Wednesday, 30 April 2008

ADP Report Indicates Slight Rise in April Payrolls

Actually last months ADP report also suggested slight growth in payrolls, however non-farm payrolls reported by the BLS were down 80k. From

Nonfarm private employment increased 10,000 from March to April 2008 on a seasonally adjusted basis, according to the ADP National Employment Report™. The estimated change in employment from February to March was revised down from an increase of 8,000 to an increase of 3,000.

Though April’s estimate for a small increase in employment is above consensus forecasts of an outright decline, it nevertheless suggests that a sharp deceleration of employment continues.

Employment in the service-providing sector of the economy grew 64,000, while employment in the goods-producing sector declined 54,000, the seventeenth consecutive monthly decline. Manufacturing employment fell 26,000 in April and marked the twentieth consecutive monthly decline.

Large businesses, defined as those with 500 or more workers, saw employment decline 18,000, while medium-size companies with between 50 and 499 workers declined by 14,000. Conversely, employment among small-size businesses, defined as those with fewer than 50 workers, advanced 42,000 during the month.

Two sectors of the economy hit hardest by recent problems in mortgage markets have been residential construction and financial activities related to home sales and mortgage lending. In April, construction employment fell another 28,000. This is the seventeenth consecutive monthly decline, bringing the total decline in construction jobs since the peak in August 2006 to 288,000. Employment in the financial activities sector advanced just 2,000 for the month.

So, can we really put much stock in the ADP report as a predictor for Friday's non-farm payroll report from the BLS? Probably not, but we can probably also say that Friday's report won't be terrible (ie. more than -150k).

XAO breaks five month losing streak

The XAO broke its five month losing streak in April notching up a 4.6% gain from the previous month and breaking my winning streak of calls on the direction of the Aussie market. So what about the old adage, 'go away in May?' As can be seen below, that is largely a myth when applied to the Aussie market. Since 1985 the month of May has only declined 8 times as opposed to rising 15 times.

Of course much will depend on the data coming out of the US. The markets seem to have decided to look beyond the valley of declining earnings a worsening housing crisis and deteriorating economy. The consensus seems to be that any recession in the US will be short and shallow. Rebate checks being mailed out this month are expected to give a boost to GDP and spur a second half recovery.

That view I think is overly optimistic, I think the US recession will be longer and deeper than most expect and that is certainly not priced into the markets. We could well see a bounce in US economic growth in the third quarter this year but that may just be setting up for a replay of the 1980's. The US dipped into a short, shallow recession in 1980 only to plunge into a deep 16 month long recession in 81-82.

The consensus is that the bottom is in for equities. If that is the case it will indeed be disappointing as that means equity market returns over the coming years will be average at best. I keep hearing the nonsense about the market looking cheap based on forward earnings. Earnings that have very poor visibility.

As always, I don't rule out the possibility that the stockmarket can delude itself higher despite deteriorating company and economic fundamentals. Afterall, earnings took four years to recover to previous highs in the early 1990's yet stocks continued to go higher for most of that period.

However, given the deteriorating fundamentals on a number of fronts - the economy, company earnings, housing, inflation and a stretched consumer, I think the market is has to take a few steps back before it can start to march forward again. Thus I think May will see a decline in the XAO.

Morgan Stanley Gets Some Religion

Morgan Stanley seem to be waking up to the fact that the era of outsize profits for banks is over for the forseeable future, slashing their profit forecasts for bank earnings for FY08 and FY09. From Yahoo Finance:

Morgan Stanley see big bank woes just beginning

Morgan Stanley (MS) analysts on Monday told clients to "sell the rally" in financial stocks, slashing forecasts for big bank earnings and warning that the current credit crunch is only just beginning.

In aggregate, Morgan Stanley reduced its estimates for 2008 large bank earnings by $17 billion, or 26 percent, and reduced 2009 forecasts by $13 billion, or 15 percent. The analysts expect higher loan losses and expenses, offset by higher net interest income, though profits could fall further still if the Federal Reserve stops lowering interest rates.

"More capital hikes and dividend cuts (are) coming as our credit deteriorates and forward earnings decline," analysts led by Betsy Graseck wrote in a report. "We think we are only in the third inning of the credit cycle and expect this credit cycle will be worse than (the slump in) 1990-91."

A growing number of investors, and industry executives including Morgan Stanley Chief Executive John Mack, in recent weeks have predicted markets are closer to the end of the current mortgage and corporate credit crisis than to the beginning. These more upbeat comments, and recent efforts by banks to bolster their balance sheets, helped spark a rebound in bank stocks last week.

Morgan Stanley's top "long" picks have less credit sensitivity or better capital structures: Bank of New York Co (BK), JPMorgan Chase & Co (JPM) and PNC Financial Group (PNC).

By contrast, investors should "underweight" banks with greater exposure to mortgages -- Wells Fargo & Co (WFC) and Wachovia (WB) -- and those that operate in harder hit sections of the United States -- Fifth Third Bancorp (FITB) and KeyCorp (KEY).

Morgan Stanley also called for underweighting Citigroup (C), citing its exposure to risky assets relative to common equity.

US Home Prices Continue to Dive

The latest Case-Shiller Home Price numbers show that US Home Prices continue to fall at an accelerated rate. From S&P:

Data through February 2008, released today by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices, the leading measure of U.S. home prices, show declines in the prices of existing single family homes across the United States worsened in the second month of the new year, with 17 of the 20 now reporting MSAs posting record low annual declines, 10 of which are in double-digits.

The chart above depicts the annual returns of the 10-City Composite and the 20-City Composite Indices. Both of the composite indicies are now reporting annual declines in excess of 12.5%. The 10-City Composite posted a new record low annual decline of 13.6%, and the 20-City Composite recorded an annual decline of 12.7%.

“There is no sign of a bottom in the numbers,” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor's. “Prices of single family homes continue to drop across the nation. All 20 metro areas were in the red for the February-over-January reading. In addition, 19 of the 20 MSAs are still reporting negative annual returns. The monthly data show that every one of the MSAs has now declined every month since September 2007, marking six consecutive months. On top of that, the declines have remained steep with eight of the 20 MSAs and both composites reporting their single largest monthly decline in February.”

The bottom-callers were notably absent yesterday and rightfully so. A bottom in house prices and sales is still not in sight.

Tuesday, 29 April 2008

Analysts Still Playing Catch-up With Earnings

As stated ad-nauseum here analysts are typically behind the curve at turning points in the earnings cycle. The graph above certainly bears that out. 6 months ago 1Q08 S&P500 operating earnings were projected to show a 9.1% increase. As late as the end of February, operating earnings were still projected to be marginally positve for 1Q08. As of last week they are expected to be down -12.6%. Also for the first time 2Q08 earnings are now expected to be down -5.1%.

Also 3Q08 operating earnings projections have come down in the last fortnight from 19.9% to 15.5% and 4Q08 has come down from a ridiculous 73.6% to a slightly less ridiculous 69.1% . However, whilst analysts are getting more realistic they still have their heads in the clouds for 3Q08, 4Q08 and beyond. The chart below lends credence to that idea.

As seen above in the two previous earnings cycles, earnings took about 4 years to recover to previous highs. Analysts expect earnings to recover in just 1.25 years. As always, I am open to the possibility that "this time will be different", but given the historical nature of previous earnings cycles, it is highly unlikely. It is also unlikely that a protracted earnings slump of 4 years is priced into the stockmarket.

Monday, 28 April 2008

Pipe Networks raises $26m

Pipe Networks (PWK) announced today that they raised $26m via a private placement of 6.5m shares at $4.00 per share. The purpose for the capital raising was to complete the funding for PPC-1, (the Guam to Sydney undersea cable) and for additional working capital purposes.

The company had flagged in the half year report that they were considering different funding options for PPC-1 so the capital raising does not come as a complete surprise. The company also vaguely refers to the possibility of using a portion of the funds for 'other strategic opportunities.'

Whilst the injection of capital boosts the equity per share in the business it also has the effect of lowering the return on equity and thus the valuation. In fact the ROE is significantly impacted to the point of lowering the valuation substantially from $3.63 per share to $2.11 per share.

Remember also that my valuation does not ascribe anything to PPC-1. I am only valuing the company based on the company's own forecasted profit numbers out to FY09. That is the difficulty with valuing a company in such a strong growth phase. The current price is well ahead of the current value as so much is contingent on future potential.

That future potential is huge and coupled with the management's exceptional track record of delivering on promises, are the key reasons I continue to hold the stock.

Thursday, 24 April 2008

ANZ result sign of things to come?

Yesterday ANZ reported a -14% decline in cash earnings (cash earnings is what you need to pay attention to) and a -16% decline in cash eps for 1H08. A lot of that had to with the sharp increase in loan loss reserves which was flagged to the market back in February.

At that time I raised the prospect that ANZ could see close to $1 billion dollars in loan loss reserves in FY08. That was a big underestimation on my part as they took close to the $1 billion in the first half alone.

It would be easy to dismiss this result as due to provisioning against a couple of one off credit exposures, however that is the nature of the business and particularly as we approach a turning point in the credit cycle. This comment from CEO Michael Smith should be taken as a warning sign of things to come:

"The global environment is challenging and in areas like retail sales we are seeing early signs of a downturn in our domestic markets,"

Starbucks Feels The Pinch

Last November Starbucks began talking about cost pressures due to the rising price of milk and also sluggish traffic in their stores. Those headwinds are now affecting the bottom line. From

Starbucks issues profit forecast below expectations

Starbucks Corp. warned late Wednesday that fiscal second-quarter and full-year profit will be hurt by decreased traffic at its U.S. stores as well as a "sharp weakening in the U.S. consumer environment."

Its already bruised stock tumbled more than 12% in late trading on heavy volume.

Starbucks, in the middle of rolling out new initiatives aimed at luring more customers into its vast network of stores, pegged fiscal second-quarter earnings at 15 cents a share, below the consensus analyst target of 21 cents, according to FactSet Research.

Seattle-based Starbucks (SBUX) announced that fiscal 2008 profit will be "somewhat lower" than the 87 cents a share it earned in fiscal 2007. Analysts are now forecasting the coffee-shop chain to earn 96 cents a share. The company's fiscal year ends in September.

For the quarter ended March 30, Starbucks said that it had a "mid-single decline" in revenue at U.S. stores open at least one year, a key retailing metric known as comparable-store sales. The downturns in the California and Florida housing markets have hurt company sales, according to Starbucks. Combined, the states account for 32% of its U.S. retail revenue.

"The current economic environment is the weakest in our company's history, marked by lower home values and rising costs for energy," Chief Executive Howard Schultz said in a statement.

Wednesday, 23 April 2008

AMBAC Continues its AAA Rating Charade

AMBAC again demonstrated why its AAA rating is a farce after losing more than a billion and a half in the first quarter of 2008. From

Ambac reports quarterly net loss of $1.66 billion

Ambac Financial reported a first-quarter net loss of $1.66 billion on Wednesday as the bond insurer continued to struggle with the effects of the mortgage meltdown and broader credit crunch.

The net loss was $11.69 a share, versus net income of $2.02 a year earlier, the company said. Its operating loss in the latest quarter was $6.93 a share. Ambac (ABK) was expected to report a loss of $1.51 a share, according to the average estimate of seven analysts polled by Thomson Reuters. However, the range of forecasts varied widely, from a profit of 71 cents a share to a loss of $5.34 a share.

....The firm said its latest results include pretax mark-to-market losses on credit derivatives exposure of $1.73 billion and a loss provision of $1.04 billion on direct exposure to mortgage-related securities. There was also $292.2 million of other losses from direct and indirect exposure to residential mortgages....

...."While we realize that these are disappointing credit results, we continue to believe that the capital raised and strategic business actions taken during the quarter will enable us to get beyond this credit market," said Michael Callen, chairman and interim CEO, in a statement Wednesday.

A loss of $11.69 per share versus average expectations of $1.51. Even the most pessimistic forecast was light by more than 100% at $5.34 per share. It will be interesting to see the spin that the rating agency spin doctors apply this time around to justify keeping their worthless AAA ratings in tact.

UPS cuts FY08 Outlook

Much has been made by Dow theorists about the bullish confirmation of the dow transport index and the dow industrials in recent weeks. However, the outlook for major transportation companies continues to look weak. Back in September of last year both Federal Express and Knight Transportation issued profit warnings. Now it's UPS turn, from

United Parcel 1st Quarter Net Up 7.5% To $906M, Cuts 2008 EPS View

United Parcel Service Inc.'s (UPS) first-quarter net income increased 7.5% to $906 million, or 87 cents a share, from $843 million, or 78 cents a share, a year ago. Excluding an impairment charge related to aging jet aircraft, adjusted earnings for the year-ago period were 96 cents a share. The Atlanta package delivery company said revenue for the period increased 6.5% to $12.68 billion from $11.91 billion a year earlier. On average, analysts polled by Thomson Reuters expected earnings of 87 cents a share on revenue of $12.31 billion. The company expects second-quarter net income of 97 cents to $1.04 a share. UPS also cut its 2008 earnings forecast to $3.90 to $4.20 a share from $4.30 to $4.50 a share.

Tuesday, 22 April 2008

Are Things Getting Better or Worse?

A few articles that run counter to the rosy outlook some major market pundits are claiming:

S&P: Home Equity Delinquencies Rise Rapidly

Standard & Poor's said delinquencies on home-equity lines of credit issued in 2005 and 2006 shot up in March, underscoring continued trouble in the U.S. economy.
S&P said that 9.19% of lines issued in 2005 and 11.45% of loans issued in 2006 are delinquent, up 6.49% and 6.51% from February.

Big rise seen in unoccupied office space Vacancy rate expected to jump from 13.6% to 18% by end of 2009; takeaway: cheaper leases

Office vacancies rose sharply in the first quarter, a trend that is expected to continue as a result of layoffs and new construction adding to supply.

According to the real estate services firm Grubb & Ellis, first-quarter office vacancies rose to an average 13.6% nationally, up from 13% in the previous three quarters.

“With demand turning negative at the same time that the construction pipeline will deliver the 94 million square feet still underway, vacancy is expected to peak at 18% by the end of 2009,” Grubb & Ellis economist Robert Bach wrote in a research note today.

The recession’s impact on employee levels “is just getting started, so the office market is reacting pretty quickly and I would suspect that it will rise to a vacancy rate of 15% to 16% by year end,” he said in an interview

Mr. Bach expects that by the end of 2009, vacancies will peak at about 18%, a level that was seen in the last two economic downturns, during the first quarter of 2004 and the third quarter of 1991.

In addition, about 15.1 million square feet of new construction was completed during the first quarter. But net absorption—the amount of new space coming to market that found tenants—came in at a slim 1.8 million square feet. That’s the lowest rate of absorption since the second quarter of 2003, Grubb & Ellis said.

How about some more rosy news from financial companies to add to yesterdays news from BofA and National City? From Bloomberg:

RBS to Sell $24 Billion in Shares After Markdowns

-- Royal Bank of Scotland Group Plc, the U.K.'s second-biggest lender, will sell 12 billion pounds ($23.7 billion) of new shares to investors to boost capital depleted by writedowns.

RBS fell as much as 5.7 percent in London trading today after saying it marked down 5.9 billion pounds of assets and will cut the 2008 dividend. Chairman Tom McKillop defended Chief Executive Officer Fred Goodwin, saying ``our executive team has all the ability to steer the bank through this tricky period in financial markets.''

RBS's capital cushion has shrunk after credit markdowns and its part in last year's 72 billion-euro ($114 billion) purchase, mostly in cash, of ABN Amro Holding NV with partners Banco Santander SA and Fortis. The Edinburgh-based company said the outlook still is ``inevitably clouded'' by market turmoil sparked by the U.S. subprime mortgage market meltdown.

Downey Announces First Quarter 2008 Results and Dividend

NEWPORT BEACH, Calif., April 21 /PRNewswire-FirstCall/ -- Downey Financial Corp. (NYSE: DSL - News) reported a net loss for first quarter 2008 of $247.7 million or $8.89 per share on a diluted basis, compared to net income of $42.9 million or $1.54 per share in the year-ago first quarter.

In addition, the Board of Directors has declared a quarterly cash dividend of $0.12 per share payable on May 20, 2008, to shareholders of record on May 6, 2008. The Board also decided to suspend future dividend payments. Maurice McAlister, Chairman of the Board, commented, "Although it was a difficult decision, our Board of Directors believes the suspension of future dividends is in Downey's best interest, as it will allow us to preserve capital during this difficult operating environment. The Board plans to reassess the dividend when economic conditions normalize."

Also of interest yesterday was the comments from BofA's CEO in the conference call. From Calculated Risk:

BofA Conference Call Excerpts

As you realize by now, first quarter was much worse than our expectations three months ago with the most notable duration in the latter part of the quarter. The issues we faced in capital markets in the fourth quarter continued into the fourth quarter with March being particularly difficult. Consumer credit quality deteriorated substantially from fourth quarter, particularly in home equity. ... Credit quality will continue to be an issue with charge-offs at least at first quarter levels but probably higher for the rest of the year."....

....We believe net charge offices in home equity will continue to rise given softness in the real estate values and seasoning in the portfolio....

....Two issues that is playing home equity and could drive losses are a prolonged deterioration in home values and further deterioration in the economy."

Comments from CEO's suggest that things were getting worse toward the end of the March quarter. LIBOR is on the rise and 30 year home mortgage rates are rising. Things are going to get worse before they get better.

Monday, 21 April 2008

New Bull Or Another Bear Market Rally?

Back in January after the market rallied almost 12% from the January 22nd lows I cautioned 'beware of the suckers rally'. That turned out to be fairly accurate. So what to make of the latest bout of market euphoria on the back of the Federal Reserve's new role as corporate welfare provider and some admittedly very respectable earnings results from non-financial companies?

Personally I think there's not much to make of it at all, it's just another bear market rally. At times like these I think the words of John Hussman are worth reiterating:

It is crucial to recognize that the market downturns associated with recessions are never one-way movements. The basic feature of bear markets is that they maintain the hope of investors all the way down. The stock market often rides the Bollinger band lower, becoming more and more oversold, but will then unpredictably clear those oversold conditions by producing explosive advances that are fast, furious, and prone-to-failure.

I find the claims that the market is looking over the valley and has discounted all the bad news to be little more than wishful thinking. Economic Data continues to get worse and banks continue to write down asset values, slash dividends and significantly raise their loan loss reserves.

Today alone we hear that Bank of America reported a -77% drop in profit whilst National City is raising $7 billion in new capital and slashing it's dividend just to stay afloat. The US consumer continues to struggle with the headwinds of higher food and energy costs, rising unemployment, tighter credit conditions and falling house prices. B of A's CEO Ken Lewis put it well today commenting on his company's results:

"We remain concerned about the health of the consumer given the prolonged housing slump, subprime issues, employment levels and higher fuel and food prices,"

The sheer masses now proclaiming that the lows have been seen and that a new bull market has emerged should be enough to frighten anyone with a contrarian perspective.

Another false platitude doing the rounds is that the market at current levels is cheap. Such statements are usually made with reference to forward P/E ratios. Forward P/E's as mentioned here many times before are practically useless when changes in the earnings cycle are occurring and earnings visibility is poor. Again it is worth listening to John Hussman who writes in this week's missive:

If the market trough a few weeks ago represented a final bear market low, it would be yet again at the highest level of valuation in history for a bear market trough, and the lack of compelling improvement in market action from the recent low will also have delayed a favorable shift in the Market Climate beyond what we normally observe at the start of a new bull market cycle.

If Hussman's words sound at odds with most mainstream financial markets commentators that's because Hussman looks at trailing earnings and profit margins. On both metrics stocks are nowhere near cheap.

However as always I keep my mind open to all possibilities including the one that says the bear market lows have been seen. However if that is the case, we are setting up for some very mediocre returns over the next few years for the stockmarket.

Friday, 18 April 2008

Signs of Retail Weakness in Australia

Evidence is mounting that the Australian retail picture is softening. Seasonsally Adjusted Retail sales fell slightly in both January and February. Now we are seeing evidence of retail companies coming under pressure:

Shops struggling as interest rates halt spending

TWO major retailers are on the brink of collapse thanks to sustained Reserve Bank interest rate hikes which have knocked the economic life out of our suburbs.

Sporting goods and apparel chain Paul's Warehouse is facing a nationwide shutdown while furniture retailer Dare Gallery is battling to find a rescue funding package.

Both have been handed over to administrators. They blame their problems on a slowdown in sales caused by higher interest rates.

White goods manufacturer Fisher & Paykel yesterday sacked 740 staff across Australia and New Zealand, saying it was shutting down its Brisbane plant and relocating it to Thailand.

The company blamed the decision on exchange rates, higher interest rates, and competition from low-cost labour countries.

The news comes as figures from the Reserve Bank yesterday showed the average credit card balance grew to $3085 in February -- at the slowest rate in more than a decade -- as consumers tightened their belts.

More than 300 Paul's Warehouse staff are at risk of losing their jobs, with the company forced into a nationwide closing-down sale to pay off its debts.

One of its 20 stores has already closed, with another two in the Sydney metropolitan area shutting the doors within a fortnight.

"Three weeks ago we thought we had lost everything that we had worked for," managing director Paul Dwyer told The Daily Telegraph, adding that he hoped at least one store would be salvaged from the fire sale.

One Paul's Warehouse store manager said his store could close within weeks.

"Everything is unsure at the moment, a lot of my staff are looking for jobs. I have not kept anything back from my staff, even if I have been asked to," he said.

Paul's Warehouse administrator, PKF corporate recovery manager John Morgan, said the combination of interest rate rises hurting consumers and the spiralling cost of its debts had hurt the company.

"The fact that interest rates have gone up and perhaps disposable income has gone down adds to the problems," Mr Morgan said.

"Paul opened a lot of stores very quickly and it proved to be unfortunate for him."

Furniture retailer Dare Gallery, which employs 60 staff, has been forced to shut down its Castle Hill store, with stores at World Square and Moore Park on notice.

Deloitte was appointed voluntary administrator of the company earlier this month, with the sale of the company and its remaining 12 stores a possibility.

"I'm continuing to trade the business, I've advertised the business for sale and I'm talking to interested parties looking to acquire the business as a going concern," Deloitte's Tim Norman said.

The NSW Business Chamber has warned there could be more pain for retailers.

"Sydney businesses are doing it tougher than in other states," the chamber's public affairs manager Paul Ritchie said.

Wednesday, 16 April 2008

Nothing but Red Ink for WaMu

As posted here last week, Washington Mutual (WM) continues to go from bad to worse. In November I raised the possibility that WM would struggle to post a profit for 2008 as loan loss priovisions would gobble up their bottom line. Late Tuesday that scenario became worse when the cmpany report a loss of $1.14 billion for 1Q08. From

WaMu reports $1.14 billion quarterly net loss Lender sets aside $3.51 bln of provisions; finance committee director resigns

Washington Mutual Inc. reported a $1.14 billion first-quarter net loss late Tuesday as the lender suffered from the mortgage meltdown and broader credit crunch....

....The Seattle-based company also said it closed a previously announced deal to raise $7 billion from a group of investors led by private-equity firm Texas Pacific Group. It also reported "steady" results from its retail banking, credit card and commercial businesses.

WaMu shares edged 28 cents higher to $10.60 in after-hours trading on Tuesday. The stock gained 3% during regular trading.

WaMu said it lost $1.14 billion, or $1.40 a share, in the period, vs. net income of $784 million, or 86 cents a share, during the first quarter of 2007.

The company (WM) set aside $3.51 billion of provisions to cover potential loan losses as the economy weakens and home values continue to slide. That's more than double the amount the lender set aside in the fourth quarter of 2007.

The chart above tells a very nasty story, even more nasty than the one told by Wachovia just a few days ago. It now looks likely that WaMu will rack up losses in the billions in 2008.

Also consider this. Mortgage rests peaked in March of this year. It typically takes 6 months from the reset date until foreclosure. Thus loan loss provisions will remain extremely elevated for the remainder of this year and well into next.

Already it is becoming obvious that 2009 will be a tough year for companies like WaMu and Wachovia and that some hope of a return to a normal operating environment will be pushed out until at least 2010 but possibly even further.

Tuesday, 15 April 2008

Is the RBA done raising rates?

The RBA today released the minutes of their Monetary Policy Meeting on April 1st. The tone of the minutes seemed to indicate that the RBA is done raising rates for now and quite possibly for the forseeable future. Below are some of the highlights:

On the domestic economy:

Members were informed that the CPI data for the March quarter, to be released towards the end of April, were likely to show inflation of around 4 per cent on a year-ended basis in the March quarter. A large quarterly increase was expected partly because of recent rises in retail petrol prices. Underlying inflation was also expected to rise in year-ended terms in the March quarter, before declining over time. The staff’s inflation forecast through to 2010 would be revised after the release of the March quarter CPI, but the preliminary assessment, based on current policy settings, was that inflation on both a CPI and underlying basis would fall by a little more than earlier thought over the next two to three years. This was premised on demand growth slowing sufficiently to reduce capacity pressures. Members recognised that a considerable degree of uncertainty continued to surround the outlook for both demand and inflation.

On the outlook for Monetary policy:

Members noted that the economy continued to be affected by a number of cross-currents. Large increases in real income were likely to flow from further increases in the terms of trade, foreshadowed by recent contract price negotiations for key bulk commodities. On the other hand, the slowing global economy and tighter financial conditions in Australia were likely to reduce expansionary forces on the economy. Members judged that, taking account of the additional rises in funding costs that banks had passed on to borrowers, the current stance of monetary policy was exerting a significant restraining influence on both households and businesses. Further, there had been some tightening in credit standards for more risky borrowers.

These developments were working to foster the moderation in demand growth that was needed to ease the pressure on inflation. Provided this moderation continued, members expected inflation to decline over time, though they recognised that there were significant risks in both directions. Members also noted that in the short term inflation was likely to remain relatively high, with both the CPI and underlying measures expected to rise further in year-ended terms in the March quarter.

The important parts are in bold. Basically the RBA sees evidence that the economy is slowing and believe that interest rate rises are having the desired restraining effect on the economy. However they also acknowledge that risks remain that inflation could get out of hand.

The RBA is essesntially hedging their bets. If things play out as they expect and the Australian economy slows then we may not see another rate rise in the current cycle. However further rate rises cannot be ruled out if inflation stays stubbornly high.

Monday, 14 April 2008

Wachovia's Turn To Dilute Shareholder Wealth

Last week it was Washington Mutual (WM) this week it's Wachovia's (WB) turn to slash their dividend, dilute the crap out of existing shareholders by raising new capital and raise their loan loss provisions to parabolic proportions: From

Wachovia to raise $7 billion of capital, slash payout
Banking giant posts loss and increases loan-loss provisions

Wachovia Corp said on Monday that it would raise $7 billion of capital and slash its dividend as it posted a $350 million first-quarter net loss and a higher loan-loss provision....

....Wachovia's need for capital comes only two months after the Charlotte, N.C., bank raised $3.5 billion through a preferred-stock sale.

At the time, The Wall Street Journal reported, the company told shareholders that those funds made the company more confident that it was well positioned in 2008, and Wachovia officials denied that dividend payments would be reduced to conserve cash.

But on Monday the company said it cut its dividend to 37.5 cents a share from 64 cents, payable June 16 to holders of record May 30. The move will preserve $2 billion of capital annually.

Reflecting preferred-dividend payments, Wachovia posted a loss of $393 million, or 20 cents a share, compared with net income of $2.3 billion, or $1.20, in the year-earlier period. Revenue fell 4.5% to $7.9 billion.

"The precipitous decline in housing-market conditions and unprecedented changes in consumer behavior prompted us to update our credit-reserve modeling and rely less heavily on historical trends to forecast losses. As a result, we have substantially increased our reserves," said Ken Thompson, Wachovia's chief executive officer, in a statement.

The provision for credit losses in the 2008 first quarter was $2.83 billion, compared with $1.5 billion in the fourth quarter and $177 million in the year-earlier first period.

The chart speaks for itself, loan loss provisions are growing to astronomical proportions for a number of banks. Whilst many have been focusing on the dollar amount of writedowns, they have neglected the staggering increases in loan loss provisions.

The enormous hike in provisions is going to eat into profits for a number of banks for the rest of 2008 and into 2009. Returning to some sense of normalcy for some of these banks could be 2 - 3 years away.

Saturday, 12 April 2008

US Consumer Sentiment Hits 26 Year Low

Consumer Sentiment plunged to levels not seen since 1982 according to the latest to the latest Michigan survey. If that translates into a 1982 like recession, things could get really ugly. From

Consumer sentiment plunges to 26-year-low

Consumer sentiment sunk to its lowest level in 26 years in early April, according to a report on Friday from University of Michigan/Reuters, as worries about the economy, unemployment and inflation deflated hopes for future.

U.S. consumer sentiment index fell to 63.2 in early April from 69.5 in March. Sentiment is at its lowest level since March 1982. Economists surveyed by MarketWatch were looking for an April result of 68.8.

The expectations index fell to 53.4 in April -- the lowest since November 1990 -- from 60.1 in March, noted Ian Shepherdson, chief U.S. economist at High Frequency Economics. There's no sign that confidence bottomed out yet, he said.

"If sustained at this level, the index is consistent with a 0.5% year-over-year rate of outright decline in real consumption," Shepherdson wrote. "Bearing in mind that more than half of all consumption is non-discretionary (food, energy, housing, etc) this means discretionary spending will fall at a 1% rate or more, something we haven't seen since 1991."

Consumers have been more cautious about spending, according to recent confidence readings. Last month, after reporting a drop in consumer sentiment, Richard Curtin, the director of the survey, said a recession has occurred whenever the index has declined as much as it has fallen during the past year.

The current conditions index fell to 78.4 in April from 84.2 in March. The one-year inflation expectation rose to 4.8% from 4.3%.

"One-year inflation expectations have moved above the post-Katrina spike to the highest levels seen since 1982," wrote John Ryding, U.S. chief economist for Bear Stearns.

Elsewhere Friday, the Labor Department reported that a surge in prices for imported petroleum pushed prices of goods imported into the U.S. higher by 2.8% in March, the most since November 2007.

Friday, 11 April 2008

PWK Upgrades 2009 Guidance

Pipe Networks continues to go from strength to strength upgrading their FY09 earnings forecast to a range between $11 - $12m up from $10.7m previously. The company stated that by July this year, recurring revenues will increase to $3.5m per month up from $2.0m per month currently.

The company also announced that they are currently conducting due diligence on a strategic acquisition in the range of $1m but are unable to release any further details at this time.

At a time when earnings at listed companies may start to feel some pressure Pipe Networks continues to power ahead. Of course the key risk is still the company's ability to execute the Guam to Sydney pipeline. However, given the company's excellent track record on delivering on forecasts they overwhelmingly get my vote of confidence.

Thursday, 10 April 2008

Citigroup - Less Than Meets The Eye

Citigroup has managed to get rid of $12 billion in loans it doesn't want for what seems to be a reasonable price, from Rueters:

Citi financing its $12 bln sale of loans: source

Citigroup Inc's (C.N: Quote, Profile, Research) plan to sell $12 billion of loans and bonds made to private equity firms is seen as a positive for the bank and the loan market, but the deal will leave the largest U.S. bank with exposure to those private equity firms even after the sale.

That's because Citi is financing much of the sale itself, according to a person familiar with the deal. It is lending some money to the private equity firms, which will combine it with some of their own money to purchase the debt.

Essentially, Citigroup is re-lending money, but on different terms. The new loans are obligations of the private equity firms, and Citi is selling the original loans to the firms at somewhere around 90 cents on the dollar.

"The bank still has some of the same risk, but they have a lot of equity in front of them, and it's not on their balance sheet anymore," said David Bailin, head of alternative investments at Bank of America, speaking at the Reuters Hedge Funds and Private Equity Summit. Bailin had no direct knowledge of the Citi deal.

After the sale, Citi would no longer have to mark down the original leveraged loans if their value falls further, a real possibility in the currently disrupted credit markets. It also allows the bank to confirm the recorded values of other leveraged loans in its portfolio.

Or is it a reasonable price? The part in bold is the most interesting. Basically Citi is lending private equity money to buy these loans at around $0.90 on the dollar. What isn't mentioned is that Citi has agreed to indemnify the buyers of the first 20% of losses.

So the real price is somewhere between $0.70 - $0.90. Mr Practical summed up the situation best on Minyanville's Buzz and Banter yesterday:

Less than meets the eye...

As investors bid up the Citigroup (C) stock price early on the news that the bank sold $12 billion of bad loans at not too much of a discount, perhaps they should look closer at the deal.

In order to get that price, C had to agree to indemnify the buyers of the first 20% of losses.

Citi obviously did the deal at this artificial price so that it would not have to mark down too significantly the rest of its portfolio. Not to let facts get in the way, but the price it sold the loans at, if you include the indemnification, is very poor.

Risk is high and growing.

Anything to avoid real price discovery is the name of the game. Even whilst Citi dodges another bullet, I suspect that will still need to eliminate their dividend to shore up yet more capital.

Wednesday, 9 April 2008

WaMu's Great Dilution

I've written repeatedly here about the woes of Washington Mutual. Back in November I noted that Wamu's loan loss provisions would wipe out their entire profit for 2008. That now looks like an optimistic scenario.

The company now expects $3.5 billion in loan loss provision for 1Q08 up from the previously forecast $3 billion and expects costs of $1.4 billion from uncollectible loans. On top of that the company slashed its dividend from $0.15 to $0.01 and plans to lay off 3,000 employees.

Back when Bear Stearns decided to give itself away I noted that it would be worth keeping an eye on WaMu as it was a prime candidate for chapter 11 or to be taken out. Today we learnt that WaMu rejected an offer from JP Morgan to be taken out. Probably because they got a lifeline in the form of $7 billion in capital yesterday.

The company will issue 804 million new shares which amounts to almost a doubling of the number of shares outstanding. That is a massive dilution for existing shareholders who are already staring down the barrel of a 75% drop in the share price. Of course the stock rallied on the news as bankruptcy fears have receeded.

So the bottom callers continue to believe that this another sign that the end is near. However Minyan Peter at Minyanville had a different view yesterday:

WaMu's $7 billion Share Offering Doesn't Spell Bottom

Washington Mutual's (WM) capital raising effort is being cited a sign of a healthy bottoming process.

Despite how it may be portrayed by others in the media, this is an all “common” deal. The distinction between common and preferred is solely due to the number of available shares. Once the existing shareholders approve more common shares, the “contingently” convertible will become common at the same $8.75 per share price.

As I have written previously, when things get worse, banks have to issue common stock. Because of how the bank regulations work, preferred stock “credit” for capital purposes is limited by the amount of common stock below it. With its first quarter writedowns, WaMu had no choice. And importantly, many other banks that have been to the straight preferred and convertible preferred troughs recently in size are in the same position.

Big losses increasingly mean flat out dilution. Ask UBS (UBS), ask Societe Generale. That the market is celebrating all this as a sign of the bottom confounds me. Closer to the bottom? – absolutely, but bottoms are when deals don’t happen.

Be careful about the phrase “increased due to investor demand” – a near 30% discount to market is bound to drum up a little interest. Even with the deal’s generous terms, some of the investors were given additional warrants for agreeing to a five year lock up. Don’t underestimate the role of the regulators telling WaMu how much capital the bank needed to avoid action.

Finally, notwithstanding the company’s current $12.00 trading price, $8.75 is now the ceiling for additional WaMu common equity, should the bank need to come back.

I have a lot of respect for the team at TPG and have no doubt that based on their prior experiences in banking crises, WAMU looks cheap, particularly at $8.75. I would emphasize, however, the phrase “based on their prior experiences in banking crises.”

I think the problem for most market participants right now is that the assumption is what we're experiencing looks something like “their prior experiences in banking crises.” And to me that's why we have seen such a big rally over the past two weeks – because, based on prior experience a rally feels very right, right about now.

But for all the reasons I have shared before, this one is different.

UPS downgrade

Putting paid to the notion that profit outlooks outside of financials, retailers and homebuilders and just fine and dandy was this downgrade out of UPS yesterday:

UPS Lowers 1Q 2008 Guidance

Deteriorating U.S. Economic Conditions Restrain Domestic Volume

ATLANTA--(BUSINESS WIRE)--UPS (NYSE: UPS) today announced it had lowered its first quarter earnings expectations to $0.86 or $0.87 per diluted share from a previously anticipated range of $0.94-to-0.98.

At UPS’s investor conference on March 12, Chief Financial Officer Kurt Kuehn stated that UPS’s earnings guidance for the quarter would be difficult to achieve if lower volume trends experienced in February continued through March. The U.S. economy has continued to weaken, causing a reduction in domestic package volume and a shift away from premium products. Significantly increased fuel costs in the quarter also contributed to the lower-than-expected results.

On April 23, the company will discuss first quarter results and its outlook for the year.

Expect more of this and expect the behind the curve analysts to continue lowering forecasts for companies across a wide range of sectors.

Tuesday, 8 April 2008

NBER Chief says US in Recession

Martin Feldstein is chief at the NBER - the organization that will ultimately decide if the US has entered a recession. A couple of months ago Feldstein wrote a piece in the WSJ warning that Fed rate cuts wouldn't work in trying to prevent a recession, something I've expressed here numerous times. Now Feldstein believes the US economy is already in a recession.

NBER's Feldstein says U.S. sliding into recession

Martin Feldstein, who leads the group that is considered the arbiter of U.S. recessions, said on Monday that he personally believes the economy has been sliding into a recession since December or January.

"I think that December/January was the peak and that we have been sliding into recession ever since then," Feldstein, the president of the National Bureau of Economic Research, said on CNBC television.

Feldstein said he believes that the recession will linger. "I think it could go on longer" than the "last two recessions (which) lasted eight months peak to trough," he said, adding the current recession could last about twice as long.

He also said the first quarter U.S. gross domestic product number will be a "misleading" number in that it may not reflect the economy was in a recession in the first three months of the year.

The NBER, a non-profit research organization, typically declares start and end dates for U.S. recessions. The group has not officially declared the U.S. is in a recession.

Sunday, 6 April 2008

Permabulls In A State Of Desperation

I was thinking of calling the title of this post "Brian Wesbury is a Complete and Utter Moron" but a) that wouldn't fit in the title bar and b) if you've been watching CNN over the last 6 months you already knew that.

Remember Wesbury has been consistently saying that the US economy is not in recession and wouldn't even come close. He is still of that view after Friday's jobs report. However, what is different now is that Wesbury doesn't have any real data to support his claims.

For example, he can't turn to low jobless claims as he did just a couple of months ago and he's gone past the point of the lies and exaggeration exhibited by Don Luskin to outright delusional fantasizing. Let's take a look at few of Wesbury's latest gems that he produced on a couple of CNBC segments on Friday:

"...we're in a period of time where the baby boomers are retiring. Bob Reich knows this, as the secretary of labor I'm sure he's studied this is that, baby boomers are beginning to retire, what used to be a strong job number lets say up 200 thousand now is really up 100 thousand so really when you talk about it, when it 80 thousand decline, it's really like a flat job market because we're seeing so many people retire."

So let's get this straight, the US economy is not shedding jobs, it is just the effect of baby boomers retiring that is distorting the numbers. OK Brian, so how do you explain the next mystifying comment in a later segment that same day?

"I think these interest rate cuts and the fear that the Fed has helped spread, have actually caused part of the quarter million job losses we've had in the first quarter. That's the point."

Fuck me, does this guy not have any shame? I can't believe he actually said that on live TV. The Fed has helped contribute to the job losses, but wait a minute there aren't really any job losses, it's just baby boomers retiring isn't it? I'm confused.

You can see where he's headed with this. Wesbury not that stupid that he can't see the writing on the wall. He's looking for someone or something to blame in place of his own incompetence. It's all the Feds fault because they scared businesses out of hiring by cutting interest rates.

Brian Wesbury you are an utter joke, your credibility is shot and you should be sacked from whatever position you pretend to occupy.

Saturday, 5 April 2008

US NFP's Fall For Second Straight Month

Last month I said that the February NFP report confirmed a recession. The March report lends more credence to that conclusion. US non-farm payrolls declined -80k in March. In addition, January's decline was revised down to -76 from -22 previously whilst February was revised to -63k from -76k. From the Department of Labour:


The unemployment rate rose from 4.8 to 5.1 percent in March, and nonfarmpayroll employment continued to trend down (-80,000), the Bureau of LaborStatistics of the U.S. Department of Labor reported today. Over the past3 months, payroll employment has declined by 232,000. In March, employmentcontinued to fall in construction, manufacturing, and employment services,while health care, food services, and mining added jobs. Average hourlyearnings rose by 5 cents, or 0.3 percent, over the month.

Unemployment (Household Survey Data)

The number of unemployed persons increased by 434,000 to 7.8 million inMarch, and the unemployment rate rose by 0.3 percentage point to 5.1 per-cent. Since March 2007, the number of unemployed persons has increased by1.1 million, and the unemployment rate has risen by 0.7 percentage point.

Highlights from the March report:

51,000 construction jobs were lost
48,000 manufacturing jobs were lost
12,000 retail trade jobs were lost
35,000 professional services jobs were lost

18,000 government jobs were added

The employment rate reversed sharply to 5.1% after dipping to 4.8% in February. That was widely anticipated as more workers returned to the workforce after 374k dropped out the previous month.

The debate has shifted from, if there will be a recession to how deep and protracted it will be. Mainstream economists seem convinced that it will be short and shallow and I have to admit that the economic data whilst negative is at this stage commensurate with the mainstream view.

However the mainstream, as usual, has completely missed this turning point in the economic cycle. Lets look at how badly the mainstream has been at predicting the course of events over the past 9 -12 months.

First we were told, the housing downturn and credit crunch was contained and would not spill over to the broader economy and there would be no slowdown in economic growth let alone recession. Then of course it did spill over to the broader economy, corporate earnings turned negative and growth slowed.

Then they conceeded that there would be a slowdown but a recession would be avoided. Now some (amazingly many Wall Street lemmings believe there is still no recession) are conceeding recession but that it will be short and shallow.

Is it time to believe them? Sooner or later they will be right about something of course but I suspect it will be a while yet. The Fed and the US government seem ready to throw everything but the kitchen sink at the economy to prop it up. The non-stimulus package is expected to give a kicker to growth in the second half of 2008.

However I'm not buying it, at least not yet, a one-off stimulus package is not a long term solution to a consumer buffeted by higher food and energy costs, with their housing ATM having been removed from their front lawn, credit harder to access, mortgage rates resetting higher and more people losing their jobs.

Thursday, 3 April 2008

Initial Jobless Claims Breach 400k in Latest Week

Ex Cyclone Katrina Initial Jobless Claims rose to their highest level since September 2003 punching through the 400k mark. The 4 week moving average shot up to 374,500. From the Department of Commerce:



In the week ending March 29, the advance figure for seasonally adjusted initial claims was 407,000, an increase of 38,000 from the previous week's revised figure of 369,000. The 4-week moving average was 374,500, an increase of 15,750 from the previous week's revised average of 358,750.

The advance seasonally adjusted insured unemployment rate was 2.2 percent for the week ending March 22, an increase of 0.1 percentage point from the prior week's unrevised rate of 2.1 percent.

The advance number for seasonally adjusted insured unemployment during the week ending March 22 was 2,937,000, an increase of 97,000 from the preceding week's revised level of 2,840,000. The 4-week moving average was 2,859,000, an increase of 32,250 from the preceding week's revised average of 2,826,750.

Lets have a flashback for a moment to a quote from Brian Wesbury that I noted back at the end of January this year.

Brian Westbury on CNBC on, 1/22/2008, “There is really no evidence that the economy has turned over”

“Initial unemployment claims were at 301 thousand in the latest reporting week. This is so far from a recessionary level I’m like, I’m shaking my head at anybody who thinks we’re in a recession.”

How are those unemployment claims looking now Brian? Are you still shaking your head?

Wednesday, 2 April 2008

ADP Report Suggests Small Growth In March NFP's

As mentioned previously, the ADP employment report has been mixed at best when it comes to predicting growth in non-farm payrolls. from

Nonfarm private employment increased 8,000 from February to March 2008 on a seasonally adjusted basis, according to the ADP National Employment Report™. The estimated change in employment from January to February was revised up 5,000 to negative 18,000. Though positive, the slight increase of 8,000 in March signals a continuing sharp deceleration of employment growth from previous levels.

Unlike the weakness of employment reported in February, which was widespread across businesses of all sizes and apparent in all major sectors of the economy, the weakness of employment in March was concentrated among larger businesses in the goods-producing sector.

Employment in the service-providing sector of the economy grew 85,000, while employment in the goods-producing sector declined 77,000, the sixteenth consecutive monthly decline. Manufacturing employment fell 58,000 in March and marked the nineteenth consecutive monthly decline.

Large businesses, defined as those with 500 or more workers, saw employment decline 52,000. Conversely, employment among small-size businesses, defined as those with fewer than 50 workers, advanced 55,000 during the month, up from a revised 16,000 in
February. Employment increased just 5,000 among medium-size businesses with between 50 and 499 workers.

The positive here is that small businesses, at least according to this report, are still hiring. Adding in the job growth from the government sector, today's ADP employment report points to a rise in non-farm payrolls of about 30k in March.

The table above compares the BLS NFP numbers with the ADP report for the previous 3 months. As you can see they are all over the place. So get your dartboards out on Friday for the BLS non-farm payroll report and as always watch the revisions to prior months.

Tuesday, 1 April 2008

UBS Writedowns Total 1/3 of Equity

In a timely reminder that the credit crisis is nowhere over, UBS managed the biggest single writedown of any financial institution writing off $19 billion or the equivalent of 1/3 of their equity. From

UBS plans $19 bln write-down, capital injection
Chairman Ospel to resign; first-quarter loss seen around $12 billion

Swiss banking giant UBS on Tuesday revealed a further $19 billion hit from the credit crisis, doubling its write-downs so far, and said it will have to issue around 15 billion Swiss francs ($15.1 billion) in new shares to shore up its capital base.

The latest hit means UBS (UBS) will report a net loss of around 12 billion francs for the first quarter and marks the end of the road for beleaguered Chairman Marcel Ospel, who will step down later in April.

Click on the link for the full story. And just so UBS doesn't feel lonely Deutsche bank chimed in with some losses of their own. Also from

Deutsche Bank sees $3.9 billion mark-downs in Q1

Deutsche Bank (DE) said Tuesday that conditions have become significantly more challenging during the last few weeks and it expects first quarter mark-downs of around 2.5 billion euros ($3.9 billion). The mark downs are related to leveraged loans and loan commitments, commercial real estate, and residential mortgage-backed securities (principally Alt-A). Deutsche Bank said that it expects a BIS Tier 1 capital ratio at the end of the first quarter of between 8 and 9%, consistent with the bank's published targets.

Here we go again, it's writedown season. Buckle up for some more fun in April as US financials re-visit the confessional.