by John Labunski ~ September 22, 2008
Author: Australasian Investment Review
The US economy is in far worse shape than many in the US think, and is heading for a hard landing.
American consumers, who account for 70% of demand and consumption in the huge, $US14.4 trillion economy, are in trouble and cutting back spending, thanks to falling levels of credit.
In fact the credit cuts are now much deeper than anyone thought after the release of up to date figures.
The IMF said overnight that the US appeared to be sinking into a recession, it said.
The Fund said in its latest World Economic Outlook that the US was now poised to expand 1.6% this year and a bare 0.1% in 2009.
That was an increase of 0.3% and a decrease of 0.7%, respectively from the prior forecast just three months ago, in which the IMF had lifted its April WEO forecasts, citing improving economic conditions in the US.
That improvement for this year relates to the 2.8% rise in second quarter economic growth.
The estimates were made before the latest figures though on consumer borrowing which tell a story of US consumers cutting back, or being cut back on credit, the lifeblood of the economy.
Figures for September store sales from some major retailers overnight showed sluggish growth for most, with downturns for those selling more expensive products, such as department stores.
Wall Mart managed a 2.4% rise in same store sales, but that was less than forecast, discount bulk chains lost Costco did OK, but Target reported a 3% drop in comparable store sales.
JC Penny, the big department store chain reported a massive 12.4% drop in same store sales in September, far worse than expected.
But it’s no wonder after the Fed’s earlier report.
Figures Tuesday night from the Federal Reserve on consumer credit show the biggest fall in the history of the recorded figures.
At the same time major industrial, Alcoa, suffered a 52% drop in third quarter earnings and has joined the mighty General Electric in eliminating a share buyback to conserve capital.
The national body for US car dealers warned that 700 would go out of business this year alone, and more would follow in 2009, if the credit freeze was not eased soon. Car sales fell 27% last month and the way the credit freeze is working, that drop will increase in the coming quarter.
And in a dramatic move the Fed extended the boundaries of its ‘Lender of Last Resort’ understanding by supplanting temporarily the frozen $US1.6 trillion commercial paper market, the day to day lifeblood for American business activity.
At the same time Fed chairman, Ben Bernanke held out hopes for a rate cut, but said the US economy was heading into tougher times.
The Fed said it would set up a new Commercial Paper Funding Facility to buy three-month debt from banks and non-financial companies.
It’s probably one of its most important decisions because if this vital short term debt can’t be rolled over for US companies (end employers) when it falls due; the American economy will be crunched to a halt.
The move was desperately needed with figures showing that 28% of the market would fall due this week and a further 12% next week.
The Fed’s figures last Friday showed that in the week to last Wednesday, the market had already contracted $US215 billion in the past three weeks and virtually all new lending was being done overnight.
If that 28% to 40% of that huge amount can’t be rolled over, the US economy will be crunched by the end of October at the latest, so the Fed had to act.
Without the Fed’s move to being a sort of bank, the US economy will crunch to a complete halt in a matter of weeks, throwing hundreds of thousands of people out of work and setting off a domino chain of corporate failures across all sectors.
This freeze in the commercial paper market is why the likes of Alcoa and GE have cut their share buybacks and why Bank of America cut its dividend by 50% and is seeking to raise $US10 billion in new capital.
It has to support the acquisitions of Countrywide Financial Services and Merrill Lynch and the added burdens they will impose on its finances: but it is like all other banks and has cut lending across the board.,
But it’s clear consumers, the engine of the US economy, were being denied credit by banks and other lenders well before the eruption of this latest phase when the credit crunch turned to a freeze.But there’s nothing the Fed can do immediately to ease the squeeze on consumers: each week tens of thousands of them are losing their jobs, their homes, having their pay cut and hours trimmed and are being denied credit at a rate not thought possible until the Fed released the credit figures for August, a month before the crisis worsened with the spate of failures and bailouts in the US starting with Lehman Brothers.
The Fed reported that consumer credit fell by $US7.9 billion in August, the biggest fall since the statistics began being collected in 1943, to $US2.58 trillion.
Bloomberg said that economists forecast an increase of $US5 billion in consumer credit during August, so the Fed’s report came as a complete shock to the market.
Total consumer borrowing dropped at a rate of 4.3% in August, the most since January 1998.
Revolving debt such as credit cards decreased by $US612 million during August and non-revolving debt, including auto loans, dropped by $US7.3 billion.
That fall was a month before the 27% plunge in US car sales last month, so it’s likely that consumer credit again fell sharply in September.
The news of the Fed’s move and the sharp contraction in consumer credit (one of the Fed’s ‘Key Economic Indicators’) makes it easier to understand the contents of a speech overnight by chairman, Ben Bernanke in which he painted a gloomy picture of the US economy.
He would have known of the move to try and stop the rot in the commercial paper market and the sharp fall in consumer credit, so it was no wonder he was saying:
“Economic activity had shown signs of decelerating even before the recent upsurge in financial-market tensions.
As has been the case for some time, the housing market continues to be a primary source of weakness in the real economy as well as in the financial markets. However, the slowdown in economic activity has spread outside the housing sector.
“Private payrolls have continued to contract, and the declines in employment, together with earlier increases in food and energy prices, have eroded the purchasing power of households. This sluggishness of real incomes, together with tighter credit and declining household wealth, is now showing through more clearly to consumer spending.
“Indeed, since May, real consumer outlays have contracted significantly. Meanwhile, in the business sector, worsening sales prospects and a heightened sense of uncertainty have begun to weigh more heavily on investment spending as well.
“The intensification of financial turmoil and the further impairment of the functioning of credit markets seem likely to increase the restraint on economic activity in the period ahead.”
“All told, economic activity is likely to be subdued during the remainder of this year and into next year. The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth.
“To support growth and reduce the downside risks, continued efforts to stabilize the financial markets are essential. The Federal Reserve will continue to use the tools at its disposal to improve market functioning and liquidity.”
Meanwhile the chairwoman of the National Automobile Dealers Association says the credit crunch and economic problems are likely to cause 700 auto dealers in the US to go under this year.
Speaking to the Automotive Press Association in Detroit, Annette Sykora said quick action will be needed to ease the squeeze and restore consumer confidence and help the industry.
An estimated 94% of American car buyers finance their purchases, Ms Sykora says but even those with good to high scores and solid credit records can’t get financing.
Dealers with good credit also are having trouble getting financing for their inventories.
It’s the same story in home lending and also in credit cards where credit lines and revolving credit arrangements are being terminated or refused.
According to the National Auto Dealers Association, there are around 20,000 auto dealers in the US. About 430 dealerships closed last year and 295 closed in 2006.
The estimate of 700 dealers going out of business does not include new dealers that will enter the market.
According to the Fed’s credit figures, lenders were cutting back on car loans (and other credit in August) and car sales fell 11% in the month. The 27% fall in September reflects the intensification of the credit freeze and helps explain why car sales sank 27% to less than 1 million for the month for the first time since 1993.
Some buyers are not committing because they fear for their jobs or can’t get the right vehicle when they are looking for more fuel-efficient models.
Regardless of the reason, it means consumers are spending less. September’s retail sales figures are out in about 10 days or so and are likely to make miserable reading, along with the consumer spending figures a little later in October.
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John E Labunski John Labunski
by John Labunski ~ September 19, 2008
Author: Jay Wagner
The current economy is in bad shape – at least that’s what all of the pundits tell us. The conventional wisdom in times like these is to put stop loss orders on everything, put everything you can into blue chips, or settle for the safe, low returns of Treasury securities.
I’m here to tell you that the conventional wisdom is foolish.
In the first place, the conventional wisdom is contradictory. You can’t have automatic trades to comply with stop loss orders going on constantly and maintain major holdings in blue chips. Even the blue chips – maybe especially the blue chips – are subject to market volatility. When the economy is bad, inflation becomes a major concern, and the market starts requiring a higher return on investment. At the same time, the bad economy drives sales downward, reducing corporate incomes and, by extension, return on stockholders’ investment. The result is market dissonance that exacerbates existing market volatility. The general trend is for prices to go down, and the easier a security is to trade the more precipitous its price decline tends to be. This is simply a function of supply and demand: more people want out than in, so supply exceeds demand and prices drop.
Supply and demand also accounts for what happens with bonds, notes, and commercial paper. In a difficult economy, fixed income securities are less appealing because of inflation concerns. Here again, people trying to get out of fixed income securities outnumber those trying to get in, so prices go down and both current yield and yield to maturity go up. At the same time, new debt issues of any kind are almost impossible to sell, and, with the rest of the credit market similarly tightened, companies are unable to borrow necessary cash at reasonable rates, forcing them to offer their debt placements at rather deep discounts. The bottom line is, they must raise cash to weather the economic storm, and they will pay handsomely to get it.
You’re seeing it today on every news channel: the prices of securities are declining virtually across the board. Your broker may be telling you to cover everything with stop loss orders and trade, trade, trade. That may be a case of your broker subscribing to the conventional foolishness, or it may be a case of your broker trying to protect his income: after all, commissions come from trades, and your broker lives on commissions. The question I have to ask is why would you want to sell now? It makes about as much sense as buying merchandise at Nieman Marcus to resell at Wal Mart. This is not, I repeat not, the time to sell. The economy is on an express elevator to the bargain basement, to be sure, but history tells us that when it comes to the stock market, what goes down must come up. Knowing that, this is the time to get in on the bargains. That “next Microsoft” that everyone is looking for might be trading for far less than its legitimate value right under your nose right now!
Growing up in Kansas, I was acquainted with a man who had amassed vast holdings of farm and ranch land. He was an eighth grade dropout, and I often wondered how he came to be so wealthy, so I finally asked. “Son,” he said, “Most of my land was bought back during the dust bowl, when farmers and ranchers were selling off their land or bankers were foreclosing and then trying to get what cash they could from the deal. I was just a farmhand back then, but I had a little money saved up, and when land dropped below twenty-five cents an acre I started buying. As the economy started to pick up, I used that land to borrow against and buy more land. By the time the drought was over, I owned almost ten sections [note: there are 640 acres in a section] and hadn’t spent $1,000 to get it.” At the time that we had that conversation (about 1972), his $1,000 investment made between 1930 and 1939 was worth over $3 million, an annualized return on investment of around 25%.
Do you have “a little money saved up” that could be used to pick up the bargains available in the current markets? My friend knew that the drought that caused the dust bowl wouldn’t last forever, and he made a fortune from other people’s panic. Investors are in a panic now, but if you’re smart their panic is your opportunity.
Investments to Avoid
In a struggling economy, investors tend to make the same mistakes over and over, and those mistakes take two forms: running for “safe harbor” and becoming extremely active traders in anything that is going up.
The safe harbor crowd always runs to one of two places, blue chip stocks and Treasury securities. As we have already discussed, blue chips are probably the roughest safe harbor you can go to, rather akin to anchoring in Galveston Bay during Hurricane Ike. Market volatility tends to have a more pronounced effect on blue chips: add the fact that blue chip companies like General Motors, General Electric, and AIG are all fighting for life right now and a run for the blue chips is borrowing trouble rather than escaping it.
Treasury issues are, without a doubt, safe. After all, if the Treasury defaults the money is meaningless anyway. The problem is, this is a “safe” harbor full of purchasing power pirates. The return on Treasury securities rarely keeps pace with inflation in an economic downturn, so while your safe harbor investment may be earning you a return in nominal dollar terms, in real dollar terms you’re losing purchasing power. It doesn’t do much good to earn 3% on your money if prices are going up an average of 6%.
Sadly, many investors who don’t run for safe harbor become speculators, moving money constantly into anything that is going up at the moment. Since most of the market is going down, this all too often drives them to the derivatives market, especially in today’s economy where oil futures have, at times, exceeded $140 per barrel. The problem is, if you’re short at $120 per barrel and the spot market on the settlement date is $140 per barrel, you’ll have to either lose money on an offsetting long position, sell your short at a loss, or have 1,000 barrels of crude setting around that you can part with. On the other hand, if you have a long position for $140 and the spot price is $120, you get to lose money going short or selling the long position at a loss, or you get to take delivery of 1,000 barrels of crude that you’ll lose $20,000 selling on the spot market if you can’t store it and wait.
Some investments, especially derivatives, will go into bubble mode early in an economic downturn, but don’t let that fool you into entering the bubble with them. As any kid who ever chewed bubble gum or blew soap bubbles can tell you, bubbles burst. If your money is in the bubble when it bursts, you can wave goodbye to it as it is scattered on the winds of economic caprice.
Investments to Make
Some companies and industries have proven themselves to be amazingly resilient. Like everything else, their securities are or soon will be selling at bargain basement prices, and if they appear to be struggling the discounts may be extra deep. Do your homework, make sure that they are positioned to bounce back, but if they are, buy while the price is low.
The current debacle started with a meltdown in the sub-prime mortgage market. The result is a large number of foreclosures, with lenders ending up holding real estate when they need cash. As a result, real estate prices are falling, so if you can, this is a good time to buy real estate or invest in companies that are investing in real estate. The prices will go back up, just as they did for my friend who invested in farm and ranch land during the dust bowl.
Many brokers and analysts have an innate fear of high yield (so called “junk”) bonds. Admittedly, some high yields have gone under and become no yields, but as a rule the returns have been in line with the risks, and sometimes a little higher. During an economic downturn, there tend to be two types of high yield bonds on the market: those with something behind them and those with nothing behind them. The former are usually issued by companies that want the capital to invest while the market is down, generally in either income real estate or leveraged buyouts. These tend to be pretty good bets for a sizeable profit in a relatively short period of time, and they offer your investment some diversification while providing at least partial collateral from the assets they invest your money into. The latter are usually issued by companies that are cash strapped and have credit problems, and they’re offering them to raise working capital: as a rule, they’re a bad investment and far more likely to default than the secured high yields.
The best bargains, however, may be in small cap (so called “penny”) stocks, initial public offerings (IPOs), and various kinds of notes, especially those backed with some kind of collateral. Some of these securities (especially the notes) can have some pretty creative terms, but if you understand the terms they can be a good, and often high yield, investment.
However, He Said . . .
While you’re doing all of this bargain basement buying, it doesn’t hurt to put a few safeguards into your portfolio. These can take several forms, as you’ll see.
After spending the first part of this article giving you all of the reasons to avoid the rush to blue chips and Treasury securities, I now need to backtrack just a bit. I’m not going into the famous politician’s gambit that “I was against it before I was for it.” I’m still adamantly opposed to loading your portfolio with volatile blue chips and low yield Treasuries, but having a portion of your portfolio in these securities isn’t a bad thing. The blue chips may recover a little more quickly than the market at large, and the Treasury issues will at least provide a good final position in the event of a major, long-term depression.
There are, of course, other ways to protect your portfolio. As you know, I’m against riding bubbles, especially in the derivatives markets. However, derivatives can be used to hedge your positions. Worried that a rise in interest rates will devalue that investment in mortgage notes? Just hedge the position with Treasury note or Treasury bond futures. For example, one long 10 year Treasury note contract can effectively insure one $100,000 10 year mortgage against excessive value loss due to rising interest rates. This doesn’t tie the two inextricably together, but as 10 years Treasury note rates rise toward the level of the long position, its value increases to cover the value lost by the mortgage note.
Another thing that can help your portfolio is investment grade bonds, especially if they can be converted to common stock. The conversion capability tends to buoy the price some, and the bond income can provide money to cover short-term losses in other areas or help your income weather the economic storm.
Of course, you can never go wrong with liquidity. A little reasonably ready cash, whether held in a bank or a mattress, is always a good idea.
There are other areas that you can investigate, such as precious metals, gemstones, and collectibles, but keep in mind that the value of most such items is dependent upon the demand for them, and since most are viewed as luxuries that demand tends to drop off precipitously in an economic downturn.
If you follow the crowd, a bad economy can leave you in dire financial straits. The real trick to making money is patience: buy when everyone else wants to sell, sell when everyone else wants to buy, and wait patiently in between. In the end, life will be a chicken dinner and you’ll be the kid with the drumstick.
John E Labunski John Labunski
by John Labunski ~ July 22, 2008
Author: Stephen Harvey Jr.
Outsourcing or off sourcing is a new trend among companies that operate and facilitate operations out of the United States. These companies use outsourcing as a way to cut costs and use cheaper labor by subcontracting to foreign companies or setting up offices in foreign countries. This takes away much needed jobs from the American economy. The decision to outsource is often made in the interest of lowering firm costs, redirecting or conserving energy directed at the competencies of a particular business, or to make more efficient use of labor, capital, technology and resources. . Business segments typically outsourced include information technology, human resources, facilities and real estate management, and accounting. Many companies also outsource customer support and call center functions like telemarketing, customer services, market research, manufacturing and engineering.
Outsourcing is not the only way that companies cut costs though. The other way that these companies shift jobs away is by becoming offshore companies. Offshore Outsourcing is when a company takes its business to another country and sets up operations outside its main office. The companies choose to move certain aspects of their business to developing countries where wages and labor are cheaper. Many of these Outsourced and offshore jobs go to young people in those developing countries who look for placement in their country’s job sector. For Example, Dell Computers is based, owned and operated in the U.S but will choose to outsource jobs and create offshore jobs in its customer service and call center departments. This allows Dell to get more “bank for their buck” by eliminating the wage restrictions of the U.S and hiring cheaper labor. This move cuts costs to the company while still addressing the needs of the consumer.
As the outsourcing and offshore job practices are becoming more common among these large corporations and conglomerates that reside in the United States, the United States economy is suffering and beginning to feel the effect behind the corporations’ cost cutting maneuvers. Instead of those same jobs being offered to the American public, they are quickly shifted to a developing country in need of a new job market. Places such as India and England are now benefiting from these corporations’ decisions to move elsewhere in search of cheaper labor.
On the other hand, it is a common rule of business to attempt to keep costs at a minimum and all the while to raise capital. It allows for the company to grow at a more rapid rate. When companies keep labor costs down, they are able to use the additional resources in the operating budget.
Offshore jobs and outsourcing can also be detrimental to the economy that gets involved with such practices because the outsourcing can be in flux unless kept to a strict contract or agreement. Moreover, a company can decide to move to another developing country at any time and set up business and resources for even cheaper labor and training.
Off-shoring is not popular among the private sector because it takes jobs away from the American People. While Americans fight to maintain and keep jobs, it is also up to the Government to make sure that these companies don’t take their business elsewhere in search of cheaper labor and lighter labor regulations. Many business people might dispute this but I believe that the government must regulate these companies in order for our economy to thrive. If the government doesn’t determine fair labor practices than companies would be able to set any standard they want for their employees. It all revolves back into the economy which allows for more jobs to be created instead of being placed elsewhere. It is the job of the Government to make sure the economy is steady for the livelihood of the country. If there is no governing board or regulations to oversee company’s business practices then there would be no success in the economy. Every company would possibly be monopolies and set standards way above and or below means. The companies that base operations out of off-shore locations do not worry about labor regulation or practices. This allows the companies to overlook the integrity and policies of the company in favor of profits. For Example, the Great Depression that plagued the United States during the latter part of the 1920’s and early 1930’s was brought along by the reckless judgment of companies and investors. Companies were allowing money to be poured into stocks of companies and precious metals. Then, when companies pulled their interest in those stocks and precious metals the stock market crashed causing consumers and companies to lose vast amounts of money. The government had to step in and make sure that this never happened to the American economy. The government setup regulatory institutions such as the Securities Exchange Commission (SEC act of 1934) to make sure the public interest were protected.
Is the outsourcing of jobs the cause to blame for our slow economy? You cannot say for sure but it has something to do with it. When there are fewer jobs for the American people, there is less money being spent on goods, services, and items that fuel the American economy. These multinational corporations also impact the offshore locations where they set up operations. Companies such as Dell and Microsoft use off shoring and outsourcing to cut the costs but they pump money back into those countries allowing the countries’ people to spend the money they earn on the products and services the companies provide. Outsourcing and off-shoring can be a way of companies and corporations’ to expand their capital and revenue. If done correctly, outsourcing can be a benefit. However, Outsourcing especially to other countries can hurt the American economy and the American people.
This year is a pivotal year to the livelihood of a World Power and Economic Power, which is the United States. There has been a lull over the economy for the last eight years with the Nation’s overwhelming aptitude for taking on debts as result of funding downtrodden wars. The year 2008 marks a race for a new face in the oval office. With this being an election year, there are two candidates vying for the position: Barack Obama (democrat) and John McCain (republican). These two opponents are ready to tackle the nation’s economic problems head on, albeit in different ways. Obama feels that we should rebuild the nation from the ground up, meaning from infrastructure (highways, roads, airports etc.) to the oval office. Obama has already put his plans in motion by introducing the Patriot Employer Act of 2007 to provide a tax credit to companies that maintain or increase the number of full-time workers in America relative to those outside the US; maintain their corporate headquarters in America; pay decent wages; prepare workers for retirement; provide health insurance; and support employees who serve in the military. (Barack Obama)
Obama’s competitor John McCain has a similar plan in place. According to JohnMcCain.com, “John McCain Will Reduce The Federal Corporate Tax Rate To 25 Percent From 35 Percent. John McCain believes the taxes we impose on American companies should be no higher than the average rate our major trading partners impose on theirs. We currently have the second-highest combined corporate-tax rate in the industrialized world, and it is driving many businesses and the jobs they create overseas.” (JohnMcCain)
This is what little each candidate has to offer regarding the outsourcing of jobs and a plan to prevent the American economy and worker to succumbing jobs to outsourcing. I’m sure there will be more said and more developments as we get closer to Election Day. Hopefully, either candidate can turn the outsourcing trend around while creating more jobs for the American people.
John E Labunski John Labunski