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

Japanese 4th Q GDP declined by -0.6% Q/Q or -2.3% on an annualised basis (-3.1% on a Q/Q basis in nominal terms), much more than the decline of just -1.3% expected – net exports reduced GDP by a massive -2.6%. Growth was impacted by floods in Thailand (supply chain issues) and by weaker Global demand. The GDP deflator came in at a negative -1.6%. The only good news was that capital spending was up by +7.9%
and consumer spending rose by +1.2%.However, the overall data is yet more bad news from Japan. GDP should pick up in coming Q’s as a result of spending related to the earthquake/tsunami reconstruction spending, though I remain of the view that the Japanese economy, with the Yen at current levels, is going to suffer significantly;

Premier Wen states that China should “fine tune” economic policies as early as the 1st Q. He added that economic conditions in the 1st Q deserved attention and that quick action was necessary. Clearly, the Chinese economy is suffering (sounds like materially), the authorities are pretty concerned and are considering a mixture of policy actions (including stimulus measures/monetary easing?), with the announcement of the appropriate policy action imminently. (Source Bloomberg);

The Chinese authorities have told the country’s banks to roll over loans to local Governments, thought to amount to US$1.7tr – essentially China’s version of “kicking the can down the road” policy, which numerous countries have utilised. The obvious problem is that the vast majority of these loans can never be repaid, as the underlying projects are uneconomic. The local Governments are implicitly guaranteed by the Central authorities. Oops. (Source FT);

The Pakistani PM has been charged with contempt of Court for not
pursuing a corruption charge against the President Mr Zardari. There
have been widespread allegations of corruption by Mr Zardari – indeed,
his nickname is “Mr 10%”. However, the current problems reflect
growing tensions between the civilian Government and the military.
Pakistan has, since independence, rarely had a civilian Government
and, if the current issues escalate, may not have one again for some
time;

The Greeks passed the austerity measures in their Parliament necessary
to secure the 2nd bail out – by 199 to 74 votes – not a ringing
endorsement. However, all leaders of the main political parties have
to sign up to the measures – something that is going to be difficult.
All very, very boring stuff and Greece will both default and have to
exit the Euro Zone. The likely next PM, following impending elections,
Mr Antonis Samaras talks about renegotiating the deal following the
elections – yeah really. I think Mr Samaras is in cloud cuckoo land -
does he not understand that the Euro Zone, in particular, is totally
fed up of the Greeks and would love to get shot of them. The German’s
keep talking about the “Greeks needing to do their homework”. Well,
they wont and does that mean that they get to wear the dunce cap.

Greece exiting the Euro Zone – getting more and more convinced that it
is not a major problem (ex an initial knee jerk sell off) for the Euro
Zone;

Portuguese 10 year bond yields are down to around 12.4% – some 20bps
lower. Spanish and Italian bong yields are also lower – Italian by
more. Looks as if Spanish and Italian yields will converge. Will
Spanish yields be higher than Italian – I certainly think that they
should. Spain’s largest unions are calling for a mass protest on the
19th of this month;

Want to buy a cheap Ferrari. Well go to Italy. Early this year, an
Italian friend of mine advised me that Italian tax authorities had
raided a fashionable skiing resort in Italy and had checked out owners
of expensive car, restaurants, luxury shops etc. A week thereafter one
shop reported an increase in sales of 400% – yep that’s 400%. Italian
authorities continue to target owners of expensive cars according to
Bloomberg, who are dumping them asap. May well, go back to London via
Milan or Turin. Joking aside, an increase in tax collection will make
a significant dent – possibly even result in a balanced budget in
Italy. The IMF believe that the “black economy” is about 30% of
Italy’s GDP – who knows – however, its a big number;

Rupert Murdoch is facing additional problems in the UK. A number of
journalists, including the deputy editor, have been arrested as have
people at the Ministry of Defence and the police. Allegations of
widespread phone hacking, combined with paying off the police and
other Government departments continue to surface. The Sun newspaper is
Murdoch’s most profitable and indeed, influential newspaper. The
problem, however, could worsen much further, in particular if its
extends to the US, as the authorities could charge News Court under
the US Foreign Corrupt Practices Act. Bad news for Murdoch, as if this
does indeed happen and News Cort is found in violation of this Act,
his licences for various parts of his US media empire could be
threatened and/or cancelled. This is going to be extremely difficult
for Murdoch and, I for one, would be particularly cautious;

The UK’s Confederation of British Industry (“CBI”) sees signs that the
UK economy is improving and, indeed, they expect GDP to be positive in
the current Q, thereby avoiding a technical recession. Interestingly,
they suggest that the BoE need not increase the size of the QE
programme current Sterling 325bn, following last Thursday’s increase.
It does appear that the UK economy is improving faster than
anticipated, though GDP for the current year is forecast at a lack
luster +0.9%. The BoE has, in the past stated that they would wish any
recovery to become embedded and QE, off the table following this
round, well lets see. Having said that the BoE owns so many gilts -
over 30% when the current programme ends that it might actually be
difficult to buy any more. I suppose they could buy corporate bonds
and or mortgages etc. In any event, its too early and the BoE is one
of the most transparent of Central Banks – they will signal their
intentions nearer the time;

Asian markets are higher, though China closed flat to slightly lower.
European markets are around 1.0% higher. The miners and the A$ are
higher on the likelihood of stimulus in China – hope they climb a bit
more, as I want to add to my shorts. If the Chinese markets dont rally
on the prospect of stimulus measures……..

The Euro is strengthening on the better? Greek news – currently
US$1.3270 – still remain of the view its a great short against the
US$, especially above US$1.33. Gold is at US$1734 and spot Brent at
US$118.50 – really hate oil at these levels.

The beach is beckoning, as are the mojitos.

-Kiron

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My Washington Post Sunday Business column is out. This morning, we look at how overvalued the $100 billion dollar Facebook IPO is.

The print version had the full headline What’s Facebook worth? Much less than advertised — in the online edition, it was Less than meets the eye at Facebook.

Its based on my discovery from the Facebook S1 filing that merely clicking on a “Like” button anywhere on the internet counts you as an active user according to FB’s unique metrics.

Here’s an excerpt from the column:

“Last week, I made a surprising discovery about Facebook: It has far fewer “active” users than it claims. I learned this from a note buried deep in the company’s S1 — the IPO document it filed with the SEC in order to go public. Based on its S1, the social-networking giant’s value is probably much less than most investors seem to think.

One advantage of working in finance is that you get to meet lots of very nice, really smart people such as David Wilson, who writes the Chart of the Day column for Bloomberg. His column is my Sudoku, as I challenge myself to poke holes in the correlations it identifies between various assets. It’s good wonky fun.

On Feb. 3, the column used Facebook’s SEC data to show how fast the firm was growing. FB was becoming a “daily habit for more users,” and the numbers from the IPO filing were extraordinary: 845 million Monthly Active Users and 483 million Daily Active Users.

MAU? DAU? I had never heard of either metric, and novel accounting for public companies is always a red flag. Don’t just take my word for it, ask a Groupon investor.

I thought these metrics were suspect. If you do not have to go to Facebook.com to be counted as an active user, are the metrics misleading? I asked Wilson, who pointed to details in the S1:

“Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our Web site or a mobile device, or took an action to share content or activity with his or her Facebook friends or connections via a third-party Web site that is integrated with Facebook, on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement.”

Let me translate: If you clicked a “Like” button anywhere on the Internet, then you are a Daily Active User. Even if you never go to Facebook.com.”

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I really like that the Post used the Limericks Économiques I referenced right at the start of the column:
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click for ginormous version of print edition

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Source:
Less than meets the eye at Facebook
Barry Ritholtz
Washington Post, February 12 2012
http://www.washingtonpost.com/business/less-than-meets-the-eye-at-facebook/2012/02/09/gIQA7RtF7Q_story.html

Washington Post Sunday, February 12 2012 page G6 (PDF)

I have been arguing that $100B is rather rich for Facebook. Perusing the S1, and discussing this with Bloomberg’s Dave Wilson has further confirmed this.

Why? It has to do with what they consider a daily or monthly “user.” Indeed, this is extremely significant, because the excitement about Facebook’s reach and user base is driving valuations to levels that may be setting the company up for investor disappointment.

Consider the 843 million monthly users and the 450 million daily users. Those sound like enormous numbers — but what do they really mean?

As it turns out, there is far less to being counted as a FB user than meets the eye. If you click on a Like button any given day, you are counted by Facebook as an active user that day.

From the S-1:

Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our website or a mobile device, or took an action to share content or activity with his or her Facebook friends or connections via a third-party website that is integrated with Facebook, on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement. (emphasis added)

All of those people clicking all of those “Like” buttons are counted as active that day, EVEN IF THEY NEVER GO TO FACEBOOK.COM.

Think of what this means in terms of monetizing their “daily users.” If they click a like button but do not go to Facebook that day, they cannot be marketed to, they do not see any advertising, they cannot be sold any goods or services. All they did was take advantage of FB’s extensive infrastructure to tell their FB friends (who may or may not see what they did) that they liked something online. Period.

This helps to explain why Facebook’s annual revenue per user is so low:

Facebook – $5.02
Google $30
Netflix – $148.20

It also helps to explain why Facebook’s valuation may be so greatly exaggerated. Retired Neuberger Berman value investor and present CNBC commentator Gary Kaminsky observed that at similar multiples as Facebook, Google would be trading at $850 and Apple trading at $1250.

The question for investors: Can Facebook monetize their users at a rate 5-10X greater than what they are currently doing? If they can, their valuations are far more reasonable. If they cannot, then this is a very very expensive company.

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Valuation Issues

Source: Barron’s

Via Venturebeat, we see this massive Google revenue review:
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click for ginormous version

I love these giant long term charts. This one covers more than two centuries. It looks at long term US interest rates — the 30 year bond where available:

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Click to enlarge:

Source: What Drives The Bond Market?
Chicago CFA Handout by Bianco Research LLC
January 18, 2011

Over the past few years, I watched bemusedly, as analyst after analyst upgraded ole Mister Softee. First the value guys loved it, then the dividend buyers, next the growth-at-a-reasonable-price (GARP) crew. It got added to lots of “conviction lists.” The company is cheap, they are a cash cow, it has a great dividend, they are a turnaround story, blah blah blah. The only guy I don’t recall hearing from was the analyst from Nostalgia Capital Management.

History informs us that leaders from prior bull markets do not lead in the next bull — and MSFT was a leader two bull markets ago.  I doubt they will be pulling the Nasdaq Qs Train up the hill back towards 5100 anytime soon.

Investors should be aware of a few other things when it comes to companies like Maytag Microsoft. You may have memories of the company as a fast growing, fearsome monopoly competitor dominating the technology landscape during the 1980s and ’90s. First DOS, then Windows, Office, SQL, gaming, and the massive potential of the internet.

But that was then, and they are no longer that firm. The Anti-Trust case slowed them down just enough to allow competition to explode in techland. Enterprise has been built to the point where it is replacement cycles, not innovation driving their profits. Consumers are migrating from desktop to mobile to handheld — none of which plays into their strengths. Besides, their genius was the original contract which paid them regardless of whether their operating system was in the PC; not delighted consumers with magical new products.

During the past decade, MSFT has returned exactly zero to investors, including dividends. They are a bloated, bureaucracy run by bloated, bureaucrat. The paradigm has shifted repeatedly, and they have failed to make the turn. They missed literally every major new technology, every innovation, every great idea from search to social to handhelds to tablets over that period.

The Kinnect is certainly a hit, but it is not the sort of product that moves the needle for a $234 billion company. X Box is also a consumer winner, but the firm spent billions to grab the franchise from Sony — with far less ROI than such a massive investment would should ever warrant. Everything else from Online to Search to Social to MP3 players to even their well reviewed but 5 years too late cell phone — has been a bust. Their bread and butter franchises — Office, Windows and SQL — are under assault from completely new product categories to which they have no response.

If you want to trade Mister Softee, go right ahead. You covered call writers and swing traders, have your fun. But this is no Widows & Orphans stock, no Buy & Hold long term investment. At least, not any longer. Its Apple or Oracle or Google that threatens the franchise, but a million entrepreneurs moving the ball forward, taking us into the future. They are in the process of turning into Maytag, a boring producer of appliances, with a modest dividend and not a whole lot of growth ahead of them.

Steam engines, leather belts, copper wires, bloatware all had their day in the sun. It happens to nearly every company eventually, Apple, Facebook & Google included.

The thing is, it has already happened to Microsoft . . .  No one seems to have bothered to tell them this yet.

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Microsoft (MSFT) 2000-2012

click for ginormous chart

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Last month, I presented to the National Association of State Treasurers. The room had all 50 State Treasurers, lots of Deputy and Asst Treasurers, and staff. I was realistic about how credit crises unwind over long periods of time.

The prior panel had the major ratings agency reps, and they had discussed Pension Return Assumptions. Given their utter incompetency, it was no surprise the Ratings firms were okay with expected blended returns of 8%.

An audience member asked a question to me about this, and I laughed. I told the Treasurers that the consultants who tell them they should have expected 8% blended returns for the past 5-10 years were dead wrong, and the ones who told them they could expect 8% blended returns for the next 5-10 years were probably high. My joke was to get to 8% required bad math — blended expected returns of 8% requires taking 5% gains in equities and adding 3% gains in bonds (5+3=8).  How often do you get to make a wonky accounting joke to a room full of treasurers?

But, as it turns out, its even worse on the Corporate side: S&P 500 companies pension funds. They currently assume future equity returns of above 10%, according to their own financial statements. As I made clear to the State Treasures, that is an absurd expectation.

Andrew Lapthorne of Société Générale’s Global Quantitative Research group points out how absurd this is:

“No-one believes these ridiculous – earnings flattering – pension fund return assumptions, not even US CFOs themselves.

A couple of months ago we highlighted how the implied yield on a traditional balanced portfolio comprising a mix of bonds, equity and cash had fallen to below 3%  less than half of what it was 20 years ago. We suggested (and still do) that with such low yields, generations of investors are facing a potential future income crisis going forward.

Low yields (and as a consequence low returns and annuity rates) is not a new problem. Although particularly compressed now, yields have been depressed for the past decade. However, the consequences being felt today are becoming more acute. Pension entitlements are falling, some companies (AMR, for example) are entering Chapter 11 to help avoid paying them, and endowment mortgages, plus a whole raft of other investment products, are coming up short.

The reality of low yields is the need to save more and spend less. But rather than accept the notion of lower returns and adjust behaviour accordingly, the path of least resistance appears to be total denial…”

We have ultra low yields after 3 years of ZIRP and a market that is precisely where it was 11 years ago. Valuation using forward earnings estimates are at best reasonable, and using trailing 10 year and/or CAPE are subject to potential reversals off of an earnings peak. US equity returns may quote possibly be in the single digits over the coming decade.

Is this the circumstances that lead to 10% plus blended returns for the next decade?

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Click to enlarge:

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Source: Quant Quickie, 5 January 2012
Societe Generale – Global Quantitative Research

Long term look at Composite Earnings and P/E, using 10 year average:

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click for ginormous version

All charts courtesy of Bianco Research

James O’Shaughnessy is a well known “value quant” for his book What Works on Wall Street (4th Ed). He has a new column in Marketwatch discussing what he calls  “the top stock-market strategy of the past 50 years.”

According to Jim, using a combination of value and momentum strategies — “Trending Value” — is the best performing strategy since 1963. To capture this, he ranks stocks based on:

• Price-to-Sales
• Price-to-Earnings
• Price-to-Book
• Price-to-Cash Flow
• EBITDA/Enterprise Value
• Shareholder yield (dividend yield + rate of share repurchases)

O’Shaughnessy ranks all of these on a 1-100 basis for his Trending Value portfolio. He works with the top 10% of those ranked stocks with the best composite score. He selects a concentrated portfolio of 25 stocks based on trailing six-month momentum, creating an extremely cheap group of stocks that are on the mend.

Its an interesting ideas, one worth exploring . . .

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Source:
The top stock-market strategy of the past 50 years
James O’Shaughnessy and Patrick O’Shaughnessy
Market Watch, December 16, 2011
http://www.marketwatch.com/story/the-top-stock-market-strategy-of-the-past-50-years-2011-12-16

I don’t often find myself in agreement with bulge firm research, but this is in line with my beliefs:

“This year, inexpensive stocks have simply grown cheaper, with the most notable example of this being Financials. Three of nine industries that make it into our value trap model this month are in the Financials sector, and in aggregate, the sector appears to be inexpensive for the wrong reasons: prices are falling faster than earnings expectations are deteriorating.

We are underweight Financials in part because this model suggests it is too early to buy the sector . . . Risks from Europe, weak investment banking/trading, tepid loan growth, pressure on net interest margins, regulatory risks, and challenging mortgage fundamentals. When will valuation matter again? Valuation is generally rewarded when profits are accelerating and volatility is declining, neither of which we expect to occur in the near future.”

Ahh, I see its from the Quantitative Strategy group of Mother MER. (That makes it less of a surprise)

Of course, as this idea becomes more mainstream, I would have to start thinking of Banks as a contrary play — But we are not there yet . . .