February 27, 2008
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Commodities have been on fire. Which will perform best through year-end? | ||||||||
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37%Pretty interesting result. I’ll examine some of the underlying fundamentals later.
Business Cycle
Archived Posts from this Category
February 27, 2008
From the Financial Times:
In an introductory chapter to the newest edition of the late Charles Kindleberger’s classic work on financial crises, Robert Aliber of the University of Chicago Graduate School of Business argues that “the years since the early 1970s are unprecedented in terms of the volatility in the prices of commodities, currencies, real estate and stocks, and the frequency and severity of financial crises”*. We are seeing in the US the latest such crisis.
All these crises are different. But many have shared common features. They begin with capital inflows from foreigners seduced by tales of an economic El Dorado. This generates low real interest rates and a widening current account deficit. Domestic borrowing and spending surge, particularly investment in property. Asset prices soar, borrowing increases and the capital inflow grows. Finally, the bubble bursts, capital floods out and the banking system, burdened with mountains of bad debt, implodes.
With variations, this story has been repeated time and again. It has been particularly common in emerging economies. But it is also familiar to those who have followed the US economy in the 2000s.
When bubbles burst, asset prices decline, net worth of non-financial borrowers shrinks and both illiquidity and insolvency emerge in the financial system. Credit growth slows, or even goes negative, and spending, particularly on investment, weakens. Most crisis-hit emerging economies experienced huge recessions and a tidal wave of insolvencies. Indonesia’s gross domestic product fell more than 13 per cent between 1997 and 1998. Sometimes the fiscal cost has been over 40 per cent of GDP (see chart).
By such standards, the impact on the US will be trivial. At worst, GDP will shrink modestly over several quarters. The ability to adjust monetary and fiscal policy insures this. George Magnus of UBS, known for his “Minsky moment”, agrees with Prof Roubini that losses might end up as much as $1,000bn (FT.com, February 25). But it is possible that even this would fall on private investors and sovereign wealth funds.
In any case, the business of banks is to borrow short and lend long. Provided the Federal Reserve sets the cost of short-term money below the return on long-term loans, as it has for much of the past two decades, banks can hardly fail to make money.
If the worst comes to the worst, the government can mount a bail-out similar to the one of the bankrupt savings and loan institutions in the 1980s. The maximum cost would be 7 per cent of GDP. That would raise US public debt to 70 per cent to GDP and would cost the government a mere 0.2 per cent of GDP, in perpetuity. That is a fiscal bagatelle.
Because the US borrows in its own currency, it is free of currency mismatches that made the balance-sheet effects of devaluations devastating for emerging economies. Devaluation offers, instead, a relatively painless way out of a slowdown: an export surge. Between the fourth quarter of 2006 and the fourth quarter of 2007, the improvement in US net exports generated 30 per cent of US growth.
The bottom line, then, is that even if things become as bad as I discussed last week, the US government is able to rescue the financial system and the economy. So what might endanger the US ability to act?
The biggest danger is a loss of US creditworthiness. In the case of the US, that would show up as a surge in inflation expectations. But this has not happened. On the contrary, real and nominal interest rates have declined and implied inflation expectations are below 2.5 per cent a year. An obvious danger would be a decision by foreigners, particularly foreign governments, to dump their enormous dollar holdings. But this would be self-destructive. Like the money-centre banks, the US itself is much “too big to fail”.
Yet before readers conclude there is nothing to worry about, after all, they should remember three points.
The first is that the outcome partly depends on how swiftly and energetically the US authorities act. It is still likely that there will be a significant slowdown.
The second is that the global outcome also depends on action in the rest of the world aimed at sustaining domestic demand in response to a US shift in spending relative to income. There is little sign of such action.
The third point is the one raised by Harvard’s Dani Rodrik and Arvind Subramanian, of the Peterson Institute for International Economics in Washington DC, (this page, February 26), namely the dysfunctional way capital flows have worked, once again.
I would broaden their point. This is not a crisis of “crony capitalism” in emerging economies, but of sophisticated, rules-governed capitalism in the world’s most advanced economy. The instinct of those responsible will be to mount a rescue and pretend nothing happened. That would be a huge error.
Those who do not learn from history are condemned to repeat it. One obvious lesson concerns monetary policy. Central banks must surely pay more attention to asset prices in future. It may be impossible to identify bubbles with confidence in advance. But central bankers will be expected to exercise their judgment, both before and after the fact.
A more fundamental lesson still concerns the way the financial system works. Outsiders were already aware it was a black box. But they were prepared to assume that those inside it at least knew what was going on. This can hardly be true now. Worse, the institutions that prospered on the upside expect rescue on the downside. They are right to expect this. But this can hardly be a tolerable bargain between financial insiders and wider society. Is such mayhem the best we can expect? If so, how does one sustain broad public support for what appears so one-sided a game?
Yes, the government can rescue the economy. It is now being forced to do so. But that is not the end of this story. It should only be the beginning.
February 25, 2008
Even the fully fledged economists are arguing this one.
Inflation is defined as; a loss of purchasing power.
Deflation is defined as an increase in purchasing power.
So here is the situation, outside of America, the US$ is purchasing less today, than it did. You could purchase Gold, Oil, far cheaper 2yrs ago, than you can today, thus our definition of inflation [outside of the US] is fulfilled.
Within the US, we have a mixture of Inflation and Deflation.
Deflation; you can buy stocks [DJIA] cheaper today, than you could 4mths ago. You can buy a house, cheaper today, than you could 6mths ago.
Inflation; it is more expensive to buy petrol today, than it was 6mths ago. It is more expensive to purchase your groceries today, than it was 1yr ago.
The reasons for this are fairly straightforward; the US$ is losing value.
Easy to see, the Dollar has headed down, losing value from the peak in 2002. Meanwhile, the prices of commodities have been rising;
Meanwhile the Treasury has not been printing money, thus the usual suspect is innocent in this case;
Money supply M2, is contracting.
The source of the “Deflation” is the extreme credit contraction. This has been generated from the Financial system that is currently capital impaired, or insolvent, due to poor lending standards causing excessive credit creation, that is now driving the deflation in financial assets, that creates deflation, or increased purchasing power for financial assets.
February 23, 2008
NEW YORK (Reuters) - One-tenth of U.S. homeowners hold mortgages that are larger than the worth of their homes, Moody’s Economy.com said on Friday.Nearly 8.8 million homeowners, or 10.3 percent, are in over their heads, its chief economist, Mark Zandi, estimates.As a result, millions of U.S. homeowners have the incentive to abandon their properties.With an already unwieldy supply of homes for sale, more inventory could prolong a recovery of the hard-hit U.S. housing sector, suffering one of the worst downturns in history.Zandi earlier this week told Reuters he expects home prices to drop by 20 percent from their peak in 2006.He expects home sales to hit bottom this spring, housing starts to reach a nadir this summer and house prices to trough in the spring of 2009.The surge in foreclosures is putting further downward pressure on the housing market because it adds to the inventory of homes for sale, already at a lofty level.Each foreclosure on a neighborhood block reduces the value of all homes on that block by almost 1.5 percent, Zandi said
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The screen shot, stolen from “Mish” rather highlights the aforementioned article in very stark terms.
February 18, 2008
Profit performance nearly always suffers in an economic downturn. The reason for this is the interplay between Fixed costs, Variable costs and Revenues.
Revenues can drop overnight. Costs on the other hand cannot be trimmed anywhere near as quickly. Fixed costs, Rents/Mortgages, Debt interest payments, Wages/Salaries to name a few are very sticky and cannot be cut due to their contractual nature. Variable costs, Energy, Commisions etc can generally be reduced proportionately.
The result is bad, or terrible. It is simply bad if Net Profit falls. This is due to the very short term nature of Wall St, where EPS is watched hawklike. Falling Net Profit, in a high multiple growth company will almost invariably reduce the shareprice.
Terrible however is where falling Revenues drive a fall in EPS and concurrently falling cashflow. This is potentially a bankrupting development. Growth companies generally show rising EPS while showing falling cashflow in a growth cycle.
In a business contraction, EPS growth will fall and potentially go negative. In a strong business, this can drive an increase in cashflow via the Receivables, Inventory and Accounts Payable accounts. If however these accounts still drive a negative cashflow result, the implications are very serious.
Thus while evaluating potential value plays in smaller companies, cashflow becomes a much more important consideration. Liquidation values are a good starting point in the search for value.
