I can't help but notice a little macroeconomic testiness here on the LL. I think it's a little unfortunate that this board has tilted away from stock specific talk and company research slash accounting Q&A towards a bunch of stuff I don't think people are (or can be) nearly as smart about as they think. But given that I haven't contributed much in the way of of good stock talk, I really have no right to complain. So I figured I would instead exacerbate the problem by making good on my previous suggestion that anyone who wants to post their though-out macroeconomic opinions post the other side instead. However, because I just can't stand to make an irritatingly long post like this without any specific stock discussion, I will now proceed to make several completely arbitrary stock-related comments before proceeding. Become a Complete Fool
-I give Safeway credit for creating a $100m EBIT (and growing) business out of nowhere, but I wonder if anyone will ever notice that they are spending $1.7 billion in capex to basically run in place.
-The now-horrific drought in the home decor market knows no end. Bombay hasn't even managed a dead-gadzooks bounce on its trip toward microcapville. Kirklands, Cost Plus and Pier One have not fared much better. Recently, even WSM showed signs of strain at Pottery Barn. It is started to took like a little like the toy category.
-Casual Dining Restaurant stocks rebounded incredibly hard relative to their traffic, which only rebounded slightly. This is the worst year in casual dining restaurant traffic in a long time (more than ten years, in terms of year over year changes), market did not cooperate with the cheapo stocks you'd normally get as a result.
-It's hard to know whether or how gas prices are having a big impact on various retailers. Many, such as the auto parts stores, the restaurants, some discounters, have blamed gas prices, but you haven't seen many signs of positive bounce-back when prices ease. On the other hand, I don't seem to hear very often the fairly stark fact that miles driven in the US has basically been flat for the last two years after increasing an average of 2.8% for the previous 25.
-Essentially none of the monoline subprime lenders from the 90s are still around in their present form today. LEND has survived and a few others are around in slightly altered form (New Century, Delta Financial), mostly without GOS accounting and with multiple, staggered warehouse lines. It will be interesting to see if this shakeout really obliterates the industry again or looks more like a standard financial industry shakeout five years from now.
-I heard Ed Lampert speak in New York. I didn't learn anything, but I think it's notable that the interesting questions about the most daring retail strategy in recent years are still completely unanswered at year end 2006. While we can agree that Lampert is terrifically smart and has probably already reaped more value from both KMRT and S than most managements would have over time, it is still an open question (to me) whether his higher-price, lower-capex methods will run into a wall. KMRT has shown signs of stalling, but a brief stall does not a wall make.
Okay, macroblog mode on. Voting on the winner is ok, but offering your own blogoff is probably more interesting.
2006 Year-end Battle of Blogbots
Entry A: by globalstreamer1973xprt@ beartrap.blogspot.herbgisnakedbeneathhisshorts.net
Inflated asset prices and unsustainable consumption leaves corporate profits and thus equity prices likely to suffer after a correction of recent US profligacy.
Bear's Eye View
According to the Federal Reserve Flow of Funds report, US corporate profit margins before accounting adjustments were 13.9% pretax and 10.3% after-tax in the third quarter. This compares to multi-decade averages of roughly 9.5% and 6% respectively. Meanwhile, spending continued to exceed disposable income, resulting in a negative personal savings rate of 1% versus historical and international savings rates of 8% or higher. These imbalances are reflected in the continued ascent of the US trade deficit, as the country continues to sell its assets and/or credit to foreigners to finance current consumption.
These spending and savings imbalances have been caused, in part, by the imposition of artificially low interest rates by the Federal Reserve. Aggressive rate reduction to a trough Fed Funds rate of 1% in the wake of the 2001 recession offered consumers and investors the prospect of negative real-short term interest rates. This synthetic inducement to abandon actual time and risk preferences helped bolster waves of reactive borrowing and consumption, intensified by investors' perceptions that temporarily low interest rates could be arbitraged through some version of a yield curve trade.
The most significant by-product of these warped time preferences was an unsustainable boom in housing prices. Substantially lower interest rates in concert with the increased ease of conducting mortgage transactions resulted in a large increase in credit. This credit funneled into the housing industry. Real housing prices, mortgage debt and homebuilder profits increased at unprecedented rates in many US markets as temporarily low interest rates together with unfortunately sophomoric (because they are based on current payments as opposed to the present value of all payments) "affordability" qualifying heuristics deluded buyers into increasing their bids. Higher prices then reflexively boosted housing markets further: Housing investment optimism increased while expanding LTVs reduced defaults and thus increased lending aggression. The housing equity investors, meaning the homeowners, immediately transferred an extraordinary portion of their appreciation into consumption via an enormous level of capital extraction. Progress in genomic research was painstaking but innovations in exotic mortgage lending were suddenly radical.
These imbalances were able to escape the usual checks and balances due to additional artificial intervention. Namely, extreme but blind foreign central bank demand in the market for US credit prevented a steep increase in interest rates and/or currency decline to account for the increased risk imposed by this excessive consumption and unsustainable asset appreciation. The short-term importance of the US currency and import market to world governments overwhelmed typical market precaution, allowing US households to continue consuming in excess of their production with little immediate penalty. As a result, many foreign markets were able to benefit from growing US consumption without yet feeling pain from their poor investments in dollar denominated assets.
The excess consumption generated from these temporary, synthetic forces juiced corporate profits, resulting in historically high profit margins (which were not yet competed away because surprisingly high demand consistently exceeded reasonably cautious capital allocators). These inflated profits were of course immediately capitalized by equity investors, resulting in a second leg to the housing wealth effect in the form of a stock market resurgence: stocks increased for the fourth consecutive year. Leading the charge of corporate wealth were cyclical commodity and financial businesses, the most direct beneficiaries of rapidly expanding but unexpected asset-based consumption, and of a term structure of interest rates heavily manipulated by extra-market forces. And the simultaneous appreciation of so many asset markets created a predictable increase in investment aggression: Capital flowed towards leveraged hedge funds, derivative markets exploded and implied volatilities and risk spreads squeezed beyond historical lows toward microscopic levels.
These events, rather than standing alone, reflected what will likely be the final leg of an extended quarter-century bull market in US equities, bonds, and corporate profits. In fact, the genesis of the credit explosion which proximately started the unsustainable US housing bubble came from the government's attempt to revive already unsustainably high consumption levels in the wake of the stock market bubble of 1996-2000. Rather than allowing free market forces to impose increased savings and continued capacity reduction following the giant misallocation of technology bubble capital, the Federal Reserve postponed reversion. As a result, US consumers are saving (or rather, not saving) at record low levels just as their demographics turn against them. This imprudence will be amplified when the effects of the Government's failure to accrue for its health and retirement promises is distributed to the citizenry in coming years. Moreover, substantial increases in savings to normalized levels will severely hurt frothy corporate profit margins (probably eviscerate them in the short term), which in turn will lower stock market values and induce a reverse wealth effect. The usual economic implications of this cyclical trough will temporarily worsen already fragile credit performance, undoing much of the outsized housing price increases. Again, the much ballyhooed household net worth will decline with housing, and ultimately fleeing foreign capital will likely create financial market turbulence as it rushes to exit its suddenly unreliable dollar denominated investments.
Although it is difficult to predict what will precipitate this cascade, there is abundant evidence that the key catalysts are already in motion. The housing market has weakened significantly. The extent of the downturn has only been stayed by a downtick in long term interests sparked by recessionary fears. But the impact of these housing woes has only begun to be felt. Subprime delinquencies have increased markedly, but the full seasoning of the worst tranches is coming in 2007 and 2008. Meanwhile, the ARM resets will also peak in 2007, pressuring the last of the great beneficiaries of the negative real interest rates of prior years. Once the cumulative impact of these events grow large enough to either roil financial markets and increase risk spreads or hurt consumption demand enough to dent the corporate economy, the snowball of de-consumption described above will begin. And when it does, the corporate capacity slowly built toward a world of 10% after tax margins will create some ugly earnings numbers. Anyone paying 115% of GDP for corporate equities versus the 80% historical average at a consumption and profits peak should be very afraid.
Entry B: by wikitubelover11%36K @ bullpen.blogspot.tooefficientforbuydotcompartdeux.net
The US economy is experiencing a golden age of phenomenol productivity, low real and nominal interest rates, political hegemony, and pristine corporate balance sheets, yet the 500 most efficient companies in the world are trading at an absurdly cheap 14.7X forward operating earnings.
Bull's eye view
The only real creator of wealth in the United States, productivity, is in the midst of an enriching, sustainable boom. The lagged but continuous benefits from technological advances and increases in the global labor pool have generated incredible US productivity gains of roughly 3% per annum since 1998 despite an interim market swoon, almost double the previous thirteen years. This underlying wealth creation is fueling a boom in corporate profits, non-corporate profits, real asset values and household net worth without creating significant inflationary pressure. The resultant strength of the US economy has left it with an extremely attractive but warranted cost of real long term capital, allowing households to improve their standard of living while also compounding the value of the net assets they own.
Every 26 year-old journalist who can spell Shiller is screaming that the housing bubble is about to blow this great economy to bits. Meanwhile, real housing prices have grown by less than 2% per annum over the last thirty years, and if a truly accurate measure of quality-adjusted housing were possible that meager number would be even smaller. That is, despite this country's perpetual clustering fetish and the fairly dramatic increase in zoning and permitting constraints over time, housing has shrunk significantly as a proportion of GDP. While some worry that the bulk of what small increase did occur has been squeezed into the last several years, lumpy and volatile returns are extremely common features of all sorts of financial market movements. If anything, Housing's supposed extreme price movements of late are terrifically tame relative to the fit-and-start return characteristics of most assets. Excesses in local markets and periods of volatility are trivial scratches on the pane of long term value.
In fact, the Consumer is doing fine. These supposedly over-levered, gluttonous materialists are more flush than ever. Credit card debt growth has slowed while mortgage debt has risen, and households still own over 53% of their property free and clear. Savings, meanwhile, is dramatically understated. Forget for a minute about the excluded benefit of home appreciation. The more sustainable omission comes from undistributed corporate profits. In Q3, this amounted to an extraordinary 5.4% of GDP (ex-accounting adjustments). Including this measure, net private savings of 4.5% are doing just fine. In fact, if it weren't for the looming social security and Medicare problems, you'd wonder if the US was saving too much. After all, shouldn't the most wealthy person on the block (in the world) with the lowest cost of capital think about saving less and consuming more? This savings shows up in corporations via sizeable growth in share repurchases and unusually strong corporate balance sheets.
But despite these strong financial positions and the benefits of productivity showing up in healthy profit margins, stocks are unreasonably cheap. The S&P 500 yields 6.8% on forward operating earnings whereas real returns offered by TIPs are only 2.5%. Economists across the world puzzle over the supposedly outsized historical equity premium and here were are poised to get the same juice all over again. Imagine if the 21st century comes without two world wars and a Great Depression.
As luck would have it, here at the end of 2006 you don't even have to wait to see if the housing bomb is going to blow you up. It already went off. Real short term interest rates have been "normal" for almost a year now. New home sales have imploded as has the profitability of the home builders to the point where they are trading near or below replacement values. Subprime whole loan prices are likewise at or below originations costs. Home equity extraction has dropped considerably and both housing starts and housing prices have seen their largest declines in years. Yet the effects on the economy have been muted, with GDP, consumer spending and corporate profits still positive, long term real interest rates still attractive and inflation still under control. Meanwhile, recent signs have even indicated that the big housing apocalypse may be stabilizing in large sections of the country. Given that today's efficient and flexible economy survived the Nasdaq crash with only a whimper, the pain from any additional housing volatility seems likely to temporary and benign. Meanwhile, permits have plunged and public builders have curtailed investment, so don't be surprised to see scarce assets in the most attractive economy in the world see increased demand and pricing resume sometime soon.
The blogbears sit perched awaiting the negative shock that will send the supposedly fragile and inflated financial markets into tumult, spanking the consumer for their greed and returning the world to the equal distribution of wealth that existed in the good old days of the robber barons. There's the negative shock of option-ARMs, or inflation, or deflation, or terrorism, or oil prices, or derivative melt downs, or Chinese capital flight, or a housing crash just waiting to chase this market down to half of GDP. Meanwhile, factories in Guangzhou producing things at half the cost know within seconds when an item has left a warehouse in Topeka awaiting replenishment which in turn knows within seconds when it has left a store shelf in St. Louis. Public school teachers can afford more computing power than Fortune 500 companies of only a couple of decades prior. Retired household savers in Asia can efficiently lend money to recent home buying graduates in Seattle, who can sell unused textbooks to security guards in Jersey taking online MBA class who can buy stocks at almost no frictional cost. And that's only the past. In the world's most flexible economy atop a highly envied University education system, there is reason an precedent for optimism in additional innovation. When the worrywarts were holding the Gulf War or the Twin Deficits under their magnifying glasses 15 years ago, they couldn't conceive that those blemishes would be rendered economically microscopic by advances in computing, programming and communications. The list of negative shocks makes the front page of the business section, while speculation on the next internet (commodity extraction or replacement? Transportation efficiency?) is relegated to promoters or the Lifestyle section. But in truth we live in a country built for positive shocks. And you get all this for less than 15X earnings.
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I can't help but notice a little macroeconomic testiness here on the LL. I think it's a little unfortunate that this board has tilted away from stock specific talk and company research slash accounting Q&A towards a bunch of stuff I don't think people are (or can be) nearly as smart about as they think. But given that I haven't contributed much in the way of of good stock talk, I really have no right to complain. So I figured I would instead exacerbate the problem by making good on my previous suggestion that anyone who wants to post their though-out macroeconomic opinions post the other side instead. However, because I just can't stand to make an irritatingly long post like this without any specific stock discussion, I will now proceed to make several completely arbitrary stock-related comments before proceeding.