Sunday, 30 November 2008

XAO Has Worst November in 25 years

Although October was a horrible month for stocks, the last week of the month saw the market rally hard and look likely to set the stage for a sustained rally in November. A lot of fears eased and confidence returned. At the time I made the comment that I get suspicious when others get comfortable.

That suspicion was warranted as the XAO fell a further -7.8% in November and at one point being down more than double that amount. What happened? Well it appears that US government, far from having solved the current crisis, is simply making it up as they go along. Citibank, after repeated claims that they were fine, wasn't and has now essentially been nationalized.

Australian banks too, made visits to the confessional about exposures to failed institutions. Allco Finance Group (AFG) appointed a voluntary administrator in early November followed a couple of days later by ABC Learning Centres (ABS) with Babcock and Brown (BNB) soon to follow I suspect. Even with the rally in the last week of November it was the worst November in the last 25 years surpassing the -7.3% decline in November 1988.

But thankfully, president elect Obama rode to the rescue and has appointed a wonderful economic management team to save the day. Yes, in case you are wondering, I'm being sarcastic. The idea that a guy at the center of action over the past 18 months, Timothy Geitner, is well equipped to take over the reigns of Treasury Secretary is counter intuitive.

The logic goes that Geitner has been in the thick of things starting with the LTCM bailout in 1997 right up to the present day bailouts of Bear Stearns, Fannie and Freddie and Citigroup. He is someone who is "not afraid to take action" and will get the job done. Yes but what good is taking action and getting the job done if the job you do is second rate? I'd actually prefer someone who took no action. The time to take action was years ago. Where was Mr "not afraid to take action then?" Anyway, enough of that rant.

What can we expect in December? As we did in October, we ended November on a positive note. Volatility has declined and a semblance of confidence has returned to the markets. Still, even with the rally in the last week of November, the XAO is down a monumental -30% since the end of August. One aspect of the current bear market that has been missing since that time is a sustained bear market rally lasting a number of weeks rather than the 4 or 5 day rallies to date.

Once again I have no strong convictions about short term market movements, nor does my investment philosophy depend on it. During October, the XAO was officially down more than -50% from the November 2007 peak. Was that the bottom? We won't know until well after the fact. I suspect it won't be. When the market comes to grip with the fact that Obama has no silver bullet to fix all that ails us and the analysts get their head around how bad earnings will be in 2009, I think we will at the very least, retest the lows seen in October sometime in the next few months.

However, Since we have not had a sustained bear market rally for some time, I think December could be it. Therefore I'm going to call the XAO higher in December but ultimately it will prove to be just another bear market rally. Also, Don't forget to have your say in this month's poll.

Wednesday, 26 November 2008

US Home Prices Continue to Fall

The September report of the S&P/Case-Shiller Home Price Index showed home prices down -17.4% from a year ago for the 20 city index and are off -18.3 for the 10 city index. From their peaks, the 10 city index is down -23.4% whilst the 20 city index has plunged -21.8%. From the report:

“The turmoil in the financial markets is placing further downward pressure on a housing market already weakened by its own fundamentals.” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s.

“All three aggregate indices and 13 of the 20 metro areas are reporting new record rates of decline. Looking at the returns of the U.S. National Index, prices are back to where they were in early 2004. As of September 2008, the 10-City Composite is down 23.4% from its peak, the 20-City Composite is down 21.8% and the National Composite is down 21.0%.”

The part in bold is interesting. Home prices are only back to levels they were in early 2004 as depicted in the chart below. Whilst the year over year declines may slow and even reverse in coming months, house prices will continue to come down to more affordable levels as the huge inventory of unsold homes is worked off.

Tuesday, 25 November 2008

Whalen - No Bank is too Big to Fail

I'm fast becoming a fan of Chris Whalen of institutional Risk Analytics. He pulls no punches and talks common sense. In this segment he makes the case that noone is too big to fail and the likes of Citigroup should be liquidated rather than being put on life support. Unfortunately I think Whalen's points are falling on deaf ears. The quote below from Chris Whalen is one of the most salient statements I've heard in a long time:

We have got to stop pretending that size gives you a pass on economic reality

Citi Bailout
Citi Bailout

Monday, 24 November 2008

Citibank Gets Bailout

The United Socialists of American government decided to bailout Shitigroup by guaranteeing $306 billion of Citigroup's assets and injecting a further $20 billion in equity.

Citigroup Gets Guarantees on $306 Billion of Assets

Citigroup Inc., facing the threat of a breakup or sale, received $306 billion of U.S. government guarantees for troubled mortgages and toxic assets to stabilize the bank after its stock fell 60 percent last week.

Citigroup also will get a $20 billion cash injection from the Treasury Department, adding to the $25 billion the company received last month under the Troubled Asset Relief Program. In return for the cash and guarantees, the government will get $27 billion of preferred shares paying an 8 percent dividend. Citigroup rose as much as 41 percent in German trading today....

....The government’s preferred shares come with warrants to buy 254 million Citigroup shares at $10.61 each, allowing taxpayers to profit if the stock rallies following the government’s investment, according to a term sheet that accompanied the agencies’ statement. Citigroup is required to pay a quarterly dividend of no more than 1 cent a share for the next three years, down from 16 cents in the most recent quarter.

....Terms of the asset guarantees mean Citigroup will cover the first $29 billion of pretax losses from the $306 billion pool, in addition to any reserves it already has set aside. After that, the government covers 90 percent of the losses, with Citigroup covering the rest from assets, including residential and commercial mortgages, leveraged loans and so-called structured investment vehicles....

Let's be clear, Citigroup is insolvent, it's as simple as that, along with Fannie and Freddie and AIG they are being propped up by the government. I guess we should expect a pop in Citigroup stock folowing the bailout announcement, however you definitely wouldn't buy Citigroup stock for yield, since they won't be paying much in the way of diviends in the next 3 years. And if you think Citigroup is going to have any earnings in the next year, think again. They'll be taking writedowns and making losses for at least another 12 months.

Claims by CEO Pandit just last week that Citi had adequate capital ring hollow, and for anyone paying attention that was obvious. As I said yesterday and have been saying for a month, the capital injections under the TARP program would not even come close to being adequate because of the amount of losses linked to toxic assets on bank balance sheets.

Sunday, 23 November 2008

Bloomber Interview with Niall Ferguson

Niall Ferguson is a historian and professor at Harvard and fellow at Oxford. Unlike a lot of academics his head is not lost in some ivory tower. He has made some fairly accurate predictions of what has come to pass in the last 18 months. He has also written some excellent books on financial history.

In this interview he talks about his latest book and more specifically how bubbles were created in the past. Also of interest was his comment about the latest problems in the banking sector. Ferguson is of the opinion that the reason the US banking sector is still cratering is becasue they have yet to own up to the massive losses they are carrying and that the injections of capital to date are not enough.

I am of the same opinion and expressed that view a month ago in Bank Injections just the Beginning. In my humble opinion, this is exactly the reason why Citigroup is on the brink of implosion. They have so much in the way of losses from bad assets coming down the pike that the $25 billion injection by the US government is far short of what they need to stabilize the company's balance sheet. I wouldn't be surprised if they need an AIG like amount of money to see them through.

Friday, 21 November 2008

Initial Jobless Claims Highest Since 1992

Last week US intial Jobless claims hit a 7 year high, just one week laterand they hit a 16 year high. Initial Jobless claims hit 542,000 in the week of November 15th pushing the 4 week moving average through the 500k mark. I've extended the graph above back 10 years to show how high jobless claims got in the nasty recession of the early 1980's.

Turning to continuing claims, in the latest week they punched through the 4 million level, the highest level since December 1982.

Forecasts of double digit unemployment in the US would need to see intial claims push through the 600k mark stay there for some time, whilst continuing claims would head up through 4.5 million. we are not there yet, but it can't be ruled out in the current environment

Thursday, 20 November 2008

Doublling Down with REF

"When stocks go down and you can get more of them for your money, people don't like them anymore." Warren Buffet.

What Buffet was getting at in this quote is that whilst people are willing to pay for a stock at say $2 they are unwilling to buy them when they fall to $1, even though you can get more of them for the same amount.

That's not to say that you should double down on any stock because the price halves. However, if the fundamentals remain in tact and you are paying a price significantly below intrinsic value, then why wouldn't you buy more? That is at least my rationale for purchasing another 10,000 REF shares today for $0.98.

I first purchased REF shares back in February at $2.22, at that time I was a little overly optimistic about earnings growth. Not because I thought the business would do better but I didn't anticipate the strong AUD which affected REF's GBP profits, from which they derive the bulk of their earnings. That exchange rate has improved in 1H09 to an average of0.454 as opposed to an average of 0.468 in 2H08. However it is still above the average for FY08.

Consensus earnings estimates are forecasting a decline of about -7.1% for FY09 and a cut in the dividend from $0.24 to $0.21. No, that is not a misprint, the stock is currently $0.96 and is forecast to deliver a FY09 dividend of $0.21 cps, for a dividend yield of almost 22%.

Using the consensus number, I value the stock at around $1.80 - $1.90. Remember this company has a return on equity in excess of 200%, has no debt and generates a trememdous amount of free cashflow which they pay out as dividends.

Of course, the effect of the current economic malaise is as yet unknown, however even if the company were to slash their dividend by a third from last year's level, at current prices you would still be receiving a 16% dividend yield. If earnings and divdends were halved, a scenario I think is very unlikely, you would still be getting a 12% yield. That's much better than I can currently get in the bank and thus an offer I can't refuse.

Missed this yesterday but thought it worthy of a mention the emphasis in bold is mine. From

The annualised growth rate of the Westpac–Melbourne Institute Leading Index, which indicates the likely pace of economic activity three to nine months into the future, was 1.1% in September, well below its long term trend of 3.9%. The annualised growth rate of the Coincident Index was 1.6%, also below its long term
trend of 3.6%.

This is a very disturbing fall in the growth rate of the Leading Index. The growth rate fell from 3.5% in August 2008 to 1.1% in September 2008. That represents the largest percentage point fall between two months since the mid 1980's – sharper even than we saw in the 1990/91 recession.

The growth rate is signalling a very weak growth outlook through at least the first half of 2009. It is consistent with Westpac's view that growth in the first half of 2009 will be barely positive with a decent risk that the first two quarters of growth in 2009 could be negative.

So basically Westpac is toying with the idea of the first Australian recession in almost 2 decades. With the US going ino the worst recession since at least 1981-2 how can Australia possibly avoid at least a mild one?

US Building Permits & Starts Hit Lowest Level in History

The bottom callers must be exhausted by now. US Housing records continue to be smashed. Today, both US housing starts and building permits hit new historic lows. Records have beeen kept since 1959. Click here for the October report on Starts, Permits and Completions:

Firstly Building Permits:

Privately-owned housing units authorized by building permits in October were at a seasonally adjusted annual rate of 708,000. This is 12.0 percent below the revised September rate of 805,000 and is 40.1 percent below the revised October 2007 estimate of 1,182,000.

Single-family authorizations in October were at a rate of 460,000; this is 14.5 percent below the September figure of 538,000.

That beats the previous low of a SAAR of 709,000 set back in March 1975.

Housing starts:
Privately-owned housing starts in October were at a seasonally adjusted annual rate of 791,000. This is 4.5 percent below the revised September estimate of 828,000 and is 38.0 percent below the revised October 2007 rate of 1,275,000.

Single-family housing starts in October were at a rate of 531,000; this is 3.3 percent below the September figure of 549,000.

That beats the previous low of a SAAR of 798,000 in January 1991.

Privately-owned housing completions in October were at a seasonally adjusted annual rate of 1,043,000. This is 10.2 percent below the revised September estimate of 1,161,000 and is 25.6 percent below the revised October 2007 rate of 1,401,000.

Single-family housing completions in October were at a rate of 760,000; this is 7.7 percent below the September figure of 823,000.

Completions have not yet hit record lows but remember that completions lag starts so you can expect them to go quite a bit lower in the coming months. didn't hear any bottom calling today, maybe they've finally given up?

Wednesday, 19 November 2008

Aussie New Car Sales Continue to Slide

New Motor Vehicle Sales Fell a seasonlly adjusted -0.5% in October and are now down -10.6% from a year ago, the biggest year over year decline in 7 years. Don't expect those year over comparisons to get anything but worse in the short to medium term.

Tuesday, 18 November 2008

Macquarie Bank 1H09 Profit down 43%

Macquarie Bank today announced that 1H09 profit fell -43% from the previous year to 217 cents per share. However that headline number disguises the extent of the deterioration in MQG's business. In the review section of the Appendix 4D, the company had this to say:

Subsequent to balance date there has been a further significant deterioration in equity markets which has impacted the market prices of our co-investments in listed specialist funds. If the market prices at the date of this report had been used in the Group's assessment of recoverable amount rather than the 30 September 2008 prices then profit after tax would have been reduced by approximately $130 million.

So Assuming that the value of MQG's satellite funds are not going to revcover materially in the next 6 months, MQG's forecast profit of 483 cents a share is looking to be on shaky ground. For some reason the stock ralled more than 16% today, probably because whilst the result was bad, there were no nasty surprises.

I'll repeat something I said many times last year and early this year when I talked about US banks and the outlook for profits going forward. The easy money leverage up environment is gone, and since Macquarie has largely depended on that for growth they will have to get used to a lower earnings base for the next few years.

Sunday, 16 November 2008

Imminent Earnings Meltdown

I've been closely following US corporate earnings for a better part of a year now, and for good reason. More than a year ago I argued that analysts are perennial optimists and are unable to anticipate changes in the earnings cycle and thus when a change occurs they have to play catch up.

more than a year later and they are still playing catch up. Just 4 months ago, analysts expected 3Q08 S&P500 operating earnings to show a double digit increase. As of last week, 91% of S&P500 companies have reported earnings and have registered a decline of -21.6%.

Notice in the graph above how sharply earnings expectations declined as the reporting season got underway. That trend is now playing out in the graph of 4Q08 expectatons below.

Earlier in the year when 4Q08 earnings expectations were expected to rise in excess of 70% I said that was ridiculous and they would end up being slashed. As of last week those expectations are a more realistic 26%. However that is still way too high.

A couple of months ago I would have said a 10 - 15% increase in 4Q08 earnings would have been possible given that earnings dived off a cliff in 4Q07, thus making the current quarter's comparisons much easier. However, now I believe 4Q08 earnings will be much worse.

As seen above 4Q07 represents the trough in earnings for the current cycle. However, in light of the tsunami of downgrades for 4Q08 in the last couple of weeks, I am confident that the $15.22 of earnings in 4Q07 will be breached to the downside in 4Q08. In fact 3Q08 may even come close when you consider that more than $2.30 was lopped off 3Q08 operating earnings just in the latest week.

Why will 4Q08 be so bad? Take a look at the chart below from What this shows is the ratio of earnings upgrades to earnings downgrades for S&P500 FY08 earnings. A number greater than 1 means more upgrades than downgrades whilst a revisions ratio of less than 1 means more downgrades than upgrades.

As you can see, the revisions ratio for the S&P500 is currently at 0.33, which means for every upgrade there are 3 downgrades for FY08 earnings. Healthcare is the only sector with more upgrades than downgrades. In the consumer discretionary sector, there are 6 times the number of downgrades as upgrades. This, in my opinion, will result in 4Q08 earnings falling below $15.Why the sudden huge increase in earnings downgrades? Until recently, most of the earnings destruction was in the finacial sector, however that has now spread across the entire economy.

So what you say, the stockmarket has already discounted a horrible fourth quarter and is looking ahead to 2009. If you go back to the chart showing actual and forecast S&P500 earnings, you can see the nice linear path that analysts have mapped out for future earnings to return to record highs by 4Q09. Mark my words, there is no way in hell US corporate earnings will be reaching record highs by the end of next year, that is fantasyland stuff. But don't take my word for it, take a look at the revisions chart for FY09 below.

The revisions ratio for FY09 is currently at 0.13 which means that there are a staggering 8 downgrades for every upgrade to FY09 earnings. Even the healthcare sector has more downgrades than upgrades.

As shown below, FY09 earnings forecasts have started to fall precipitously in the last few months. Currently FY09 S&P500 operating earnings are forecast at $91.85. That is way too high, my best guess at the moment would be somewhere in the vicinity of $60.

Slap a 12 multiple on S&P500 earnings of $60 and you get an S&P level of 720. Thus it is easy to see how the S&P500 can go substantially lower from current levels. This is not a forecast but just an indication that the stockmarket can go signifcantly lower and still not be ridiculously cheap.

Saturday, 15 November 2008

US Retail Sales Fall off a Cliff in October

As expected retail sales fell off a cliff in October dropping -2.8% from a lower revised September number. That is the fourth straight month of falling retail sales, a trend that has not been seen since 1974. This attest to just how tapped out the US consumer is as unemploymnet rises sharply and access to credit is much tougher.

The mainstream view is that the US economy will turn around in the second half of 2009, funnily enough if you remember, that was what was expected to happen in the second half of 2008.

Friday, 14 November 2008

Initial Jobless Claims Hit 7 Year High

I used to often post about US initial jobless claims when trying to demonstrate why the US was heading for recession. I haven't done so for some time because it is obvious to all and sundry that the US economy is in a deep recession.

In the latest week to November 8th, intial jobless claims rose to 516,000, the highest since September 2001. Continuing claims hit 3.897 million, the highest level since January 1983.

If this recession is going to be as bad as the early 1980's we should expect intial claims to exceed 600k and continuing claims to punch through 4.5 million. KWhilst the employment data is backward looking it pays to keep an eye on the weekly jobless claims number as it is the most current barometer of employment conditions.

Thursday, 13 November 2008

CBA Profit Warning ... I mean Trading Update

CBA today released their quarterly trading update for September which you could easily mistake for a profit warning. Here is the money quote:

While there is no evidence of systemic credit issues, the Group‟s exposure to Lehman Brothers, Allco Finance Group Limited and ABC Learning Centres Limited will result in significantly higher first half provisions.

Significantly higher than what? The first half of 2008? If that were the case you'd have to think that 1H09 would at least match the level of 2H08. Currently consensus estimates have CBA's FY09 profit basically flat compared to FY08. That is looking doubtful after today's announcement.

On the positive side, deterioration across CBA's entire asset portfolio has been relatively mild. However the risk is of course that the Australian economy gets materially worse, unemployment rises and therefore credit impairments. Given the recent barrage of negative economic data that is much more of a possibility than most mainstream economists expect, and know how well the mainstream has done over the past 18 months.

Still, if I had to pick one Australian bank to invest in over the long term, it would be CBA. After today's routing the stock is now yielding over 8%. But can that dividend yield be relied upon?

Update: I just spied this article which suggests CBA's total provision for bad debts could rise to as much as $2.3 billion in 2009, more than double that in 2008. That would definitely mean the current projected dividend yield won't hold up.

Making it up as you go along

That sums up neatly what the US treasury and Federal Reserve have been doing for the past year. Confirmation came yesterday with secretary treasury Paulson's announcement that the original use of bailout funds has now been scrapped in favour of capital injections.

When will the mainstream media get their collective heads out of their arses and figure out what most people with a modicum of common sense have long known? Paulson doesn't have a clue what he is doing. Back in July 2007 I labeled Paulson a comedian for his repeated claims that the subprime problem would be "contained". This story from put his latest moves this way:

But in a striking admission, Paulson said that buying up mortgage assets "is not the most effective way" to use government funding....

...Alex Merk, president of Palo Alto Calif.-based Merk Investments, a mutual-fund firm, said that market participants were frustrated with Paulson's communication skills and changing tactics.

"He's been flip-flopping on every plan and it doesn't look like he has a plan," Merk said in an interview.

Yes Alex, that would be because he doesn't have a plan, he's making it up as he goes along. The proposal to buy toxic assets from banks was not a well thought out idea to begin with, refer to my previous post in September for the reservations I had about the proposal. So what are they going to use the funds for instead?

Some of the money saved from not buying mortgage assets will now be used to shore up the market for credit-card receivables, auto loans and student loans, according to Paulson.

In other words it's just a free for all, bring us your huddled masses and every other piece of toxic crap out there. Not surprisingly the markets pushed the major US indices down more than -5% followed by a -5.4% drop in Australia today. You can't instill confidence in financial markets with a make it up as you go along approach.

Wednesday, 12 November 2008

How Bad Can it Get for Retail?

Hot on the heals of the Circuit City bankruptcy announced on Monday, Best Buy today announced a sharp revision to it's full year profit forecast citing the worst times in 42 years of retailing. From Bloomberg:

Best Buy Cuts Annual Profit, Sales Forecasts on Slump

Best Buy Co., the largest U.S. electronics retailer, said full-year profit will be lower than it expected because of the recent turmoil in the financial markets and the U.S. economic slump

The shares dropped as much as 17 percent in early New York trading after the chain said profit for the year through February 2009 will be $2.30 to $2.90 a share. Revenue may range from $43.7 billion to $45.5 billion, Best Buy said today in a statement.

Sales at stores open at least 14 months may decline as much as 15 percent in the four months through February as consumers grappling with the worst financial crisis since the Great Depression cut back on spending. Circuit City Stores Inc., Best Buy’s largest electronics competitor, filed for bankruptcy protection Nov. 10 after suppliers cut off credit and demanded cash for shipments.

“In 42 years of retailing, we’ve never seen such difficult times for the consumer,” Brian Dunn, president and chief operating officer, said in the statement. “People are making dramatic changes in how much they spend, and we’re not immune from those forces.”

Best Buy forecast in September adjusted full-year profit of $3.25 to $3.40 a share on revenue of $47 billion. Analysts surveyed by Bloomberg estimated profit of $3.04 a share on sales of $46.4 billion.

Best Buy dropped $2.79, or 12 percent, to $21.09 at 8:29 a.m. in trading before the New York Stock Exchange opened.

With such a wide range given on profit numbers it's clear that there is very little visibility with respect to earnings in the next couple of quarters and in such an environment it is difficult for investors to have confidence buying stocks when CEO's are saying the type of things highlighted above.

Australian Business Confidences Plunges

Yesterday NAB released their monthly business survey for October, not surprisingly it was grim. Key points were as follows:

  • Business confidence fell (a record) 21 points to a new record low of -29 index points.
  • Business conditions also fell sharply - down 10 points to -11 index points – a level around the bottom of the slowdown in late 2000/early 2001 (-13 points).
  • Trading conditions fell 11 points to an index reading of -10. Profitability fell 9 points to -13 index points and employment fell a relatively sharp 8 points to -10 index points.
  • The latter is now indicative of labour shedding occurring and is more bearish than the official ABS employment estimates. All three sub components are at levels last seen in the 2001 slowdown.

I found this part of the commentary to be of interest also;

Clearly, the most marked feature of the October survey is the unprecedented collapse in business confidence – after a number of months of relative steady (but weak) readings notwithstanding global turbulence. It appears that the continuing volatility in global equity markets, emergency financial packages, falling commodity prices, and continuing talk of global recession have finally broken business optimism and now fear reigns supreme. Indeed it is worth noting that confidence readings worse than the bottom of the 1990s recession has more to do with fear of the unknown than actual current outcomes. That said, the reading for business conditions for October does point to a further sharp slowing in activity – to levels similar to that reported at the bottom of the 2000/01 slowdown.

The emphasis in bold is mine. Based on available data the economy is not as bad as the sentiment indicates but that is of concern in itself as it begs the question, what does it portend for the future? NAB is saying that we are at least headed for a slowdown equal to 2000/01, that in my view will prove to be overly sanguine.

Tuesday, 11 November 2008

Can I be a bank too?

Seriously, you couldn't make this stuff up. American Express is now a bank, from Bloomberg:

American Express Wins Federal Reserve Approval to Become Bank
American Express Co. won Federal Reserve approval to become a commercial bank, gaining access to funds as credit losses build and sales of asset-backed bonds plummet.

The Fed waived a 30-day waiting period on the application ``in light of the unusual and exigent circumstances affecting the financial markets,'' according to a statement released yesterday in Washington. Chairman Ben S. Bernanke and his colleagues unanimously voted for the action.

I was going to have a rant about how ridiculous this is but Yves Smith did a great job of that over at Naked Capitalism.

Seriously, Amex becoming a bank? This is patently ludicrous. Amex poses no systemic risk, so they don't have a case for needing access to the Fed window. They once owned a bank in connection with their wealth management business, but that is a thing of the past.

The process has now become ludicrous. Amex gets to become a bank to help with its credit card business, which in case you have not been paying attention, has been cutting credit lines to existing customers en masse (I have heard of a case with eight figure net worth, infrequent user, impeccable credit score, who nevertheless had his credit line cut by 50%).

And since no credit card bonds were sold last month, the purpose of this exercise is so that Amex can borrow against its credit card receivables at the Fed window at preferred rates. I am not making this up.

Willem Buiter once said that US regs permitted the Fed to lend against any collateral, including a dead dog. We are getting perilously close to that.

America needs to get its consumption down, but apparently the powers that be are going to use any trick possible to try to keep the American shop-a-holic habit going.

Monday, 10 November 2008

More Visits to the Confessional for the Big 4

Back in February I asked the question Time to Buy the Big 4? and concluded that it wasn't. Then in August after even bigger declines I said Still Not Time to Buy Aussie Banks. If you bought the major banks back in August you haven't made any headway, but we have learned a few extra things we didn't know back then.

Firstly we knew Allco and ABC Learning Centres were in trouble but we didn't know they would be insolvent less than 3 months later. Below are the exposures of each bank to both.

It also should be noted that CBA holds 4.456m ABS hybrid notes at a carrying value of $220m whilst NAB has no direct exposure to Allco it does have exposure to entities within the Allco group. NAB also has a $20m exposure to the recently insolvent Rubicon group. In addition NAB made the following announcement today.

NAB to strengthen further its capital position

National Australia Bank (NAB) has launched an institutional placement of shares to raise approximately A$2.0 billion to strengthen its balance sheet and take advantage of organic growth opportunities. The placement has been fully underwritten by Goldman Sachs JBWere, Merrill Lynch and UBS AG, Australia Branch.

I must say I nearly fell off my chair laughing when I read the heading of the announcement. As if raising capital was a sign of strength. The truth is they need the capital to cushion the writeoffs coming down the pike.

I said months ago that the news for Australian banks would get worse before it got better. Now it is getting worse and is not likely to get better for some time and thus there is no reason to go out and buy the major banks with your ears pinned back just yet.

Sunday, 9 November 2008

My Portofilo: Year 2, 12 month return

Well, what a difference a year makes. Last year I reported a 45% return and this year gave almost half of that back with a -21.3% return after brokerage and dividends. That compares to a decline in the XAO of -39% over the same period. The graph shows my relative poerformance compared to that of the XAO over the past 2 years.

The outperformance in the past year compared to XAO is due in most part to a timely trade in ANH taken back in January. The companies I have held on to, PWK and REF have both declined by more than -40%.

I'll continue to hold these companies as I think they are strong businesses and will outperform over the long term - and that is what my aim is. I want to own shares in strong businesses that will outperform over the full market cycle. If own such businesses then my overall portfolio should outperform that of the broader market.

A note of reality here. My portfolio is hardly what you would call a portfolio. There is a reason I only own shares in two companies and that is because I have had an unfavourable view of the markets for the best part of a year now - most of my assets are sitting in cash.

However, I expect to put some more cash to work in the coming year. There are already compelling valuations out in the market but I am also aware that they could get even more compelling as economic reality comes home to roost.

I don't expect the overall market to have a great year in 2009 but I do expect to able to add some good businesses with sound fundamentals at reasonable prices to my portfolio.

Saturday, 8 November 2008

US Unemployment Rises Sharply in October

The US unemployment rate spiked sharply in October to 6.5% as US non-farm payrolls declined by -240k. Details of the report were as follows:

Construction -49,000
manufacturing -90,000
Retail trade -38,000
service providing -108,000
professional & business services -45,000
education and health services -21,000
leisure and hospitality -16,000
government +23,000

There is a reason why I always harp on about watching the revisions. The revisions to September and August were enormous. In total NFP's were revised down by a total of 179k. August was revised from a loss of -73k to a loss of -127k whilst Spetember was revised from a loss of -159k to a whopping -284k. As mentioned before, whilst the headline gets the most attention, the revisions give a more accurate picture of what is going on because they incorporate additional data that was not available previously.

Always a good source of amusement was the controversial Birth/Death model which claims that a net 71k new jobs were created in November.

Forecasts of the unemployment rate peaking at 8% are now common with 9% being floated around and some more extreme calls talking about the possibility of double digits. I'm now leaning towards a rate closer to 9%.

However, in terms of the stockmarket, you don't want to be waiting for the unemployment rate to top out before investing or it is likely that you will miss out on some of the upside. You want to focus on the point where the rate of job losses start to abate. That point will not be reached in the remainder of this year but may start to appear in the latter part of 1Q09. In the last US recession there were 3 consecutive months of of job losses exceeding -200k or more peaking with a loss of -325k in October 2001.

Given that this recession looks like being the worst since 1981, we can look forward to some ugly job reports probably showing job losses of more than -300k per month in the immediate future. The effect of layoffs on consumer spending and thus on profits is sure to be felt across the board in corporate America and in my opinion has not yet fully been discounted in stock prices.

Friday, 7 November 2008

Shiller - More tough times ahead for the US

Great interview with Robert Shiller on the 7:30 report. Shiller is admiringly honest, amongst other things he admits that economic forecasting is a lot of guesswork. He touches on a particularly interesting subject which is basically that in times of relative stability, economic forecasting is easy because you just extrapolate previous trends, However in times such as we are in now, extrapolation doesn't work, so technical forecasting models don't work.

Again these are the same themes that Nassim Nicholas Taleb talks about in the Black Swan. That's why when I hear mainstream economists and other market pundits compare this bear market or recession to previous ones and then try to draw conclusions based on those previous experiences I become very skeptical.

I have to admit I am sucker for this as well, we always try to look for patterns that repeat themselves, however you need to cognizant of the fact that some of the events we are seeing now have no historical precedent and therfore it is unreasonable to think they will play out the same way.

Thursday, 6 November 2008

Whitney on the Future of Financials

I've posted about Meredith Whitney a number of times. She's been out in front of the problems facing the major banks for more than a year now. She talks commmon sense backed up by facts and as the finaical crisis has played out she has been vindicated in her views and I implore readers to listen to what she has to say in the interview below.

Future of Financials
Future of Financials

Amongst other things she says:

  • Securitization market is not coming back.

  • Pullback in credit extension to consumers like we've never seen before.

  • Unemployment could approach double digit levels.

  • Wall Street analysts are anywhere from 30% - 70% higher than her forecasts for the banks and she thinks she is on the high side.

  • Banks will come back to the market for more capital.

  • More dividend cuts.

  • Citibank will go to single digits.

  • Well worth a watch.

    Cisco Warns on Earnings, Economy

    Back in August, when Dell reported a global slump in technology spending I asked the question "Is Dell the Canary in The Coal Mine for Tech?" It should come as no surprise given what happened to the global economy in September and October that Dell's announcement was a sign of things to come. Yesterday Cisco confirmed what Dell warned about back in August.

    Cisco First-Quarter Sales Growth Slowest in 3 Years

    Cisco Systems Inc., the world's largest maker of networking equipment, said first-quarter sales rose at the slowest pace in three years and revenue this quarter will drop as the slumping economy crimps customers' budgets.

    Second-quarter sales will decline as much as 10 percent from a year earlier, Chief Executive Officer John Chambers said today on a conference call. The shares sank in late trading.

    ``It is the second most difficult time in my career in terms of the forecast,'' Chambers said. Cisco sales also slumped after the dot-com bubble burst in 2000.

    We will continue to see these kinds of company announcements about earnings. Many have suggested that this is priced into the market but analysts have yet to fully discount the extent to which earnings will suffer in 2009 as the world economy experiences recession.

    The Part-time Full-time Employment Divergence

    The headline employment number of a rise of 34k jobs in October looked good until you take a closer look at the details. Full-time employment fell -9.2k after a downwardly revised fall of -23.3k in September. The overall rise in employment was driven by strong growth in part-time employment which added 43.5k jobs during October. The unemployment rate remained at 4.3%.

    The graph below shows the year over year % change in both part-time and full-time employment. You can see in the two large shaded areas that a sharp divergence between part-time job growth and full-time job growth occcured in the recession of the early 1980's and the economic slowdown in the early part of this decade when Australia just barely escaped recession.

    Although the early 1990's recession is not shaded, part-time employment continued to grow year over year whilst full-time employment contracted sharply. The shaded area on the far right of the graph, whilst hard to see, is starting to show that divergence again.

    ADP Report Suggests Big Drop in October NFP's

    The ADP report seemingly caught up with the BLS numbers in October, showing a drop of -157k in US payrolls. As mentioned numerous times, the ADP report has been a poor proxy for the BLS numbers to be released on Friday. In fact the the ADP report overstated payroll numbers by an average of about 80k for each of the past 3 months. For me the following pasage was the key take away from the ADP report:

    Employment among small-size businesses, defined as those with fewer than 50 workers, declined 25,000.This is the first outright decline in small business employment reported by the ADP Report since November of 2002, and the largest percentage decline since the economy was emerging from recession in early 2002.

    As we have so often been reminded throughout the presidential campaign small business is the driver of US employment growth and now that they laying workers off in large numbers, we can expect a string of very bad employment reports through the end of next year and into next.

    The consensus is looking for a loss in NFP's on Friday of about -200k, as usual it could be 100k in either direction around that estimate. However it seems likely that it will be an ugly number.

    Wednesday, 5 November 2008

    More Weak Aussie Economic Data

    First off the blocks, building approvals fell a seasonally adjusted -7.2% in September and are down -21.6% year over year.

    Following on from yesterday's weak PMI report the Performance of Services Index released today showed that the Australian services sector contracted for the seventh straight month. Of note that sales component fell sharply particularly amongst discretionary retailers.

    Tuesday, 4 November 2008

    China Will Save Us...... Not

    Whilst it has now been acknowledged that the Chinese economy has slowed, there is still a lot of talk about how the voraciaous demand for commodities by the Chinese economy will underpin Australian economic growth. However, there are growing signs that China is slowing much more than those wearing the rose coloured glasses expect. From the LA Times:

    Some owners deserting factories in China

    Reporting from Shaoxing, China -- First, Tao Shoulong burned his company's financial books. He then sold his private golf club memberships and disposed of his Mercedes S-600 sedan.

    And then he was gone.

    And just like that, China's biggest textile dye operation -- with four factories, a campus the size of 31 football fields, 4,000 workers and debts of at least $200 million -- was history.

    "We're pretty much dead now," said Mao Youming, one of 300 suppliers stiffed last month by Tao's company, Jianglong Group. Lighting a cigarette in a coffee shop here, the 38-year-old spoke calmly about the bleak future of his industrial gas business. Tao owed him $850,000, Mao said, about 60% of his annual revenue. "We cannot pay our workers' salaries. We are about to be bankrupt too."

    Government statistics show that 67,000 factories of various sizes were shuttered in China in the first half of the year, said Cao Jianhai, an industrial economics researcher at the Chinese Academy of Social Sciences. By year's end, he said, more than 100,000 plants will have closed.

    As more factories in China shut down, stories of bosses running away have become familiar, multiplying the damage of China's worst manufacturing decline in at least a decade.

    Even before the global financial crisis, factory owners in China were straining under soaring labor and raw-material costs, an appreciating Chinese currency and tougher legal, tax and environmental requirements. When the credit crunch took hold -- prompting Western businesses to slash orders for Chinese goods and bankers to curtail loans to factories -- many operations were pushed over the edge.

    It's worth reiterating again that China derives approximately 40% of its GDP from exports and as the US economy falls more deeply in recession dragging global demand down with it, China will defintiely feel the effects. That's why a year ago I called the concept of "decoupling" a myth.

    Also of note today the RBA slashed the cash rate by another 75bps after cutting 100 bps last month. Maybe the RBA doesn't think China will save the day either? As mentioned before I wouldn't be surprised to to see the cash rate get as low as 3% some time next year. However don't expect the banks to able to match the RBA cuts as their funding costs remain elevated.

    Monday, 3 November 2008

    Australian Economy Slows Sharply

    A raft of economic data out today confirms what we already suspected and that is that the Australian economy slowed markedly in October. Firstly some numbers for September. Retail Sales rose 0.2% in September and are up 2.3% year over year. That may sound OK but remember that is a nominal number so adjusted for inflation retail sales are down something like -2.5% year over year.

    Also out today, the ANZ job series fell sharply in October, internet job ads which comprise almost 95% of the total are now down almost -15% from the peak in April this year. As mentioned in previous posts the job ad series is a decent indicator future employment.

    The Performance of Manufacturing index also released today was the worst in 16 years, the index registered a reading of 40.4 well below the 50 level that marks the separation between expansion and contraction. October marks the fifth straight month of a contracting manufacturing sector. The plunge in the employment component to a reading of 37.6 points to more job losses in the Australian manufacturing sector coming down the pike.

    Also of note, the abs released quarterly home price numbers for all Australian capital cities. A year ago all capital cities were hitting new highs, as of September 2008, only Darwin continues to make new highs. It should be noted that Darwin is subject to a much larger margin of error.

    From it's peak Australian home prices are down -2.1% from their peak on a weighted average basis. Apart from the new peak in Darwin the other capital cities are down from their peaks as follows:

    Sydney -2.7%
    Melbourne -1.9%
    Brisbane -3.3%
    Adelaide -0.3%
    Perth -5.1%
    Hobart -1.7%
    Canberra -3.6%
    Weighted Average -2.1%

    This is just the beginning for home price falls in Australia, despite the government's senseless efforts to prop up prices with their home buyer grants. And yes yes I know, sought after areas such as the eastern suburbs of Sydney won't plummet as much as other areas like the west because people want to live there. I get it, all real estate is local.

    Saturday, 1 November 2008

    XAO Has Worst Month Since October 1987

    Firslty to the person who voted for a decline of ten percent or more in October in last months poll, stand up and take a bow. After a fall of more than eleven percent in September the All Ords plunged -14.0% in October to record it's worst month since October 1987. Interestingly of the 5 worst months in the last 25 years, 3 of them have occured in 2008 and 3 of them occurred in the month of October.

    The glass half full persepctive might say that with 3 of the worst months in the last 25 years occuring in 2008, the odds of another horrible month are very low. The glass half empty might say that it indicates just how bad this financial crisis/recession is.

    Another persepective that I subscribe to, would say that it doesn't mean much at all for what lies in the future. A theme that I have been harping on for some time and has been heavily influenced by the author of the Black Swan, Nicholas Nassim Taleb, is that, in an ever increasingly and complex world we are going to continue to have large volatile events of increasing frequency.

    Take one measure of stockmarket volatility, the VIX. The VIX averaged about 60 during the month of Ocober, it has never averaged more than 45...ever. We have unprecedented meddling by governments in financial markets, what will be the unintended consequences? We have the most complex and global financial system ever that contain the most arcane financial instruments ever created. We have seen some of the consequences of that.

    Any objective measure of how the US Federal Reserve and Treasury have handled the current crisis would have to say they have made some blunders. However the consensus view is that they have finally got it right and that things will turn out fine. Yes 4Q08 will be bad, estimates of a contraction in US GDP of about -3% are now common. Unemployment will continue to rise, house prices will continue to fall and corporate earnings will continue to disappoint.

    However, that is apparently already discounted in stocks, just like it was in January, in March and in July. Sure stock prices look much more attractive than they did 12 months ago but the idea that they reflect all the risks going forward I find dubious at best.

    So what for November? Whilst October was the worst month since 1987, the last week of October was one of the best weeks for stocks in some time. Can that momentum carry over into November? All signs seem to say yes. Credit spreads have come in, the VIX has come down, some of the Federal Reserve programs have begun to kick in and markets are focussing on boring econmic data rather the spectre of financial meltdown.

    However, I get suspicious when others are get comfortable, I don't know what the new 'normal' is but I do know it is not going to be the same as the normal that has prevailed for the last few decades. This is not a contrary call for the sake of being a contrarian but rather a recognition of the uncertainty that remains going forward.

    Once again I have no strong views about short term market direction. I would certainly not be surprised to see the market continue to rally in November but I am going to stick my neck out and say that the market will finish lower in November for no particular reason.

    Also don't forget to have your say in this month's poll.