The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

My new favorite Tumbler blog is the hilarious Things Apple is Worth More Than !

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Apple’s Market Cap is Now $340 Billion. What’s Littler?

Total Corporate Income Tax for 2011

Via @TheArmoTrader:

Corporations will pay a total of $247.2 billion in state, local and federal income tax this year.

The Recession of 2011?
By John Mauldin
August 20, 2011

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The data this week was just ugly. Even the uptick in the leading economic indicators, seized upon by so many talking heads, must have a large asterisk beside it. This week we look at the increasing probability that we are headed for recession, and the follow-on implications. Then I take a perilous and speculative journey into the realm of the political, commenting on Texas (and my) Governor Rick Perry’s rather interesting comments about the Fed and Ben Bernanke. There is a lot to cover, and lots of charts, so we will jump right in. But please read at the end about two events coming up in the next few months that you might be very interested in attending.

The Recession of 2011?

It was relatively easy for me to forecast the recessions of 2001 and late 2007 over a year in advance. We had an inverted yield curve for 90 days at levels that have ALWAYS heralded a recession in the US. Plus there were numerous other less accurate (in terms of consistency) indicators that were “flashing red.” (For new readers, an inverted yield curve is where long-term rates go below short-term rates, a [thankfully] rare condition.)

And since stocks drop on average more than 40% in a recession, suggesting that you get out of the stock market was not such a challenging call. Although, when Nouriel Roubini and I were on Larry Kudlow’s show in August of 2006, we got beaten up for our bearish views. And you know what? The stock market then proceeded to go up another 20% in the next six months. Ouch. That interview is still on YouTube. Timing can be a real, um, problem. There is no exact way to time markets or recessions.

My view then was based on the inverted yield curve (as an article of faith) and, not much later in 2006, my growing alarm as I realized the extent of the folly of the subprime debt debacle and how severe a crisis it would become. I changed my assessment from a mild recession to a serious one in early 2007 as my research revealed more and more fault lines and the damning interconnection of the global banking system (which has NOT been fixed, only made worse since then). I should note that my early views were rather Pollyannaish, as I thought (originally) that losses to US banks would only be in the $400 billion range. I keep telling people that I am an optimist.

With the Fed artificially holding down rates on the short end of the curve, we are not going to get an inverted yield curve this time, so we have to look for other indicators to come up with a forecast for the US economy. We grew at less than 1% in the first half of the year. That is close to stall speed. And that was with a full dose of QE2! So now, let’s look at a series of charts that cause me to be very concerned about the near-term health of the economy. Then we turn to Europe and problems compounding there.

The Streettalk/Mauldin Economic Output Index

Last year I was having a discussion with Lance Roberts of Streettalk Advisors in Houston about how to build an indicator that might give us a clue as to the direction of the economy. Most indicators use one or two data points and thus can be suspect.

For instance, the Philly Fed Economic Index went from 3.2 in July to -30.7 in August, helping to tank the market. Almost every subcomponent (new orders, employment, etc.) was not just down but negative. This was truly a shocker. You can see the gory details here.

The Empire Index (New York) went from -3.8 to -7.7. The Empire Index suggests that the August ISM manufacturing number will be 49, or in a state of negative growth. The Philly Index suggests a very dismal 42, which if true would suggest we are already in recession. But these are regional indexes.

Now, just for fun, let’s look at a combined index that David Rosenberg created from the Philly Index plus the Michigan Consumer Confidence Index. (Those of us old enough can remember Jack Nicholson playing the Joker in Batman back in 1989. When Batman escaped with the help of something from his tool kit, Nicholson said, “Where does he get all those wonderful toys?” When I read Rosie’s newsletter, I have the same reaction. “Where does he get all those wonderful charts?” He swears he makes them himself. I stand in awe.)

Notice that with Rosie’s combined index where it is today, we are either at the beginning of a recession or already in one. And the Philly Fed Index is consistent with a 90% chance of a recession.

And that is again consistent with the following chart from Rich Yamarone, which I used last month but that bears looking at again. Rich is chief economist at Bloomberg. (By the way, for Conversation subscribers, I just recorded a powerhouse session with Rich, which will be available as soon as we can get it transcribed.)

Is There a Recession in Our Future?

I previously wrote, in late July:

“And the last chart is one I had not seen before, and is interesting. Rich notes that if year-over-year GDP growth dips below 2%, a recession always follows. It is now at 2.3%.”

Oops. Last week David Rosenberg updated that chart. This from Rosie:

If Rich is right, then the next revisions to second-quarter GDP will be down from an already abysmal 1.3%. And the growth in the second half is not going to be all that good for jobs and consumer spending

But these are charts of single data points. You can quibble that the Philly Fed could be influenced by something local or that the 1.6% number might be different this time. So Lance Roberts of Streettalk Advisors (with me looking over his shoulder) created an index that combines a number of economic indexes in an effort to build an index that is not subject to single (or double) indicators. The Streettalk/Mauldin Economic Output Index is composed of a weighted average of the following indexes:

Chicago Fed National Activity Index
Chicago PMI
The Streettalk ISM Composite Index
Richmond Fed Manufacturing Survey
Philly Fed Survey
Dallas Fed Survey
Kansas City Fed Survey
The National Federation of Independent Business Survey
Leading economic indicators

Note that there are six regional and national indicators, plus the NFIB survey, which is national. Lance’s index is not driven by one region or index or survey. When the combined indicator falls below 30, it has always indicated either that we are in a recession or about to be in one. The chart is overlaid, below, against GDP and LEI (leading economic indicators) – both tend to have a fairly high correlation to our Economic Output Composite Index. And LEI is currently supported by the yield spread and money supply (more on that below).

A few quick notes before the chart. First, note the increases in the index with the onset of QE1 and QE2 and the sharp drops when QE ends. The red at the end of the chart is the recent drop, and it takes us into recession territory. Recessions are indicated by gray bands

Read the rest of this entry »

Some interesting reads for your weekend reading pleasure:

• 5 lessons from the stock market’s turmoil (Market Watch)
• Bear Market Far From Over (Comstock Partners) see also Bottoming is a messy process (Market Watch)
• Triumph of the Pessimists (Psy-Fi Blog)
• S&P’s French Kiss (Slate)
• BofA Mortgage Risk May Rise $9 Billion If Judge Sides With MBIA (Bloomberg) see also 2 States Where Foreign Investors Are Propping Up the Housing Markets (Wall St. Cheat Sheet)
• Gold Standard: 40 Years Gone — Good Riddance (WSJ) see also MMT, Again (Paul Krugman)
• Let’s Get Real: Yields Fall Short of Inflation (Barron’s)
• Hey, Rick Perry: Printing Money Is Patriotic (The Atlantic)
• Is Scott Brown Gettin’ Worried About Elizabeth Warren? (Talking Points Memo)
• 13-Year-Old Uses Fibonacci Sequence For Solar Power Breakthrough 374 (Slashdot)

What are you reading?

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Normally, I don’t follow political coverage in financial publications.

But this week, I found Jim McTague’s column — he writes the political coverage for Barron’s — rather fascinating. He looks at the financial holdings of Ron Paul via congressional financial disclosures:

“Gold-mining stocks, where Paul has the bulk of his money, have also hit pay dirt, albeit rising at a slower pace. Gold is up about 28% this year, through Thursday, to $1,823.80 a troy ounce, and 106.8% since 2009. In the same periods, the NYSE ARCA Gold Miners Index is down 2.9% and up 78.6%. The S&P 500 is down 9.3% and up 26.3%.

In his most recent financial disclosure, which covers the year 2010, Paul had $1.6 million to $3.5 million in gold- mining stocks. He also has a stake in three bear-market funds—and has for many years.

In all, Ron Paul’s portfolio amounts to a super bearish bet against the U.S. economy. If the country had defaulted on its debt earlier this month, he likely would have made a bundle. The congressman voted against House Speaker John Boehner’s plan to lift the nation’s $14.3 trillion spending cap.”

Rather intriguing.

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Pot of Gold: Ron Paul’s Top 10 Holdings

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Note that the inverse funds are not designed for long term positioning, and suffer from slippage and drift from the underlying index.

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Source:
Candidate of Doom and Gloom
JIM MCTAGUE
Barron’s AUGUST 20, 2011
http://online.barrons.com/article/SB50001424052702303822904576516114289723344.html

Hilarious:

Anger and frustration are the two emotions pulsing through my veins as I write this.  HP, once the symbol of innovation, is being dismantled by its high-pedigreed board and the CEO of the hour (I truly hope his tenure will be measured in hours, not years).  I vividly remember the early 2000s, when Carly Fiorina, then CEO of HP, engineered the HP merger with Compaq.  She argued that the merger was a must for HP’s future to be bright.  Walter Hewlett, the son of one of the founders, was publicly opposed to it, and I remember the drama of the proxy fight, the TV interviews and arguments from both sides, and the finale – Walter Hewlett lost and the merger went through.  But it was not the finale, because nine years and two CEOs later HP has announced that the PC business, the one it so desperately wanted just a decade ago, is too hard a business and that it will look for ways to get rid of it.  Almost in the same breath HP announced that it will kill WebOS devices, a business it acquired in April 2010 for $1 billion; and management, possibly missing the irony in those two announcements, went ahead and announced another acquisition, which this time will for sure transform the company.

HP will buy Autonomy, a UK software company, for $10 billion. I understand $10 billion doesn’t sound like a lot of money in today’s post-trillion-dollar-bailout world, but it is plenty for HP, especially considering what that money bought.  There are many ways to illustrate how expensive and meaningless to HP’s future this acquisition is: $10 billion is about a fifth of HP’s market capitalization, while Autonomous will contribute 0.7% to HP’s revenues, and 2.7% to its earnings; and HP paid 10x revenues and about 25 times earnings.

Leo Apotheker, HP’s CEO, bragged about Autonomy:

“Autonomy has grown its revenues at a compound annual growth rate of approximately 55% and adjusted operating profit at a rate of approximately 83% over the last 5 years.”

Keith Backman, a sell-side analyst from BMO Capital, asked a very pertinent question about Autonomy:

“… metrics that you threw out for Autonomy, particularly on top-line growth, included a lot of acquisitions for Autonomy. What’s the organic growth rate that Autonomy has achieved lately?”

Leo did not have an answer, whereupon HP’s stock started to drop.  HP had reported an OK quarter, expectations were already low (its stock was at about 6x times 2011 estimates, which remain intact), and Dell had already lowered guidance a day before; so no one was surprised when HP lowered its revenue guidance for 2011 by a few percentage points.  Management said that since it will pay for Autonomy from cash on the balance sheet, it will not be buying much of its stock in the near future, and then they mentioned that this acquisition will be accretive.  Yes, accretive!  Nothing to worry about.  This transaction is accretive only for illiterates in economics and those short on common sense.

HP is using cash on the balance sheet to pay for this transaction, and thanks to the Federal Reserve this cash yields zero and thus brings zero income.  As long as Autonomy’s income is greater than zero (I am oversimplifying a little) then it will be accretive (at least on a cash basis).  However, this assumes that HP’s cost of capital is equal to the return it receives on its cash.  Which is not the case, as that would ignore such minor details as the time value of money, inflation, the risk premium (after all, unlike the US government, HP cannot print money and doesn’t have nuclear weapons) and, simply, opportunity cost.

Any investment HP makes today should be compared against an opportunity set that includes its own stock, which at 6x times earnings results in about a 16% yield (cost of capital).  In fact, if HP used $10 billion to buy its own stock, its earnings per share and dividend would jump by 16%.  Autonomy will not be able to match this return, by a long mile.

I don’t need to have a great imagination to envision another conference call in August 2015, where a new CEO decides that the software business is too difficult, and HP needs to come back to its roots (maybe going back to making calculators) and will spin off the software business into a new company, take an enormous charge, and then maybe announce an acquisition that the same highly pedigreed board will rubber-stamp.

HP’s valuation has not changed that much – the PC business only represents about 16% of operating profit, so even if HP gives it away, earnings power will not decline greatly.  HP should still be able to get a decent price for it, as there has got to be a Chinese company out there swimming in US dollars that wants to put them to work before they become worthless.  HP’s core businesses, will be slightly impacted by the global economic weakness, but the company should maintain its earnings power largely intact.  Autonomy reduced HP’s value by about $3; but with my lack of confidence in management, I’d not buy HP at a P/E higher than 10, which would bring the stock to the mid to high 40s.

HP’s stock sold off not because the company disappointed Wall Street but because Wall Street grew tired of the overpriced “must-have” acquisitions.  Wall Street has smartened up and assumed that this acquisition, as with many other “transformative” acquisitions, will do nothing of the sort.  And so, today we are faced with a decision: buy, hold, or sell.  At 4.6 times earnings HP is not a sell; but considering that the company is still trying to figure out what it wants to be when it grows up, it is hard to add to our holdings of the stock; so unfortunately this company has turned into a hold.

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

Succinct summation of week’s events:

Positives:

1) Gasoline prices fall another few pennies to 6 week low, relief for consumer
2) IP rises greater than expected .9% but not sustainable as auto snapped back after Japan and hot weather boosted utility output
3) Multi family housing starts bounce, helping to partially offset drop off in single family construction
4) Refi’s rise 8% to most since Nov
5) Fitch says US AAA ok for now
6) Thanks again to the ECB, Spanish and Italian debt trade well. What happens though when they stop? They do fully sterilize the purchases and the euro continues to trade great vs the Fed money printed backed US$
7) Japan’s Q2 GDP contracts only 1.3% instead of expectations of 2.5%

Negatives:

1) European markets get hammered again, bank funding sources in question
2) Merkel/Sarkozy break bread with no further bailout as no change in the size of the EFSF, no Eurobond and they throw down the hammer of a transaction tax just as the region is capital starved, brilliant!
3) Initial Claims at 408k, 8k higher than expected but 4 week avg falls to lowest since April
4) Existing home sales 230k below forecasts, Purchase apps fall 9% to one yr low
5) Philly mfr’g plunges to -30.7 from +3.2 and NY falls 4 pts to -7.7
6) Inflation figures all run hot, import prices, PPI and CPI. While all may back off with economic slowdown, stickiness will be theme and the rest of us will continue to be force fed REAL negative interest rates
7) Greek yields spike, everyone wants Finland’s deal of collateral in return for funds
8) Gold continues its amazing move up, paper currencies turning into paper towels

It has been an amazing month for science.

MIT researchers have succeeded in printing solar panels onto any piece of paper.

Dutch company PlantLab has figured out how to triple the yield of plants using only 10% of the water typically needed:

When grown outdoors plant photosynthesis is only about 9% efficient. With the correct balance of colored LED light, PlantLab has increased that efficiency to 12 or 15%, aiming for 18%. Double the efficiency means increased yield (or more likely equal yield with less energy). By keeping the plants in a contained system, PlantLab can also recycle evaporated water, which helps them grow crops using just one tenth the water as with traditional greenhouses. Because PlantLab’s harvest is indoors, they don’t have pests (and could quickly isolate rooms that somehow got contaminated) and they don’t need pesticides. Finally, PlantLab’s production facilities can be built almost anywhere: from the Sahara to the Artic, it’s all going to look the same indoors. So everyone’s food can be grown as local as possible. That means fresher food with less costs of transportation.

PlantLab’s Gertjan Meeuws recently discussed some of the other benefits and results of their work on Southern California public radio (KPCC). He claims they’re able to increase crop yield by a factor of three so far!

Scientists at MIT have designed a drug that can cure virtually any viral infection.

Scientists at the University of Pennsylvannia have found a way of “turning the patients’ own blood cells into assassins that hunt and destroy their [leukemia] cancer cells.”

Physicists at Niels Bohr Institute maintained quantum entanglement for an hour.

Quantum entanglement means that two objects should be too far apart to effect one another but – due to quantum mechanics – change to one instantly induces changes the other.

Quantum entanglement will one day allow much better computer cryptography, form the backbone of quantum computing, and may allow for interstellar communication systems between spacefaring humans traveling among the stars, make it possible to store information in black holes, or even allow information to instantly pass from past to future.

And for the first time ever, scientists filmed (from a spacecraft) a coronal mass ejection from the sun washing over the Earth. Watch the video (40 megs, takes a while to download; the Earth is the blue ball on the left).

Click here for more amazing science discoveries.