Aug 23, 2009

Feds Announce Creation of New Bubble!

Feds Announce Creation of New Bubble!

August 24, 2009

“UPS and FedEx are doing just fine. It’s the Post Office that’s always having problems.” -- Barack Obama, trying to demonstrate the government can do a better job managing healthcare

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: 1.9%
SPX: 2.2%
COMPQ: 1.8%
RUT: 3.1%

The week started softly following news out of Japan that the economy grew slower than expected in Q2. An interesting relationship has evolved as both oil and stocks rallied to their highest levels of the year. Much of this bounce has been attributed to hopes of an economic rebound in the US, which is the real question facing the market today. Are we seeing an economic recovery in the making or are the “improved” economic readings a result of easy comps and low expectations? We feel that it is a combination of the two, that comps are easy but the economy has seen its worst days for this cycle.

The market closed the week with a flourish on Friday, riding home to gains on lighter volume after a stronger than expected existing home sales report. The strength was focused in small caps, value and an interesting combination of sectors (industrials, basic materials and healthcare). Volume was very light for the week, even considering late August is typically a low volume month.

I have been questioned quite a bit the past couple of weeks about my position on the market. Early in the year we looked for a stall of the rally exiting 2008, a deeper correction, and then a more robust rally. We have seen all three, although the rally has been more robust than we every imagined-which is typical for markets. They run longer and correct harder than you ever anticipate. Where do we stand now? Still looking for a significant pullback, which has been a frustrating position to maintain. We are net neutral, and should the market move into the 1050 range (currently at 1026), then we will move net short.


Actual Consensus Prior
Empire Manufacturing 12.08 3.00 -.55
Housing Starts 581K 599K 587K
Building Permits 560K 577K 570k
PPI -0.9% -0.3% 1.8%
Core PPI -0.1% 0.1% 0.5%
Initial Claims 576K 550K 561K
Leading Indicators 0.6% 0.7% 0.8%
Philadelphia Fed 4.2 -2.0 -7.5
Existing Home Sales 5.24m 5.00m 4.89m

The big boom this week came from existing home sales, which increased for the fourth straight month as housing prices continue to decline. This is the first time in five years that this measure has increased four consecutive months. Strength was noted in the markets where pricing is down the greatest- over 50% in some markets. The strength was also noted at the low end, with starter homes and condo units strong while the middle and jumbo markets remain weak.

The chart below, courtesy of, shows housing starts and building permits since 1993, plotted over the past two recessions (gray bars). As you can see the decline from the peak has been dramatic, and while recently there has been an upturn, it pales in comparison to the drop. This week’s announcement of a 38% decline in housing starts was less than consensus. Building permits were also below expectations, primarily due to weakness in multi-family unit permits.

Much of the weakness in multi-family is being attributed to a substitution effect, whereby renters are choosing to rent homes versus apartments given their prices are approaching parity. Rents on single family homes are falling due to the high percentage of recent foreclosures being used as rentals. We discussed the potential of this occurring back in a November note, but are amazed how rapidly this has unfolded.

The index of Leading Economic Indicators also rose for the fourth straight month, and the Conference Board announced that the recession is near its bottom. Only three of the components were negative: building permits, money supply, and consumer expectations. The chart below, also courtesy, shows the leading and coincident indicators over the past thirteen years. The blue line shows the four month rise in the leading indicators, after a multi-year decline, and apparent stabilization of the coincident indicators.

The Philly Fed general economic index climbed above expectations. Factory output is up after record inventory cuts, and output gains in the autos seem to be helping. The inventory measure (positive means increasing inventories) spiked to 0.3 from -15.4.

The ECRI announced that their Weekly Leading Index rose to a 4 year high of 124 while the growth rate of the index rose to a 26 year high. The organization is calling for an economic recovery stronger than that of the early 1980’s.

The alphabet soup of government programs designed to address the financial crisis is daunting. The PPIP (Public Private Investment Program) is a program that authorizes the Treasury to match funds from a private investor to buy distressed assets and also to provide 6x the capital in the form of credit. As an example, someone putting up $1billion would receive a matching amount from the US Treasury and then an additional $12 billion in credit. The credit is guaranteed by the FDIC.

As Barry Ritholtz said this week, “taxpayer dollars are subsidizing Chinese purchases of US assets at a discount. This is insanity!” Or as David Kotok said when discussing the lopsided risk return of PPIP “Heads you win $100; tails you get nothing.”

Credit Conditions

The Financial Times reported that for the first time in a single year, global issuance of corporate bonds has exceeded $1 trillion. The boom partially has been because of investor demand as well as a tightening of loan standards by banks. "Corporate bonds are the No. 1 asset choice. We are very overweight in corporate bonds. The spread of corporate-bond yields over government-bond yields more than compensates for any company default risk," said Richard Batty, investment director at Standard Life Investments.

Capacity utilization measures the percentage of manufacturing capacity in production versus the available manufacturing capacity. The argument against inflation has hinged on the low level of capacity utilization-how can prices rise when excess manufacturing capacity exists (see chart below)? Our argument has been that the coming inflation in 2011 (give or take a year) won’t be the classic supply constraint induced inflation, but instead will be dollar induced. A decline in the dollar will result in inflation due to higher energy and import prices.

Natural Gas
Natural gas prices fell under $3.00, a dramatic decline especially given the concurrent run-up in oil. Natural gas is a local market, whereas oil is a global market, and local demand for natural gas is weak due to lower energy demand from electric utilities. Gas storage is at capacity, and we may see production begin shutting down as prices fall below the marginal cost of production.

Bloomberg reported that Japan experienced its first economic growth in five quarters, a 3.7% annual rate of expansion in the second quarter that missed consensus. While the Cabinet Office announced the results marked the end of its worst postwar recession, traders fear that Japan's recovery will stumble when the government completes its stimulus spending and dragged the Nikkei down to its lowest level in four months. "Growth was supported by stimulus packages and exports, but it's hard to believe they'll both keep lifting the economy at this pace," said Takahide Kiuchi, chief economist at Nomura Securities.

Real Estate
BB&T reported that The Portland Cement Association released its
Summer 2009 U.S. Cement and Construction Forecast. The PCA now believes total cement consumption will decline 22% in 2009 and then increase 11%, 13%, 11%, and 8% in 2010, 2011, 2012, and 2013, respectively. The previous forecast called for volumes to decline 18%
in 2009, increase 7% in 2010, 17% in 2011, 8% in 2012, and 8% in 2013.

The bank opines that even though the rate of growth for 2010 increases, it is due to the lower base in 2009. The PCA expects cement consumption in 2009 to be 75.3M metric tons, the lowest level since 1991. The reduction to 2009 leaves a lower starting point for 2010 and the PCA now sees cement consumption of 83.6M tons next year vs. a previous estimate of 85.3M tons. In fact, it now believes total consumption during the years of 2009–2013 will be about 19M tons less than previously forecasted with a reduction of about 4M–5M tons in each year except for 2010.

They cite that the reduced forecast is due primarily to disappointing trends in public construction, notably highways and streets, where despite the passage of the stimulus bill, bureaucratic delays and state deficits have muted the expected impact.

Retail Sales
Over the next few weeks we will be exploring retail sales capacity. An exceptionally high closure rate amongst retailers during this recession may actually benefit the survivors as competition is reduced and in the long run price increases could support better margins. Additionally, most retailers we have spoken with have renegotiated rents lower, providing an additional boost to margins.

On The Lighter Side
Some readers may not fully appreciate this one, but for those of us who grew up in the GI Joe era, this picture, sent in by a reader, is priceless. We thought it was worth including and hope you enjoy.

I am traveling this week on the east coast, so this week’s note is a bit brief (as will be next week’s note). Good luck this week.


"In their effort to bring the good times back, most central bankers have conveniently chosen to ignore the second-round effects of exceptionally loose monetary policy." Francisco Blanch, head of global commodities research at BofA/Merrill.

Aug 16, 2009

Commercial Real Estate Market Continues Deteriorating

Commercial Real Estate Market Continues Deteriorating

August 17, 2009

"One day, we will awake to find that we have socialism. One of these days, you and I are going to spend our sunset years telling our children, and our children's children what it once was like in America, when men were free."-Ronald Reagan

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: -0.5%
SPX: -0.6%
COMPQ: -0.7%
RUT: -1.5%

The market pulled back hard on Friday on disappointing news about consumer sentiment. In spite of the strong market run up over the past five months, government stimulus, a steepening yield curve, and improving leading economic indicators, consumers still seem to be in retrenchment mode. This doesn’t necessarily mean the economy is or isn’t in recovery mode as many economists are now insisting since consumers are typically lagging indicators coming out of recessions. What this does indicate is that any recovery is going to be long and slow, a “two steps forward, one step back” process.

Since the crisis began we have been recommending adding to core, strong companies on pullbacks and trimming weaker holdings on run-up’s. This most recent run-up certainly has exceeded our expectations; however, we still suggest maintaining a high quality portfolio during this rough economic period. Barron’s highlights a similar strategy this week, commenting on the strength of the rally among the weaker companies at the expense of the Blue Chips.

The two charts below, courtesy of The Big Picture and, compare the 1973-74 bear market (first chart) with the present bear market (second chart). There are strong similarities between both the economic environment and the market action during these two periods. If this market were to follow the path of the bear of 35 years ago, the S&P would top out in about 17 points before pulling back and then continuing to a peak around 1050. The recent rise in the S&P 500 has also resulted in a jump in the PE ratio of the index, from 10x in March to 18.4x today (according to Bespoke Investment Group). With earnings continuing to decline and no growth on the horizon, the market is getting quite expensive.


Actual Consensus Prior
Productivity 6.4% 5.5% 0.3%
Unit Labor Costs -5.8% -2.5% -2.7%
Wholesale Inventories -1.7% -0.9% -1.2%
Trade Balance -$27.0 bil -$28.7 bil -26.0 bil
Initial Claims 558K 545K 554K
Retail Sales -0.1% 0.8% 0.8%
Retail Sales ex-auto -0.6% 0.1% 0.5%
Business Inventories -1.1% -0.9% -1/2%
Core CPI 0.1% 0.1% 0.2%
CPI 0.0% 0.0% 0.7%
Capacity Utilization 68.5% 68.3% 68.1%
Industrial Production 0.5% 0.4% -0.4%
Michigan Sentiment 63.2 69.0 66.0

The trade deficit widened in June on an increase in imports of $3.5 billion to $153 billion. Exports increased to $126 billion from $124 billion. Imports remain 31% below year ago levels.

Surprisingly to those not living in the real world, retail sales fell in July as consumers continued to cut back on spending. As we discussed last week, spending on autos was supported by government incentives, and may have diverted spending from other areas. Furniture, electronics, building materials, groceries and sporting goods were all weak in July. Department store comps were down 1.6%, the biggest decline of the year.

Consumer Sentiment fell well short of optimistic expectations as the Michigan Consumer Confidence Index came in at 63.2 versus 69.0. Consumer confidence tends to track the stock market, but also is reliant upon the employment outlook, which really hasn’t improved despite some recent reports interpreted otherwise.

Capacity utilization remains low, and this is the fly in the inflation ointment (for now). While excess dollars are being pumped into the system, it is doubtful that supply constrained inflation will develop because of the amount of excess capacity. If capacity utilization improves significantly, inflation will be a concern. We have been focused on inflation created by a collapse in the dollar and a resulting spike in commodity and import prices, which could happen with or without an improvement in capacity utilization.

Industrial production rose for the first time in almost a year, led by a 20% increase in auto production month over month. Year over year auto production is still down 32%.

Government Spending

According to the US Treasury Department, government outlays exceeded $330 billion in July, an all time record for any month. The deficit was $180.7 billion for the month. The government is pushing hard to stimulate spending, however, with consumers in retrenchment it is like pushing on a string.

With two months left in the U.S. government's fiscal year, the budget deficit is now at a record high, hitting $1.27 trillion in July.


In addition to the recession related layoffs occurring across the country, large corporations have been in an international outsourcing mode for many years. Companies in all industries have been moving their call centers to India, and according to a contact IBM recently released a large portion of their domestic sales force, also outsourcing those positions to India.


Germany and France, typically laggards in the economic cycle to the US, both posted positive GDP in the second quarter. Both countries reported GDP of 0.3%. "The data is very surprising," French Economy Minister Christine Lagarde said. "After four negative quarters, France is coming out of the red."

Commercial Real Estate

The Wall Street Journal reported that Maguire Properties, one of Southern California’s largest office-building owners, will be handing over buildings layered with $1.1 billion in debt to the creditors. Rising vacancies and declining rents are pressuring the sector.

Fitch reported that CMBS delinquency rates jumped 0.5% in July to over 3%, a record. They are expecting a rate above 6% by the first quarter of 2010, citing exceptional weakness in hotel and retail space.

As we have discussed since last fall, commercial real estate will come under severe pressure during this downturn as tenants close their doors, while the ones left standing will push for decreases in rents. Starbucks cited a $500 million savings through renegotiated leases, and virtually every CEO and small business owner we speak with has pushed hard on their landlords for concessions.

Ford announced they would be boosting their second half output by 26% to address increased demand generated by the Cash for Clunkers program. The leading sellers have been the Ford Focus and Escape.

Rising gasoline prices have preceded or been coincident with the past four recessions. The chart below, courtesy, shows the inflation adjusted price of gasoline since 1980. As you can see, while the price has fallen significantly from its 2008 high, it still sits well above the levels of the 2001 and 1991 recessions. If the recent spike isn’t temporary, these higher fuel costs will keep a lid on any recovery as both consumers and producers will face the prospect of higher expenditures in a slower growth economy.

Bloomberg reported that at least 150 publicly traded banks own nonperforming loans equal to 5%(+) of their holdings. Walter Mix, the former commissioner of the California Department of Financial Institutions, said “at a 3% level I’d be concerned that there’s some underlying issue, and if they’re at 5%, chances are regulators have them classified as being in unsafe and unsound condition.” So far this year 72 lenders have failed, the most since 1992. The list of “problem banks” was over 300 at the end of the first quarter.

Real Estate
Real estate website reports that as many as 30% of US homeowners could be underwater by mid 2010. Today nearly 25% of homes are underwater. According to Stan Humphries, chief economist of, "The negative equity rate will rise and spin off more foreclosures.", reported July 2009 foreclosure filings were filed on 360K U.S. properties, an increase of 7% from June and an increase of 32% from July 2008. The report also shows that one in every 355 U.S. housing units received a foreclosure filing in July.

“July marks the third time in the last five months where we’ve seen a new record set for foreclosure activity,” noted James J. Saccacio, chief executive officer of RealtyTrac. “Despite continued efforts by the federal government and state governments to patch together a safety net for distressed homeowners, we’re seeing significant growth in both the initial notices of default and in the bank repossessions.”

According to Reuters, home sales are showing signs of life, but 24.4% of the houses on the market at the beginning of the month had their prices marked down in July, according to a survey by real estate website The average reduction was 10%. "Sales are increasing, but prices are still falling," said Pete Flint, CEO and co-founder of "Homes that are priced competitively are the ones that are selling in today's market."

The New and Improved GM

The Washington Post reported that GM will begin selling new cars via the internet, utilizing eBay Motors for distribution in California. If the test succeeds, they may roll the program out nationwide. “GM and our dealers are reinventing the car-buying experience” said Mark LaNeve, GM’s VP of US sales. The company also said the move is evidence of its “new, innovative sprit.”

Imagine that, nearly 20 years after the internet went mainstream, GM has discovered its existence. Porsche, BMW, and other auto manufacturers have allowed you to configure, order, and buy cars online for years. Autobytel, which came public sometime around 1998, has been offering new cars online for years. While I applaud GM for joining the new millennium a decade late, it’s insulting when they claim innovation when the only thing that has really changed is they are now owned by the taxpayers.

Healthcare-Is it a Right?

Cliff Asness answers this question in a well written opinion piece, which I partially quote here:

“Nope, it’s not. But we are at the nuclear bomb of the discussion. The one guaranteed to get me yelled at or perhaps picketed by a mob waving signs printed up with George Soros’s money. Those advocating socialized medicine love to scream “health care is a right.” They are loud, they are scary, but they are wrong about rights (as the 1980 kid in me resists the temptation to type “TO PARTY” – you had to be there).

This is more philosophy than economics, and I'm not a philosopher. But, luckily it doesn't take a superb philosopher to understand that health care simply is not a “right” in the sense we normally use that word. Listing rights generally involves enumerating things you may do without interference (the right to free speech) or may not be done to you without your permission (illegal search and seizure, loud boy-band music in public spaces). They are protections, not gifts of material goods. Material goods and services must be taken from others, or provided by their labor, so if you believe you have an absolute right to them, and others don’t choose to provide it to you, you then have a “right” to steal from them. But what about their far more fundamental right not to be robbed?”

Finding a job that pays on Wall Street these days may be difficult, but traders can look to the Fed for job opportunities. With their portfolio doubling over the past year to $4 trillion, the Fed has been aggressively hiring traders, going from 250 a year ago to 400 recently.

Anecdotally, we were out here in town last night to have a glass of wine with some friends, and the restaurant was absolutely packed. I discussed the improved traffic at Starbucks a few weeks ago as well. It certainly seems that consumers are beginning to stick their head out of their shells just a bit.

It’s August, and it remains relatively quiet. Congress is in recess, which means we don’t have to listen to the blowhards pontificating about evil corporations and greedy taxpayers who want to keep what they earn. The healthcare debate is raging, and the Administration is doing their best two-step to reframe the discussion. When it was pointed out that “death panels” would “pull the plug on Grandma”, the President quickly responded with a letter to the NY Times saying that improved care for seniors and cost savings via more efficient Medicare operations would be the keys to more affordable healthcare for all. Hey, they already run Medicare, how about making it more efficient first as a way to prove you can really operate an efficient healthcare system, before you try and take on an even bigger one?

Have a great week.


“On this team, we are all united in a common goal: to keep my job.”-- Lou Holtz

Ned W. Brines
O (562) 430-3232

Aug 9, 2009

Where are we Now, Recession or Recovery?

Where are we Now, Recession or Recovery?

August 10th, 2008

“American People Demand New Bubble to Invest In!” The Onion.

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: 2.2%
SPX: 2.3%
COMPQ: 1.1%
RUT: 2.2%

I’m back and marginally rested after a family vacation. A lot happened while I was gone, and I will tackle some of it in this note, the rest in subsequent notes. Over the next month or so we will be reviewing a number of economic indicators, comparing them to other recessions recoveries in an effort to determine whether the recent “less bad” economic activity being generated by the Fed’s fiscal largess is “normal” or if its different this time (that phrase always scares me). Stay tuned.

Stating the obvious, the market recovery has been robust off the bottom. At the beginning of the year we posited a range bound market with a very loose high end of 1020 on the S&P 500. We are rapidly approaching that, and based upon the market’s breadth, valuation, cash on the sidelines, and skepticism by most investors, 1020 may get eclipsed. Many technicians are looking at 1100. Wherever the market peaks, I’m still in the camp that the market will be range bound for quite some time.

In that beginning of the year note we looked for a weak but improving economy throughout 2009, and said that credit would achieve more normal levels during ’09 with bank lending subsequently picking up. We haven’t seen bank lending resume, but credit conditions have definitely improved as seen in the Bloomberg Financial Conditions Index below.

Should we be surprised at the equity market returns being generated over the past five months? No. There has been massive monetary stimulus, which is good for asset prices in the near term, especially with weak inflation and a soft economy. We have seen this type of stimulus drive markets before-think 1997, 1998, 1999-2000, 2002, and 2003 as recent examples.

Nearly 80% of companies exceeded their earnings estimates this quarter, impressive given the soft economy. Sales growth was missing as less than half of all companies posted positive revenue surprises. Margin leverage from inventory cutbacks, reduced headcounts, write-offs, plant consolidations, and other cost saving measures were responsible for much of the upside.

Earnings have collapsed, which is no surprise to anyone not in a time capsule the past three years. The two charts below demonstrate the magnitude of the decline. The first chart, courtesy of Bob Bronson, shows the long term S&P 500 earnings going back to 1870. Bob points out that a big portion of the increase in Q3 earnings was a result of substituting 15-20 new companies into the index. The second chart, courtesy of, shows the inflation adjusted EPS of the S&P 500 going back to 1935.


Actual Consensus Prior
Construction Spending 0.3% -0.5% -0.9%
ISM Index 48.9 46.5 44.8
Personal Income -1.3% -1.0% 1.3%
Personal Spending 0.4% 0.3% 0.1%
ADP Employment -371K -350K -463K
Factory Orders 0.4% -0.8% 1.1%
ISM Services 46.4 48.0 47.0
Initial Claims 550K 580K 588K
Non-farm payrolls -247K -325K -443K
Unemployment Rate 9.4% 9.6% 9.5%
Hourly Earnings 0.2% 0.1% 0.0%

There has been much discussion about potential manipulation of initial government releases. A number of months ago we cited a study which debunked this theory, but lately it seems virtually every initial release has been revised downward. Following this line of thinking, Bill King feels that the second quarter GDP report is actually worse than reported because when it was released the first quarter number was revised downward.

“We will again utilize basic math to illustrate the scam. If Q4 08 GDP was 100 units, and Q1 09 was reported at -5.5% and Q2 09 GDP was expected to be -1.5%, the expectation was for GDP of 100 units minus 5.5% or 94.5 units, minus 1.5% or 93.08 units. With the revision of Q1 09 GDP to -6.4% the Q1 GDP units become 100 minus 6.4% or 93.6 units. So Q2 is minus 1% or 92.664. Ergo aggregate GDP was worse than expected!”

This week’s economic releases were mixed, but highlighted by a better than expected non-farm payroll report. The release isn’t without skepticism as increased auto production (see “Cash for Clunkers” below) and newly hired federal census workers added somewhere around 100K jobs.

The unemployment rate actually decreased from 9.5% to 9.4% during July, the first decrease in the unemployment rate since April 2008. The chart below, courtesy, illustrates the unemployment rate since 1948. There was only one period in the post-World War II era during which the unemployment rate was higher than the current rate of 9.4%. It is worth noting, however, that a one-month decline in the unemployment rate (even a small decline) after a significant spike has tended to occur slightly after a recession had ended.

The ISM Index continued its streak of improvement, rising to 48.9% (consensus 46.5%) in July from 44.8% in June. Highlights in the report included the new orders index at 55.3% moving into an expansion phase, along with production (57.9% vs. 52.5%) and exports (50.5% vs. 49.5%). The chart below, courtesy of, shows the ISM and new orders since 1993.

2002 vs. 2009
The chart below, courtesy Gluskin Sheff, shows the action in the S&P 500 from 2001-2002 versus the current market. The current market is tracking that market in a similar fashion, although the current downturn has been much larger than that of seven years ago. This larger decline can partially be explained by the second chart, courtesy of John Mauldin, which shows the spike in the unemployment rate during this recession versus that of the last recession, and of course the credit crisis induced panic of ‘08/09.

Note how much longer this recession has lasted.

The dollar hit a 10 month low while commodity based currencies (Norwegian Kroner, Canadian and Australian dollar) all rose. Should this trend continue (and we feel it will over the long term), then it should be positive for commodities as well as domestic exporters, but bad for consumers and savers.

Bloomberg radio, among others, has been focused on recent broker speculation that a “dollar carry trade” is emerging. When Japan began their issues, arbitrageurs would borrow money in Tokyo at zero percent and short the yen. They would then take the zero cost proceeds and buy commodities, crude, and securities. Now that U.S. rates have been at zero for months, traders are beginning to explore the American version of the “carry trade”. Should this emerge, long term pressure will be exerted on the dollar. This trade may have even started a few years ago and adopted by the Chinese, with a temporary break last year as the dollar rallied in the flight to quality trade.

Cash for Clunkers
Amazingly (or not) auto dealers are running out of small, fuel-efficient cars because of the government's "Cash for Clunkers" program. Nearly 250,000 buyers rushed into showrooms as Congress gave away $1 billion of your tax dollars in the form of vouchers for trading in lower mileage cars. In further signs of the social state mentality we have entered, the program was actually extended and increased by another $2 billion.

In a subtle signal that the government hasn’t done anything of value lately, the new Administration is calling this their biggest accomplishment so far. U.S. Transportation Secretary Ray Lahood said in the New York Times "There obviously is a real pent-up demand in America. People love to buy cars, and we've given them the incentive to do that. I think the last thing that any politician wants to do is cut off the opportunity for somebody who's going to be able to get a rebate from the government to buy a new vehicle."

What? If there is demand, then why is the government creating new long term tax liabilities to encourage people to do what they were going to do anyway? Additionally, won’t this program divert spending from other consumer areas such as clothing, food, electronics and education?

Does anyone else find it ironic that the government, effectively the owners of the auto industry, are using your tax dollars to subsidize the purchases of new cars? Isn’t this effectively the same program that Congress criticized the auto makers for undertaking when they were using shareholder and bondholder capital to subsidize the purchase of cars in the form of rebates?

Glad to see a lot has changed in auto land since it was nationalized.

Auto Sales
Anecdotally, a reader in the auto industry emailed last week to say that in June 2008 they sold roughly 200 new units from their LA based dealership. In February they sold 20! As of last month sales had increased to 60, which is a far cry from 200 but much better than 20.

This is a single dealer, I’d be interested to hear if any other businesses have seen similar trends.

The Cost of Health Care
Hat tip to my good friend Ben Curtis for providing some of the data and thoughts for this section.

Just so there is no confusion, I am against socialized medicine, a single payer system, or any government encroachment into another vital industry. We have the finest and most advanced health care system in the world, and it’s available without a three year wait while a government employee decides whether your cancer is advanced enough to offer you treatment. If our system isn’t the best, then why do all of these jokers from Canada, the UK, France, and other countries with socialized medicine come to the US when they are really sick? Is our system perfect? No, but it is still the best.

Can we afford health care reform? The answer is a definitive NO!! The assumptions are being made given today’s health care economics, whereby the United States private sector develops 80%+ of the new drugs and treatments, which are then exported around the world. Do we pay more for these new, life-saving treatments? Yes. Other countries, such as Canada, then benefit by having access to LIMITED quantities of the same drugs or services, but at prices much closer to the marginal cost of production (i.e. excludes the amortization of the enormous development costs). Why does a drug in which the production of the pill costs a few dollars (or cents) end up costing hundreds of dollars? Because the development of these drugs can run over $100 million-and when you include all the failed drug development projects required to get just one drug to market, you have a large cost structure to absorb.

If the US begins paying the same rate as countries such as Canada, i.e. the marginal cost of production, then US corporations will no longer have any motivation to develop novel drugs and treatments. My (and your) investment capital will move to other industries where profits are superior (as long as investing isn’t outlawed by then), and the innovations will stop, period. The ever expanding number of diseases (think MRSA) will eventually overtake the minimal dollars that will be spent on R&D, and the globe will experience plaque-like epidemics wiping out large swaths of the population.

How are the economics affected? If the US expects to offer anywhere close to the same level of care we receive today (which, of course, they don’t plan to offer but I, for one expect), then the US government will be required to fund government run research labs through additional taxes. This will push the cost of this healthcare plan up dramatically-I’ll through a dart and say by $500billion to $1 trillion. Goodbye savings, hello middle class tax increase.

The socialists have already won, because the debate in the media and Congress has shifted to what type of reform we should have as opposed to whether we need reform or not. The more rational thinking need to push the debate back to the discussion of reform versus no reform, otherwise we will end up with another unaffordable entitlement program and worse healthcare.

More Health(s)care
A few weeks ago we quoted Foster Friess on healthcare. This week we have another quote from Foster, this time taken from IBD:

“When we first saw the paragraph Tuesday, just after the 1,018-page document was released, we thought we surely must be misreading it. So we sought help from the House Ways and Means Committee. It turns out we were right: The provision would indeed outlaw individual private coverage. Under the Orwellian header of “Protecting The Choice To Keep Current Coverage,” the “Limitation On New Enrollment” section of the bill clearly states:

“Except as provided in this paragraph, the individual health insurance issuer offering such coverage does not enroll any individual in such coverage if the first effective date of coverage is on or after the first day” of the year the legislation becomes law.”

So we can all keep our coverage, just as promised — with, of course, exceptions: Those who currently have private individual coverage won’t be able to change it. Nor will those who leave a company to work for themselves be free to buy individual plans from private carriers.”

China’s stock market has bounced 100% off the bottom as the country pursues a policy of massive stimulus spending. Some have called the bounce in China a massive Ponzi scheme. Andy Xie, formerly of Morgan Stanley, writes about the emerging bubble on his website. The article can be found at

Real Estate
Our initial view back in 2005 was that the residential real estate cycle would bottom mid-year 2009-we have adjusted that estimate out to 2010+. The Economic Cycle Research Institute (ECRI) has become more bullish on the housing cycle. They state:

“One key reason for the turnaround in the outlook is housing affordability, which is hovering around all-time highs. The current combination of drastically reduced home prices and very low mortgage rates has hardly ever been seen in living memory.

Most importantly, the U.S. Leading Home Price Index (USLHPI), designed to predict cyclical turns in real home prices, has now been rising for five months. The recent upturn in the USLHPI is almost as pronounced as the median in comparable past cycle-it is almost as pervasive; and it is just as persistent. The implication is clear: this is a genuine cyclical upturn in the level of the USLHPI. Such an upturn in the USLHPI amounts to a forecast of a cyclical upturn in the level of home prices this year.”

They are more bullish than we are; however, their analysis has been one of the more accurate amongst economists over recent years.

Financials and Beneficial Accounting Rules

From the Washington Post: An accounting expert studied the earnings reports of financial firms and found that 45 posted higher earnings in the first quarter because of a recent change in accounting rules. Bank of New York Mellon and other large companies were able to post profits instead of losses because of the change. The Financial Accounting Standards Board is considering another change that could force financial institutions to take paper losses, reversing the paper gains.

The Bearish One
From David Rosenberg: “We can only sit back and marvel at how the U.S. government has managed to put the economy back together, but it's the same problem as the first little pig had in fending off the big bad wolf. Straw will only hold up for so long. There is tremendous fiscal largesse associated with this economic turnaround, which we expect will be a one-quarter wonder, not unlike the 2002Q1 experience with a flashy bear market rally and brief inventory and stimulus-led rebound in growth. The foundation for any durable recovery in a modern industrial economy rests with the organic dynamism of the private sector. Ask anyone in Japan as to how repeated rounds of fiscal stimulus played out over the past two decades. We are still in a post-bubble credit collapse world and there are still too many uncertainties associated with the outlook for the economy, corporate earnings, financial stability and fiscal rectitude (or recklessness is more like it). Wages are deflating at a record rate and credit in the banking system is still contracting as banks continue to shrink their balance sheets. Three-quarters of the corporate universe have no revenue growth to speak of and only one-third of the ISM industries posted growth in July and barely more than one in ten were adding to payrolls.”

An Emerging Bubble?
From Peter Boockvar: “1000 in the SPX is not just a round number that we’ve reached; it makes it an official 50% rally off the 666 March 6th low. The 5 month time frame of the rally is very similar to the 5 month rally of 48% from Nov 1929 to April 1930 after the dramatic 50% fall in Sept thru Nov. I’m in no way implying that we are headed to the lows and the economy is about to roll over again. I remain bullish on commodities and emerging markets. It is just a comparison of the extent of that rally following the huge, quick selloff that in % terms was similar to what we experienced in late ‘08 into ‘09. The Fed and US government are trying to bubble blow our economy to recovery (again) and that can continue to show up in asset prices with of course some spillover into the real economy, with the bill to be paid later.”

More Financials
Mike Mayo of CLSA notes that banks showing better earnings were those with heavy capital markets exposure. He feels that traditional banks suffered significantly and that their credit problems may eventually exceed those of the Great Depression. He also feels that the better delinquency trends cited by Bank of America may be seasonal.

Much like every month so far in 2009, August appears to be on its way to being anything but a normal, quiet August. Healthcare reform seems to be the boiling point between fiscal conservatives and fiscal liberals. Despite the Administration’s aggressive push to complete the bill before the Congressional summer recess (and before anyone had a chance to review it), some fiscally conservative Democrats have stalled the plan until after the recess. The success or failure of the plan passing should set the tone for the next three and a half years, and beyond.

We also face many questions as the 3rd quarter ends. September and October should be key months as we approach Christmas. Will hiring (or firings) improve? Will the recent increase in inventory be absorbed by end market demand? Will credit markets continue to improve? Will earnings releases continue to impress the street or will pension liabilities and soft sales crash the party? Will the commercial real estate market hold up long enough for the banks to regain their footing? Will the weak dollar presage the return of inflation? There are many more questions as this economy attempts to regain its footing.

Good luck this week.


“There is a real danger this is going to be a double dip and that after six months or so we’ll have some more bad news. We could slide down again in the fourth quarter.”-Martin Feldstein

Aug 3, 2009

Vacation Post

August 3, 2009

Based upon the enormous number of hits to this site some of you may have missed my note a couple weeks ago saying that I would be on vacation and not posting a note the week of August 3.

I am available for questions, and will be posting again beginning August 10th.

Have a great week.