Showing posts from 2007

Consumer Co-dependency

It appears that the abused average American has finally had enough. Target reported that Christmas sales were very weak and lowered their revenue growth numbers for December quite a bit. Add in the margin pressure from discounting and earnings in that sector should be a mess. The problems seem to be widespread and for once, stocks actually seem to be reacting to obvious fundamental problems. This should really be no surprise at all but sadly, equities have ignored fundamentals for so long that it's a shock when reality intrudes on the feeding frenzy.

Here at Financial Jenga, we've been documenting the many pressures facing consumers for some time now. Housing and mortgage debt were covered in Where to Start? We wrote about the deteriorating employment situation and failure of government statistics to reflect it in Behind the Numbers. The collapse of personal savings and explosion of total household debt was the theme of First Principles. Why is anyone surprised that a consumer …

Tactical Nukes

The fundamental case for a bull market died a long time ago and has not terribly sound in a long, given the combination of high valuations, slowing growth and a significant portion of earnings that were an outright illusion. Strategically speaking, the last time the bull case made any sense was in early 2006. That has not prevented tactical factors from pushing an overvalued market still higher in the interim. The primary tactical focus has been "liquidity" which readers of this blog will recognize as simply a synonym for growing debt.

The UDB threw off a tremendous amount of this "liquidity" as debt expanded rapidly. The serial collapse of mortgage finance, CDOs, MBS, asset-backed CP and other debt markets has reversed the flow as outstanding debt/credit shrinks. But how is this affecting stocks, you might ask? Well, there is the obvious collapse of profits in the building and financial sector as well as similar impending action in the consumer sector. But these ar…

Sea Change on the Street

Guys, there was a huge change of tone over the last two weeks and especially this week. The denial that has ruled Wall Street for so long is beginning to show major cracks. We're finally seeing grudging admissions that this is a much bigger problem than they were willing to admit. What used to be just a "subprime" crisis is now a "mortgage" crisis.

The terrible reports from major retailers like Pennys, Macys, Kohls and the spectrum of apparel shops along with restaurants like Starbucks, PF Chang, Chipotle, Brinker and Panera are causing the Street to question the "resilient consumer" thesis. They should since it is based on the ability of the consumer to dig themselves into an every deeper hole of debt. But McDonalds and Target did well and Walmart OK. What does it tell you when spending is switching from department stores to discounters and from premium or sit down restaurants to the golden arches?

We don't hear the word "contained"…

Tech Wreck

We've had ongoing weakness in profits for much of the technology sector so far this reporting season. But the sound of all the earnings misses has been drowned out by a handful of rapidly-growing companies with high multiples and even higher expectations. Jim Cramer of CNBC infamy has dubbed them the Four Horsemen. GOOG, RIMM and AAPL produced big numbers to feed the Nasdaq frenzy but the 4th horseman stumbled badly after the close today.

AMZN delivered strong revenue growth and beat profit expectations slightly - which was fine. Then they dropped a bombshell with their guidance.

Operating income is expected to be between $221 million and $291 million, or grow between 12% and 48% compared with fourth quarter 2006.First problem is the range is wide enough to drive a truck through. That tells you they have no real idea what is going to happen - rarely a good sign. Second problem is that expected EPS growth for 4Q is 100% year over year. At the top of their guidance, they only fall …

Special News Bulletin

Hello Avid Readers-

On October 20th, 2007 the 1998 Mercedes C280 of which this site is dedicated to was officially saved. This blog is dedicated to this event with....

The Top 5 Reasons Why the W202 Mercedes Kicks Ass!

1. The Bloodline
The W202's bloodline is quite prestigious. Before the W202 came into fruitation, the car's predecessor was the 190E. This car is number 10 on a recent Top 10 Greatest Mercedes' List 2.3-16 (1983) Mercedes 190E 2.3-16 The W201 series was introduced in 1982 to sit below the E-Class range and was quickly dubbed the 'Baby Benz'. By Mercedes own admission the car was 'massively over-engineered', the company spent £600 million on its development. That hewn from solid quality did mean the car wasn’t a fireball however. To remedy this Mercedes called in the wizards from Cosworth to breathe on the basic 2.3-litre four cylinder engine. Thanks to double overhead cams…

Reserves, Profits and Multiples

One of the key problems with valuation in the stock market today is the difficulty of determining actual profits are trying to compare the numbers that are reported to previous years where different standards were used. Many bulls have tried to tell me that I should buy because the S&P 500 is selling at a P/E of only 16x 2008 earnings. Well, there are a ton of problems with that statement so let's just cover the fatal flaws.

First, I don't know what 2008 earnings are going to be and neither do they. They are using a guess as the denominator to get that multiple. The number we do have is the historical reported numbers and based on that the multiple is 18x, significantly higher.

Second, 18x is very expensive and even 16x is far from cheap. 16x would be a normal peak multiple over the business cycle. 18x would be extreme territory normally. During the 20th century, the P/E for the S&P 500 has exceeded 18x on a sustained basis 3 times: the late 1920s, the mid 1960s and the …

The Top 5 Differences Between German and Italian Cars

Cars, like women (minus the whole crazy aspect), vary when they are from different parts of the world. For example, the general perception with American cars is that, like the nation's populace, grow exponentially every year in terms of gas guzzling and power. Thinking along these lines, The Autoblog presents the Differences Between German and Italian Cars.

1. Italian Cars cannot be pushed to their limit.
Apparently, you can beat a German car like a red-headed stepchild and the sicko will beg for more.They are masochists, just begging for more pain. On the other hand, Italian cars are like Paris Hilton on The Simple Life- You put it to work, it bitches and moans, breaks a nail (or a clutch) and calls it a day. Winner- German

These two pictures are one in the same

2. Italian Cars are Sexier
Well, there is a reason that these Ferraris cannot be pushed- they are too friggin' beautiful to drive. You wouldn't put a supermodel (that you owned and paid 100,000k for nonetheless) to ru…

Why SaveMyBenz hates Volvos

We hate Volvos. Now, with that out of our way, here is why.

1. Volvo's Engines are Mechanical Freakshows
Five Cylinder engines are not natural. Engines should be in divisible by twos- 4 Cylinder, V6, V8, V12. None of this T5 bullshit. What the hell?! Manufacters claim that a 5 is inherinatly smoother than a 4, but c'mon. Frankie the Mechanic does not want to work on a Swedish 5 when he can work on more orthodox engine with six friggin' cylinders. Anywho...Volvos are the anti-savemybenz brand...and Top Gear, with their various destruction of Volvo Estate Wagons seems to agree. (Youtube Top Gear and Volvo for my case in point. Besides their use of 5 cylinder engines.

2. They are a disgrace to their Viking Heritage.
Volvo is as badass as Melissa Etheridge. Their ancestors however...are the Vikings. Yea...the guys lead by Thor... with his Hammer of the Gods. In our minds, the Swedes of yesteryear didn't give a flying fuck about safety, because they are too busy trying to res…

Global Reversal

It's been a few weeks and there's been a bit of excitement surrounding the Fed. But from an economic and credit standpoint, it's largely "sound and fury, signifying nothing." Risk spreads are still wide, lots of high-grade and few low-grade bonds are being issued, market rates (all but the shortest maturities) are higher not lower. Sure, stock markets are rallying on the promise of inflation but the Fed may not be able to deliver, especially since only the Bank of Japan is using the same playbook.

If you look closely, the recent past is very similar to the 1970s. We have rising inflation everywhere, though masked this time using statistical manipulation in the First World. Inflationary credit excess driving unsustainable demand for all kinds of stuff. This benefits rising industrial exporters (Japan then, China now) and commodities producers (OPEC, Chile, Brazil, Canada, Australia, Texas, Alberta and various African nations). We experienced a co-ordinated global b…

Australia Leads the Way

The race to the bottom in financial responsibility reached a new milestone today. The Reserve Bank of Australia - their equivalent to the Fed agreed to take asset-backed debt paper as collateral for repo loans to commercial banks. The Wall Street Journal reports this morning:

Banks that may be forced to assume assets from the conduits that have financing coming due could themselves face shortages of capital.

To head off such a problem, Australia's central bank, the Reserve Bank of Australia, has relaxed rules on collateral it will accept for short-term funding. This would enable banks to take more time to evaluate which portions of the asset-backed commercial-paper market are most affected by ailing subprime mortgages.

In doing so the Australians went beyond the Federal Reserve, which doesn't accept such paper as collateral in repo operations but did recently clarify it was willing to accept a wide variety of such paper for its lesser-used, and costlier, "discount window&quo…

Behind the Numbers

Today we hear that 4,000 fewer people had jobs in the USA in August than in July. Don't believe that - the losses are much worse than just 4k.

The numbers of losses have just gotten too big for the statistical "adjustments" to hide. The actual employer survey data showed job losses throughout the second quarter and minimal gains in the first quarter. The Birth/Death Model added 120k jobs in August. That is the assumed net addition from startup businesses, less the losses from existing firms folding. Does anybody actually believe that number should be positive instead of negative given the number of small business failures? The actual employer survey showed 124k losses. The reality is likely to be worse than that once the actual net jobs from business startups and failures is measured.

The household survey has been flashing danger even longer. No jobs created since November of last year. August household survey shows 316k jobs lost. The unemployment number stayed…

Ongoing Credit Implosion

The rate of implosion in the credit markets continues to accelerate. In fact, the process seems to be proceeding very rapidly and the only element missing is mass bond defaults. According to Bloomberg, the asset-backed commercial paper (ABCP) market has shrunk by 20% in a mere three weeks and the total CP market is 11% smaller over that period. This type of credit has contracted by $244 billion in a very short time. For those who think the Fed can simply "print money" to revive asset inflation, $244 billion is roughly 4x the $68 billion total of all US currency in circulation today. And of course, the CP market is just one of many credit markets undergoing a buyers' strike.

Private label MBS of any kind is very hard to sell right now, which is why even Countrywide is doing almost nothing but conforming loans.

[Countrywide] says that soon about 90% of its originations will conform to either bank loan or such so-called "Government Sponsored Enterprises" standards.T…

First Principles

Well, it's been one heck of a week. With all of the insanity going on around us, sometimes it's best to take a step back and return to first principles. One of those is the Business Cycle - you know that thing that the Fed has supposedly abolished? The two questions that come to mind immediately are "why did the cycle exist?" and "how did the Fed get rid of it?"

The first one is easy. Economic cycles have existed throughout our history and always will exist as long as emotional humans are making economic decisions. The National Bureau of Economic Research has tracked US economic cycles going back to the mid-19th century. In the immediate postwar period, the cycles became more predictable as the Fed began to regulate them and induce the occasional recession to purge excesses before the market did it for them. During this period, it was discovered that the cycle could be manipulated though not controlled. The typical pattern was roughly three years of exp…

Fed Actions and Terrorist Attacks

We are beginning to see severe impairment of credit functions - the fruits of massive and long standing frauds that have recently come to light. By now, many of you are familiar with the 'mark to model' fraud, where the imaginary prices generated by a computer model are preferred over the actual prices which are being paid by actual people - especially when using the former allows firms to report gains rather than the losses they have suffered in reality. With some 'investment grade' paper trading at huge discounts to par, the rating services have a lot of explaining to do. The fee structures for structured finance create serious conflicts of interest."S&P, Moody's and Fitch have made more money from evaluating structured finance--which includes CDOs and asset-backed securities--than from rating anything else, including corporate and municipal bonds, according to their financial reports. The companies charge as much as three times more to rate CDOs than to…

Humpty Dumpty Repair

It appears that the CBs have managed to stave of an immediate disaster in the financial markets - at least for the moment. Yet any hope of a material turnaround in market conditions seems distant indeed. The entire system was built on an ever-rising tide of debt and confidence. Debt served to expand the money supply and confidence ensured that the larger pool of money would move through the economy at accelerating velocity.

Now, fears of default have undermined the willingness to lend and borrow - undermining the psychological conditions necessary to sustain debt growth. At the same time, confidence has been crushed, slowing the headlong rush of money around the globe. The sale of CDOs has fallen dramatically - 35% from June to July. These instruments epitomize both trends; they serve to direct capital into new debt deals quickly while simultaneously taking out loans themselves to leverage the profits from those deals.

Confidence has not merely broken, it is shattered. The Fed and other…

Legions of the Damned

In Leverage and Its Uses, we discussed the large and growing cohort of companies with shaky credit and bond ratings in the CCC to C range. Many of these firms are effectively bankrupt already, borrowing just to pay the interest on existing debt. Such a practice was only possible in the loose money conditions of the UDB (Universal Debt Bubble), which is now bursting with shocking speed. These companies form one one cohort within the Legions of the Damned.

Today's actions by the European Central Bank and the Federal Reserve cofirm that the real threat is DEFLATION - not inflation. Central Banks don't pump $150 billion dollars into the banking system because they are afraid of creating too much money.
Central banks move to counter liquidity crunch

Central banks no longer expand the money supply by literally printing currency. They create new money by expanding credit through the financial system - mostly the banks but with other financial institutions playing an increasingly importa…

Leverage and Its Uses

During the Universal Debt Bubble (UDB), corporations borrowed a lot of money, so where did it go? Quite a bit of it went into buying other companies as worldwide buyouts reached a record $4.06 trillion in 2006, with about 40% of that in the USA. That was well above the previous record $3.3 trillion in 2000. The difference was that the M&A boom in 2000 was done largely with stock; this one is funded with debt. When things went bad in 2000, the equity didn't have to be paid back, but the debt from the current frenzy will.

While a lot of money went to buy other companies' stock, another big chunk funded companies who bought back their own stock. Naturally, all of this debt-funded stock buying has served to prop up equity prices. Many shareholders came to believe that they were in a no-lose position because of continuous demand from buybacks. And if anything went wrong, someone else would swoop in and buy the whole company as part of the M&A wave. That sort of overconfidenc…

Corporate Finance

The Universal Debt Bubble (UDB) has enabled many activities that could never be sustained in anything resembling a normal environment. Perhaps nowhere is this more clear than in the field of corporate finance and the related debt and equity markets. Let's look at the borrowing side first.

Just as with housing, cheap credit was widely available in the corporate sector. Anybody could borrow and at much lower than normal interest rates too.

One of the most important effects is that it was almost impossible to default on a debt. Since there was almost always another lender lined up to make a loan, companies refinanced instead of going bankrupt. This was very similar to the way homeowners refinanced instead of facing foreclosure. The magnitude of the drop in defaults was astounding. A study by Moody's showed that over 32 years the lowest rated bonds (Caa, Ca and C) averaged 23.7% defaults each year.…

Where to Start?

This is such an enormous subject, it's difficult to know where to begin. I'm going to start with the prevalence and destructiveness of excessive debt. The best illustration of that so far is in the housing market. The symptoms there are more obvious and advanced than elsewhere. So let's go to the stats.

According to the Federal Reserve mortgage lending grew from $153.8 bil in 1995 to $1,051.8 bil in 2005 - a mere 584% in 10 years.

The results were amazingly predictable: housing prices rising rapidly, with a speculative frenzy at the end. It's axiomatic that bubbles can only last as long as there is more money coming in. I'll freely admit that I expected a top in housing in 2004 as the pool of qualified buyers was drained. The lenders fooled us by making further loans to unqualified buyers to keep things going for another 15-18 months. In the end, this has only made things worse naturally.

We are at the front e…