The Haiku of Finance for 07/31/10

U.S. banks still broke
They endanger the system
Need more capital

China's Place In The Sun Now Up To Second Place

This is happening faster than most mainstream analysts expected.  China's economy is supposedly about to become larger than Japan's:

China is set to overtake Japan as the world's second-largest economy in a resurgence that is changing everything from the global balance of military and financial power to how cars are designed.

By some measures it has already moved to second place after the U.S. in total economic output -- a milestone that would underline a pre-eminence not seen since the 18th century, when the Middle Kingdom last served as Asia's military, technological and cultural power.

I gave it the caveat "supposedly" because China's own stats on growth are even more malleable and unreliable than the U.S. government's stats (which isn't saying much).  This news gives Japan an incentive to adjust its own growth stats upwards to preserve national pride, as if what the world needs is more fudged numbers. 

The larger story is of course how this affects the Anglo-West.  China's projected ability to match the U.S.'s GDP by 2010 with its workers earning one fourth the income of a U.S. worker will further arbitrage global wages downward.  U.S. workers can thus expect to see their standard of living shrink by, oh, let's say 75% or so to entice global capital markets to commit investment here.  Try unionizing a shop in that environment, Teamsters.  Maybe we could then view the U.S. as a new emerging market.  The more appropriate term might be re-emerging market; after the U.S. gets rid of its debt through default or hyperinflation, it will be about as desirable a place to commit investment as Argentina. 

Full disclosure:  Long FXI with covered calls and cash-covered short puts.

GDP Growth Peaks For 2010

The important numbers are in and are quite disappointing for anyone hoping to avoid a double-dip recession:

U.S. economic growth slowed to a 2.4 percent annual rate in the second quarter as consumer spending remained weak and the trade deficit widened, the government said.

John Williams' Shadow Stats estimates that the government's model overestimates GDP annual growth by about 3%, so doing some simple math means the reported numbers actually signify a renewed annualized contraction of about -0.6%.  Future economists will date the beginning of the double-dip to right about now IMHO.

Declining truck tonnage in June signals confirmation of slackening economic activity.  That's bad news for all of my brand new Teamster fans who were hoping for a turnaround at YRCW.  Too bad folks!  More bad news will hit truckers if a proposed new federal law sneaks in new employment mandates under the guise of more stringent clean truck requirements.  Passing that bill would be extremely bad for the trucking industry if it retains a requirement for direct hires by trucking companies, as that will make it easier for unions to penetrate harbor trucking companies and hold them hostage to insane demands.  Harbor trucking companies need the flexibility to hire owner-operators and ports already have the ability to impose their own emissions requirements for truck engines. 

Thanks for nothing, Teamsters. 

The Haiku of Finance for 07/29/10

Wall Street yelling, "Buy!"
With renewed downturn coming
Don't be so stupid

Stupid Choices Abound In The Markets

Many investment professionals want you to do stupid things with your money.  Some analysts tracking IPOs will probably give bullish ratings to the upcoming public offering of GM to their clients, and predictably enough the dumb money will stampede into an uncompetitive firm in a mature industry.  They'll forget that the government is still going to lose billions on that company; that's okay with them as long as you lose money too. 

Some advisors will tell their clients that bank stocks are a screaming buy, never mind that taxpayer guarantees of their capital structures are the only force keeping many banks in business.  Business prospects for banks remain so poor that they need to pole vault through every loophole in the recently passed financial reform law just to survive.  That ensures a return of the credit crunch and a repeat of megabank insolvency scares. 

Some people will tell you it's time to go all in on U.S. equities given anecdotal evidence of recovery.  Betting on the U.S. economy to grow has been a smart choice for the past two centuries, but the timing right now may not be right given the likelihood the economy will stagnate. 

It's very hard to tune out stupid advice and commentary.  Sometimes it's even hard for me to do so and I do this for a living.

Healthy Logistics Carriers Can Thank Constrained Shippers

Most railroads and some truckers are doing all right.  Kansas City Southern just posted a massive jump in net income.  Norfolk Southern reported a significant percentage jump in net income that far exceeded its topline growth rate.  Even the German railroad Deutsche Bahn posted healthy income gains, indicating that whatever is driving this industry to renewed health isn't confined to the U.S.  Not to be ignored, 3PL provider C.H. Robinson benefited from healthier air forwarding revenue and trucker Old Dominion doubled its net income thanks to enormous tonnage growth. 

Such impressive all-around logistics success ought to herald a global economic rebound.  Results like this make sector-rotation investors submit "buy" orders like mad to get in before more bulls do.  Before we get all excited about railroads and other carriers, let's consider the effects of constrained capacity in another link in the global supply chain - shippers.  Ocean-going carriers trimmed a lot of capacity in the first leg of this Great Recession.  Container ships joined ghost fleets that sat idle near Singapore while shippers waited for rates to turn up again.  Now shippers are faced with a mad scramble to add boats, containers, and crews to meet order backlogs. 

This leaves carriers in land-based logistics modes - trucking and rail - with a temporary boost to their pricing power.  They now have a short window of opportunity to set rates and accept higher-paying customers while ocean cargo carriers add back lost capacity.  The smart carriers are raising prices now while retailers are frustrated.  There is no telling how long these new salad days will last. 

Full disclosure:  No positions in any companies mentioned in this post. 

The Haiku of Finance for 07/28/10

Metro job picture
Joblessness rose everywhere
No recovery

New Study Provides Theoretical Cover For Further Stimulus

In lieu of an economic downturn that puts unproductive enterprises out of business, America opted to mortgage its future earnings in perpetuity and possibly even its sovereignty.  Two prominent economists have now provided an empirical gloss for the nation's immaturity:

In a new paper, the economists argue that without the Wall Street bailout, the bank stress tests, the emergency lending and asset purchases by the Federal Reserve, and the Obama administration’s fiscal stimulus program, the nation’s gross domestic product would be about 6.5 percent lower this year.

In addition, there would be about 8.5 million fewer jobs, on top of the more than 8 million already lost; and the economy would be experiencing deflation, instead of low inflation.

Each of those points is contentious.  TARP's impact may have exceeded that of the fiscal stimulus but it will still probably result in a very large loss for the taxpayer.  It's disingenuous to argue that 8.5mm jobs have been saved when many of those jobs are in sectors that have been partially nationalized - automakers and financial services among them. More government control will make those sectors less productive and more corrupt.  The economy is already experiencing some deflation in asset prices that will permanently crimp consumer spending in a reverse of the "wealth effect."  I could go on and on. 

I don't trust this study.  It can be easily used by proponents of a second fiscal stimulus to accelerate the federal government's rush into insolvency.  A Second Great Depression wouldn't be so bad if it would only bankrupt economists who think we need more stimulus.

China Heading For Its Own Credit Crunch

I recently blogged about China's hankering for its own flavor of faked financial stress tests. It will need to test a much wider swath of its financial community if its local governments are insolvent:

Chinese banks lent huge amounts of money to provincial financing vehicles for construction projects after Beijing called for nationwide efforts to spur the economy.

But now only 27 percent of projects financed by the loans are generating adequate cash flow for repayment, the Century Weekly said in its latest issue, citing the China Banking Regulatory Commission.

A quarter of a trillion dollars worth of bad development loans is a pretty serious chunk of change.  One set of insolvencies will trigger cascading defaults.  China is also about to experience the same loss of confidence in its bond rating system as the U.S. suffered in 2008:

Credit ratings assigned to yuan- denominated bonds issued on behalf of local governments in China are misleading and don’t reflect risks investors face, Dagong Global Credit Rating Co.’s chairman said.

How soon we all forget.  Investors should wonder whether any investment can be trusted if solvency tests and credit ratings are rigged to deceive even sophisticated professionals.  The best alternative to reliance upon opaque methodologies is one's own experience.  Do your own research on a bank's capital adequacy and double-check your numbers.  Make your own assessment of a bond issuer's solvency and double-check your numbers.

Full disclosure: Long FXI with short puts and short calls.

Occidental's Earnings Looking Great

Occidental Petroleum (OXY) is one of those companies that's difficult not to like.  It's Q2 earnings are up an impressive 56% thanks in no small part to the high price of oil (lately in the high $70s). 

I would be more than happy to open a long position in OXY at a price significantly less than $80/share, where it's been hanging for some time.  It's priced a bit too high for superior long term returns, but it has healthy fundamentals.  The last 12 month's ROE of just under 13% is pretty close to its ten-year norm.  This one stays on my radar.

Full disclosure:  No position in OXY.

The Haiku of Finance for 07/26/10

Fund bulls jumping in
Ready to buy at the top
Do they like to lose?

Stress Test Fever Catching On

This whole stress-test craze is sweeping the globe.  Days after Europe discovered that seven continental banks will have to pretend they're not bankrupt a while longer, another sovereign regulatory body decides it wants to join the fun.  China will now fake its way through stress tests:

China's banking regulator has run stress tests in the country's trust firms to see if they can withstand a downturn in the property sector, the Economic Observer reported on Saturday, citing unidentified industry sources.

Chinese developers have been using property trust products sold by the trust companies as a channel to raise funds for new projects.

It's not enough for the Chinese to copy the West's intellectual property.  Now they covet our innovative fraud-hiding regulatory games.  What's this world coming to nowadays?  Next thing you know, they'll be copying our provisions for backstopping mortgage underwriting with taxpayer guarantees just to keep their property market bubbling. 

Full disclosure:  Long FXI with short puts and short calls. 

The Limerick of Finance for 07/25/10

One most troubled resource is oil
Its sale makes Venezuela boil
Spilling it gets you fired
Without it, we're un-wired
Violence makes the global price roil

Pay Czar Leaves Payouts Alone

The administration's rationale for appointing a Wall Street pay czar (i.e., the U.S. Treasury Department's Office of the Special Master for Executive Compensation) was to ensure that executive compensation at firms bailed out with our tax dollars does not get out of hand.  The government's bailout of Goldman Sachs via payments to AIG is old news by now.  What's new is that the pay czar put in place to prevent abuses of those payouts has largely abdicated his role:

For all his tough talk about excessive pay for bankers, the Obama administration's pay czar let the executives go without a fight.

Kenneth Feinberg announced Friday that he would not try to recoup $1.6 billion in compensation given to top executives at bailed-out banks because he thought shaming them was punishment enough.

A slap on the wrist and the robber barons are free to rob some more.  I guess this means he'll run the $20B BP compensation fund the same way.  Hey, who's been more hurt by that oil spill than BP itself? Using that logic, BP executives can pay themselves the $20B and not worry about any consequences more severe than a stern cross-eyed look from the pay czar. (sarcasm filter off)

Full disclosure:  No position in GS, BP, or AIG. No chance of ever being appointed a Special Master for Executive Compensation.

Countdown Begins To Bursting Of Defense Bubble

Crashes were inevitable after the dot-com bubble and housing bubble.  U.S. sovereign debt is probably a bubble that in turn feeds yet another bubble  - in defense spending.  Uncle Sam's war on a radical Islamic mafia since 2001 has cost over one trillion dollars and has fed explosive growth in parts of the military-industrial complex that have little direct involvement in warfighting.  One such part is U.S. Joint Forces Command in Norfolk, VA. 

I recently had the opportunity to visit Virginia and spent some time in Suffolk, home to USJFCOM's Joint Warfighting Center.  The Center's businesslike complex is near a cluster of office parks occupied by the usual suspects:  Lockheed Martin, SAIC, Raytheon, Northrop Grumman, and smaller subcontractors too numerous or secretive to name.  All of them are enjoying the bubble times and flush feelings that come from riding a gravy train.

That gravy train may very well come off the tracks, at least where they end in this neighborhood.  The Defense Business Board is studying ways to make the U.S. military more cost effective and is recommending the shutdown of Joint Forces Command:

A Pentagon advisory board is recommending that the Defense Department eliminate the Norfolk-based Joint Forces Command as part of a plan to significantly cut defense spending.
(snip)

Joint Forces Command is the linchpin of Hampton Roads' blossoming high-tech industry, a segment that provided almost 4,500 high-paying jobs and pumped about $365 million into the local economy in 2007, according to a 2007 Old Dominion University report.
(snip)

It employed more than 3,000 contractors, 1,491 military personnel and 1,533 civilians as of May, said Lt. Cmdr. Robert Lyon, a Joint Forces spokesman in Hampton Roads. Those figures include personnel deployed throughout the world, he said.

It's worth noting that the number of contractors at USJFCOM just about equals the number of traditional staffers from the armed forces and civil service.  There is no clearer reminder than this of where the money went in the war on terror.  Many of these contractors are retired military officers themselves.  I'd love to find out how many are making more than what they made on active duty in addition to their standard pensions.

Scaling back defense spending is inevitable.  America's current wars are among the costliest in our nation's history when measured in inflation-adjusted dollars and we have little to show for the investment besides uneasy strategic stalemates.  World War II bought us new allies and revolutions in crossover technologies (radar, plastic, rocketry).  This war has bought us little so far.  The one remaining benefit is the prospect of opening up Afghanistan's hidden trillions in untapped natural resources for the world market.  The U.S. recently forgave the debts owed to it by Afghanistan as a down payment to ensure access to ore.  All those rare earth metals lying under the mountains are very necessary for our standard of living.  Many Afghan tribesmen are going to get rich.  Many defense and mining contractors will continue to get rich; just not as many as before. 

The end of the defense bubble is coming.  It may come with a bang if the global bond market revolts or with a whimper if defense spending gradually tapers off to the minimal level needed for a multi-decade Afghan footprint.  Defense spending will never end and in some ways it may increase if unmanned vehicles, smart sensors, and precision logistics are brought to maturity.  Some defense projects will be great investments but the low-hanging fruit has probably been picked clean.  Military historians define surprise as an event that occurs in the mind of a commander.  Deflating bubbles always come as surprise to those inside them. 

Full disclosure:  Long put under LMT as hedge against decline in U.S. defense budget. 

The Haiku of Finance for 07/23/10

EU bank stress tests
They all pass, what a surprise
Future shocks await

GATX Hits Earnings Out Of The Park

Wow!  GATX is one of the few firms that I don't hold a grudge against for not answering my resume submissions years ago.  I can't be mad at them because their bottom line results are so clearly stellar:

Rail equipment leasing giant GATX depended partly on a pickup in its shipping operations to post a 69 percent profit jump to $21.5 million in the second quarter, from a year earlier, while earnings at its dominant rail segment slid 34 percent to $29.4 million.

The rail segment's performance is disappointing given its high utilization rates.  GATX may lack the pricing power of major carriers; owning the track, not necessarily the cars, gives railroads their monopoly power.  In that sense GATX is just another supplier to the industry, albeit a very large one.  It also certainly helps that rail carriers get anti-trust exemptions that allow them to keep rates high. 

Rail traffic has a bright future as long as demand for bulk commodities like coal remains high.  GATX should have more than a decent future given its absence of long term debt, although it really ought to get its operating cash flow under control.  Its dividend of $0.28/share has been steadily climbing since it dropped in 2004 from $0.32 to $0.20.  Good news on earnings is important, but improving the company's dreadfully low ROE and ROA (single digits!) is even more important. 

Full disclosure:  No position in GMT.

The Haiku of Finance for 07/22/10

GM goes subprime
They must love going bankrupt
There they go again

Updates To The Alpha-D for July 2010

I waited a couple of days thinking I could get more cash out of my covered options tactic.  The results weren't as good as I'd hoped.  Getting some cash is still better than getting nothing.

My covered calls on TDW, FXI, and GDX all expired worthless.  So did my cash-covered short puts under GDX.  I refreshed them all and made no other changes.

Sometimes investing really is that simple. 

The Haiku of Finance for 07/21/10

More jobless payments
Keep people from finding work
No incentive there

A Quick Comparison Of Knight Transportation (KNX) to Arkansas Best (ABFS)

Knight Transportation (KNX) is having a banner year.  Its net income leapt 26% in Q2 on revenue growth of 14%.  Almost every conceivable operational metric improved.

Arkansas Best (ABFS) is still traveling a bumpy road.  Its losses narrowed in Q2 thanks to more tonnage carried.  It's not out of the woods yet, but their CEO attributed their improving performance to lower nonunion fringe benefit costs. 

Comparing a truckload carrier like KNX to an LTL carrier like ABFS isn't as much of a stretch as an apples-to-oranges comparison since they're both segments of the same broad industry.  Finding the key drivers (no pun intended) is never easy in trucking.  I'll hazard a guess as to where we can start.  KNX's emphasis on owner-operators gives them cost flexibility.  They don't have an overhang of underutilized drivers on the payroll who are just sitting around waiting for loads, and the independent operators they use have a pride in ownership that only entrepreneurs can understand.  ABFS is gaining a similar operating flexibility by cutting costs for the nonunion part of its workforce, but they're still hampered by obstructionist Teamsters who refuse to accept wage cuts!  ABFS can't even compete on cost with YRCW, my favorite whipping boy of late.

The lessons are clear.  Owner-operators in trucking take pride in their work, get the job done, and help KNX's bottom line.  Unions at ABFS get in the way of very necessary cost cuts.  Unions need to take a hike.

The Haiku of Finance for 07/20/10

Cure rate in decline
Clueless homeowners can't pay
They should walk away

Unions Grasp At Straws To Avoid Home Foreclosures

The union worker's sense of entitlement knows no limits.  These idiots aren't satisfied with demanding restored bennies from nearly bankrupt companies (not just YRCW).  They also demand organized action to remain in homes they could never afford:

On Wednesday, at a press conference at the Manhattan Municipal Building, the most powerful local union presidents and the city’s chief financial officer told the Big Banks enough is enough. Rather than wait on the Obama Administration to finally put some teeth into its voluntary mortgage modification program (that the banks are voluntarily taking a pass on), these leaders are taking matters into their own hands.

 

I can ignore The Nation's pro-union polemics to see the real problem here.  First, banks don't have a whole lot of leeway to rewrite underwater mortgages.  Doing so would destroy the book value of their loans and immediately make many banks insolvent.  Mass mortgage mods would immediately relaunch the credit crunch. This is why forced mortgage modification programs like HAMP are doomed to fail.  The principal writedowns necessary will destroy the banking system. 

Furthermore, homeowners in default who get mortgage modifications tend to default anyway when their underlying economic situations fail to improve.  Recent data on deteriorating "cure rates" makes this clear. 

I congratulate union leaders for once again demonstrating their extreme stupidity.  They've jumped on another slow train to nowhere. 

The Haiku of Finance for 07/19/10

Oh woe are unions
End of high pay for no work
Just get a real job

Handling Unions Right In Montreal and Wrong At YRCW

Productive enterprises at the Port of Montreal show us the right way to handle unions - lock them out of their jobs when they get unruly:

The action at 8 a.m. EDT followed mounting tensions that began with the Maritime Employers Association's call for a new labor agreement and the union's refusal in recent weeks to work overtime hours aimed at clearing cargo at Montreal. The lockout was intended to pressure union leaders “to look more realistically" at the jobs situation ahead, said the Montreal branch of the Maritime Employers Association.

Take that, fat slobs!  Big-time kudos to the Maritime Employers Association up north for doing right by their shareholders and customers.  Diverting traffic will cost them some business in the short run but will earn them the respect of the business community over the long run.  No one wants commerce to be held hostage to the limited work hours of workers who don't really want to work. 

It would be terrific if American companies could adopt the same common-sense approach.  Let's start with YRC Worldwide, where shareholders concerned about the firm's survival have to contend with whining from unions about lost pay and benefits.  Some time spent walking a picket line might actually be good for drivers if it helps them burn calories and lose weight. 

While they're painting their protest signs (replete with spelling errors), they should note that last week's news release from YRCW trumpeting a "confirmed expected positive EBITDA" for Q2 comes with a bunch of caveats that render it meaningless.  The biggest warning is the net cash usage from operating activities.  Less cash on hand means less ability to pay bills.  Even union drivers should be able to figure that one out.  Furthermore, amending their loan facility netted the company $22mm worth of flexibility against a looming bond payment of $21.7mm due in August.  Learning-impaired drivers who flunked high school math might not realize that this hole will prove hard to fill, as any creditor willing to grant such a facility probably covets the assets securitized against the loan.  That's a bet on bankruptcy, folks.  The rest of the bullet points in the news release amount to little more than hope; begging customers for a few more loads, stretching out negotiations with its lending group, selling more assets, and other tactics will only stall for time.  They will not materially change business conditions on the cusp of a double-dip recession.

I'll be happy to watch YRCW's flame-out from the sidelines if it forces unions to take a hard look at their bleak futures.  The next market crash (perhaps precipitated by a Hungarian insolvency contagion) will be a hard wake-up call.  The Port of Montreal is attempting to answer that call successfully before it arrives.  There's still time for YRCW to do the same.  Hammer your unions hard if you want to survive. 

Full disclosure:  No position in Canadian logistics providers or YRCW. 

The Limerick of Finance for 07/18/10

Now banks want to increase their fees
They think they can do as they please
For a nickel and dime
They'll charge you each time
Just watch as the customer flees

The Haiku of Finance for 07/17/10

Two year note yields drop
No one wants zero interest
During deflation

Friday's Fun Miscellany

Let's take a look at a big jumble of newsworthy stuff on an options expiration Friday.


Goldman Sachs' wrist-slap SEC fine is being spun as a victory for Lloyd Blankfein's skill in negotiation and strategy.  Maybe so, but I think influence peddling among Goldman alums (now lobbyists) and SEC staffers' i-banking aspirations played a strong role too. 

BP caps the Deepwater Horizon well.  I think it's going to hold.  They didn't even have to hire SpongeBob SquarePants to get the job done on the ocean floor.  Maybe a short-expiration covered call strategy on BP is a special situation worth playing.  I have all weekend to think that one over. 

Greece continues to take its austerity medicine by raising retirement ages for government workers.  Great!  Now let's do the same thing here and stick it to government employee unions, who BTW are now the majority of unionized employees nationwide. 

The Creature from Jekyll Island grows more tentacles.  The Fed is now the fourth branch of government, a development that puts it outside the Constitution's system of checks and balances.  A central bank owned by private interests that has veto authority over a broad swath of economic activity is something the Founding Fathers never envisioned.  The U.S. has entered unchartered territory with its population completely unaware of the new reality.  What did Ben Franklin say we had?  "A republic, if you can keep it." 

An overhaul of housing finance is coming three years too late.  The time to break up Phonie and Fraudie and unwind their obligations has passed.  China threatened Uncle Sam with the nuclear option of dumping Treasuries back in summer 2008 and Uncle Sam caved in.  Now Uncle Sam is stuck with the bill for supporting 95% of all new mortgages.  "Overhaul" now means just another way of disguising wealth transfer from American taxpayers to Chinese agency debt owners. 

Full disclosure:  Anthony J. Alfidi has plans for the weekend.

Goldman Sachs Gets Over In Civil Suit And Regulatory Reform

Why is this man smiling?

He's Lloyd Blankfein, CEO and Chairman of Goldman Sachs.  He ought to smile because the SEC just settled its civil suit with Goldman for $550mm:

Goldman Sachs Group Inc. agreed to pay $550 million and change its business practices to settle U.S. regulatory claims it misled investors in collateralized debt obligations linked to subprime mortgages.

The penalty is the largest ever levied by the Securities and Exchange Commission against a Wall Street firm, the agency said in a statement announcing the accord today.

 

Claims of the largest settlement ever notwithstanding, this is just 4.1% of the $13.39B in net income GS earned in 2009.  It's really a teeny, tiny kind of tax for being so good at prop trading.  If it were larger the SEC enforcers wouldn't stand a chance of getting their resumes past GS's HR inbox. 

Blankfein and his pals in C-suites across the nation have another reason to smile.  The Dodd-Frank Financial Reform Bill passed Congress today.  The bill does little to prevent a relapse of the national credit seize-up that sent the U.S. economy into a nosedive in 2008.  It does give the FDIC power to unwind large financial firms but given the industry's capture of lawmakers we can expect that power to be used sparingly. 

The bill's loopholes for unwinding proprietary trading operations inside banks are so large as to be meaningless.  GS can look forward to many more years of betting against its own clients. 

Upstart Chinese Credit Agency Downgrades U.S. Debt

It had to happen sooner or later.  The Dagong Global Credit Rating Company, a Chinese "credit agency," has issued a downgrade rating for U.S. sovereign debt.  That's quite a gutsy move for an upstart. 

U.S. institutional investors are likely to laugh off this move as meaningless since Dagong's application to become an NRSRO is still pending with the SEC. It needs that accreditation to be taken seriously with U.S. investors. 

I'm not sure whether this would have happened without the express approval of China's ruling elite (the nouveau riche in the Central Committee of the Communist Party of China).  Is Dagong truly a pure entrepreneurial effort?  Or is it a stalking horse in the ongoing slow-motion attempt by Chinese elites to build a case for the Middle Kingdom's displacement of the U.S.?  I'm merely a spectator. 

Full disclosure:  Long FXI with covered calls and cash-covered puts.

The Haiku of Finance for 07/13/10

European banks
Too many bad loans and bonds
But rules don't matter?

Troubled European Banks Get Reprieves Instead Of Reprobation

Europe's banks are becoming just as proficient as their American cousins when it comes to hiding bad fixed-income assets with phony accounting and central bank recapitalizations:

The EU banking system is in big trouble. Many of the Union's largest banks are sitting on hundreds of billions of dodgy sovereign bonds and non performing real estate loans. But writing down their losses will deplete their capital and force them to restructure their debt. So the banks are concealing their losses through accounting sleight-of-hand and by borrowing money from the European Central Bank. This has helped to hide the rot at the heart of the system.

Not to worry.  Insolvency no longer means failure.  We can count on cooperative regulatory bodies to rescue banks on either side of the Atlantic.  European regulators are about to hand down plenty of gifts:

European banks, rattled by investor uncertainty about their ability to withstand a sovereign-debt crisis, are poised to win a reprieve in Basel, Switzerland, this week as regulators from 27 countries shape new capital rules.

A push to water down stringent standards proposed last year by the Basel Committee on Banking Supervision, and to allow more time to implement them, is led by France and Germany, according to bankers, regulators and lobbyists involved in the talks.

I've been saddened lately to hear know-nothing investors brag about their genius at having bought banking stocks.  I've even heard a tale from an aspiring finance professional about how i-bankers were regaling him with rationales for aggressively buying U.S. bank stocks.  I tried to talk this guy out of listening to those fools.  Banks that hold garbage assets and report them as healthy deserve rejection and reproach, not recommendations. 

I just shrug my shoulders now.  I take small comfort in the existence of others who are dumb enough to take the other side of any smart trade I can make.  Our world is upside-down. 

Full disclosure:  No positions in European bank stocks. 

Game Theory Musings

Hondo's recent comment got me thinking again (as he usually does). Game theory is extremely useful in decision making but few decision makers actually use it. Too many CEOs got their MBAs for the brand name and networking value and threw away their class notes at the end of each semester.  That leaves the playing field wide open.  I have binders full of my class notes. 

The web gives us plenty of resources for applying game theory to business and financial strategies.  Here's some food for thought:

Are decision trees good enough without game theory?  I've enjoyed using them but incorporating game theory would probably help by minimizing the uncertainty of picking subjective probabilities.

Is game theory useful in scenario analysis?  The easy answer is yes.  Game theory should lend itself easily to forms of scenario analysis that can't be easily stress-tested with tornado diagrams and Monte Carlo simulations.  Mutually exclusive scenarios should be subjected to game theory.  It may even apply to estimates of value at risk when data on trends and volatility is unavailable. 

Constructing a minimax payoff matrix is simple enough for zero-sum games but not every business decision is a win-lose proposition.  Merger arbitrage is sometimes a win-win solution for both targets and acquirers.  An optimal decision for both parties in a proposed merger would require them to work through the Prisoner's Dilemma.  Hmmm . . . sounds like this requires further study. 

CVAC Goes To Alabama!

The CVAC sensation is sweeping the nation.  Check out this video from a brand new wellness clinic in Alabama founded by an enthusiastic CVAC client.

Word of mouth from satisfied customers is how a revolutionary product gains acceptance.  Go CVAC!

Full disclosure:  Anthony J .Alfidi is an early-stage investor in CVAC Systems. 

The Haiku of Finance for 07/11/10

Debt commission speaks
No more mortage deductions
End of the free lunch

Debt Commission Urges Americans To Wake The Hell Up

Elected leaders who are unwilling or unable to solve urgent civic problems appoint a commission to give themselves political cover.  The National Commission on Fiscal Responsibility and Reform is one such body, charged with providing politicians with the appropriate cover for unpopular decisions.  This commission on has some inconvenient news for American taxpayers:

The heads of President Barack Obama's national debt commission painted a gloomy picture Sunday as the United States struggles to get its spending under control. 

Republican Alan Simpson and Democrat Erskine Bowles told a meeting of the National Governors Association that everything needs to be considered -- including curtailing popular tax breaks, such as the home mortgage deduction, and instituting a financial trigger mechanism for gaining Medicare coverage.

This is the first of what will prove to be several trial balloons designed to alert the American people to the unavoidable decline in their standard of living that they should expect.  Americans have postponed this decline for two decades by whittling away national strengths inherited from our ancestors.  The dollar's status as the world's reserve currency allowed us to borrow from foreigners on the premise that we can print our own payments in an emergency.  That status won't last once China's central bank or one of the Middle Eastern SWFs sends our Treasury department a foreclosure notice.

The mention of the home mortgage tax deduction ought to raise eyebrows among lowbrow Americans but it probably won't.  Americans have come to view home ownership as both a financial entitlement and right of passage into adulthood.  Those of us born a century too late to settle the frontier as pioneers could have our own little suburban homestead, mortgaged to the hilt, as a memento of America's westward progress.  Millions of Americans have incorporated that tax deduction into their household budgets for years as a lifestyle subsidy on the advice of their tax preparers.  Taking it away will do much more than pull the rug out from under consumer spending (remember, that's 70% of GDP).  It will cut a psychic swath through a bourgeoisie that aspired to own a little piece of the frontier in the safe, predictable confines of suburbia. 

The mere suggestion that entitlements like Medicare should be means-tested will provoke further howls form the aging Boomers in what used to be the middle class.  Sixty-somethings might somehow escape the means tests since they're now the largest and most active voting constituency, so Gen X (that's me!!) will get stuck with at least part of the tab.  My contemporaries can forget about upward mobility or discretionary spending.  We will pay for the excesses of our parents. 

The commission's work is far from done.  There will be more trial balloons, more leaks, and a final report that most Americans will blithely ignore.  I'll read it because I'd like to know how far I'll have to dial back my own spending (which isn't much BTW since I value frugality) so Uncle Sam can pay his creditors.  I personally endorse eliminating the mortgage tax deduction and all entitlements like Medicare and Social Security.  That puts me at odds with most Americans for now, but they'll all eventually have to come around anyway.  Americans need to wake the hell up about the bill coming due, but most of them are sound asleep. 

Full disclosure:  Anthony J. Alfidi had to drink a rum and soda cocktail to write this post.

The Limerick of Finance for 07/11/10

BP thinks about asset sale
The check may now be in the mail
BP needs cash quick
To clean that oil slick
Lest all of its Gulf efforts fail

The Haiku of Finance for 07/10/10

New rules in finance
Wealthy can steal even more
No one will stop them

Gloomier Economists And Rosier Bond Picture

Consensus economic forecasts are pretty much worthless but Wall Street needs them to keep herding suckers into proprietary funds and other bad ideas.  A new forecast summary paints a weakening picture

The Blue Chip Economic Indicators survey of private forecasters found analysts increasingly glum about the outlook. They now see the economy expanding just 3.1 percent in 2010, down from 3.3 percent in the June poll.

The forecasters aren't bold enough to push the stagflation button so they settle for a modest restatement of "more of the same."  They ought to read the Shadow Government Statistics primer on GDP; one of its chief findings is that cumulative revisions to the methodology for estimating GDP overstate its annual growth by three percent.  Adjusting the Blue Chip forecast downward using the SGS correction of 3% leaves it at just about zero.  Call it stagflation. 

Bond dealers find the new consensus useful in marketing Treasury debt:

Primary dealers cited the growing consensus that the U.S. economic recovery will be slow and anemic as a driver for demand for three-year notes, even as their yields held at 1.02 percent late on Friday.

Bond strategists are counting on little to no inflation as a prop for demand.  The strategy of "don't fight the Fed" that PIMCO and other large bond managers have followed for the past two years has so far born fruit. 

The Haiku of Finance for 07/09/10

Trucker out of cash
See what union drivers do?
They break the whole firm

YRCW Out Of Cash Already?

Forget about the turnaround plan for YRCW.  They now need a "turn out the lights" plan.  A court order to pay bondholders is sounding the firm's death rattle:

A federal court has ordered struggling U.S. trucker YRC Worldwide to pay bondholders who opted out of a debt-for-equity exchange last year that kept YRC out of bankruptcy court.

The company is going to have a very hard time coming up with that $21.7mm by Aug. 9.  Its balance sheet as of March 31 shows current assets of $825.7mm and current liabilities of $1.2B.  The balance sheet ending June 30 will be quite telling and most likely will seal the company's fate.  If the current ratio isn't positive by then, YRCW is probably finished. 

These stubborn bondholders may have done the smart thing after all by refusing to convert to equity, as they now hold a senior claim against what will remain of the firm's assets when it ultimately goes into liquidation.  The bondholders' claims will likely be held as senior to employees' claims for pay in any bankruptcy action.  Drivers are probably looking at their last paycheck right now. 

Stick a fork in this turkey, because it's done.  Let this be an abject lesson to any logistics company that can't destroy its unions.

Full disclosure:  No position in YRCW.

Consumers Won't Spend And Retailers Won't Recover

The American consumer may finally be going down for the count.  Consumers aren't prying open their wallets:

Consumer borrowing fell again in May, more evidence that Americans remain jittery over their finances and the durability of the economic recovery. 

The Federal Reserve said Thursday that borrowing dropped by $9.1 billion in May. It also said borrowing declined by $14.9 billion in April, revising an initial estimate that showed a gain of $995 million for the month.

 
This has the predictable effect of hurting retailers, and no amount of discount offers can improve their prospects: 

Stores deepened discounts more than planned in June to draw recession-scarred shoppers to buy summer tops and other merchandise. But shoppers bought mostly items they needed, resulting in small revenue gains.

We'll see the pain show up when Q3's GDP proves to be disappointing even after accounting for back-to-school spending.  Retailers looking for innovative sales tactics should consider posting strippers at their entrances.  If Wal-Mart can offer free greetings from a geezer, other retailers need to one-up them and offer free dinner and drinks.

The Haiku of Finance for 07/07/10

(special anti-union edition!)

Greedy union pigs
Suck money from our wallets
Time to fire them all!

Illinois' Greedy Unions Get Raises That Break Taxpayers

Just when I thought unions couldn't hit a new low for rapacity (good luck getting a union ignoramus to understand that word), they manage to sink even lower.  Illinois state taxpayers are about to pay a lot more for even less union work:

More than 40,000 unionized state workers got a pay raise last Thursday, bringing to 7 percent the amount they're gotten since last year. These same state employees are in line for another 7 percent by next July 1, all at a cost of a half-billion tax dollars a year. 

It's more than the virtually bankrupt state can afford, and some Republican lawmakers say the raises need to be rolled back.

 
This is criminal!  Illinois is facing a budget deficit of about $11B for FY2011 and shiftless union slobs get a $500mm raise?  It's not like they need 7% more dough to make it through deflationary times.  I guess all those school teachers and prison guards are so hung up on sugar rushes from three daily servings of doughnuts in the break room that they feel the extra 7% is the baseline they need to fill their orders at the corner doughnut shop.  Disgusting! 

What is it with unions and their greed these days?  Can anyone wearing the union label see past the fat wallets protruding from their fat behinds, or are they all dumb enough to think that economically productive taxpayers will take this outrageous behavior indefinitely?  Union jerks won't voluntarily sacrifice for the public good because after years of getting their way unchallenged they think they are the public good! 

Government employee unions are playing with fire.  It's time for state attorneys general to open racketeering cases against government unions that get salary step-ups thanks to their campaign contributions.  It's time for governors to do to their union dregs what Reagan did when air traffic controllers got out of hand:  FIRE THEM ALL. 

Full disclosure:  No exposure to Illinois muni bonds. 

Unions Turn Up Pressure On Weakened YRCW

I've written recently about my disgust for organized labor in the United States.  I briefly thought that union truck drivers were capable of doing the right thing when they agreed to wage givebacks at YRCW.  I had set my hopes too high.  The Teamsters can't wait to get their greedy paws on YRCW's cash and are willing to place that company's cash flow at risk:

The Teamsters union is aiming to get YRC Worldwide to resume some pension contributions starting in January 2011, union officials said Tuesday.
(snip)

The $5.3 billion trucking operator won an 18-month suspension of pension contributions from the Teamsters last August, along with a 15 percent wage cut.

I don't care whether they're only looking for a partial resumption of payments.  Once that camel's nose gets under the tent, they won't hesitate to bite the whole burrito and demand full resumption even if it destroys the company.  Someone should tell the Teamsters that YRCW isn't remotely close to being out of the woods yet.  The sale of YRCW's logistics unit won't raise nearly as much cash as expected due to termination costs.  Good luck trying to tell uneducated union schmucks to look at numbers.  We can look at YRCW's own short-term estimates for confirmation that their situation is still tenuous:

YRC Worldwide still believes it will "generate positive adjusted EBITDA" in the second quarter, the company said June 29, as it concluded its annual stockholder meeting.
(snip)

At its annual stockholder meeting June 29, the company replaced outgoing director Carl W. Vogt with Teresa Ghilarducci, the Teamster pick for YRC's board of directors.

Using EBITDA is a bit of an optimistic stretch, as many analysts learned to their chagrin during the dot-com era.  More bad news may be on the way for truckers if they have to compete against rapidly-strengthening railroads.  Railroads kept up their capital spending while truckers like YRCW were forced to sell assets.  Wanna bet who's going to win that race in the short term?  That's especially noteworthy if the short term is all YRCW has to make itself profitable but union workers just can't think that far ahead. 

Hey, what's this about unions getting a say in picking a board member?  If YRCW's shareholders are dumb enough to let unions get a say in board leadership then maybe they deserve to see their share price drop to zero.  Union pick Dr. Ghilarducci (who taught at my undergrad alma mater, Notre Dame) is an advocate for replacing self-directed retirement accounts with government-guaranteed annuities.  I have no problem with government-mandated savings programs (like Australia's superannuation accounts or Uncle Sam's Thrift Savings Plan) so long as they truly operate as investment management programs.  The problem with Dr. Ghilarducci's reform program - and others that rely on government-directed investments - is that they can too easily become permanent deficit funding mechanisms.  Try living on that guaranteed "3% above inflation" when the government controls the measurement of inflation and the schedule for indexing your inflation-tracking portfolios.  I'll bet union workers think that's just great. 

Trying to explain any of this to a typical union member is probably a waste of intellectual energy.  Thankfully, ports in SoCal remain open despite greedy striking secretarial pools, so we should be grateful that unions don't always get to bully the rest of us around.  The day of the union is long past.  Executives in unionized firms need to get tough and push these dinosaurs out to pasture. 

I avoid investing in unionized companies because they have a hard time doing what they need to do - cut costs, discipline unproductive employees, shut down unprofitable business units - thanks to union interference.  It's time to break up unions before they break the United States economy with their greed and stupidity. 

Suburban Studies Herald The Onset Of Peak Cheap Oil

I can't make this stuff up.  Folks in Shawnee, Kansas want a national museum to study suburbs as a way of life and cultural phenomenon:

Enough, say the Johnson County civic leaders planning a National Museum of Suburban History. Their contention: With more than 50 percent of the country living in places like Shawnee, it's past time to take the suburbs seriously.

(snip)

In southern California, the Center for Sustainable Suburban Development at UC-Riverside was formed in 2003 to promote economic research and examine regional planning as well as the political, cultural and environmental impact of suburbia.

In Long Island, New York — home to Levittown, the epicenter of the mid-20th Century suburban boom — Hofstra University's National Center for Suburban Studies also aims to advance the public conversation about modern American life beyond cheap laughs, or pulp fiction melodrama.

I think it's hilarious that these "suburban study institutes" are located in suburban enclaves themselves.  Apparently nobody told these folks that the onset of Peak Cheap Oil is going to render much of suburbia unlivable, let alone unworthy of study.  Flight from suburbia will begin in earnest as McMansions are foreclosed and municipal services are shut down (check out Detroit!).  This will leave these study centers high and dry.  The last person to leave the institutes at Hofstra and UC Riverside should turn the lights out, but they won't have to if the lights are out all over their neighborhood anyway. 

Let me save them all some work.  It's what I do as a public service.  Suburbs are a temporary phenomenon enabled by a confluence of factors, including the wide availability of cheap petroleum in the United States after World War II, the federal highway program, and the successful lobbying from automakers that convinced municipalities to replace local trains and trolleys with roads and freeway easements.  All of it was based on cheap gasoline.  All of it has now begun to contract in size and vitality. 

Why study something that's about to disappear?  Americans can't seem to come to grips with the reality of declining national power and a resource base constricted by scarcity and lack of future investment.  Suburbophiles are longing for the good old days, but the trouble is we've left those days behind.  This kind of pining can easily lead to a sense of loss and betrayal when the double-dip recession is finally recognized.  The national zeitgeist can turn ugly if Americans have to be pried from suburbs.

I'd short suburbs if they were a security in the financial markets. 

The Limerick of Finance for 07/04/10

Independance Day we celebrate
When Americans took charge of fate
Now we're all fat and lazy
With prosperity hazy
Our empire, oh wasn't it great!

Factory Orders And Logistics Data Diverge On Double-Dip

Right now I'm listening to an NPR broadcast of a mainstream economist from the Economic Cycle Research Institute coming around to an admission that the U.S. economy is creeping into a double-dip recession.  Does data confirm this yet?  Factory orders have fallen off a cliff:

Orders to U.S. factories declined 1.4 percent in May, the biggest drop since March 2009, after eight straight months of gains, the Commerce Department said.

In spite of weaker factory orders, the Cass Freight Index is up both mom and yoy:

The closely watched Cass Freight Index for shipments grew 9.1 percent in June over the previous month, accelerating at a pace that contrasted with other slowing economic signals and reaching a new high for the recovery.
(snip)

The growth in the freight shipments index came as other key measures, including the Institute of Supply Management’s manufacturing index and the American Trucking Associations’ truck tonnage index, showed weaker activity.

The Cass Freight Index is a statistical sample adjusted to achieve a monthly smoothing effect.  It is best considered alongside other logistics data to get a fuller picture of the economy.  Reconciling this index with gross tonnage figures from the railroad and trucking industries is difficult and requires some intuitive leaps.  The major railroad and trucking associations represent the largest carriers in the economy; their data shows weaker activity among major carriers but may miss smaller carriers covered by Cass' sampling. 

Taken together with other macro data, the Cass report is noteworthy but does not change my mind.  The double-dip is coming. 

The Haiku of Finance for 07/02/10

What, no free bennies?
Get up off the couch, you jerks
Get a stinking job!

Job Market, No Market

Mainstream journalists can try to put a happy face on this news but the truth is hard to ignore.  Jobs lost since the start of this Depression aren't coming back:

The jobless rate fell to 9.5 percent in June, still far too high to signal a healthy economy. It came in slightly lower than the month before only because more than a half-million people gave up looking for work and were no longer counted as unemployed.

 

Do workforce dropouts expect unemployment benefits to be extended past 99 weeks?  They're bound to be disappointed for a while, as the latest attempt to extend payments is stalled due to Congress' summer recess.  Joe Six Pack didn't save any of his unemployment checks, so he's going to have to bum cigarettes from his trailer park neighbors until Congress gets back to work.  The anti-bailout mood on Capitol Hill is another headwind that advocates of more handouts will need to overcome.

I think the majority party will eventually carry through an extension of the bennies only because this is an election year and they need the votes from dummies.  I've been wrong before but I couldn't care less.  I did the smart thing and saved money all of my life, and now I get to pay higher taxes to feed my deadbeat countrymen who wouldn't know a saved dollar if it bit them in the pants.  Yakov Smirnoff used to exclaim "What a country!" when he made some observation of American life that he found astounding.  Now I feel like saying the same thing in shame, as I can hardly believe that so many Americans think the government owes them a living.  At least Mr. Smirnoff still has a job. 

Bears Winning in Q2 and Q3 2010

No, silly, not the Chicago Bears of the NFL.  I'm talking about the market's bears:

U.S. stocks fell on Thursday as manufacturing and labor market data heightened fears of a double-dip recession before Friday's key employment report. 

Major indexes were lower for a fourth straight day after suffering their worst quarter since late 2008, but losses eased near the end of the session.

This here third quarter is getting off to an exceedingly inauspicious start, if you catch my drift.  I'm not happy to see my fellow Americans' 401(k)s get gored, but I don't mind to see Wall Street's sell-side permabulls look like fools for predicting an early end to Great Depression 2.0.  How many of you believed the hype from politicians, CNBC, and other shills that we were out of the woods?  Go ahead and raise your hands, as I won't call on you individually. 

Am I the only one here who's mostly in cash?  Give me some decent stocks with single-digit P/E ratios (like TDW) and I'll put some cash to work.  Until then, I'm watching the carnage from the sidelines.