineffectually so, instruments, will have to realize their lower values eventually.

I found much sense and value in Dachille's observations and recommendation. After years of a charade, the missteps by the bond insurers into non-municipal waters have accidentally exposed the lack of true economic utility of even their core business.

Changing Oil Industry Dynamics

Today's Wall Street Journal carried an article in the 'breakingviews' column about ExxonMobil's inability to replace its oil reserves at historically high rates. According to the piece, the replacement rate, per Exxon's calculation, was 101% in 2007. Its 5-year average rate of replacement has allegedly fallen, according to Oppenheimer, from 121% to 112%.


The source of this trend, of course, has been the recent, increasing nationalization of oil reserve ownership and control. Where non-state-owned oil companies such as Exxon, Chevron, BP, and others used to bid on and purchase the right to develop and own oil from fields, in exchange for royalties paid to the country in which the oil resided, China, India and Russia have begun to effectively remove their oil reserves from the world's markets.


With each passing year, it seems that the amount of tradeable, shippable oil is becoming a smaller proportion of the oil pumped globally.


What does this portend for ExxonMobil, Rex Tillerson, and the private, non-state, publicly-held oil companies?


I thought about this while running errands this morning, and came to some tentative conclusions. After discussing them with my business partner over a working lunch, I feel they have been sustained.


Here's what I think the near-term and long-term reprecussions of the nationalized oil policies may be.


First, recall the 1974 Arab oil embargo. By withholding supply from the market, the near term effect was to hamper and, in some cases, cripple American automotive energy usage. But the longer term result was the halving of the amount of oil required to produce a dollar of US GDP two decades hence. Parenthetically, the price of oil eventually fell, too, to just $30/bbl only a few years ago.


As I wrote here a few months ago, Julian Simon noted years ago that the constant-dollar price of most commodities remains fairly stable over time, due to the process by which a rise in price causes new supplies to appear. Or substitutes to be developed, causing demand for the commodity to ebb, and, again, prices to fall.

Back to the present, what would the probably results be, near- and longer-term?

First, I think that oil firms such as ExxonMobil will have a tough time in the near-term. As I wrote here, in December of last year, if you need a commodity that you don't own, and the owners of the bulk of the commodity use it for their own purposes, you have a problem. I wrote,

"As I told my daughter, I think cars of the future will use other fuel sources than petroleum, because of the long term consequences of the world's major oil supplier electing to consume its own commodity for rather uneconomic purposes.

And, by the way, when the Saudis burn oil to make electricity, they are doing the equivalent of a Dutch tulip 'investor' buying a bulb in order to destroy it, and make his own worth that much more. The more oil the Saudis foolishly waste, the more valuable their remaining below-ground reserves.

In a world like this, American innovators have historically stepped in with creative solutions. In fact, this situation is virtually identical to our invention of synthetic rubber (the Buna process) before WWII, when the Japanese seized the Southeast Asian natural rubber plantations.

More than any other single driver of a change in how we fuel US autos, trains, planes and ships, this looming demand increase by the Saudis for their own commodity will, I think, cause a radical change in fuel technologies in this country over the next twenty years.

Rather than governmental standards, I told my daughter, you can usually count on some creative, hungry American inventor to develop a technological solution to the problem of ever more scarce and expensive gasoline to power our cars.

Imagine, a decade from now, Dupont, GM and ExxonMobil collaborating to power, build and fuel new technology cars. Or perhaps not Dupont, but some venture-capital funded new fuel technology startup. With the assurance of the production of the fuel, GM will build vehicles using it, and ExxonMobil will use its existing fuel distribution system, if relevant, to provide the new fuel's ubiquitous availability."

The larger global impact would almost certainly be similar, as in 1974. When oil becomes less available because China, India and Russia effectively bought nationalized reserves at implied high prices- north of $70/bbl- you might expect global oil markets to begin to disappear. Alternatives would be sought.

For example, in the US, if automotive energy needs were able to be supplied by improved batteries, then our former need for petroleum-refined gasoline for vehicles could be transitioned to coal-based electrical power to (re)charge those batteries.

In time, it's even possible that world production of various downstream products using non-petroleum energy sources could undercut the more costly products made using high-priced petroleum.

In the longer term, I think it's quite possible that the value of the petroleum reserves bought at such high prices by countries such as China and India would become a burden. Demand for the scarce commodity would fall, as alternative fuel sources were developed and commercialized. Eventually, the oil-owning nations might want to return to some market-oriented system, only to find that the new clearing price for their commodity was much lower than that at which they took the supplies private.

In effect, if a substantial proportion of world oil supplies are removed from the market, for internal consumption, the remainder of the world will have no choice to, where possible, behave similarly, and, then, where there are shortfalls, develop alternative energy sources.

Over time, then, total demand for the energy commodity would fall, and its implied price would, as well. Any country having built inventories of oil at high prices would have to absorb the loss in some fashion, if only in the national balance sheet value of oil reserves.

Like any other commodity supply disruption, that of oil may cause pain for industry players and consumers in the short term. ExxonMobil may become more of a refiner and distributor of what petroleum products are available to it for the foreseeable future. However, where market forces are allowed to function, substitutes will arise, demand for oil will wane, and it's effective market price will eventually fall.

I think Julian Simon's theory would still obtain in this scenario. Whether the ExxonMobils of the world could hold out that long is another matter.

Paul Ingrassia On The Source of Progress on Automotive Fuel Efficiency

Today's Wall Street Journal features an excellent editorial on the historic sources of progress on automotive fuel efficiency. Written by former Dow Jones senior executive, Pulitzer Prize-winner and my former squash partner, Paul Ingrassia, it's entitled, "Detroit's (Long) Quest for Fuel Efficiency."

Paul Ingrassia knows cars and the auto industry. Probably better than any other American observer around. He was the WSJ bureau chief in Detroit, which provided him the opportunity to write his prize-winning book years ago. He's well-connected to various former and current senior industry executives. When you talk with Paul, cars and the auto industry are never very far from his mind, or your discussion.

In his piece, Paul provides a rare, valuable examination of the progress that America's, and the world's automakers have made on this front over the past sixty years. Coming, as it does, amidst a Presidential campaign which includes calls for 'energy independence' and 'higher fuel economy standards,' this piece provides great value.

He's organized his thoughts to offer three "lessons" about automotive fuel efficiency:

1. Incremental progress shouldn't be dismissed.

2. Market forces, not government regulation, provide the most effective impetus for higher gas mileage.

3. New technology will require new infrastructure, presenting a chicken-or-egg problem.

All three points have tremendous bearing on the current 'debate,' if you can still call it that, in the business and popular media regarding energy usage by automobiles.

Specifically, Paul cites the 1959 GM Corvair as having made significant advances in fuel economy for its time. By contrast, he notes that GM's electric EVI failed miserably thirty years later.

Among current incremental technologies, Paul describes the current European diesel as having great potential to improve fuel economy incrementally, without the need for a radical technological innovation.

His second lesson is perhaps the most politically astute one. That is, it addresses the aspect of this issue that generates the most heat, but least light, if you will, in current political debate.

As various Presidential candidates excoriate Detroit for its failure to build more fuel-efficient cars, they turn to Congressional CAFE legislation, as if this will really matter. Holman Jenkins, Paul's former colleague at the Journal, wrote similarly in a piece on which I wrote this post late last year.

Paul's meticulous retelling of the SUV story puts the lie to any belief that CAFE standards actually affect real consumer behavior. Gasoline prices and actual vehicle gas mileage do, but the standards do not.

Along with Jenkins, Paul notes that, when consumers want high fuel-efficiency cars, Detroit will build them. When they don't, Detroit will still have to meet consumer demand, but CAFE standards will become another constraint that doesn't actually accomplish anything except providing politicians with a false sense of having 'done something' about this issue.

Finally, Paul provides a detailed explanation of how one GM executive, then-president Ed Cole, simply introduced catalytic converters into the GM product line in 1975, forcing the oil refiners and gasoline retailers to provide unleaded gasoline, which is necessary for cars with these air-cleaning devices.

Paul notes that Cole showed more decisiveness and leadership more than thirty years ago then any current figure, public or corporate, seems to be capable of doing to move forward on this issue.

If anything, Paul's recitation of history, and the forces at work today, are cause for me to remain leery of expecting Ford or GM, or even Chyrsler/Cerberus to realize significant value-added, profit, and consistently superior market returns for their shareholders from their responses to the fuel efficiency dilemma.

Last Week's S&P500 Performance

We seem to be in a period of weeks of indeterminate financial markets behavior.

For the evolving month of February, the S&P is down, with roughly a -2.2% return. That's including last week's +1.4% return, and the prior week's -4.6% return.

Looking at my newly-devised monthly standard deviation measure of daily S&P500 Index returns, it's hard to get excited about last week's return. That is because it falls within the confidence interval of 68% that such a return could occur, plus or minus, in one day for the S&P.

The daily returns last week were: +0.59%, +0.73%, +1.36%, -1.34%, and +0.08%.

Tuesday's rise was attributed to Warren Buffett's self-serving offer to reinsure municipal instruments. Wednesday's gain was allegedly due to positive corporate earnings reports and some positive sales data. This, by the way, amidst what more pundits, and a few economists, including former Fed chairman Greenspan have decided is, or is about to be a recession.

Thursday's large drop occurred as Treasury Secretary Paulson, Fed Chairman Bernanke and SEC Chairman Cox all testified before Congress. Given the typically-hostile attitude of the Democratic-chaired committee to the Republican administration officials, it's not all that surprising that the subsequent testimony roiled markets.

Some felt that Bernanke left the door open to a further rate cut of 1/4% point at the next Fed meeting.

Finally, on Friday, despite poor manufacturing data and a low Michigan Index of Consumer Confidence, as well as reported investor concerns about inflation, the index managed a small gain.

Confused about investors' reactions to various 'news' items? You're not alone. At least I'm with you.

So, as we head into the last half of this month, the S&P is so volatile that there is a good chance it will either slice most of the negative return, or add another -1.4% to it, on any given day. In any two day period, the index could turn positive, or more than double its negative return for the month.

After reviewing this past week's sample of putative causes and effects on the index's daily performance, it gives one pause to have any sense of which way it will finish this month.

It's so tentative that my partner and I are actually watching daily S&P performances, in order to keep up with the latest moves in this very unstable market. Until one of the major indicators which we monitor either confirms its current position, or moves significantly in another direction, we are unlikely to take any new positions in equities or options.

It's simply too difficult to discern a longer-term market direction for the next few months at this time.

Auction-Rate Securities Troubles

Yesterday's article in the Wall Street Journal regarding the Maher family, Lehman Brothers, and auction-rate securities sheds new light on yet another corner of the troubled fixed-income markets.

The most interesting portions of the article, to me, were the relatively new information about this type of securities, and Lehman's suspect actions in putting a client in them.

According to the Journal article,

"The Mahers rank among the earliest victims of "auction rate" securities, a once-obscure type of bond now sending shock waves through broad swaths of the U.S. economy. Auction-rate securities -- an unusual type of long-term bond that behaves like a short-term bond -- have become a keystone of modern finance. They are routinely used to fund everything from college student-loan programs to municipal road-and-bridge projects.

These bonds became popular with investors looking for cashlike investments, because they offered better returns than traditional money-market investments but were just as easy to buy and sell.

Recently, however, that advantage has disappeared. The market for auction-rate securities has dried up amid fears about fallout from the subprime-mortgage crisis. This week, New York's Port Authority saw the interest rate on some of its debt jump to 20% from 4.2% amid disruptions in this market."

From what I can deduce from this, auction-rate securities have their interest rates reset by market-auctions, rather than, like a long-term bond, simply carry a fixed or variable, according to some index like LIBOR, rate.

Thus, the price of the securities which, of course, varies inversely with the yield, can plunge if, for some reason, the auction reset results in a very high interest rate being paid to new buyers of the debt. This is evidently what happened to the Maher's Lehman-based holdings.

The Journal article goes on to report,

"The brothers have filed a claim against Lehman, saying it mismanaged their money. The complaint, filed last month with the Financial Industry Regulatory Authority, which resolves disputes between investors and brokers, says Lehman ignored the Mahers' request to put the money in short-term, low-risk investments such as Treasurys and municipal bonds."

According to the Mahers, they didn't realize that Lehman was putting their money into these potentially volatile securities. As the fixed-income markets became increasingly unstable late last year, these securities fell victim to demand simply evaporating, necessitating very high rates of interest to result from the auctions. The Mahers had informal asset management advice from a banker, Mr. Liu, at the firm that sold their business, Greenhill & Co. So abstruse were the instruments that even Mr. Liu didn't fully understand them.

The article continues,

"Baffled by the codes, Mr. Liu says he phoned Lehman and learned that many were corporate auction-rate securities. Mr. Liu, who had only a vague understanding of the securities, asked Lehman for details.

Auction-rate securities usually are long-term bonds with interest rates that are reset periodically (usually once a month) at an auction. Because the auctions happen so often, the bonds traditionally were much easier to buy and sell than other forms of long-term debt. Auction-rate securities worked well for over 20 years and were regarded by Wall Street as cashlike investments, since they were highly liquid and highly rated.

But if buyers stop showing up for auctions, they become tough to sell, or even to value."

So we see yet another instance in which investors failed to completely understand that, for some instruments, there is no way a market can be guaranteed to exist continuously. In this case, rather than frequent auctions keeping yields competitive, but leaving the securities reasonably valuable, the lack of risk appetite by buyers has caused rates to skyrocket, correspondingly sending the bond values plummeting.

And, in a page right out of the CDO story, sometimes the bonds can't be valued at all, because the auctions draw no bidders.

Oops!

Regarding Lehman, the article continues,

"Mr. Liu says he came away from his conversation with Lehman unsure of the quality of the bonds' underlying assets. He consulted with the Mahers, and they agreed the bonds should be sold as soon as possible. Mr. Liu told Lehman to "unwind the positions and give the Mahers their money back."

Lehman, however, had trouble selling. In early August, the market for auction-rate securities grew skittish as one auction for lower-grade securities failed.

Lehman had put the Mahers into most of their auction-rate securities a few weeks earlier, in July. It reinvested about $100 million of the Mahers' money in auction-rate securities in mid-August, the Mahers say."

So Lehman, according to the Maher's and their informal advisor, Mr. Liu, failed to invest the Maher's money as directed. Apparently, the Maher's aren't the only investors displeased with Lehman's conduct involving auction-rate securities. The Journal article concludes with the passage,

"Many companies, including 3M and US Airways, are already writing down the value of their auction-rate securities. Bristol-Myers Squibb in January took an impairment charge of $275 million because of auction-rate securities it held.

Merrill Lynch & Co. recently bought back $13.9 million in debt securities that it sold to the city of Springfield, Mass. The Massachusetts secretary of state has since filed a civil lawsuit against Merrill charging the firm with fraud and misrepresentation.

In their claim, the Mahers are demanding their $286 million back from Lehman, along with interest, and are seeking punitive damages of up to an additional $857 million."

Just when you thought you had understood some of the more exotic credit market instruments, this story appears. It turns out that the Port Authority of New York and New Jersey saw its interest rate on auction-rate securities it issued jump to 20% this week, amidst weak investor demand for the notes.

How is it that with so many educated, intelligent investment bankers working in fixed-income departments throughout the industry, instruments such as CDOs and auction-rate debt fail to observe that there are times when demand for such exotic securities evaporates? And current 'values' cannot be easily determined?

If well-compensated, experienced sellers and investors continue to trade these instruments, without realizing all of the risks, can any regulator or government really have an impact on this business?

Or do investors and issuers simply need to experience the pain of loss with these securities, in order to learn not to participate in those markets anymore?

Are We All (Liberal) Economists Now? CNBC's Aftermarket Debate

This afternoon, after the close of the market, CNBC featured a sort of on-air verbal brawl between three people- Steve Liesman, Ron Insana, and Larry Kudlow.

The topic was the overall health of financial markets as they affect the US economy.

It should be noted that only one of the "debate's" participants is a trained, recognized economist. That would be Larry Kudlow. Before going further, here are the relevant elements of the three persons' bios, from the CNBC website, regarding their educational background and economics credentials.

Liesman's CNBC bio,

Liesman joined CNBC from The Wall Street Journal where he served as a senior economics reporter covering monetary policy, international economics, academic research and productivity. At the Journal, Liesman previously worked as an energy reporter and, from 1996-98, as the Journal’s Moscow bureau chief. He was a member of the reporting team recognized with a Pulitzer Prize for stories chronicling the crash of the Russian financial markets.


Liesman holds a Masters of Science from Columbia University Graduate School of Journalism and a B.A. in English from the State University of New York, Buffalo.



Insana's CNBC bio,


Insana began his career in 1984 as an FNN production assistant, rising to managing editor and chief of FNN's Los Angeles bureau at the time the two networks combined. Insana graduated with honors from California State University at Northridge.



Kudlow's CNBC bio,


Kudlow is consistently ranked one of the nation’s premier and most accurate economic forecasters according to The Wall Street Journal’s semiannual forecasting survey.

He is a Distinguished Scholar of the Mercatus Center at George Mason University in Arlington, Virginia.

In 2005, New York Governor George Pataki appointed Kudlow the chairman of the New York State Tax Reform Commission.


For many years Kudlow served as chief economist for a number of Wall Street firms. Kudlow was a member of the Bush-Cheney Transition Advisory Committee. During President Reagan’s first term, Kudlow was the associate director for economics and planning, Office of Management and Budget, Executive Office of the President, where he was engaged in the development of the administration’s economic and budget policy.

He is a trusted advisor to many of our nation’s top decision-makers in Washington and has testified as an expert witness on economic matters before several congressional committees. He has also presented testimony at several Republican Governors Conferences.

Kudlow began his career as a staff economist at the Federal Reserve Bank of New York, working in the areas of domestic open market operations and bank supervision.

Kudlow was educated at the University of Rochester and Princeton University’s Woodrow Wilson School of Public and International Affairs.

It's clear from CNBC's own information that neither Liesman, their so-called 'senior economics reporter,' nor Insana, have any credible economics credentials, or, for that matter, much experience with financial markets, other than reporting on them.

Insana is alternately described as a "CNBC contributor" and a "principal at Insana Capital Management," or some other similar title of a similarly-named, obviously self-started boutique. Before that, he was a regular CNBC employee who was moved about, unsuccessfully, in search of some sort of regular hour show on the cable network. Between his rather boring demeanor and lack of in-the-trenches experience, as, say, Rick Santelli, Insana never seemed to catch on with viewers. One gets the feeling he has the CNBC "contributor" gig as a sort of exit deal with the network, in order to help him get visibility for his new 'capital management' startup. Being seen on CNBC would obviously confer the image, perhaps incorrectly, that Insana is a well-regarded, sage, experienced capital markets veteran whom the network is fortunate to have as a guest commentator.

What began, ostensibly, as a discussion of the current interplay of the economy and capital markets quickly descended into a political scuffle, with Liesman and Insana declaring that the Fed and the Bush Administration, in the person of Hank Paulson, had failed miserably to mobilize governmental power to magically solve the current crisis. Both non-economists railed that the financial markets, and the economy, were damaged, and both Bush and Bernanke had failed the American people by being 'behind the curve' in somehow resolving both crises by now.

Kudlow weighed in on the economics of the current situation, pointing out that financial markets would be best-served by simply being allowed to sort out valuations and credit allocations themselves. In this, he echoed Rick Santelli's comments from this morning, wherein he opined that the more Washington interceded in financial markets, the longer it would take for them to eventually sort out valuations and capital flows.

What was incredible about the spectacle that developed between Liesman, Insana and Kudlow is that the two un-credentialed, non-economists behaved so condescendingly to a genuine economist, and one of note, Kudlow, on such fundamental issues as financial markets and macroeconomics, pointedly denying and ignoring Kudlow's simple and correct assertion that they just wanted government intervention.

It's a crucial point. Liesman went further to assert something like,

'Congress is fed up with Paulson's and Bernanke's excuses and late awareness of these problems,'

as if Congress' opinion matters. Translation: Liesman and Insana think that any lack of admission by the current Administration, or the Fed, that investors and bankers got themselves into this mess, and are more or less going to have to get themselves out of it, constitutes failure.

Kudlow steadfastly called their position what it is- interventionist governmental politics pandering to an incorrect populist belief that, somehow, the Federal government can and should cure all naturally-occurring market cycles that are temporarily more painful than people wish to experience.

To take Liesman's and Insana's arguments to their logical conclusions, the US economy should never experience economic slowdowns, recessions, or financial markets cycles.

We just won't have it. We'll demand that Washington simply stop them. Cycles- whether economic or financial market in nature- are inconvenient, and, henceforth, outlawed.

Sounds a lot like that song from the musical Camelot, where rain is forbidden until after sundown, doesn't it?

Of course, the real tragedy here is that CNBC employs Liesman and Insana and presents them as economically- and financially-savvy, without apology.

On Recent Consumer Spending Data

Yesterday's Wall Street Journal reported the better-than-expected consumer spending data released that morning. It was a major topic of discussion on CNBC, as well.

Despite December's -.4% reading on this measure, yesterday's January value was +.3%.

I confess to being puzzled by the resulting, if it was a result, or at least subsequent S&P500 rise of 1.36% yesterday.

If you think, as so many would-be and wannabe economists contend, that the US economy is either in, or entering, a period of recession, then how can this spending number be good?

Isn't this the sort of data point that has doomsayers wringing their hands about American consumers borrowing and spending China's and the Gulf's wealth?

Where are the harbingers of US economic decline, telling us that, once again, we are failing to save, and behaving in spendthrift ways?

If you believe that available wealth has diminished, due to last year's credit markets turmoil, which ultimately helped lead the S&P500 to 12 percentage points of decline in recent months, how can this spending be good for our economy?

I don't get it.

Mind you, personally, I don't buy the now decades-old worries about the American consumer being on his/her last few months of creditworthiness. That any time now, the economy will collapse under a mountain of unsustainable, unserviceable consumer debt.

And I am not concerned about the spending rise. I think it's a sign that the US economy is probably not in, nor actually going to experience, a recession. More likely, after a perhaps two more quarters, we will see that our economy simply underwent a decline in its positive growth rate from a higher level, to a lower, but still-positive level.

But if you do believe those who warn of the end of creditworthy consumers as we knew them, as many pundits continue to, please explain how this +.3% rise in consumer spending is possible and/or desirable?

And why did it lead to, or is associated with, a hefty rise in the S&P500 that day?

Could it be that the investors are not as gloomy as many pundits. Could it be that, upon seeing the positive consumer spending number for last month, many investors concluded that economic woes are neither as severe as some would have us believe, nor likely to be as long-lived?

GM's Latest Setback- Updated For 2008

Is it a new model year yet? Does Detroit even have them anymore?

If they did, it would be a great time to showcase your new, updated, downgraded 2008 General Motors Company! Driven further into decline by that devil-may-care hotshot, Riiiiiiiick Waaaagoner!

Yesterday's Wall Street Journal featured an article in the Marketplace Section, headlined thusly,

"Huge Loss Dents GM's Hopes for a Turnaround"

Those newspaper guys. They have to go for the cutesy turn of a phrase. "Dents GM's hopes" indeed.



The real news, of course, is that this marks yet another big step down the road of mediocrity, toward bankruptcy, for the now-perennially-ailing US carmaker. Following on the bad news only last November, about which the Journal reported, and I posted, here, writing,

"The fact is that GM just lost $39B this past quarter. The face that I watched Rick Wagoner try to put on this appalling loss, in an early morning CNBC interview with correspondent Phil LeBeau, was that it is a non-cash charge that has no real meaning for investors. Skipping over the implicit acknowledgement that removing the asset from GM's balance sheet means the firm has no expectation of returning to profitability anytime soon, Wagoner attempted to paint a rosy picture of the firm's recent UAW contract, and longer term future."

The last six months have been another rollercoaster ride for GM shareholders, as the nearby Yahoo-sourced price chart of the company and the S&P500 Index illustrates.


About the time of GM's November travails, the brief uptick in the stock price ended, and it slid all the way through last month. It's almost become a timing vehicle.

Looking back two years, as this next chart does, shows that GM performed pretty much the same over that timeframe, too. It outpaced the index for much of the period, but the late-2007 downturn pulled it all the way back to parity with the S&P by year's end.

When we examine the five-year chart of GM and the S&P500 Index, the picture is quite different.

The recent 'recoveries' become just volatile investor reactions to GM's and Wagoner's attempts to halt the company's stock's long slide toward bankruptcy.

Yesterday's Journal article noted,

"In a fresh sign that its turnaround plan is sputtering, General Motors Corp. yesterday reported a $722 million fourth-quarter loss, to end the year a staggering $38.7 billion in the red -- believed to be the largest annual loss ever by an auto maker.

In the past three years the company has lost nearly $50 billion, more than all the profit it made in the preceding decade.

GM's latest quarterly loss came even though the company is showing signs of progress in certain areas. New models like the redesigned Chevrolet Malibu and growth overseas lifted the company's automotive revenue. Fixed costs in 2007 were $9 billion lower than in 2005.

But those improvements are being wiped out by other factors such as a softer U.S. car market and higher material costs."

So much for Wagoner's latest bid to turn the ailing auto giant around. The article goes on to observe,

"Meanwhile, GM's full-year 2007 loss of $38.7 billion in large part reflects a huge loss in the third quarter because it removed from its balance sheet certain tax credits it could only keep if it expected to become profitable soon."

This is what caused another sizable loss in November of last year, just one quarter ago. Failure to assure reasonably near-term profitability meant then, as now, the elimination of tax loss carry-forwards. This is a loss, make no mistake about it. It's not just some paper accounting entry. Had GM been able to forecast profits in the near future, that $39B credit would have shielded profits from tax.

With this as a backdrop, the Journal piece concludes,

"Chief Executive Rick Wagoner, 55 years old, now faces a monumental task in trying to turn GM around. After losses began piling up in 2005, Mr. Wagoner had to fight to keep his job when billionaire investor Kirk Kerkorian bought a stake in the company and placed a trusted adviser on GM's board. Mr. Kerkorian eventually gave up and sold his stake.

But as Mr. Wagoner heads into 2008, most analysts expect the company to lose money for a fourth year in a row. Most forecast U.S. auto sales this year at about 15.5 million to 16 million, which would be the lowest in a decade. GM may also have to take further Delphi-related charges."

Can it really be almost two years ago that Wagoner fought off Kerkorian and Toyota's Goshn? Thus, that two-year price chart reflects how bitter GM shareholders' disappointments must be with the ultimately flat performance of the stock since Wagoner fended off those potential saviors.

About the only good thing shareholders might celebrate was a relative rise in the stock price during the period, at which they could at least sell out before last year's bad news.

The Dow-Jones Industrials: Out With The Old....

The Wall Street Journal reported this week on the change in complexion of its major market index, the Dow-Jones 30 Industrials.

Out went Honeywell and Altria, in came BofA and Chevron.

I suppose there are various reasons for the changes. One is that Altria is effectively going away shortly, as the company's offshore tobacco businesses are being split from the old Phillip Morris.

As for Honeywell's ouster, apparently the folks at Dow-Jones feel that oil now represents a greater component of US economic activity than the diversified, high-value-added manufacturing and distribution of engineered material and systems produced by Honeywell.

Curiously, BofA was added, again, on the pretext that financial services is now underrepresented in the 30 company group.

Out of curiosity, I produced charts of all four companies on Yahoo, over 2-year and 'maximum' year timeframes.

The nearby two-year chart shows all four companies moving more or less in a band together until early last year. Then things got interesting.

Honeywell, one of the exiting companies, spurted ahead of two of the others, with Chevron slightly outperforming it, but with a similar pattern.

Altria, also exiting, also outperformed BofA, the worst of the lot. Of course, as the year wore on, and Ken Lewis had "about as much fun as (he could) take" in investment banking, BofA's performance slid sharply. In fact, so sharply that it nearly ended the two years back where it began.

The DJIA itself actually underperforms all the firms save BofA.

Turning to a much longer-term view of the four companies' stock prices, we see that all of them, except Altria, had remarkably similar paths for the past 38 years. There was a bit of untracking in the late '80s to mid '90s, and, as I noted above, in the last few years. And Honeywell declined noticeably from the path that Chevron and BofA shared for the early years of this decade.

Amazingly, the outperformer of the bunch has been the tobacco-and-sometime-packaged-goods giant, Altria, once a/k/a Phillip Morris..

What does all this mean for the Dow? I guess the rough parity of the three non-tobacco firms means you might expect similar Dow-Jones performance going forward. Maybe there's even a sort of central-tendency play going on, wherein the outliers over time, Honeywell and Altria, are dropped, in favor of two more attenuated stocks, BofA and Chevron.

Since the DJIA, over this long timeframe, nests right in among BofA and Chevron, this would seem to be true, even if it's not actually why Dow-Jones made these specific replacements.

Being focused more on the S&P, I really don't pay any serious attention to the Dow. If anything, this sort of shuffling merely points out how sensitive to membership is any market index composed of only 30 companies. Did the staff at Dow-Jones have to work exhaustively to choose a mix of outgoing and incoming companies, such that their effects upon at least the recent past of the Dow's performance would be minimal?

Choosing a bank and an oil company in an era of huge write-offs among commercial banks, including BofA, and dwindling opportunities for oil reserves acquisition by US majors worldwide, poses an intriguing question about the real reasons behind these choices.

As a few pundits opined, you can bet the folks at Dow-Jones want the index to do better, not worse, over time. Thus, they must be placing an implicit "call" on BofA and Chevron and, by extension, financials and oil in the US economy. And an implicit "put" on tobacco and diversified manufacturing onshore.

That's not a view I would have expected them to take, all other things equal. It should be interesting to see what sort of comments are made on these changes in the months and years ahead.

Esther Dyson On Microsoft-Yahoo Deal & Online Advertising

Yesterday's Wall Street Journal featured an excellent editorial by Esther Dyson, a longtime, well-regarded observer of technological trends and developments for nearly 30 years.


Her topic was the proposed combination of Microsoft and Yahoo, and its effect on Google's advertising business. She began her piece with,

"While the big news in the online world focuses on Google, Yahoo and Microsoft, a more profound revolution is taking place on the online social networks: The discussion about privacy is changing as users take control over their own online data. While they spread their Web presence, these users are not looking for privacy, but for recognition as individuals -- whether by friends or vendors. This will eventually change the whole world of advertising."

I've always liked Ms. Dyson for her ability to objectively and clearly explain evolving trends in technology, stretching all the way back to when I worked on digital PBXs and business strategy at AT&T in the 1970s and '80s.

As I no longer specialize in telecommunications, computing or online business, per se, Ms. Dyson provides an easy way for me to catch up on these sectors. Her identification of the differently-developing and increasingly-important social networking area is of interest to me.

She continues in this vein in her editorial,

"The current online-advertising model will become less effective, even as it gets increasingly sophisticated. New players are emerging to devalue the spaces that the ad giants are currently fighting over. Companies you've never heard of called NebuAd, Project Rialto, Phorm, Frontporch and Adzilla are pitching tools to Internet service providers that will enable them to track users and show them relevant ads. This approach (called behavioral targeting and already in service by ad networks that track users through so-called tracking cookies) undercuts traditional online publishers, who employ content to lure users and to sell adjacent ads. Now, the ISPs can sell advertisers direct access to the same users.

Take user number 12345, who was searching for cars yesterday, and show him a Porsche ad. It doesn't matter if he's on Yahoo or MySpace today -- he's the same number as yesterday. As an advertiser, would you prefer to reach someone reading a car review featured on Yahoo or someone who visited two car-dealer sites yesterday? His identity is still private: The ISP and behavioral-targeting networks don't know 12345's name and don't care. They just know what they think he wants.

This market will get more competitive, and users will be barraged by ads to which they will pay less and less attention. Call that public space, a world of billboards and cacophony. Even though the ads will be more "relevant" than ever, users will increasingly tune them out.

Now consider the new world of social networks. Facebook, unwittingly or on purpose, has been teaching people to manage their own data about themselves. Facebook's launch of the Beacon service -- which informs Facebook of members' activities (i.e., purchases) on other sites -- was a PR fiasco. But it still familiarized millions of users with the notion that they can control information about themselves online -- and determine to whom it is visible."

Ms. Dyson provides a clear illustration of why the very prize for which Microsoft is begging to pay a hefty premium is, even now, gradually losing value.

Leave it to Gates and Ballmer to ignore Schumpeterian dynamics and buy the last online trend, while another slowly builds elsewhere.

Ms. Dyson then gets to the heart of the matter- the economic value proposition these social networks offer. That's important because, as Dennis Berman wrote in the Journal a few months ago, about which I posted here, these online sites have traditionally had difficulty making money for anyone but the founder, after he sold out to a deeper-pocketed media or technology firm. In that post, I wrote,

"Aside from the marvelous business strategy expose, Mr. Berman makes it hard for the reader to avoid asking the question,

"If no other, larger firm, had bought, or bought stakes in, GeoCities, or was trying to buy or invest in Facebook, would Bohnett and Zuckerberger realize millions in wealth simply from the profitability of their businesses and business model? Or would they become, like Amazon, long on initial market value gains, but short on realized profits?"

Thus, leading to the ultimate question,"Were/are the acquiring giants of these online social networking businesses the greater fools?""

With this as background, Ms. Dyson, with her wealth of technology sector background as an observer over many decades, writes,

"So what's the business model? I'll "friend" British Airways, which will say, "We see you're going to Moscow next month. Why not fly through London and we'll give you 10,000 extra miles?" I'm no longer in a bucket of frequent travelers, my privacy protected. I'm an individual with specific travel plans, which I intentionally make visible to preferred vendors. British Airways, of course, will pay Dopplr a handsome sponsorship fee to be eligible to be my "friend" (just as a Nike rep might pay to sponsor a basketball game and be part of the community). Someday NetJets may show up, offering to ferry me and my friends to a conference we'll be attending together.

I'm far more likely to respond to BA or NetJets within a trusted site, and for a specific offer, than I am to heed their ad while reading a newspaper article on the troubles in Russia. (As for Orbitz, my old standby: After five years, it still doesn't acknowledge my preferred airlines.)

The new model creates a more trusted environment for reaching high-value, frequent purchasers, whether of airline tickets, electronics, clothes or other items. Where does that leave the less-frequent purchasers? Probably looking to their friends rather than to advertising for advice. I'm an expert on travel; my friends may look to me for hotel choices. When I'm in the mood to buy a book or a new computer, I'll check out what my friends on Facebook are doing.

This does not mean that traditional online advertising will go away, just that it will become less effective. Value is being created in users' own walled gardens, which they will cultivate for themselves in real estate owned by the social networks. The new value creators are companies -- like Facebook and Dopplr -- that know how to build and support online communities."

Thus, Ms. Dyson not only identifies the upcoming competitive forces which will eventually diminish the value of current online advertising models dominated by Google and Yaoo, but explains how and why the new approaches will displace the older ones.

Ironic, isn't it? It's not enough that Microsoft is now several generations old in terms of its basic, profitable technology- single-computer or network operating systems and applications software. Its leaders have now decided to risk a sizable amount of their retained earnings to buy into a fading online technology/firm.

Evidently not content to dividend their earnings to shareholders, Gates and Ballmer, already wealthy in their own rights, are determined to squander Microsoft's legacy cash horde on a business to which they really own bring money. Just as that business model's probably successor is appearing on the scene.

Truly, you can't make this sort of thing up.

Product Development Fiascos

Wednesday's Wall Street Journal contained a review of "Why Smart Companies Do Dumb Things," by Calvin Hodock. Daniel Akst wrote the review.

The article is a great read about some really inept and stupid corporate mistakes. It's hysterical to read about these marketing snafus. Specifically product development mistakes.

For instance, Mr. Akst writes, of Mr. Hodock's book,

"Coca-Cola executives were traumatized in the early 1980s by "Pepsi Challenge" commercials that showed real people, in blind taste tests, repeatedly choosing Pepsi over Coke. The folks in the taste tests really did prefer Pepsi, and in response Coca-Cola decided to reformulate its flagship product. The problem, Mr. Hodock says, is that a sweeter beverage -- in this case, Pepsi -- will always win in a "sip test." But real people, in the real world, don't take just one sip. They drink perhaps 16 ounces, and that's a different story. Millions of consumers had long ago decided that they preferred a less sweet cola -- as they loudly let Coca-Cola know when their favorite drink was supplanted by a sugary replacement."

I vividly recall this particular story. It was a major business headline for months, and called Coke's entire franchise, and its management, into question. Ironically, though, it also unleashed both Coke and Pepsi to realize something about shelf facings.

When Coke brought back the original formula as "Coke Classic," retailers were obliged to assign it substantial shelf space, as well. The result was that Coke's initial blunder actually increased its shelf space at the expense of smaller bottlers' products.

Still, it's quite revealing that the Coke executives failed to distinguish the differences between sipping tests, and satisfaction with full bottles of the soft drinks.

Says about all you need to know regarding creativity and confidence in senior management ranks at Coke in that era, doesn't it? Pepsi's Roger Enrico managed to put the entire senior management of his major, larger rival off balance with one simple marketing trick.

Another great story highlighted in the review is this one,

"One of the most interesting case studies in the book concerns a failed effort in the late 1980s by Campbell Soup Co. to launch a line of frozen soup-and-sandwich products called Souper Combos. Early tests indicated that consumers liked the concept, and Campbell projected $68 million in annual sales, just about hitting the company's target for new products. But as more data became available, the forecast was cut to about $40 million. "The innovation team didn't want to hear talk about a revised forecast," Mr. Hodock reports. "It was too far off the mark from the $70 million threshold level."

Nor did anyone at Campbell seem to want to take aboard the idea that, as Mr. Hodock says, "the product was a nightmare to work with." The frozen soup took twice as long to microwave as anticipated, and the directions required consumers to repeatedly insert and remove the soup and the sandwich. Mr. Hodock observes: "It was easier to prepare a bowl of soup and a sandwich from scratch." "

This is classic product development-gone-wrong material. Corporate denial and an insistence on customer acceptance of the product, despite warning signs to the contrary.

It reminds me of two additional product development fiascos, one of which was also a Campbell's flop.

The first was a staple of product development classes when I was a college and graduate school student- DuPont's legendaery Corfam. The synthetic shoe material was to revolutionize footwear and vault DuPont into another large, engineered product market, just like nylon and rayon.

But it wasn't to be. The material didn't really wear well. Even some of DuPont's own employees, recruited to test the idea, reported this. But, as with the Campbell's soup-and-sandwich example, DuPont's management refused to acknowledge the feedback. This led to an embarrassing failure of the product in the market.

The other Campbell's new product disaster was dry soups.

When I worked at the Wharton Applied Research Center as a graduate student, one of my projects involved the study of using Campbell's soup for dieting. Without going into details, this, too, flopped.

Howeve, a friend of mine who ran the overall project told me of a Campbell's initiative a few years earlier. The company had studied the dry soup market, and determined that there was room for a Campbell's product line.

Being Campbell, the packaging was, of course- a can!

That's right. Rather than a smallish, rectangular box, like Knorr or Lipton, Campbell's put their dry soup in a can.

Not unexpectedly, it, too, failed in the marketplace. The firm's management was simply too narrow-minded to consider other packaging than its standard approach.


I agree with the book's explanation for these mistakes, as Akst summarizes,

"Why do such innovation blunders occur? Mr. Hodock cites several convincing reasons: a company's me-too impulses, which can lead to me-too products that people don't need or want; the high turnover rate among marketers, who are often young MBAs with more attitude than experience; an unwillingness to give the boss bad news ("That Apple Newton you've been counting on to save the company? It doesn't work."); chummy and inattentive boards of directors; and the short-term focus of chief executives, which can lead to the hasty development of new products.

Worst of all, marketers are just human. "People fall in love with what they create," Mr. Hodock says. "All too often that love is blind . . . normally rational people become evangelical salesmen for their dreams rather than practical, objective business executives." "

Of all the reasons, though, I think the last is the most significant. It's significant because, with an effective product development process in place, it should be easily avoidable. In my marketing education, at two separate business schools, product development was taught from the perspective that companies need to successfully balance and reconcile two opposing forces: a need to generate many potentially profitable new product ideas, and a need to efficiently and effectively winnow these ideas, via routine, objective procedures. The result should be genuinely creative, profitable products which have been objectively vetted, tested, improved and molded to have a good chance of market success.

Maybe they don't teach this in business schools anymore. Or perhaps the ever-more frenetic pace of business in the past few decades has resulted in the shredding of a carefully-designed and managed new product development process.

Or perhaps too many inexperienced MBAs have gotten involved, and the process has degenerated into individual attempts to ride a new product to fame, riches and success.

Whatever the reason, it makes for very entertaining reading. And reminds us that not all new products become iPods, iPhones or Crocs.

Yahoo's Continuing Troubles

A Wall Street Journal article released just prior to the announcement of Microsoft's proposed takeover of Yahoo catalogued the company's dilemma.

In part, it read,

"Yahoo Inc. issued a sober revenue outlook, saying it faces "headwinds" in 2008 amid weak online spending by some advertisers, prompting an 8.5% drop in its shares to 2003 levels.

The Sunnyvale, Calif., Internet company also announced it is laying off about 1,000 of its 14,300 employees in mid-February as it reported a 23% drop in fourth-quarter profit and an 8% rise in revenue. Some of the employees targeted by the layoffs will have the opportunity to find other posts at Yahoo in its priority business areas.


Yahoo also announced that it renegotiated a contract set to expire this spring with AT&T Inc. that shifts from focusing on selling Internet access together to sharing ad revenue and offering content on AT&T's TV service, Web portal and mobile services.

The new financial terms weren't disclosed but Yahoo said it expects to receive $300 million to $400 million upfront from AT&T as part of the contract. In exchange, AT&T will "retain full ownership of the customer relationship," an AT&T spokesman said, and will no longer share revenue from broadband subscriptions with Yahoo.


But one person familiar with the matter said that Yahoo expects to exceed its annual revenue from the current deal -- which has been estimated around $250 million -- on average over the four-year life of the new agreement, when the upfront payment is factored in."

One has to ask, irrespective of Microsoft's bid, is:

"Does Yahoo have much value as a going concern, rather than, say, a marketing partner or just some assets to strip?"

It's retro-CEO, Jerry Yang, hasn't really moved the needle at the firm in six months. Now they acknowledge facing 'headwinds' in 2008.

They renegotiated the ATT deal, but at what ultimate price? Yes, they get greater upfront cash flow, but they lost any direct connection with the customers. How long before ATT replaces Yahoo's content, or offers less for it? Is there really that much content on Yahoo that is proprietary?

The Microsoft bid offers some consolation to Yahoo shareholders that they might soon have a way out of their current mess. From the looks of the latter's management's recent statements, it's about the only hope their shareholders have anymore.

On Market Volatility & Downturns

Market downturns are historically difficult to gauge, ex ante, in terms of their depth and length.

Further, it would appear that no two are alike.

To wit, the proprietary long/short allocation signals we employ have been useful, but not perfect, in this downturn.

Developed in the timeframe of the technology bubble collapse early this decade, the two indicators which comprise the signal alerted us that a downturn worthy of exiting long positions and taking short ones was imminent.

However, the actual January S&P500 plunge of more than 6% came faster than the signal for it.

What went wrong?

I suspect two things are different, with respect to the indicators. One is the much larger amount of investment assets now controlled by fast-moving hedge funds, relative to early in the decade. The other is the sheer speed of market reaction, helped in part by modern, high-speed, multi-channel dissemination of business and other news.

I don't typically focus on daily market changes, at least for investing purposes. I follow the market on a daily basis, but more to remain in touch with investor sentiment than to attempt to take advantage of any short-term market moves.

Further, not only are no two market downturns exactly alike, due to the evolution of environments surrounding equity investment over time. There are also few significant lengthy equity market downturns to study. Thus, unlike performing quantitative research on what works in typically upward-trending S&P500 equity markets, doing research on lengthy down markets is much tougher because there's simply less data, from fewer instances. Perforce, the certainty with which one can draw inferences and build indicators is much less than that for long-allocation periods.

Nevertheless, my partner and I fretted that we should have seen, by the beginning of December, that a large-scale decay in equity values was looming.

As a result of our move to options portfolios last year, we had a string of call portfolios which, beginning in late October, were showing consistently worsening losses, despite gains in our companion small equity portfolio.

After revisiting our current indicators and making some ad hoc modifications, we were still dissatisfied with the sense that we were engaged in 'fine tuning' a rather less-sensitive pair of indicators.

As we discussed this, I conjectured that there was probably some much shorter-term volatility-oriented measure that might inform us. Perhaps a monthly-based measure of daily change.

Ironically, I had posted this piece on a measure we labelled MFQ, for "Market Fluctuation Quotient," in late November. In that post, I concluded,

"If you are a frequent trader, than the MFQ is relevant. It clearly captures the recent, heightened day-to-day volatility, when that term means changes in closing market value direction.

We, however, are longer-term investors. Even in our equity options portfolios. As such, the MFQ doesn't really affect our investment decisions very much.
Still, it's interesting to note how divergent the two different perspectives on market 'volatility' can be- a series of standard deviations of month-to-month S&P returns, and a series measuring S&P daily close sign changes.

Clearly, volatility is in the eye of the beholder, and his/her frame of reference."

Technically, that was correct. However, the MFQ, as my partner still complained, lacked a magnitude component.

Building on this, after our recent discussions of a few weeks ago, I went back to something more classic. Taking the daily S&P returns for each month since 1990, I calculated a straightforward standard deviation of daily total returns of the index.

When this is plotted with to one of our two existing allocation indicators, we believe the two become leading indicators of a significant, longish equity market downturn.

The degree to which the monthly intra-day standard deviation of the S&P rose significantly, and remained high, shortly before a pronounced and lengthy market downturn of 2001 and the recent spate of losing index months, is unerring.

When put in context by the other, existing indicator, labelled "Factor A" on the nearby chart, it is a perfect pairing of leading indicators. Factor A turns steadily down just when the intra-day standard deviation skyrockets, in advance of a market downturn. But either one, on its own, is not predictive.

Armed with this new indicator, we are viewing the current market turmoil through new lenses, and, thus, with a new perspective.

The monthly intra-day standard deviation rose ominously in November. Had we been using this measure at the time, when I wrote the prior, linked post, we would have been out of long positions as of December. And probably already into put portfolios.

January's standard deviation rose again, to near-November levels. The evolving value for February is near January's level.

We think it's going to be at least a few more months before it is safe to remain long in equities or their derivatives.