Friday, July 31, 2009

Party on! The bill is on China!

Keep Rockin'!

In the US, Wyeth, JNJ, Time Warner, Conoco Philips, Alcoa, Intel and host of other companies all beat revised earnings with negligible top line growth and extensive spending reductions. So behind the glitter of good earning reports lie a litter of disgarded workers who are victims of CEOs trying to prove they can make their financial targets.

On one hand, employment numbers are being interpreted as showing that unemployment is easing. But it could just as easily be interpreted as not improving because people are falling off the unemployment rolls.

So what is the cause for optimism? The CEO of Alcoa pointed to surprising resilience in the China market driving sales growth in that region. Catepillar also noted an uptick in sales due to large capital expeditures for infrastructure projects in the Middle Kingdom. The world's largest exporter expanding raw material consumption and investment spending in the face of the largest decline in imports across the global economy in decades? Sounds strange.

Based on initiation of the China stimulus package, in the Q1 of 2009 China increased lending 1000%. Within three months, there were more cars sold in China than in the US for the first time ever. Commodity prices took off as manufacturers in China replenished inventories to prepare for the domestic recovery. The optimism is reflected in the Baltic Dry Index chart.

Yet the amount of goods moved within the US declined to 20% YOY levels. It is probable that this indicates a significant decrease in China's exports to the US.

Moreover, the world economy overall is so bad oil demand is very weak and no amount of stimulus has been able to change that.

On the other hand, even domesticly, China's economic strength looks suspect. China claims growth is at nearly 7% annualized. But electrical output, the most reliable measure of industrial capacity utilization, is down 5% annualized and indicates that there is less production occurring.

Better yet, China's new lending spree that is authorized by the central government is executed at the local level and according to reports is carrying up to $4T in debt. I do not dare speculate how that burden come to bear on the markets. But it is bound to have an effect some time.

For now, we can just enjoy the party. In fact the Chinese are opening 4000 retail stock market accounts a day. Over the past month IPOs have been white hot at offering. Sounds like 1999, I like the music, I even might do a jigg or two. But my money is staying on the sideline so this party will not end up left with part of the tab.

Wednesday, July 22, 2009

Economic recovery around the corner?

So much talk of a recovery...I decided to check some vital signals to verify the prognosis.

Forward indicators like the Baltic Dry Bulk index definitely show a slight recovery. I was caught short when I was read articles stating that all port traffic into and out of China had virtually stopped and shipping rates to China dropped to zero for the first time. Since then, demand has snapped back and the trend is clearly upward. This is a positive sign regarding international trade, but could just be a bounce due to the artificial support programs being implemented for the credit markets that allowed trade to occur that could not move due lack of supply of Letters of Credit in the market during the 4Q 08 and 1Q 09.

Next I looked at Warren Buffett's favorite indicator, rail car traffic. Across all indicators point to ~20% YOY decrease in traffic with no major upturn in product to be moved in sight. I think we can draw from this consistent 20% margin is that the consumer demand is not returning yet, and that retailers see no need to restock to previous inventory levels. This may also indicate that the upbeat earnings reports were achieved through extended cost reductions rather than top line gains or profit margin increases.

Finally, I looked at Conference Board LEI index to get a broader view of the issue. It seems that there is a significant pick up in economic activity that is not translating to consumer spending. The distorting factor with this index is that two of the leading components are stock market prices and interest rate spreads. Both of these components have been benefiting from significant government intervention in the banking sector and auto sectors. For the sake of the economy let's hope that government facilitation of the credit markets translates into real economic demand to make this uptick sustainable. Normally, those two events happen in the other order.

Overall, there has been a marked change in business environment, even if it is not evidenced in actual economic activity. The alleviation of fear is the first step to moving to a normal economic environment. Yet for Obama and Bernanke, it may serve more to bolster confidence based on perception rather than emphasize the facts and the sober reality.