Friday, 29 February 2008

UK Home Prices Fall For 4th Consecutive Month

UK House prices fell -0.5% in February after a -0.3% decline in January. That makes 4 consecutive monthly declines in UK home prices. A trend not seen for 8 years when home prices fell for the 4 months from May 2000 - August 2000. From Nationwide:

House price inflation falls to 2.7% in February

• House prices fell by 0.5% in February, the fourth consecutive monthly decline
• The annual rate of house price inflation fell from 4.2% to 2.7%
• UK recession “a remote risk for the UK economy”

Commenting on the figures Fionnuala Earley, Nationwide's Chief Economist, said:

"The price of a typical house fell by 0.5% during February, bringing the annual rate of house price growth down to 2.7%. This is the fourth consecutive monthly fall in house prices and brings the annual rate of house price inflation to its lowest since November 2005. The trend in prices is clearly weakening, but the size of the drop in the annual rate between January and February perhaps overstates the rate of cooling as it partly reflects the particularly strong increase in prices in February last year. The 3-month on 3-month rate of price growth rate fell to -1% in February, down from -0.4% the previous month. The average price of a typical property now stands at £179,358, an increase of £4,653, or £12.75 per day, over the last 12 months.

The trend is not your friend for UK Homeowners. Expect year over price changes to move into negative territory for the first time in more than a decade by mid-year if not before.

XAO Declines For 4th Straight Month

It was a close call but as predicted last month the XAO finished down for the month of February falling by -0.4%. That makes 4 straight months of declines. The first time that has happened since 1992 when the XAO fell for 5 consecutive months from June to October.

Despite some good earnings reports the market seemed more interested in focusing on problems in the financial sector. It's difficult for the market to rise without the cooperation of the banks and that is exactly what has happened since the XAO put in it's lows back on January 22nd.

You can see from the chart above that whilst the XAO has risen almost 9% since it's lows of January 22nd, the major banks have continued to fall, CBA the worst affected dropping -14% since that date. Other big financial names to suffer since January 22nd include MQG and QBE.

So what does next month bring? With earnings season behind us, economic data may prevail domestically. Whilst business sentiment turned down in February economic data should be continue to show a strong underlying Australian economy. However expectations that the RBA will hike rates in March (currently at 83% for a 25bps rise) and a continued hawkish tone, may keep the markets in a cautious mood.

Overseas, US economic data continues to show a deteriorating economy, it's hard to find a single economic data point that looks positive. As usual next Friday's non-farm payroll data will be watched closely.

Also earnings from the likes of Goldman Sachs and Morgan Stanley will be scrutinized by the market for possible writedowns. Yesterday's big $11 billion writedown taken by AIG is a reminder that we are nowhere near the end of the writedown process with US financial institutions.

As usual then, the call on the likely direction of the XAO in March is any body's guess. As stated before, not since 1992 has the XAO fallen 5 months in a row. However, whilst the odds of a further decline in March seem unlikely, I'm going to stick with the trend and bet that the XAO finishes lower at the end of March.

Thursday, 28 February 2008

Initial Jobless Claims jumps in latest week.



In the week ending Feb. 23, the advance figure for seasonally adjusted initial claims was 373,000, an increase of 19,000 from the previous week's revised figure of 354,000. The 4-week moving average was 360,500, a decrease of 1,250 from the previous week's revised average of 361,750.

The advance seasonally adjusted insured unemployment rate was 2.1 percent for the week ending Feb. 16, unchanged from the prior week's unrevised rate of 2.1 percent.

The advance number for seasonally adjusted insured unemployment during the week ending Feb. 16 was 2,807,000, an increase of 21,000 from the preceding week's revised level of 2,786,000. The 4-week moving average was 2,777,500, an increase of 24,250 from the preceding week's revised average of 2,753,250.

The 4 week moving average declined slightly by 1,250 however that is largely due to the 2 and half year high number of 378k dropping out of the calculations. As happened last week the previous week was revised upwards, this week by 5k.

Claims remain elevated at the 360k mark. Wall Street lemmings continue to proclaim that jobless claims are not yet at recessionary levels. However by the time they are at recessionary levels, the recession will be well underway and by that time, making the recession call, as Gary Shilling recently said, is about as useful as a pocket in your underpants.

US New Home Sales Continue Downward Spiral

The above graph shows US New Home Home Sales vs Recessions. The only thing missing from the is graph is a light grey line representing the current recession. Every time in the last 40 years that New Home Sales fell significantly a recession ensued.

That doesn't mean that a decline in housing causes recessions but that it is a good leading indicator. The latest report shows that New Home Sales continue to fall to levels not seen since the 1991 Recession. From the US Census Bureau:


Sales of new one-family houses in January 2008 were at a seasonally adjusted annual rate of 588,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 2.8 percent below the revised December rate of 605,000 and is 33.9 percent below the January 2007 estimate of 890,000.

The median sales price of new houses sold in January 2008 was $216,000; the average sales price was $276,600. The seasonally adjusted estimate of new houses for sale at the end of January was 482,000. This represents a supply of 9.9 months at the current sales rate.

As seen below, the number of houses available for sale declined. That's obviously a good thing as the amount of inventory is reduced. Some of that may be sellers taking their house off the market because they don't want to accept lower prices, however the trend is at least going in the right direction.

The months supply of inventory however, continues to rise as the level of sales decline out-paces the reduction in inventory.

One final observation about the January numbers. Looking at seasonally unadjusted data, the latest month is the lowest number of sales in the month of January since 1991, the trough of the last down cycle in new home sales.

Wednesday, 27 February 2008

Case-Shiller Home Prices Plunge..... Again

The Case Shiller Home Price Index declines continue to accelerate to the downside according to the latest data for the month of December 2007. Year over year declines have now reached a record -9.8% for the 10 City composite whilst the year over year decline in the 20 city composite plunged to a new low of -9.1%. From S&P;

Data through December 2007, released today by Standard & Poor’s for its S&P/Case-Shiller® Home Price Indices, the leading measure of U.S. home prices, show broad based declines in the prices of existing single family homes across the United States, marking 2007 as a full year of declining home prices.

The decline in the S&P/Case-Shiller® U.S. National Home Price Index -- which covers all nine U.S. census divisions -- neared double digits, posting -8.9% versus the 4th quarter of 2006, the largest decline in the series 20-year history. During the 1990-91 housing recession the annual rate bottomed at -2.8%. The 10-City Composite also set a new record, with an annual decline of 9.8%. In December, the 20-City Composite recorded an annual decline of 9.1%.

"We reached a somber year-end for the housing market in 2007," says Robert J. Shiller, Professor at Yale University and Chief Economist at MacroMarkets LLC. "Home prices across the nation and in most metro areas are significantly lower than where they were a year ago. Wherever you look things look bleak, with 17 of the 20 metro areas reporting annual declines and the remaining three reporting flat or moderate growth rates. Looking closely at these negative returns, you will see that 14 of the metro areas are also reporting record lows and eight are in double digit decline. The monthly data paint a similar picture, with all metro areas now reporting at least four consecutive negative monthly returns."

From their peak the 10 city index is off -11.4% whilst the 20 city index is off -10.5%. Before we get carried away with these historic declines, it is important to remember the heights from which prices have fallen.

As you can see above, house prices shot up hugely from the start of this decade to the peak in mid 2006. Americans who bought houses prior to March 2005 are still probably in the green, however that won't last much longer. As prices continue to decline more and more homeowners will find themselves in the red.

Some economists are predicting that house prices will fall between -20% -30%. A -20% fall would bring the 10 city index down to a level of about 180. or equivalent to prices last seen in 2004. A 30% fall in the 10 city index would imply a level of 158 or prices last seen in November 2003.

You can see on the graph above that an index level of 158 is still a little more than half way up that steep increase that started about a decade ago. Thus there is no reason why house prices can't fall more than 30%.

Whilst the market seems to have become accustomed to poor housing data I doubt they have discounted a slow decline in house prices in excess of -30% from the peak for the next 2 - 3 years. As homeowners come to grips with the reality that their homes are not and never were worth what they paid for them, they will, in increasing numbers, bite the bullet and lower their prices.

Tuesday, 26 February 2008

US Existing Home Sales

From the National Association of Realtors;

Existing-home sales – including single-family, townhomes, condominiums and co-ops – slipped 0.4 percent to a seasonally adjusted annual rate(1) of 4.89 million units in January from an upwardly revised level of 4.91 million in December, and are 23.4 percent below the 6.44 million-unit pace in January 2007....

....The national median existing-home price(2) for all housing types was $201,100 in January, down 4.6 percent from a year ago when the median was $210,900. Because the slowdown in sales is greater in high-cost markets, there is a downward pull to the national median from a year ago when there were relatively more sales in higher priced areas....

....Total housing inventory rose 5.5 percent at the end of January to 4.19 million existing homes available for sale, which represents a 10.3-month supply(3) at the current sales pace, up from a 9.7-month supply in December.

Inventories continue to pile up despite the low rate of sales. The bottom callers are reluctant to come out as well they should. There is more pain to come. As always for a more in depth coverage of US Housing check out Calculated Risk.

Monday, 25 February 2008

Whitney Unrelenting on Citi

Meredith Whitney has another scathing report on Citi. Whitney has slashed her earnings forecast for FY08 by 70% and says Citi may need to sell as much as $100 billion worth of assets to shore up it's balance sheet. from

Oppenheimer slashes Citi EPS outlook, sees big asset sales

Oppenheimer analysts on Monday slashed their earnings estimate for Citigroup Inc's. (C) full year 2008 earnings per share estimate by 70%, to 75 cents from $2.70, and said the bank may have to sell $100 billion of assets to put its balance sheet right. Analyst Meredith Whitney said Monday that Citi shares could fall below $16 a share as they retreat to valuations from the last difficult credit cycle of 1990-1991. "The three largest problems for Citigroup are further writedowns to their carrying values of CDOs related to sub-prime mortgages, further writedowns from leverage lending commitments, and further writedowns associated with on balance sheet consumer loans," Whitney wrote in her report.

Reverse Corp (REF) BUY

Reverse Corp (REF) as it's name suggests, provides reverse call charge services. Basically if you are 'out and about' and need to make a call to a fixed line phone and you either have no money, or your pre-paid mobile is out of money, you can call Reverse Corp's service and get connected free of charge, if of course the call recipient chooses to accept the call.

That's it, that's all they do and they are able to do it very profitably, As can be seen below, the company is able to generate EBIT margins in excess of 50%.

The company's automated technology platform has significant spare capacity enabling increased call volumes to be handled with little or no increase in costs. Thus capital expenditure is largely by way of maintenance and support.

The biggest cost for Reverse Corp is it's marketing expenses. A well recognised brand in both it's target markets of the UK and Australia is key to the company's success. REF's biggest competition comes from the incumbent telecommunications providers, Telstra in Australia and BT in the UK. However, since the reverse charge market is a very small portion of the incumbents revenue, they have no incentive to invest substantially in building brand awareness.

This also provides some insulation from competition, which would need to substantially invest in advertising to gain a foothold in the reverse charge market. Thus REF is a niche player that can drive high profit margins due to their low cost operating model and relatively limited competition.

This is the kind of business I like. It's simple and thus easy to understand, they have a niche and there are reasonably high barriers to entry. And most importantly the company requires very little capital to derive it's profits from. So what happened to it's share price?

As you can see the share price has basically fallen off a cliff in the last 6 months losing more than -63% from the peak in August 2007. Now just because a company's share price plummets doesn't make it cheap. The first thing you should ask yourself is did it actually deserve that high share price in the first place.

In my humble opinion, the answer without doubt is no. I would never have paid $6 for a share in this company, I probably wouldn't even have paid $3. However after falling another -7.0% today I picked some up at $2.22. This price for me, provides a reasonable margin of safety, not to mention the $0.12 cent dividend the company just declared.

The company recently reported earnings of $10.9m for 1H08. Below is the track record of the company's earnings broken down by halves. Whilst the company increased revenues and profits from 1H07, they actually declined slightly from 2H07 levels.

Some of the decline can be explained by the strong $AUD. The company derives 60% of their earnings from the UK. With the RBA set to raise interest rates at least once more, the UK operations will continue to be pressured by the strong $AUD. To offset this somewhat the company has raised prices effective from January 1st. Also the company unwound a currency hedge in January resulting in a one-off $1.0m profit.

Apart from a strong $AUD, REF is currently pursuing several contracts in the UK with both mobile and fixed line service providers, however none are likely to come to fruition in the current financial year.

Look ahead the company has already completed building a platform in Ireland and is set to launch by the end of August. In addition the company is in negotiations with the major incumbent in Spain, is holding talks with Telecom New Zealand and will also submit a proposal to the French incumbent in 4Q08 providing growth into FY09 and beyond.


Because REF requires just a small amount of capital to derive it's profits, the company has an outstandingly high return on equity. That return on equity is further enhanced by the high dividend payout ratio. In the last 2 halves the company has payed out almost 100% of profits in fully franked dividends.

Given the unfavourable AUD/GBP exchange rate and the absence of further growth opportunities in the current half I have forecast flat profit growth for the second half from the first. Also I have assumed a 100% payout ratio of dividends.

Whilst the company has typically paid out less than 100% of earnings I have assumed they will pay out 100% of profits this year in an attempt to maintain the dividend at current levels.

The payout ratio is important for a company that produces such a high return on equity (currently forecast at 255%). The value increases significantly with the amount of retained profits that can be reinvested back in the business at those high rates of return. Assuming a 100% payout ratio actually lowers the value of business because it assumes profits are not reinvested.

Thus assuming flat profit growth, a 100% payout ratio and discounting back at 15% I come to a conservative valuation of $2.52.

As with all valuations, they can change significantly by making minor changes to assumptions. If for example, I assumed a payout ratio of 90%, which is more in line with the historical average, the valuation almost doubles because 10% of retained profits can be reinvested at that very high return on equity.

The point is not to get bogged down in coming up with a precise valuation, but rather as Warren Buffet says, "it is better to be approximately right than precisely wrong."

REF will do it tough in the second half due to the strong $AUD and the lack of growth opportunities. However the business fundamentals remain strong and the company is poised to leverage it's low cost base with future international growth opportunities in the years ahead.

Friday, 22 February 2008

Expect More Writedowns From The Banks

Meredith Whitney has been dead on with respect to US banks. Every one remembers her for the call that she made about Citibank needing to cut their dividend which they subsequently did.

Now she is back claiming that Citibank will need to cut their dividend again and raise more capital. Also she talks about the steepening loss curves on a number of the bank's mortgage portfolios. Again she claims Citi is the worst positioned. Click on the image below to watch a very informative interview.

Initial Jobless Claims Punch Through 350,000

Last week I said we should expect the 4 week moving average of Initial Jobless Claims to punch through the 350,000 mark. That's exactly what happened in the latest week. From the Department of Commerce:



In the week ending Feb.16, the advance figure for seasonally adjusted initial claims was 349,000, a decrease of 9,000 from the previous week's revised figure of 358,000. The 4-week moving average was 360,500, an increase of 10,750 from the previous week's revised average of 349,750.

The advance seasonally adjusted insured unemployment rate was 2.1 percent for the week ending Feb. 9, unchanged from the prior week's unrevised rate of 2.1 percent.

The advance number for seasonally adjusted insured unemployment during the week ending Feb. 9 was 2,784,000, an increase of 48,000 from the preceding week's revised level of 2,736,000. The 4-week moving average was 2,752,500, an increase of 28,750 from the preceding week's revised average of 2,723,750.

The 4-week MA excluding hurricane Katrina, is at it's highest level since Feb 2004. Interestingly last week's numbers were revised up from 349,000 to 358,000. Interesting because revisions are usually small.

To be clear there is nothing magical about the 350,000 level. From the chart above you can see that the 4-week MA briefly rose to the 390,000 level in 1996 without a recession. A sustained level of over 400,000 would be needed to confirm a recession. However, waiting for the data to confirm is of little help. Combined with other economic data I think the recession call is an easy one to make.

Thursday, 21 February 2008

PBP 1H08 Result

Occasionally you get a company with finacial statments which are clear, simple and clean of any irregularites. Unfortunately PBP isn't one of them, but I'll get to that later, firstly let's take a look at PBP's 1H08 result.

As you can see, eps grew by a strong 58.3% from 1H07 on the back of a 38.7% increase in sales. Margins and interest cover also improved. Looks good on the surface, however 1H07 is the not the best comparison as the company didn't really click into gear until 2H07. The slide below is from the 1H07 Investor Presentation.

You can see at the bottom of the slide the profit drivers for the second half of 2007 were;

  • a very strong contract manufacturing book

  • significant contribution of new products, and

  • sales mix improvement towards higher margin products.
The company achieved those milestones with a strong 2H07 performance more than doubling profit from the first half. So let's compare 1H08 with 2H07.

Whillst Sales were up, EBITDA, EBIT and Profit before tax were all down from 2H07. NPAT and eps were significantly down because of the low effective tax rate of 11% in 2H07. However, even after normalising for tax, NPAT was lower in 1H08 than 2H07. Since sales were higher but the other aforementioned line items were lower, obviously margins deteriorated, which you can also see. Why did this happen?

(click on picture for a sharper image)

The image above shows a blowout in Sales and Marketing expenses compared to 1H07. Even compared to 2H07 sales and marketing expenses almost doubled from $2.1m in 2H07 to $4.0m in 1H08.

Obviously that Sales and Marketing expenditure has yet to pay off. However given that the company expects at least 30% in profit before tax for the full year it seems likely that they expect it pay off in the second half.

30% growth would imply $7.88m profit before tax for FY08. That implies profit before tax of at least $4.38m in the second half. That result will still only be 9.6% higher than that achieved in 2H07.

Of course the company could do much better than 30% growth but they don't give much reason to think so. Below is a slide from this years investor presentation. The company is much less specific about how they will drive 2H07 profit growth this year. Instead they offer some broad brush statements on future growth.

It also seems odd that the company reported profit before taxof $2.75m for the first 4 months of 1H07 as reported in an investor update in Novemeber and then only managed $0.75m for the remaining 2 months. Maybe the company spent heavily on marketing around this time? Or maybe consumers switched their spending habits to other discretionary items around Christmas?

In addition there are small question marks over the company's financial statements. More precisely it has to do with what has been omitted. The notes to the accounts do not break out revenue and expenses. They also don't show the amount of costs they have capitalised.

As I mentioned before capitalising costs can be justified, however PBP does something dodgy and says that some of their assets have 'infinite' lives. They capitalise the research and development costs as internally generated goodwill and then never have to amortise it because they say it has an infinite life. How many assets do you know that infinite lives?

They don't capitalise much (about $1.1m in prior periods) but it's enough to make the results look prettier. There may well be reasonable explanation to all the issues I have raised, I don't have the benefit of attending analyst presentations or have open door access to management. I did send off an email with my queries although I haven;t heard back from them.

On the positive side the company paid down some debt with their free cashflow and paid their first dividend of $0.01 unfranked.

The market seems to like the result with the share price rising 6%. However, I decided to sell my small parcel of PBP shares today. After brokerage I realised a 13% profit over a holding period of abot 15 months. Not great but not too bad given that the XAO is up just 4.4% over the same period.

In summary I'm uncomfortable with the lack of disclosure by management and I am somewhat skeptical, given the 1H08 report today, of the company's ability to deliver strong earnings growth. When PBP first announced their profit guidance of 30% growth in profit before tax for FY08. I noted at that time that 30% growth could be reached by simply doubling 2H07 profit before tax - implying no growth.

Thus I was expecting much better given the companies expanding range of products and shift to a higher margin mix of products. However today's result doesn't instill me with confidence that the company can do much better at all.

Given the low effective tax rate of 18% last year, whilst 30% growth in profit before tax sounds good, eps growth will be signifcantly below that with a 30% tax rate. Again the company may do much better than 30% growth. Just cutting back to 2H07 levels for marketing expenses would produce a much better second half. However rather than hold out for a better half I will look elsewhere for opportunities with more certain earnings growth.

Why Fed Rate Cuts Won't Work

Martin Feldstein is the President and CEO of the National Bureau of Economic Research (NBER), the organzation that officially dates economic cycles in the U.S. In a Wall Street Journal article yesterday Feldstein was surprisingly candid about the Fed's inability to prevent a recession

Our Economic Dilemma

Although it is too soon to tell whether the United States has entered a recession, there is mounting evidence that a recession has in fact begun. Key measures of economic activity stopped growing in December and January or actually began to decline. The collapse of house prices and the crisis in the credit markets continue to depress the real economy.

The sharp reduction in the federal funds interest rate and the new fiscal stimulus package may, of course, be enough to avert a downturn. Many forecasters still predict that the economy will just slow in the first part of this year and then rebound after the summer. But the hope that monetary and fiscal policies would prevent continued weakness by boosting consumer confidence was derailed by the recent report that consumer confidence in January collapsed to the lowest level since 1992.

If a recession does occur, it could last longer and be more painful than the past several downturns because of differences in its origin and character. The recessions that began in 1991 and 2001 lasted only eight months from the start of the downturn until the beginning of the recovery. Even the deeper recession of 1981 lasted only 16 months.

But these past recessions were caused by deliberate Federal Reserve policy aimed at reversing a rise in inflation. In those cases, the Fed increased real interest rates until it saw the economic slowdown that it thought would move us back toward price stability. It then reversed course, reducing interest rates and bringing the recession to an end.

In contrast, the real interest rate in 2006 and 2007 stayed at a relatively low level of less than 3%. A key cause of the present slowdown and potential recession was not a tightening of monetary policy but the bursting of the house-price bubble after six years of exceptionally rapid house-price increases. The Fed therefore will not be able to end the recession as it did previous ones by turning off a tight monetary policy....

....The dysfunctional character of the credit markets means that a Fed policy of reducing interest rates cannot be as effective in stimulating the economy as it has been in the past. Monetary policy may simply lack traction in the current credit environment.

Click on the link to read the whole article. The part in bold is key for me. Cutting interest rates to help lift the economy out of a recession that was brought about by an asset bubble that fed off losse monetary policy cannot be cured by more of the same.

Wednesday, 20 February 2008

US Housing Starts, Completions & Permits

From the US Census bureau:


Privately-owned housing units authorized by building permits in January were at a seasonally adjusted annual rate of 1,048,000. This is 3.0 percent below the revised December rate of 1,080,000 and is 33.1 percent below the revised January
2007 estimate of 1,566,000.

Single-family authorizations in January were at a rate of 673,000; this is 4.1 percent below the December figure of 702,000. Authorizations of units in buildings with five units or more were at a rate of 336,000 in January.


Privately-owned housing starts in January were at a seasonally adjusted annual rate of 1,012,000. This is 0.8 percent above the revised December estimate of 1,004,000, but is 27.9 percent below the revised January 2007 rate of 1,403,000.

Single-family housing starts in January were at a rate of 743,000; this is 5.2 percent below the December figure of 784,000. The January rate for units in buildings with five units or more was 247,000.


Privately-owned housing completions in January were at a seasonally adjusted annual rate of 1,351,000. This is 1.8 percent above the revised December estimate of 1,327,000, but is 26.2 percent below the revised January 2007 rate of 1,830,000.

Single-family housing completions in January were at a rate of 1,010,000; this is 1.0 percent below the December figure of 1,020,000. The January rate for units in buildings with five units or more was 303,000.

Remember permits are generally considered a better indicator of building fundamentals than starts, which can be heavily influenced by weather conditions. The sampling error on permits is also lower.

Starts were flat for the month of January, however starts for single family units fell to their lowest levels since Jan 1991.

Walker Sees China Growth Slowing To 4% - 6%

Jim Walker of Asianomics painted a somewhat sobering picture of the Chinese economy in an interview on Bloomberg today. Walker projects that Chinese growth could more than halve to around 4% - 6% and sees the credit crunch lasting 4-5 years.

(Click on the image for interview)

Walker has a simple no-nonsense way of talking. When asked about his forecast timeline for the credit crunch to play out he replied;

"Well it's been a long time building. We've had 15 years of a super boom basically in the US. We've had 15 years of financial alchemy from the central banks. So it's probably going to take quite a long time for the whole structured products fiasco to play out and deflate. So 4 to 5 years sounds about a sensible time period for me."

No doubt Walker's forecasts would be viewed as extreme by mainstream economists. However as often happens when its too late, the extreme becomes accepted as mainstream. Anyone remember the housing bust that couldn't happen because house prices always go up?

Tuesday, 19 February 2008

Writedowns Continue to Flow

If you thought writedowns by major financial institutions were nearly over with, think again. From Bloomberg:

Credit Suisse Writedowns to Cut Profit by $1 Billion

Credit Suisse Group, Switzerland's second-largest bank, said an internal review discovered pricing errors on bonds that will cut first-quarter profit by about $1 billion.

Credit Suisse reduced the value of asset-backed securities by $2.85 billion, the Zurich-based bank said in an e-mailed statement today. The company is assessing whether 2007 earnings may be affected by the pricing errors.

The writedowns reflect ``significant adverse first quarter 2008 market developments'' and are the result of an internal review that is continuing, Credit Suisse said. The bank also ``identified mismarkings and pricing errors by a small number of traders'' in the structured credit trading business. Credit Suisse reported last week that net writedowns on debt and loans in 2007 year amounted to 2 billion Swiss francs ($1.8 billion).

``I'm speechless,'' said Georg Kanders, an analyst at WestLB in Duesseldorf with a ``buy'' recommendation on Credit Suisse. ``To announce this just a week after reporting earnings is a major blow. This will again put the whole sector under pressure.''

Also Barclays took a hit in their latest results, from Bloomberg:

Barclays Second-Half Profit Falls 21 Percent on Writedowns

Barclays Plc, the U.K.'s third- biggest bank, said second-half profit fell 21 percent on asset writedowns and a slump in revenue from fixed-income trading.

Net income declined to 1.78 billion pounds ($3.48 billion), or 26.6 pence a share, from 2.26 billion pounds, or 34.5 pence, a year earlier, the company said in a statement today. That beat the 1.73 billion-pound median estimate of 13 analysts surveyed by Bloomberg. The company raised its dividend by 10 percent to 22.5 pence in the second half....

....Barclays Capital, the company's most profitable unit in the first six months of 2007, posted 1.6 billion pounds in net writedowns related to assets including collateralized debt obligations and loans for leveraged buyouts in 2007.

The bank, which abandoned its 63.2 billion-euro ($123 billion) bid for ABN Amro Holding NV in October, posted 1.7 billion pounds of gross writedowns for the first 10 months of 2007.

Barclays writedowns were not unexpected as they had previously been flagged to the market. However more disturbing are the writedowns yet to come. The New York Times had an interesting piece today on that very subject.

Wall St. Banks Confront a String of Write-Downs

Wall Street banks are bracing for another wave of multibillion-dollar losses as the crisis that began with subprime mortgages spreads through the credit markets.

In recent weeks one part of the debt market after another has buckled. High-risk loans used to finance corporate buyouts have plummeted in value. Securities backed by commercial real estate mortgages and student loans have fallen sharply. Even auction-rate securities, arcane investments usually considered as safe as cash, have stumbled.

The breadth and scale of the declines mean more pain for major banks, which have already written off more than $120 billion of losses stemming from bad mortgage-related investments.

The deepening losses might make banks even more reluctant to make the loans needed to prod the slowing American economy. They also could force some banks to raise more capital to bolster their weakened finances.

The losses keep piling up. Leading brokerage firms are likely to write down the value of $200 billion of loans they have made to corporate clients by $10 billion to $14 billion during the first quarter of this year, Meredith Whitney, an analyst at Oppenheimer, wrote in a research report last week.

Those institutions and global banks could suffer an additional $20 billion in losses this year on commercial mortgage-backed securities and other debt instruments tied to commercial mortgages, according to Goldman Sachs, which predicts commercial property prices will decline by as much as 26 percent.

Analysts at UBS go further, predicting the world’s largest banks could ultimately take $123 billion to $203 billion of additional write-downs on subprime-related securities, structured investment vehicles, leveraged loans and commercial mortgage lending. The higher estimate assumes that the troubled bond insurance companies fail, a possibility that, for now, is relatively remote.

Such dire predictions underscore how the turmoil in the credit markets is hurting Wall Street even as the Federal Reserve reduces interest rates. Already, once-proud institutions like Merrill Lynch, Citigroup and UBS have gone hat in hand to Middle Eastern and Asian investors to raise capital. “You don’t have a recovery until you have the financial system stabilized,” Ms. Whitney said. “As the banks are trying to recover they will not lend. They are all about self-preservation at this time.”

Click on the link for the full article, it is quite lenghty but a good read and provides an interesting laundry list of the players involved. You have to take your hat off to Meredith Whitney who has been on the ball with this for many months.

As she says, banks are in self-preservation mode at the moment which severly impacts their ability to lend and drive new business. Expect writedowns every quarter for the remainder of the year and expect more injections from SWF's and expect finally someone to go under, my bet is Bear Stearns.

Monday, 18 February 2008

ANZ Profit Warning... I Mean Trading Update

Last week in Time to Buy the Big 4? I noted that despite the strong sell off in the major banks there would be further opportunities down the road to pick them up at cheaper prices. Just 3 trading days later and they are all cheaper, ANZ significantly so.

ANZ gave a trading update as they do twice a year between reporting results. Business is traveling well with the company expected to beat the 11.5% growth in profit before provisions posted in FY07. 'Before provisions' is the key phrase here, since ANZ also announced that they are raising some significant provisions for specific credit quality issues.

Firstly they are raising a provision of US$200m . As ANZ tells it:

between 2005 and February 2007, ANZ entered into derivative transactions which involved selling credit protection on a portfolio of corporate names, and simultaneously buying matching protection from highly rated US financial
institutions to remove market risk. This was perceived to involve little credit risk and generated modest trading income.

The significant increase in derivative market credit spreads and volatilities has resulted in a positive mark to market position with the sellers of the credit protection. However one counterparty, which is a US monoline insurer, has been downgraded to a CCC credit rating. The uncertainty around the ability of that firm to meet its obligations under the hedging agreement has resulted in an accounting requirement to raise an Individual Provision of US$200 million based on the current mark to market exposure to that monoline.

What they are describing here is a Credit Default Swap (CDS). If you don't know what a CDS is read here. So the risk here is that the counter-party, the monoline insurer ACA Capital goes under and cannot hold up their side of the swap agreement. Which would then mean:

The effective economic impact if the monoline insurer fails is that ANZ takes on direct exposure to a high quality portfolio of corporate names. In fact, this portfolio has a higher proportion of investment grade corporates than ANZ’s existing Institutional portfolio. For an actual loss to emerge, around 20% of names within the portfolio would need to default. This would only occur in an extreme environment in which a significant number of companies defaulted globally, which is not anticipated under any current economic scenario.

Whilst the provision will vary with movements in the mark to market, we expect that a significant proportion of the Individual Provision will be written back in future periods.

So there is a good chance that a proportion of these provisions will be written back down the road. Also in the release, other significant provisions were taken for:

• Impact of credit rating changes on a commercial property client - a significant credit rating downgrade for one large commercial property client has resulted in a charge to the Collective Provision of around $90 million although at this stage it has not been necessary to make an Individual Provision. A review indicates the factors driving this client’s credit rating downgrade were specific to that client, with the remainder of the commercial property portfolio in good shape.

• Failure of a resources client has resulted in an additional Individual Provision of $51 million.

Centro (CNP) is most likely the commercial property client, whilst Lafayette Mining was the failed resources client. According to an article in the SMH, UBS estimates that ANZ had a $500 million unsecured exposure to Centro, a $700 million secured exposure and a $150 million exposure to US-based lender Countrywide.

If Countrywide, which in all likelihood would have gone bankrupt without Bank of America stepping in, is what ANZ means by a 'high quality portfolio of corporate names' then there could be more trouble down the line. It would be interesting to know if ANZ has any exposure to the other monoline insurers or other major US banks of brokers.

Doing some back of the envelope calculations, ANZ's provisions could rise from $567m in FY07 to approximately $930m for FY08. That's assuming that credit quality, excluding the exposures above remains about the same. Not a safe assumption by any means.

Thus ANZ's provisions could run close to a billion dollars in FY08 and potentially wipe out profit growth for the year. Current consensus earnings forecasts according to Aspect Huntley are for eps growth of around 10% for FY08.

Clearly there will be a round of revisions tomorrow from analysts as there was after CBA's result last week. If analysts can manage to put 2 and 2 together they will probably start downgrading the rest of the major banks as well.

Incidentally, of the 16 brokers covering ANZ, 5 have STRONG BUYS on the stock, 4 have BUYS and 7 have a HOLD. Not a single SELL rating among them. I haven't checked analysts ratings on this stock in some time so I don't know if anyone actually had a sell on these stocks before they started falling 3 months ago and then changed to a buy, but knowing analysts, I doubt it.

This kind of news from ANZ will become more prevalent over the next 12 months as we enter the worst part of the credit cycle. As stated before, rising credit provisions coupled with higher wholesale funding costs will crimp bank earnings in the medium term. Now the question becomes how much of that has been priced into the stocks given their significant decline since the end of October?

Nobody can answer that, but I still believe time is on the side of the patient as there will be more shoes to drop as far as credit quality is concerned.

Too Big To Fail

Today the UK government confirmed they don't believe in free market capitalism by bailing out Northern Rock for idiotic business decisions. From Bloomberg:

U.K. Government Starts Northern Rock Nationalization

Prime Minister Gordon Brown's government will introduce legislation today to nationalize Northern Rock Plc after the Treasury rejected a private rescue for the only U.K. bank to suffer a run on deposits in a century.

The Newcastle-based bank was suspended from trading in London today, and an independent panel will determine how to compensate shareholders. Brown will hold a press conference at 11 a.m. in London, and Chancellor of the Exchequer Alistair Darling will outline the emergency legislation in Parliament at 3:30 p.m.

``There will have to be some threat to jobs,'' said Alex Potter, a London-based banking analyst at Collins Stewart. ``The priority will be to reduce the asset base of the bank.''

The first bank nationalization since 1984 will damage the credibility that the Labour government has established for managing the economy since it took office a decade ago. It will leave Treasury officials responsible for 113 billion pounds ($222 billion) of Northern Rock assets and 6,500 employees.

``There is a perception that Darling is not up to the job,'' said John Curtice, author of ``The Rise of New Labour'' and a professor of politics at Strathclyde University in Glasgow. ``He will only hope that people are rational and that there are no queues outside Northern Rock branches.''

Ron Sandler, who advised the government on pensions and brought back Lloyd's of London from the edge of bankruptcy in the late 1990s, will earn 90,000 pounds a month acting for the government as Northern Rock's executive chairman. Former Swiss Re Group executive Ann Godbehere will become finance director.

Click on the link for the full story. I'm sure taxpayers will delighted with this outcome. The UK government has invoked the too big to fail argument. That same discussion is going in the US right now. Given the state of many US financial companies this is bound be a topic that gets plenty of attention in the coming months.

Sunday, 17 February 2008

S&P500 Earnings Expectations Still Too High

As of February 13th, S&P 500 operating earnings for 4Q07 are now expected to show a -23.6% decline . FY07 operating earnings are now showing a -4.1% decline. Forecasts for 1Q08 and 2Q08 remain largely unchanged from 3 weeks ago at 1.9% and 2.0% growth respectively.

3Q08, 4Q08 and FY08 have all been revised upward. 4Q08 operating earnings are now forecast to rise almost 60%. As noted two weeks ago and as seen in the chart below quarter over quarter growth of more than 35% is unheard of in the last 20 years.

As said here repeatedly, S&P operating earnings estimates are way too high. This week, retailers including Wal-mart will report. As has been the case in recent weeks, forecasts will be more important than the actual results and I wouldn't expect too many rosy forecasts. It will be interesting to see what effect retailer's outlooks will have on analysts estimates going forward.

Friday, 15 February 2008

Retail Darling Falls From Grace

A few months ago, Wall Street Lemmings were lauding Best Buy's strong financial results due in part to their ability to steal market share from Circuit City. However it now seems that the tapped out US consumer is catching up Best Buy as well. From

Best Buy Cuts Fiscal Year '08 View To EPS $3.05-$3.10, Sees Revenue $40B

Best Buy Co. (BBY) lowered its fiscal 2008 earnings forecast to the range of $3.05 to $3.10 a share from its previous view of $3.10 to $3.20 a share, citing soft domestic customer traffic in January. The Minneapolis electronics company said it expects results to fall short of planned targets in the fiscal fourth quarter, which ends March 1. It expects lower revenue in home theater, MP3 devices, digital imaging and video gaming, but higher volumes from notebook computers. Best Buy expects comparable store sales to decline "modestly" in the quarter. The company forecast fiscal year revenue of $40 billion, including an annual comparable store sales increase of 2.5% to 3%. Best Buy previously forecast a gain of 4%. Best Buy plans to open 130 to 160 new stores globally in its 2009 fiscal year and expects to increase total retail square footage by 10% to about 51 million square feet by the end of that year.

Quote Of The Day

Ron Insana is one of the more sane voices on CNBC. To his credit he has been consistently claiming that the extent of the problems in the credit markets have been under appreciated. Yesterday he went a little further:

Ron Insana on CNBC, 02/14/2008, “I’m going to go way way out on a limb here, because I think this credit crisis is so viral and is spreading so quickly to all corners of the credit markets.........I think ultimately when this is all said and done, the Fed is going to have to be the Bank of Japan and got to zero interest rate policy to reflate our way out of this thing. I think this is still far bigger, far more misunderstood than anybody knows. This is a real crisis of historic proportions and still no one is paying full attention.”

Dire stuff,

Australian Employment A Picture Of Health

Yesterday the Australian Bureau of Statistics reported that the Australian Employment Picture continues to look rosy. So rosy in fact the unemployment rate reached a level not seen since 1974 at 4.1%. From the ABS:



* increased by 26,800 to 10,631,000. Full-time employment decreased by 7,800 to 7,587,600 and part-time employment increased by 34,600 to 3,043,400.


* decreased by 13,900 to 458,500. The number of persons looking for full-time work decreased by 27,500 to 296,900 and the number of persons looking for part-time work increased by 13,600 to 161,600.


* decreased by 0.1 percentage point to 4.1%. The male unemployment rate decreased by 0.4% to 3.7%, and the female unemployment rate increased by 0.2 percentage points to 4.6%.


* remained steady at 65.2%.

The 27k increase in employment easily beat forecasts of a 15k increase by economists.

This would seem to be at odds with the NAB Business Confidence Survey released earlier this week, that fell to it's lowest level since 9/11. However, employment is a lagging indicator and what we are probably witnessing in January is the peak or very close to it, of the employment cycle.

Regardless, the strong employment result just gives the RBA more ammunition to continue raising interest rates in the near term.

Thursday, 14 February 2008

Claims 4 Week Avg Highest In More Than 2 Years

The 4 week moving average of Initial jobless claims continues to inch up, the latest reading at its highest level since the aftermath of Hurricane Katrina in October 2005. Excluding Katrina the 4 week average was has not seen current levels since June 2004. From the US Department of Labor:



In the week ending Feb. 9, the advance figure for seasonally adjusted initial claims was 348,000, a decrease of 9,000 from the previous week's revised figure of 357,000. The 4-week moving average was 347,250, an increase of 12,000 from the previous week's revised average of 335,250.

The advance seasonally adjusted insured unemployment rate was 2.1 percent for the week ending Feb. 2, unchanged from the prior week's unrevised rate of 2.1 percent.

The advance number for seasonally adjusted insured unemployment during the week ending Feb. 2 was 2,761,000, a decrease of 9,000 from the preceding week's revised level of 2,770,000. The 4-week moving average was 2,727,500, an increase of 3,500 from the preceding week's revised average of 2,724,000.

The 4 week MA rose above the 340k area in December only to recede in January, however that had more to do with seasonal adjustments than a drop off in claimants. Expect the 4 week MA to punch decisively through the the 350k mark in the next few weeks.

Pipe Networks Delivers Again

After the market closed yesterday Pipe Networks (PWK) reported 1H08 earnings of $3.3m Net Profit After Tax, a 40% increase over the previous year. That was at the upper end of the company's previously forecast range of $3.1 - $3.3m. Revenue grew 47% whilst eps increased 23% as the share issue in 2H07 diluted eps growth somewhat.

Revenue growth was solid across all product areas with Dark Fibre sales growth in excess of 40%. It seems the company can't build their data centres quick enough. Their newest data centre, (DC3) completed just 6 months ago is already at capacity. A new data centre (DC4) is under construction and is expected to be fully leased by the completion date of 1st July 2008.

Pipe also stated that they have more than $300,000 per month in new contract revenue which will begin to be billed between now and July. The company was able to improve it's margins on existing assets, however that was offset by higher commission payments to personnel for securing a number of new sales contracts and continued investment in infrastructure.

The company claims the higher commission payments are one-off whilst the contracts are of a recurring nature so margins should improve over the next 6 months.

Project Runway

There was not much in the way of new information on project runway except for additional details on the funding structure. The company still sees no need to raise additional capital at this time but does not rule it out in the future.

In a separate announcement the company stated that they had secured an additional $20m in funding from ANZ taking the total debt facility to $40m. The facility gives the company the flexibility to take advantage of other strategic opportunities if they should arise.

Looking ahead, co-founder Steve Baxter has decided to step down as an executive Director whilst key appointments have been made in Jason Sinclair to the position of Chief Operating Officer for Pipe Networks and Brett Worrall as Pipe International Chief Operating Officer.

The Company also announced the 'Federation Project' which is an extension of the company's metro network in Perth and Adelaide. The project is expected to be completed by June 2008 and to be operating at break-even within 6 months of completion.

Earnings Guidance

The company made no change to their previously announced guidance for FY08 and FY09 however they were a little more specific on FY09 numbers and also offered a forecast for FY10.

Below is slide from the company's 1H08 investor presentation. As can be seen, the company is on a what can only be described as an amazing growth path. I am cautious of looking too far out into the future. Especially since the FY10 numbers hinge on the successful completion of Project Runway on time and on cost.

Given the company's consistent tack record of delivering on forecasts I expect FY08 numbers are in the bag. Also FY09 numbers are not contingent on Project Runway. They are based solely on the continued strong organic growth of the existing business and further investment in developing Australian Assets.

Thus, in the interests of being conservative I calculate my valuation of Pipe Networks on the company's earnings forecasts out to FY09 and assume nothing for project runway. Discounting back at 15% I value PWK at $3.18 per share. The current price of $4.50 is at a significant premium. That premium is obviously in some part pricing in the potential of project runway.

If I take management's forecast of $17m NPAT for FY10 and assume no further equity raising, I value PWK at $6.70 per share. Project Runway is scheduled to go live in approximately 16 months time. There is a good chance that PWK can secure additional long term contracts in that time and therefore FY10 forecasts could prove to be conservative.

The greatest risk for PWK remains the execution of project runway. Cost overruns and time delays could significantly impact future earnings beyond 2009. Given management's exemplary track record of delivering results I think they deserve the benefit of the doubt.

This will be an exciting growth story to observe in the next few years and whilst there are definite risks for investors, it is difficult to find small, profitable, ASX listed companies with comparable potential upside.

US Retail Sales Suprise...Or Do They?

The US stockmarket got excited over better than expected retail sales yesterday. From the Department of Commerce:
The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for January, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $382.9 billion, an increase of 0.3 percent from the previous month and 3.9 percent above January 2007. Total sales for the November 2007 through January 2008 period were up 4.4 percent from the same period a year ago. The November to December 2007 percent change was unrevised from -0.4 percent.

Retail trade sales were up 0.4 percent from December 2007 and were 3.8 percent above last year. Gasoline station sales were up 23.0 percent from January 2007 and sales of nonstore retailers were up 10.6 percent from last year.

Excluding autos and gasoline, retail sales were flat. That was still better than expected due to a surprising 0.6% rise in auto sales. Surprising since car companies reported earlier this month that sales fell to just a 15.3 million annual rate. So either people are buying more expensive models or car prices have gone up. Either way probably not a sustainable trend.

Revisions - as can be seen below, November retail sales have now been revised twice, bringing it down a not insignificant -0.6% from the original estimate. Also December was revised down -0.3% from the original estimate.

Revisions are a normal part of the process, it is the direction as well as the size of the revisions that is of interest. November has been revised down twice, December was revised down in the latest report. What will revisions to January bring? Not a bad report by any means, but certainly not cause to get too optimistic about the US consumer.

Wednesday, 13 February 2008

Time To Buy The Big 4?

The Australian Banks have been severely smacked about since the market peaked on November 1st 2007. Whilst the XAO is down -18% all the 4 major banks are down more making or coming very close to 52 week lows today. Since November 1st NAB is down -30%, CBA down -25%,WBC -25% and ANZ -22%.

However, considering the pummeling their counterparts in the US and in some parts of Europe have taken, the share prices of Australian banks have held up relatively well. That's mainly because their profits have held up well and they have steered clear of the sub-prime meltdown....for now.

'For now' is the important part. As we move further into the sour end of the credit cycle we can expect profits to slow and bad debts to rise. CBA showed that trend today reporting diluted eps growth of just 3% for the half year to December 2007. Also their provision for doubtful debts rose significantly but not anymore than you would expect at this point in the credit cycle.

I would expect that trend to show up in the other major banks. Fortunately for them, they won't report half year earnings until May so we'll have to wait and see.

Bad debts would have to rise significantly to set off alarm bells. Impaired Assets on the books of Australian Banks are still at record lows although you can see signs in the graph below that they are starting to tick up slightly.

Also in the above graph you can see the last turn in the credit cycle, represented by the spike in impaired assets around mid 2001. At that time, banks were well provisioned and absorbed the rise in defaults well. You can expect impaired assets to increase over the next 12 months, however they would have to push through that 1.5% level to sound major alarm bells.

Despite already significant declines in share prices, credit problems are only going to get worse before they get better. Also the banks net interest margins will come under increasing pressure as the cost of funding has increased.

Share prices typically pick up when the market can see through the tunnel to the other side. However, in Australia we've only just entered the tunnel and have no idea where it is going to take us.

Current prices may prove to be attractive entry points. All 4 major banks are now yielding in excess of 6.0%. However, as noted above, things will get worse for the banks before they get better and more attractive entry points will come for those who are patient.

Quote of the Day - Warren Buffet on Bond Insurers

Amidst all the crap, CNBC sometimes has some very good interviews. Yesterday they interviewed Warren Buffet for about 25 minutes. Listening to Warren Buffet talk for 25 minutes could potentially save you 25 years of investment mistakes.

Yesterday's interview focussed amongst other things, on Buffet's proposed plan to take the Municipal Bond Insurance business away from the three big Monoline insurers AMBAC, FGIC and MBIA. Not, as the media wrongly reported a 'bailout.' Buffet is not interested in the CDO's and other crap that the Monolines got themselves into and is the reason they find themselves fighting to stay afloat.

Buffet pointed out that despite the insurer's retaining their AAA credit ratings they are not trading that way and neither are the bonds they insure. More specifically Buffet said;

"When a company issues a 14% bond when US Treasuries are below 4% and is rated AAA, you've now seen the cow jump over the moon."

Classic stuff.

Tuesday, 12 February 2008

Lesson This Earnings Season - Don't Disappoint !

A couple of weeks ago in Worst January for XAO in at least 24 years I noted that companies that disappoint either on earnings or in their outlook, will get severely punished by the market. That has certainly rung true this week.

Yesterday, United Group (UGL) shares were absolutely smacked losing -25% even after recording a 46% rise in half year profits. It was a little less than the market had been anticipating and they compounded the disappointment by trimming their full-year forecasts from 50% net profit growth to approximately 40%. The stock recovered about 10% today but is still -45% below it's November highs.

Today Cochlear (COH) turned in a solid 17% in increase in half year profit and reaffirmed guidance for the full year. Obviously that wasn't good enough for the market which marked the shares down -9.3%.

Also today, JB Hi-fi (JBH) turned in a stellar half year performance with a 60% increase in NPAT, increased it's dividend 100% and lifted it's full year guidance. It seems the market was more concerned about the impact of climbing interest rates and petrol prices on the consumer and chose to mark the stock down -8.3%.

The message this earnings season is clear, if there is even the slightest hint of risk to a company's earnings going forward they are going to get smacked around. The good news is that some excellent businesses are looking more attractively priced.

Australian Business Confidence Lowest Since 9/11

Global turmoil in financial markets and areduced outlook for global economic growth has started to weigh on Australian Business confidence as measured by the NAB Monthly Business Survey. From the smh.

Business confidence falls to lowest level since 2001

Companies are increasingly worried about a deterioration in global financial markets with business confidence falling to its lowest level since 2001, a survey says.

Business investment is tipped to fall in coming months after confidence levels recorded the biggest slide in a decade.

The National Australia Bank (NAB) monthly business survey found that business confidence had fallen by nine points in January to minus four, which was its worst reading since the September 11, 2001 terrorist attacks in the US.Confidence also had experienced its biggest six-month fall in a decade.

The survey said recent equity market slides and the Reserve Bank of Australia's (RBA) decision last week to raise interest rates by a quarter of a percentage point, to seven per cent, also had hampered confidence.

"That confidence fell sharply in an environment of large falls in equity markets, emergency rate cuts in the USA, much talk of the potential US and even global recession, increases in mortgage rates outside RBA adjustments and strong expectations, subsequently confirmed, of an RBA rate rise, is not surprising," the survey said.

"Clearly, the sustained global financial turbulence and tighter domestic financial conditions have had a marked negative impact. "If this proves to be sustained, we would expect to see downward adjustment in actual conditions and notably capital expenditure plans during the next few months or so."

The survey also showed that business conditions in the first month of 2008 had slipped four points to 13 while profitability had fallen by six points to 13.

"Conditions remain reasonable but ease significantly and reinforce the view that the peak in demand passed in the latter part of 2007," the survey said.

That's quite a sharp in business confidence. It will interesting to see if that translates into slower business investment in the next few months. As noted in RBA Signals More Rate Rises To Come, the RBA runs the risk of being too restrictive on monetary policy if global growth slows faster than they anticipate. Some economists are forecasting that the RBA will be cutting interest rates next year.

NAB chief economist Alan Oster said the RBA would begin easing rates in 2009, with the official cash rate tipped to fall to six per cent next year.

"Indeed the RBA's more hawkish near-term view only reinforces this expectation," he said."Given our forecasts, that would be consistent with bringing monetary policy settings back to a more neutral, but still firm, policy stance by late 2009, early 2010."

The NAB forecast that the Australian economy would grow by three per cent in 2008, compared with global expansion of 3.75 per cent and US growth of 1.25 per cent.

Again, if global growth moderates faster than expected those interest rate cuts could come by the end of this year. The US Federal Reserve's inflation fear were overblown and they ended cutting the fed funds rate aggressively. The RBA could find itself in a similar position in 9-12 months time.

Monday, 11 February 2008

RBA Signals More Rate Rises To Come

If there were any hopes that the RBA was done raising interest rates after last week's hike to 7.00%, it would seem they have diminished markedly after the bank's quarterly statement on monetary policy today. The RBA lifted its underlying inflation forecast for 2008 and warned of further interest rate rises. More specifically the RBA stated that:

In the short term, inflation as measured on a year-ended basis is likely to increase further, reflecting in part the quarterly pattern of price increases that have already occurred. Given the current strength of domestic demand and pressures on capacity, a significant moderation in demand will be needed if inflation is to be satisfactorily reduced over time.

On the current outlook, then, and allowing for the inevitable uncertainties in forecasting, the risk of inflation remaining uncomfortably high for some time is considerable. Absent a further shift in economic risks to the downside, therefore, monetary policy is likely to need to be tighter in the period ahead.

In light of the hawkish comments the stockmarket sold off sharply and the SFE March Futures contract jumped from a 30% chance of a rate rise to 7.25% at the RBA's March meeting to 69% at the close today.

Clearly higher interest rates don't bode well for the stockmarket as the return on risk free assets becomes more attractive vis-a-vis stocks. In reading the whole statement, (click on the link above for the complete statement) the bank does acknowledge that slowing global economic growth could reduce the inflation outlook faster than they currently anticipate.

If a much slower global economy were to emerge, the RBA runs the risk of being too restrictive by continuing to raise interest rates. At some point the incentive to borrow by both businesses and households evaporates as the cost of capital increases and as demand abates. The Australian economy is not yet at that point but we are certainly getting closer.

PBP's little legal problem gets much smaller

Some good news today for Probiotec (PBP) shareholders with that news that the company's appeal against the Phoscal claim has been successful.

The company previously advised that their liability in this case could be anywhere from $2 - $5m. As the company states in today's ASX release;

The effect of the appeal judgment is that it has reduced Probiotech's liability from 100% of the claimant's legal costs to 10% of those legal costs. The claimant has also been ordered to pay Probiotec's legal costs of the appeal....

....Probiotec's preliminary assessment is that its liability (which is yet to be quantified) under the appeal judgement will be for an amount estimated in the range of $50,000 - $350,000.

A couple of hundred thousand sounds much better than a couple of million. The company is also proceeding against it's former legal advisers and thus may be able to recover the majority of the amount it pays under the revised judgment.

This is very welcome news for patient shareholders, who have stuck with the company through this period. It removes a lot of uncertainty around the future prospects of the stock by not encumbering the company's cash flow to pay legal damages.

I expect the company to report strong growth in half year profits sometime in the next week or two and possibly the payment of the company's first dividend.