Different Administration, Same Problems
July 13, 2009
Good morning. Dull and down for the market last week, with the SPY down 1.95, or 2%, to close at 87,96. The onslaught of earnings season continues this week, but the initial earnings report of Alcoa (AA) showing sales down over 40% from last year tells the tale. It’s true that AA has shown some management aggressiveness in cutting costs (and some solid PR in telling everyone what a good job they are doing) so the earnings, although negative, were not as bad as expected. The tale of the tape still reads that revenues were down from $7.2 B to $4.2 B, with earnings coming in at a negative $454 M vs. positive $546 million last year. I am certainly willing to toss a few kudos to management and say it could have been worse, but it sounds like one of those brilliant tactical retreats by the Germans on the Russian front we kept hearing about on Hogan’s Heroes. Revenue down 40+% is starting to be the awful truth in a few industries other than autos, very troubling. The VIX did see an increase for the week, from 27.95 to 29.02, as the continuing stagnation in the market is causing many to feel that the promised rally may be delayed, at best.
This coming week we have earnings from most of the financials, including Goldman Sachs on Tuesday. It would not surprise me to see a bounce in this sector this week, as they are prone to playing down earnings prospects and then surprising to the upside. The XLF (financial piece of the S&P) was actually down 3% last week to finish at 11.10, a drop I could easily see made up with a couple of positive earnings reports vs. estimates. Bear in mind these large banks have tremendous capacity to earn money in areas that continue to become less competitive going forward; like credit cards and other loans, as well as in attracting deposits at continuously decreasing rates. Credit card loans are showing their share of problems currently with the unemployment rate increasing, but the basic business of borrowing money from depositors at one or two percent and lending it to credit card customers (some the same people, remarkably) at 12-30%, plus fees, is surely one with huge potential. The large bank competitive position in small business loans could also improve dramatically if the rumors surrounding CIT in the last few days prove true. I could also go into the amazing position of GS, intimately involved with government and the formation of policy, and using that position and knowledge to trade aggressively against other people, but I will leave that discussion for another time.
The economic news of last week, new unemployment claims and other indicators, gives a certain credence to the idea that the free fall in the economy may be abating. Virtually everyone has the idea that the economy will begin to show improvement, the only question being how fast the improvement will come. My concern, however, is that a decrease in the rate of decline does not imply growth, and that concern is right there in the Alcoa numbers. Between production cuts and price declines for aluminum products the total revenue is off $3 B, or over 40%. Even with $1 B in cost cuts the company was left with almost half a billion in losses. Those kinds of numbers are notsupportive of a going concern in any kind of long-term situation. Even if growth were to bounce, say, 5-10% from these horrible numbers costs will have to be shaved (if possible) another $1.5-2 B dollars from these levels to approach break-even. Cost cuts of that magnitude would necessarily mean losses of jobs, probably in the thousands. My concern here is that countless companies, not just AA, are still (from a cost and size standpoint) not anywhere near where they would need to be if the economy were to stagnate even at levels moderately above the levels we see now. I think (again hoping I am way off base) that right now if you said to most business managers that the economy is bottoming roughly here, and that 4 years from now you should plan on things being 10-15% better, a lot of these managers would start cutting people and real estate. I do not believe the current employment situation accurately reflects the abyss we are in, and just staying at this level will cause significant further job loss. A lot of what I read, and a lot of business people I talk to (other business owners in the finance, legal, recreation, and food service) tell me they are bumping along keeping on as many people as they can but with no real income. The status quo, while surely better than continued declines right now, is bad enough to cause ongoing declines on its own going forward. You can certainly add to that scenario not only the risk, but the certainty, that literally dozens of states and other governmental organizations will seek bankruptcy at this economic level.
We do not need some funky 5% economic bump from here; we need an 80-100% take off from here over the next 5-7 years. How exactly do we accomplish that with former factories closing or becoming museums by the day? Can anyone even envision growth at that sort of a level after the events of the last 20 years? What would it take? Well, the first thing would be a realistic appraisal and understanding of the role of government. I thought we were making a very positive change with the Obama administration, now I am starting to believe that they are just as bad, but in a different way. I observed in disbelief years ago the incredible fraud and almost looting of the government by the Bush contributors under the guise of Homeland Security, where a several thousand page law lining the pockets of thousands was passed with the only defense being “What, do you want those bleeps coming here and doing it again?” Now I am seeing some 1200 page Cap and Trade Bill being jammed through that no one understands, and I am going to take a guess and say 80% of the wordage are various breaks and “grandfathering in” of anyone that can find an audience with a hack Democratic lobbyist. Those 1200 pages will be reduced to “Hey, do you want to ruin the world for your kids?” How difficult do you think it will be to start a new factory when you will have to go pay for carbon rights from some guy whose only asset is that he knew a Senator’s lobbyist wife? A Medical bill will soon follow, with the same issues. You would never guess that they were concentrating on the economy.
So far I see no real leadership at all from the government on any level in regards to the economy. Some have performed okay in dealing with the financial crisis, but no real vision as to the real causes of the downturn, and possible solutions. We need real leadership, someone who can focus our future. Something along the lines of Kennedy setting a goal of a man on the moon in ten years. Remember the incredible amount of innovation and new ideas that came out of that program? All we do is talk. We lambast the auto manufacturers for inefficient cars, but give no help to the millions of homes with no insulation, or to the people in the northeast with no natural gas service. There is no goal of transmission lines with 25% higher efficiency in ten years. Just pass another useless bill, except if you are one of the ones being set up for life.
Anyway, I could go on. I know it is sort of a continuing theme that is not real positive, but I am getting many emails and calls from clients pointing me in directions to research that are just not positive. Can we make money in this environment? I think so; we can tread water in the market for an extended period of time and our continued selling of calls should put us in the plus. I also think some segments of the economy will advance, and we will just have to identify those areas most likely and be there. For instance, I do believe the financial sector can advance 10-20% in the next year. Sounds like a huge move, but really means the XLF going from $11.25 to maybe $13. We can make money, and will, with moves like that. If the broad market continues to decline and the VIX does not increase by a lot, we will be able to buy at a lower level with reasonable insurance costs, something that was not possible last March. I also think the oil sector is getting to a point that is getting more appealing, a protected long term position with oil under $60, or even $55, is certainly something to consider. It is certainly positive to know that the PTI clients in the PIP program have been largely untouched by the economic carnage, and that PTI itself is growing and doing well (I would say very unique in the wealth management world). We have seen enough of negative news, it is time to get focused on the solutions, somebody? Anybody?
I encourage everyone to register and join in on a Protected Index Program Teleconference hosted by my brother Dan on Wednesday, July 29th from 6:00pm-7:30pm. All you need to join in is a phone and PC and it is free. Register on www.PTISecurities.com.