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.