The Limerick of Finance for 06/13/10

Finance overhaul is a sham
Wall Street still needs victims to scam
Lobbyists run amok
They scheme 'round the clock
Into bills, loopholes they will cram

Broken Pension Plans Magically Fix Themselves

Let's take a fun trip through the looking glass into never-never land over the rainbow, or some such nonsense.  Oh, the agony of pension fund managers who watch their unfunded liabilities gradually grow larger, unabated:

Seven states will run out of money to pay public pensions by 2020. That hasn’t stopped them from hiring new employees.

Whatever shall we do?  Fear not, my dear.  We can always borrow the money to fill up the pension plan . . . er, from our pension plan:

Gov. David A. Paterson and legislative leaders have tentatively agreed to allow the state and municipalities to borrow nearly $6 billion to help them make their required annual payments to the state pension fund. 

And, in classic budgetary sleight-of-hand, they will borrow the money to make the payments to the pension fund — from the same pension fund.

If any of the above sounds like a good idea to you, I must congratulate you for getting the quality of government you deserve.  This fun fairy tale is par for the course in economically illiterate America.  It's certainly fun reading.  My highly intellectual regular readers will of course see right through this shell game. 

If you're counting on a public pension to be there for you in any significant way, you need to stop counting.  Many Americans can't count anyway thanks to those very same public employees teaching in public schools. 

Keynesianism On Its Deathbed

Future historians will look back on this era as a time when economists discredited themselves by clinging to a theory that's on its last legs.  That theory is Keynesianism.  Simply put, Keynesians believe a sizable enough macroeconomic stimulus can jumpstart a new economic cycle of growth.  People like Robert Reich just can't let go:

American Corporations are sitting on huge piles of cash but they're not investing, and they're creating only a measly number of new jobs. And they won't invest and create jobs until they know there are customers out there to buy what they sell.
(snip)

Keynes prescribed two remedies -- both of which are now necessary: Government spending to "prime the pump" and get businesses to invest and hire once again. And, as Keynes wrote, "measures for the redistribution of incomes in a way likely to raise the propensity to consume." Translated: Instead of big tax cuts for corporations and the rich, tax cuts and income supplements for the middle class.

Reich misdiagnoses aggregate corporate strategy.  Companies aren't sitting on cash because they lack investment opportunities.  They're sitting on it because they don't want to be caught without a recourse to pay their bills if the short-term credit markets (particularly commercial paper) freeze up again in a repeat of 2008's credit crunch.  The danger of a repeat increases with each passing day as the federal government's huge borrowing needs crowd all other debt offerings out of the bond market.

The Keynesian prescription of more debt and more stimulus is distorting the U.S. economy's ability to recover.  Let's put J.M. Keynes back in the ground and let him rest.  It's time to revive a much older and more venerable economic strategy:  austerity.

The Haiku of Finance for 06/11/10

China inflation
Slows rebound from global slump
No decoupling here

Never Let Them See You Sweat

Folks at the World Bank are starting to sweat about a double-dip:

The world recovery continues to tread cautiously forward, but Europe's debt crisis could trigger a "double-dip" global recession if markets lose confidence in governments' willingness to pay off their debt, the World Bank warned in its latest Global Economic Prospects 2010 report released Wednesday.

That means you need to worry too.  Ben Bernanke knows how bad things are in Europe; he should understandably be concerned about how the destruction of Europe's common currency would evaporate all those euros the Fed has taken into its electronic vaults in swaps for dollars. 

The World Bank and Ben Bernanke are on the same sheet of music.  They just won't tell you how bad things are really going to get.

Frederick's of Hollywood Loses Its Appeal

Frederick's of Hollywood (FOH) was once the gold standard in women's intimate apparel.  It lost that mantle years ago and probably cannot recover.  Market leader Victoria's Secret, a unit of Limited Brands (LTD), has over $5B of the intimate apparel market, while FOH has only $175mm.  Catching up will prove very difficult for FOH given the following hurdles. 

FOH can't rely upon its storied brand name for pricing power.  Their target market is the aspirational middle class with average income of $87k, age 18-55.  In a macroeconomic environment saturated with employment worries, this is not a clientele with price inelastic demand for nonessential apparel. 

FOH seems to be focusing its international growth strategy on gaining a retail foothold in South Korea and Eastern Europe. The problem with this strategy is that FOH has always focused on owning and operating its own stores, seeking an A-level retail space in B-level shopping centers.  Victoria's Secret has minimized such an overhead requirement in non-U.S. markets by licensing its brands through its La Senza unit to licensees in 49 countries.  If FOH wants real long term growth it needs to penetrate markets where middle classes are still growing (the BRIC nations come to mind).  Doing so with an ownership-only strategy for retail outlets will require knowledge of on-site retail space management practices in multiple countries that FOH simply does not possess.  FOH may have come to this realization late in the game; their 10-Q for Apr. 24, 2010 mentions a global licensing agreement for a new swimwear line and discussions with potential licensees for lifestyle products in China, Brazil, and elsewhere. 

Further glaring weaknesses in FOH's marketing strategy include a lack of co-branding with comparable aspirational lifestyle products and product placement in entertainment media.  Frederick's needs placement in trendy movies or TV shows viewed by their target demographic.  Look no further than the publicity Manolo Blahnik shoes gets from the Sex And The City entertainment franchise to see FOH's huge missed opportunity for both co-branding and placement.  FOH could have minted money from a partnership with either one. 

FOH is not out of options yet.  Its brand has residual value; selling the company to a major apparel maker like Abercrombie & Fitch (ANF) would add a historic intimate line to a clothier with a large retail presence.

The company's leadership is currently determined to go it alone with a turnaround strategy.  FOH trades as a penny stock because its net income and retained earnings are both negative on an annual basis, having declined precipitously for three years in a row.  Operating margin, ROA, and ROE are all negative as well.  FOH's most recent 10-Q (dated April 24) reveals a tiny quarterly profit of $218k while total sales declined by 8.5%.  That is encouraging for short-term solvency but not long-term growth.  A new marketing strategy may not be sufficient to keep the company independent for long if topline growth continues to deteriorate.  Fortunately for any potential acquirer, the current CEO's background as an investment banker may come in handy if a larger retailer wants a classic intimate brand. 

Full disclosure:  No position in any company mentioned in this post.

The Haiku of Finance for 06/09/10

Real estate con game
One lie after another
Just stay far away

Europe Gets Its Own TALF While Bond PMs Get A Clue

The phone lines between Washington and various European capitals must be overheating as Ben Bernanke and Tim Geithner mentor their aspirants across the water.  Europe has launched its equivalent of the TALF:

The European Financial Stability Facility would sell bonds backed by the guarantees and use the money it raises to make loans to euro-area nations in need, the finance ministers agreed yesterday in Luxembourg. The new entity would sell debt only after an aid request is made by a country.

The main difference with the U.S. TALF is that ours is funded by a single sovereign authority, the U.S. Treasury.  This EFSF can be undermined if one sovereign government decides to back out and refuse to contribute, leaving other countries on the hook.  Watch the CDS market for bets on which nation will be first to heard for the exit. 

In other news, bond portfolio managers come late to the game once again.  They finally figure out that the bond market is behaving kind of bubbly.  Really?  You don't say?  I've been saying that for what, a year and a half now?  I don't expect to hear from any bond fund about a job offer since I'm too prescient for their tastes.

Airlines: The Unreliable Investment

I like the transportation sector, but I don't think I could ever buy stock in an airline.  Their earnings are just too unpredictable:

The world’s airlines will book net profits of $2.5 billion in 2010, the International Air Transportation Association said, just three months after it forecast a $2.8 billion loss. 

The $5.3 billion turn round since the group’s March forecast is driven by a faster-than-expected recovery in the global economy, IATA said in its latest market forecast today, June 7.

 

The recent drop in fuel costs is probably another factor in this turnaround.  Still, I would never commit my own money to an industry with such wild swings in fortune.  Note that European airlines are still having trouble even after the skies have cleared of volcanic ash.  That second leg down in the Sovereignty Crunch will send more airlines into a tailspin.  I like that metaphor.  Hey, I like all of my metaphors. 

The Limerick of Finance for 06/06/10

Hungary might just be a black swan
How long can this drama go on?
French banks could implode
From a sovereign debt load
The euro, once strong, will be gone

Hungary - The Next Black Swan?

Well, it looks like we need to add an "H" to the PIIGS.  Hungary's leaders are now furiously backtracking from their comments that their government may soon be insolvent:

Hungary’s economic situation is stable and recent comments about a possible default were “unfortunate,” the government said, pledging to stick to the budget deficit goal approved by the country’s creditors.

Haven't you ever wished you could take back something you said in haste, even though you knew it was true?  I've been there.  It hurts to realize that what you just blurted out in a moment of clarity and honesty can't be un-said.

All of this bad European news is certainly good for the dollar.  Uncle Sam likes it too as long as it makes Treasuries easier to sell to the nervous and gullible. 

U.S. Treasury Taking Donations To Reduce National Debt

NPR broadcast a story today on efforts by individual Americans to reduce the federal government's debt.  The U.S. Treasury has had the equivalent of a sinking fund for some time.  A small number of patriotic Americans are willing to dig into their pockets of their own volition and throw money into the gaping maw of Uncle Sam's bag of IOUs.

That's cute.  Really.

I'm not inclined to tell people that their hobbyhorse is an exercise in futility.  I'd rather just wait for the day when the government quietly defaults on most of its obligations. 

The Haiku of Finance for 06/03/10

G-20 meeting
Reshape the global system
U.S. not in charge

Is BP A Good Buy?

Today I got an email inquiry from a fellow private investor and longtime reader of my blog.  He wanted my opinion on whether BP is a good buy given its current troubles. Here's my reply in its entirety. 

Hey! You've definitely got the right mindset. Buying a beaten-down stock is often a winning play but I just don't know enough about BP's other operations to say whether this is true. Looking at some stats on Reuters for BP . . .

5yr EPS growth is abysmally low - bad
Cap spending growth exceeds industry average - bad
ROE 5yr ave is 23% - good

And from Yahoo Finance . . .
Long-term debt less than 2X net income, thus manageable - good
Free cash flow is positive - good

I wouldn't buy BP given the two bad items above. I also haven't read their annual report and thus I'm not sure what their total reserves or extraction costs look like. Those are the two most important factors in estimating a commodity producer's future profitability. 

BTW, thanks for giving me my blog post for today. I'm still not profitable yet but I'll wait as long as that takes.

 

I don't mind admitting that my business hasn't reached its breakeven point yet.  I'm well aware that it will take a very long time for me to earn an income from my online presence. 

Too Much Education Leaves A Killer Debt Load

Here's a horror story in personal finance.  Too much debt can kill your earning potential before your career even gets started:

Today, however, Ms. Munna, a 26-year-old graduate of New York University, has nearly $100,000 in student loan debt from her four years in college, and affording the full monthly payments would be a struggle. For much of the time since her 2005 graduation, she's been enrolled in night school, which allows her to defer loan payments.

This is not a long-term solution, because the interest on the loans continues to pile up. So in an eerie echo of the mortgage crisis, tens of thousands of people like Ms. Munna are facing a reckoning. They and their families made borrowing decisions based more on emotion than reason, much as subprime borrowers assumed the value of their houses would always go up.

This is becoming an all too familiar refrain.  College kids hopped on the higher education treadmill only to find themselves earning menial wages and drowning in debt.  Like homeowners who assumed real estate would always go up in value, Generations X through Z assumed their marketability in the labor force would always go up, especially with more education.  Taking out loans for bachelor's degrees, MBAs, and law degrees was the human capital equivalent of a home equity loan for a while.

The trouble with this approach to maximizing one's utility is that indebted college grads now face a job market with permanent impairments.  Global wage arbitrage pushes wages in the global North down to those in the South.  Corporate indebtedness puts a ceiling on future salary and bonus increases.  Sovereign indebtedness puts a floor under future tax assessments.  Mix it all together and you have a milieu that will kill off any middle class aspirations in most college grads for decades to come. 

Here's an easy acid test.  If you need to take out a loan to obtain a degree, you're better off without the degree.  Don't become a debt slave in hopes of paying loans off with higher future earnings.  Instead, get some affordable skill training and go right to work.  Live at home or get a roommate.  Eat cheaply.  Live simply.  Save every penny and invest in things that generate cash flow (index funds, non-leveraged real estate, and resilient communities).  Stay away from college and its endowed hucksters until you're financially independent.  You'll have something to teach your instructors if you wait long enough.