After the Commerce Department reported last week that retail sales fell 0.1% in July from June, and 8.3% year-over-year, retailers will stay in the limelight this week as several high-profile companies report second-quarter earnings. Target Corp. (NYSE: TGT), Limited Brands Inc. (NYSE: LTD), and Gap Stores (NYSE: GPS) are among the big-name retailers set to report.

Meanwhile, the Hewlett-Packard Co’s (NYSE: HPQ) report will provide a further glimpse into the world of technology, and The Home Depot Co.’s (NYSE: HD) results will confirm or counter claims that the recent housing rebound is for real.  On that note, the upcoming economic releases include July housing starts and existing home sales, while the wholesale inflation gauge may show that price pressures are not yet creeping into the producers’ side of the equation either.

Market Matters

While many more bearish analysts continue to proclaim “gloom and doom” and a drop back to the March-lows in equities, at least one noted naysayer may have shifted to the other team.  Hedge fund manager John Paulson purchased over $165 million shares of Bank of America Corp. (NYSE: BAC) to become the banking giant’s fourth largest shareholder.  Paulson was among the select few who predicted the subprime debacle, so his allocation into financials may be interpreted as a nice vote of confidence from an unexpected source.

Meanwhile, the U.S. Federal Reserve made a few bold moves to promote its case for recovery as well.  Following the policy meeting, Federal Reserve Chairman Ben S. Bernanke announced his intent to cease the program of buying up to $300 billion of Treasuries in October, as a major economic lifeline may have served its purpose well.  Additionally, banks have scaled back borrowing from the Fed’s emergency short-term lending facility, a sign that the frozen credit markets have thawed considerably.

Finally, the Car Allowance Rebate System (CARS), popularly known as “Cash for Clunkers,” was expanded, allowing car buyers to receive vouchers for future purchases as automakers report dwindling inventories.

Retailers took center stage in the earnings game as Wal-Mart Stores Inc. (NYSE: WMT) and Kohl’s Corp. (KSS) beat expectations, but still offered cautious projections for the months ahead (including the upcoming holiday season).  Macy’s Inc. (NYSE: M) posted a declining profit, but gave an optimistic outlook, as it benefits from cost-cutting measures.  Liz Claiborne Inc. (NYSE: LIZ), on the other hand, reported a wider loss and new streamlining plans and J.C. Penney Co. (NYSE: JCP) issued some pessimistic comments about the state of the consumer.

Seemingly recession-proof McDonalds Corp. (NYSE: MCD) announced strong July same-store sales as its coffee drinks competed effectively with the “big boys.”  On the transactional front, China continued its expansion into the global commodities markets as China National Petroleum Corp. and CNOOC Ltd. (NYSE ADR: CEO) have eyes on the Argentinean unit of Repsol YPF SA’s (NYSE: REP) to the tune of $17 billion. Microsoft Corp. (NYSE: MSFT) and Nokia Corp. (NYSE ADR: NOK) are teaming up to take on PDA leader Research in Motion Ltd. (Nasdaq: RIMM) in an alliance that brings the popular software together with a solid cellular player.

Fixed income investors got a boost from a successful 30-year bond auction, as $75 billion in new Treasury securities were well-received during the week.  The Treasury also announced a plan to issue more TIPS (inflation-adjusted bonds), a move aimed at alleviating concerns in China (the largest foreign holder of U.S. debt) that the government would allow a surge in inflation as it tries to finance the stimulus plans.

Higher inflation would increase the yields on TIPS and result in greater costs for the government.  Bond prices fell mid-week after the Fed announced its intent to end its Treasury purchase program, though the auction news was a welcome relief and a late-week flight-to-quality also ensued.

Investors focused on the lackluster consumer activity – illustrated by both earnings and economic releases – and worried that economic growth will be stunted as long as shoppers remain in hibernation.

Despite favorable reviews by the Fed, major equity indexes gave up slight ground during the week with the Standard & Poor’s 500 Index and Nasdaq Composite Index still flirting with 1,000 and 2,000 respectively.

Economically Speaking

No rest for the weary (especially when auditioning to keep a job).  Fed Chief Bernanke guided the latest Fed policy meeting that saw strong signs (and language) pointing to the recession nearing an end.  The Fed claimed the economy is “leveling out” and felt the Treasury purchase program could go away with no material detriment to the nation’s financial system.

The accompanying statement also indicated that the funds rate would remain just above zero for “an extended period” as many anticipate the recovery will be slow to take hold.  Noted economists apparently have Bernanke’s back as a recent survey revealed that most prefer he remain on as Fed Chair for another four-year term and President Barack Obama should reappoint him based on his strong performance in righting the ship during the worst economic downturn since the Great Depression

Treasury Secretary Timothy F. Geithner shared some tough talk as he objected to certain concerns that major financial companies have not learned their lessons and the recent profits are indications of pre-crisis-like risk-taking.

The economic data of the week offered mixed signals as retail sales surprisingly declined in July despite the popularity of the “clunker” program, though continuous claims for unemployment benefits fell to the lowest level since April.

The anticipated rebirth of the consumer may be on hold for now as the Reuters/U. of Michigan sentiment index fell again and individuals continue to worry about the state of the job market.

While the trade deficit increased in June, exports climbed for the second consecutive month and manufacturers experienced increased demand for products like semiconductors and telecommunication devises.  Likewise, industrial production rose in July as the “new and improved” domestic automakers attempt to get back on track.

On another favorable note, inflation remains a non-issue as the consumer price index (CPI) was unchanged from June and prices have fallen by 2.1% over the past year.  On the global stage, the French and German economies posted surprising growth in the second quarter and, though the broader Eurozone countries continue to contract, the recovery is already taking hold in that region of the world.

Weekly Economic Calendar

Source: Will This Week’s Earnings Reports Reflect a Recovery or a Relapse for the U.S. Economy?

Earnings Announcements: BKS, FL, GME

Monday

Earnings Announcement: LOW

Tuesday

Economic Reports: Building Permits, Housing Starts

Expectations are for both of these reports to show a modest improvement versus the previous month. With the deteriorating housing market, I don’t think these reports will meet expectations. Until the existing inventory is whittled down, these reports should show a drop in permits and starts. Of course, I have been wrong before, but I can’t imagine any builder wanting to add more inventory to the drastic oversupply right now.

Earnings Announcements: HD, HPQ

Wednesday

Economic Reports: FOMC Minutes

The market will scour these minutes for any indication of the Fed’s future course on interest rates. With inflation a growing concern, this becomes an even more important ‘heads up’ for possible moves.

Earnings Announcements: TGT, SKS, LTD

Thursday

Economic Calendar: Philadelphia Fed

This report will give some insight into the manufacturing sector in the tri-state area. Is it possible the report will show some good news? Perhaps. The report is expected to show a reading of -18, which is a marked improvement from last month’s reading of -24.4. The report is moving in the right direction, which means less contraction in the manufacturing sector.
Source: Housing Back In The News, More Retailers Report Earnings

At this point, the temptation to work as long as possible, and then blow what remains of your savings on a round-the-world cruise and a suicide pill is considerable.

However, such despair is unwarranted.

Unless you have already given up all paid employment, or absolutely have to retire in the next year or two, the current bear market may have made your eventual retirement prospects more secure, not less.

You see, the most damaging factor for your retirement happiness was not the current downturn, but the preceding decade-long bubble.

Let me explain.

Savers who devote an equal amount each month to their long-term plans benefit from an important mathematical principle: Dollar cost averaging. Under dollar cost averaging, you put in the same amount of money each month, so that amount buys more shares if prices are low than it does if prices are high.

Thus, if a mutual fund trades at $1 in month one, $2 in month two and $1.50 in month three, then a dollar-cost-averaging investor investing $300 per month will buy 300 shares in month one, 150 in month two and 200 in month three. After his month three investment, he will own 650 shares at a cost of $900, for an average cost of $1.3846. Since the average price of the shares over the three months was month three’s $1.50, he has made an extra $0.1154 per share compared with the average share price.

That’s why prolonged bull markets are so bad for retirement investors (unless they are lucky enough to retire before the bubble bursts). In this case, the Standard and Poor’s 500 Index stood at 459.27 at the end of 1994. Then after February 1995, when U.S. Federal Reserve Chairman Alan Greenspan moved to an ever-easing monetary policy with low interest rates, it took off for the stratosphere.  It passed its current level of 825 in early 1996, and except for a short period in 2002 has traded above that level ever since.

So, even though retirement savers from 1996-2008 thought most of the time that they were doing very well, in reality they were buying shares at an over-inflated price, and just about every one of their monthly contributions is currently showing a loss.

It’s not the current bear market that has caused that loss. Stock prices in 1996-2008 were always at excessive prices, so a major correction was bound to happen sometime. If the correction had happened in December 1996, when Greenspan made his famous “irrational exuberance” speech, the market would have on average been substantially lower over the subsequent 12 years. And a retirement investor who had saved over that period would be substantially richer today because he would have owned significantly more shares of the mutual fund in which he had invested.

The wise retirement savers who have a few years to go should hope the current lower stock prices stick around, maybe even go lower still provided they recover before they has to draw on the savings or convert them into an annuity. By continuing to invest regularly at these lower prices, the return from dividends and capital appreciation will compound more quickly, particularly if they buy stocks that have a substantial dividend yield.

Even if their savings remain adequate, they shouldn’t convert them into an annuity because annuity rates are currently very low. With long-term Treasury bonds yielding less than 3%, actuaries factor that exceptionally low return into their annuity calculations.

Right now, a 65-year-old man who buys an annuity can expect to receive only around $74 per $1,000 of investment, without any protection for inflation or guaranteed minimum return if he dies quickly. Once interest rates rise, as they are almost bound to, that annuity rate will rise in step with them.

Rather than convert into an annuity, the retirement saver should simply invest in stocks that are both solid and yield more than 7.4% – and there are still plenty of them out there. That way, he can achieve the same return as an annuity while preserving, and maybe even increasing, his principal – in addition of course to any further monthly payments he can make while still working.

By building a portfolio of such stocks including a selection from emerging markets, he can take advantages of the higher-dividend payouts frequently found outside the United States.

Finding stocks with dividend yields equal to or greater than an annuity yield was tough when the S&P 500 was at 1400. But at 800, it’s a lot easier, even if you want to avoid the financial sector for obvious prudential reasons.

Such solid companies as General Electric Co. (GE), BP PLC (ADR: BP), Du Pont (DD), Newell Rubbermaid Inc. (NWL) and Limited Brands Inc. (LTD) yield well over 7% currently, and that’s without venturing into emerging markets companies.

If your retirement portfolio has been decimated, don’t despair. At these lower stock prices it will be much easier to build its value up again, and because stock yields are higher you won’t need so much capital to generate the income you want to live well.

Source: Retirement Investing: How Bear Markets Can Help Your Retirement Planning

Regardless of any formal announcement of whether or not the United States drops into an actual recession, the ongoing credit crisis guarantees a contraction of the American economy by virtually every measure we know. That period of darkness will be marked by a dramatic slowdown in economic activity, as well as by rising unemployment, additional declines in U.S. stock prices, and constant volatility. It could last as long as 12-18 months.

But when the dawn does come, it will be one to remember. If U.S. President-elect Barack Obama gets it right – and I have every reason to believe that he will – then investors will be presented with the greatest investment opportunity of our generation. At that point, shares of American companies will be at such low levels that wholesale buying by individuals, mutual funds, pension funds, institutional money managers, and foreign-controlled sovereign wealth funds, will generate gains that will not only make us whole, they will make us rich once again.

A Market Mandela

Creating an analysis of the U.S. economy’s outlook for the New Year is akin to creating a mandala, a geometric work of art whose pattern, symbolically or metaphysically, represents a microcosm of the universe from the human perspective. In some Buddhist temples, mandalas are made of tiny colored beads, painstakingly created by several monks as a form of meditation. In celebration of the ever-changing nature of the universe, the mandala is then joyously shaken by its creators, until it is once again nothing more than chaos embodied in a box of colored beads.

Regardless of the big picture, analysis of a mandala – or the economy – always starts at the center and emanates outward. With the U.S. economy, that centerpiece is credit. The credit crisis has shaken the complex mandala that is our economy and transformed the United States economy into chaos. It’s complex because this economic-forecast mandala derived its form from thousands of individual pieces – in the case of the economy, from scores of data points, many of which are currently dark and foreboding.

The credit crisis we are experiencing results from the contraction – or worse, the cessation – of lending. Under normal circumstances, institutions and markets freely facilitate capital movement between lenders and borrowers. But that’s not happening, now.

Because of a lack of transparency into the balance sheets of borrowers holding such complex and illiquid securities as collateralized debt obligations, credit-default swaps, and non-performing loans, and because of increasing recessionary fears affecting businesses and households, lenders don’t want to increase their loan exposure. Banks are holding onto the cash and liquid securities they control, using them as a cushion against their own potential losses. The U.S. Treasury Department’s direct-to-bank capital injections do not alter these banking realities. In fact, as a Money Morning investigative story recently demonstrated, instead of using these taxpayer-provided infusions to increase their lending, these banks are using the money to finance takeover deals.

The Recipe for a Recession

Whether or not the United States is technically in a recession ultimately will be divined by the National Bureau of Economic Research (NBER). The business-cycle dating committee of this privately run, nonprofit economic research group is right now studying five factors in an attempt to determine if the United States has entered a recession and, if so, when that downturn started, MarketWatch.com reported. Those five factors are:

• Gross Domestic Product (GDP).
• Industrial production.
• Employment
• Income.
• Retail sales.

Regardless of any formal announcement by the NBER of whether we’re in a recession, the credit crisis guarantees a general contraction of economic activity, by every measure.

“Any doubt that we’re officially in a recession can be put aside,” Anthony Karydakis, former chief U.S. economist for JPMorgan Asset Management (JPM) – and now a professor at New York University’s Stern School of Business – recently wrote in Fortune magazine. “The rapid deterioration of labor markets points to a sharp decline in hours worked and output in the fourth quarter. This is likely to lead to a decline in personal consumption to the tune of 5.0% or so for that period. Since [consumer spending] makes up about 70% of the economy, the stage has already been set for real GDP to shrink at a more than 4.0% rate in the fourth quarter.”

Confirmation of that belief is evident by looking at each of the NBER’s five key indicators.

• Gross Domestic Product (GDP): The U.S. Commerce Department estimated that the U.S. economy, as measured by GDP, rose 0.9% in the first quarter. In the second quarter, GDP advanced an estimated 2.8%. For the third quarter, GDP declined an estimated 0.3%. My own econometric models suggest that GDP actually contracted at a 1.5% pace in the third quarter and will decline another 2.75% in the fourth quarter. For the year, that would mean the U.S. economy actually fell 0.55%. The U.S. economy last posted a full year’s negative GDP in 1991, when it declined 0.2%. Verdict: Recession.
• Industrial Production: This measure of output by the nation’s factories and mines dropped 2.8% in September, and a very steep 6.0% in the third quarter. Verdict: Recession.
• Employment: The U.S. Bureau of Labor Statistics announced Friday that October’s unemployment rate was 6.5%, a jump of 0.4%, which was double what most economists expected, and also its highest level in 14 years. The economy has now lost a total of 1.2 million jobs since the beginning of the year, with nearly half of those losses occurring in the last three months alone, pointing to an acceleration in the pace of erosion in labor markets. Karydakis, the Stern School professor, wrote in
  Fortune : “By way of comparison, during the 2001 recession and in the sluggish growth that followed in 2002-03, the unemployment rate reached a peak of only 6.3%, in June 2003. We’ve already exceeded that mark and, given that we are still in the early phase of the current recession, the unemployment rate should be expected to push toward the 7.5% range – and possibly higher – during the next three months to six months.”
  Verdict: Recession.
• Income: Personal income increased $24.5 billion, or 0.2%, and disposable personal income (DPI) increased $25.7 billion, or 0.2%, in September. Personal consumption expenditures (PCE) decreased $33.6 billion, or 0.3%. Excluding the rebate payments made to U.S. taxpayers under the Economic Stimulus Act of 2008, DPI increased $30.3 billion, or 0.3%, in September, and increased $44.0 billion, or 0.4%, in August. Verdict: Too close to call.
• Retail Sales: October retail sales are coming in well below already-diminished expectations, and some reports have been downright depressing – including The Neiman Marcus Group Inc. -26.8%; The Gap Inc. (GPS) -16%; The Nordstrom Group (JWN) -15.7%; J.C. Penny Co. Inc. (JCP) -13%; Kohl’s Corp. (KSS) -9%;  Ltd. Brands Inc. (LTD) -9%; Target Corp. Inc. (TGT) -4.8%; and Wal-Mart Stores Inc. (WMT) +2.4%. In a report last week, Moody’s Investors Service (MCO) projected that the retail sector’s woes will continue into 2009 as consumers cut back on buying apparel, footwear and accessories “in order to save money for essentials.” The credit rating firm said in a separate report that holiday spending “will prove even weaker than expected,” amid October’s financial-market swoon. Verdict: Recession.

If U.S. exports are taken out of the GDP calculations going back to January, it’s apparent that there has been very little domestic growth in the economy. And when revisions are finalized in the next few months, we’ll be looking back at the recession that we’re all but certain is upon us right now. Until the credit markets are freed up and borrowers are extended credit at reasonable rates, it’s unlikely that credit, the centerpiece of the economy, will be anything other than a major cog in the wheel.

There are some signs of a thaw, but not anytime soon. The U.S. Federal Reserve’s lowering of the Fed Funds target rate to 1.0%, and coordinated rate reductions by the Bank of England and the European Central Bank, as well as other major world-wide central banks, may start to ease the stranglehold gripping the worldwide credit markets. The London interbank offered rate (Libor), a critical interest rate against which trillions of dollars of mortgages, bank loans and derivatives are priced, dropped to 2.39% last week from a high of 4.82% on Oct. 10.

The prospect of President-elect Obama’s choosing a different means of attacking the credit crisis will be closely watched and, by itself, may create an air of confidence that perceptions will change. But changed perceptions will not be enough.

The truth about our economic outlook is that it is predicated on demonstrably better transparency. If U.S. banks follow the lead of their European counterparts, which have recently been freed from fair-value, mark-to-market accounting, and which may retroactively mark assets to “internal models” back to July, then balance-sheet clarity will continue to be cloaked in darkness. Lack of confidence in the banking system will persist, especially among the banks themselves. The first order of attack needs to be the creation of a fundamental leadership position that leads to an open, transparent and accountable measure of balance sheet assets and liabilities. As long as failing banks are being propped up, this cycle of credit contraction will persist.

The outlook for the economy is inextricably tied to the price of oil. The run-up of benchmark crude this summer to the record $145 a barrel level, and its subsequent fall to half that level, has wreaked havoc throughout the economy. Similarly, the run-up in commodity prices, and their subsequent fall, also has caused a lot of damage. Together, the dramatic rise and fall in the pricde of oil and other commodities is a harbinger of greater volatility in the future.

Follow the Money

Follow the money. Capital rapidly inflated the tech-stock bubble. When that bubble burst, capital flowed into and flooded the hard-asset world of real estate. When that bubble burst fast, speculative money dove into oil and commodities. When the U.S. and world economies looked weak, those bubbles burst. The looming threat of inflation this past summer instantly gave way after the drop of oil, gold, metals and agricultural commodities. And now, deflation is seen as the looming threat on the horizon.

Which threat should we worry about?

The answer is – both. The prospect for near-term deflation seems all too real. As raw material prices fall and finished good prices fall due to a lack of purchasing power resulting from lack of credit and world-wide recessionary fears, the U.S. consumer has fundamentally changed his or her collective psychology. Is U.S. consumerism, which is responsible for 70% of GDP, in full retreat? If it is, as all measures project, then it’s likely that government stimulus efforts will overshoot their intended mark.
Just look at what the United States has done already as it battles this financial crisis. It has:

• Handed out more than $150 billion in stimulus rebate checks.
• Floated a $700 billion financial bailout rescue plan – almost $160 billion of which has already been placed.
• Bailed out American International Group Inc. (AIG), to the tune of $125 billion.
• Covered JP Morgan Chase & Co.’s bet on taking over
  The Bear Stearns Cos. – to the tune of $29 billion.
• Looked to lend struggling automakers $25 billion.
• Agreed to guarantee depositors at all banks.
• Stepped in to buy commercial paper that no one else will buy.
• Guaranteed money-market-fund investors.
• And backstopped the Federal Deposit Insurance Corp. (FDIC), Fannie Mae (FNM) and Freddie Mac (FRE).

And now we’re getting wind of another stimulus package and more help for everyone.

If, in six months to a year, the credit markets are facilitating borrowers again, the massive buildup of U.S. debt will result in a falling dollar and higher interest rates.

That spells inflation.

A massive re-inflation of the economy portends another flood of speculative money into oil and commodities. The cycles are increasingly condensed, more volatile and will be increasingly more disruptive.

Welcome to the brave new world of global finance and speculation.

The Federal Reserve’s balance sheet has ballooned from $900 billion to more than $1.8 trillion. That’s 13% of GDP. The Treasury Department has telegraphed its intention to float $550 billion of debt in the fourth quarter and estimates it will have to float another $368 billion in the first quarter of 2009. Our national debt will then be close to 49% of GDP.

If there is an easing of credit in the economy, and borrowers come to market with the pent-up demand that has not been met for the past year, the competition for funds will raise interest rates. Higher interest rates will counter any stimulus effect from government programs.

Who will buy U.S. Treasury debt if the world is less apprehensive about credit quality? Lenders will once again seek higher returns, potentially forcing the Treasury Department to increase its rates. The potential of this event may sink the dollar if investors perceive that the U.S. economy is stagnant and the world is awash in dollars. The yield curve – the spread between the Treasury’s two-year and the 10-year paper – has been steepening. A steepening yield curve, where short-term borrowing costs are low and long-term rates considerably higher, is good for banks that borrow short and lend long.

But if the perception of risk diminishes, and the perception of future inflation increases, the yield curve will invert and the threat of rising rates will cause a sell-off in the short end of the curve and a rush into longer-dated maturities. Any increase in short-term interest rates would be painful for struggling banks. An inverted yield curve would be devastating, and inevitably would lead to more bank failures.

Home on the Range …

At the core of the U.S. economy sits a desperately ailing piece of the mandala – the U.S. housing market. The once bright prospect of home ownership, which historically formed a beautiful economic picture, right now doesn’t exist. For most Americans, the family home constituted the bulk of their wealth. Or at least it did. And this family financial portrait will get worse before it gets better, since the real estate collapse is far from over. Goldman Sachs Group Inc. (GS), for instance, projects another 15% drop in housing prices.

I think that’s conservative. Mortgage rates are actually rising as Fannie and Freddie have to pay higher interest on their short-term notes and bonds. Thirty-year fixed-rate mortgage paper averaged 6.47% last week, up from its 52-week low of 5.36%. The 15-year fixed paper was trading at 6.18%, up from its 52-week low of 4.91% (based on Bankrate.com (RATE) rate surveys). This trend is definitely not our friend. As housing prices continue to fall, and inventories stagnate and grow in many areas, homeowners are increasingly underwater and are increasingly entertaining foreclosure as a viable economic alternative to indentured servitude.
The Hope for Homeowners Plan, which looks to lower interest rates and reduce principal on mortgages, and which makes homeowners pay a share of the appreciation on their home to their lender when they sell it, was initiated in October and was expected to garner some 400,000 takers. As of last week, according to The Wall Street Journal, there had been only 42 takers. That’s not a misprint – 42 – I even checked with The Journal.

In the real estate realm, the proverbial “other shoe” hasn’t dropped yet, but certainly is dangling – and that’s commercial real estate. As homeowners writhe in agony and stop spending, retailers will go out of business, businesses of all stripes will suffer and commercial real estate will implode. The leverage left over from just the private equity foray into commercial real estate in the acquisitive 2006-2007 period is staggering. Refinancing will be impossible. Banks are stuck with hundreds of billions of dollars of leveraged loans that they took on as bridge and mezzanine financing from the private-equity shops alone, at the time believing they would  be able to securitize those loans and sell them off to investors.

There’s no chance of that, now.

One deal in particular illustrates this entire mess.  Private equity behemoth The Blackstone Group LP (BX) took Hilton Hotels Corp. private for $26 billion. Blackstone put up $6 billion of its own money as equity and borrowed the other $20 billion from Bear Stearns, Bank of America Corp. (BAC), Deutsche Bank AG (DB), Goldman Sachs, Morgan Stanley (MS), Merrill Lynch & Co. Inc. (MER) and Lehman Brothers Holdings Inc. (OTC: LEHMQ).

Based on a current analysis of the deal at the multiple of seven times projected cash flow that the market currently puts on Starwood Hotels & Resorts Worldwide Inc. (HOT) -  Hilton’s nearest rival – if Blackstone values its property comparably, it will have to mark its Hilton holdings down 50%, because it paid 13 times projected cash flow. That wipes out all of Blackstone’s equity in the deal. What’s more, the $4 billion portion of the loan that Bear Stearns took on, courtesy of JP Morgan Chase casting off Bear’s orphaned liabilities, now sits on the Fed’s balance sheet – and isn’t likely to go anywhere anytime soon.

Until the real estate cycle completes its implosion and begins to stabilize, there’s nothing that will fundamentally alter the outlook for the economy. This is Ground Zero. President-elect Obama must resist creating only a political solution to the overwhelming economic problem of declining house prices and declining real estate prices in general. Any attempt to put a band aid on this economic plague will only delay the day of reckoning. I regret deeply the conclusion that the lake must be drained before we can realistically climb out of it. But there just aren’t enough ferrymen to get us all to shore.

Always a Silver Lining – My Forecast

The outlook for the economy is not rosy – and that’s an understatement. But there is a silver lining. Even in the near term, the stock market will present innumerable wealth-creation opportunities.

• First, there are plenty of shorting opportunities out there now, and more will present themselves in the future.
• Second, in due course – in perhaps 12-18 months – we will be presented with the investment opportunity of our generation. If President-elect Obama gets it right, and I believe he’s got the potential to bring us all together and get the country through this (and if you’re reading this Mr. President-elect, I’d like to put in my vote for [New York Fed President] Timothy Geithner as next U.S. treasury secretary), American companies will be able to be purchased so cheaply that fortunes will be made. The recovery will not only make us whole, it will make our people and our nation rich again.

I have absolutely no doubt that the United States will lead the world back into balance. The sea change that has arrived is the result of the conservative experiment having lost its true moorings, pushing the economy into disaster. Not that a wholesale swinging of the pendulum to the other side would be good. In fact, it would be disastrous. We have the potential to end up with a new, fair, transparent and judiciously regulated environment where capital formation can again spread its wings and the U.S. economy can fly.

There are new hands reaching into the colorful box of beads that comprise the American landscape and economy. From any human perspective, the United States is more than a microcosm of the universe; it is the center of the world as we know it. It will take time to construct the new mandala. We all need to meditate on the process to ensure that the design we embrace will ultimately be inclusive, forward-looking and – like all great art – an inspiration to all who view it.

For the U.S. Economy in the New Year, the Pain Will Precede the Promise

Editor’s Note: This is the second installment of a new series that looks at the global investing outlook for 2009.

This from Money Morning:

If there’s a proverb that captures the outlook for the U.S. economy in the New Year, it’s the one that says: “It’s always darkest before the dawn.”

Regardless of any formal announcement of whether or not the United States drops into an actual recession, the ongoing credit crisis guarantees a contraction of the American economy by virtually every measure we know. That period of darkness will be marked by a dramatic slowdown in economic activity, as well as by rising unemployment, additional declines in U.S. stock prices, and constant volatility. It could last as long as 12-18 months.

But when the dawn does come, it will be one to remember. If U.S. President-elect Barack Obama gets it right – and I have every reason to believe that he will – then investors will be presented with the greatest investment opportunity of our generation. At that point, shares of American companies will be at such low levels that wholesale buying by individuals, mutual funds, pension funds, institutional money managers, and foreign-controlled sovereign wealth funds, will generate gains that will not only make us whole, they will make us rich once again.

The Recipe for a Recession

Whether or not the United States is technically in a recession ultimately will be divined by the National Bureau of Economic Research (NBER). The business-cycle dating committee of this privately run, nonprofit economic research group is right now studying five factors in an attempt to determine if the United States has entered a recession and, if so, when that downturn started, MarketWatch.com reported. Those five factors are:

• Gross Domestic Product (GDP).
• Industrial production.
• Employment
• Income.
• Retail sales.

Regardless of any formal announcement by the NBER of whether we’re in a recession, the credit crisis guarantees a general contraction of economic activity, by every measure.

“Any doubt that we’re officially in a recession can be put aside,” Anthony Karydakis, former chief U.S. economist for JPMorgan Asset Management (NYSE:JPM) – and now a professor at New York University’s Stern School of Business – recently wrote in Fortune magazine. “The rapid deterioration of labor markets points to a sharp decline in hours worked and output in the fourth quarter. This is likely to lead to a decline in personal consumption to the tune of 5.0% or so for that period. Since [consumer spending] makes up about 70% of the economy, the stage has already been set for real GDP to shrink at a more than 4.0% rate in the fourth quarter.”

Confirmation of that belief is evident by looking at each of the NBER’s five key indicators.

• Gross Domestic Product (GDP): The U.S. Commerce Department estimated that the U.S. economy, as measured by GDP, rose 0.9% in the first quarter. In the second quarter, GDP advanced an estimated 2.8%. For the third quarter, GDP declined an estimated 0.3%. My own econometric models suggest that GDP actually contracted at a 1.5% pace in the third quarter and will decline another 2.75% in the fourth quarter. For the year, that would mean the U.S. economy actually fell 0.55%. The U.S. economy last posted a full year’s negative GDP in 1991, when it declined 0.2%. Verdict: Recession.
• Industrial Production: This measure of output by the nation’s factories and mines dropped 2.8% in September, and a very steep 6.0% in the third quarter. Verdict: Recession.
• Employment: The U.S. Bureau of Labor Statistics announced Friday that October’s unemployment rate was 6.5%, a jump of 0.4%, which was double what most economists expected, and also its highest level in 14 years. The economy has now lost a total of 1.2 million jobs since the beginning of the year, with nearly half of those losses occurring in the last three months alone, pointing to an acceleration in the pace of erosion in labor markets. Karydakis, the Stern School professor, wrote in Fortune: “By way of comparison, during the 2001 recession and in the sluggish growth that followed in 2002-03, the unemployment rate reached a peak of only 6.3%, in June 2003. We’ve already exceeded that mark and, given that we are still in the early phase of the current recession, the unemployment rate should be expected to push toward the 7.5% range – and possibly higher – during the next three months to six months.” Verdict: Recession.
• Income: Personal income increased $24.5 billion, or 0.2%, and disposable personal income (DPI) increased $25.7 billion, or 0.2%, in September. Personal consumption expenditures (PCE) decreased $33.6 billion, or 0.3%. Excluding the rebate payments made to U.S. taxpayers under the Economic Stimulus Act of 2008, DPI increased $30.3 billion, or 0.3%, in September, and increased $44.0 billion, or 0.4%, in August. Verdict: Too close to call.
• Retail Sales: October retail sales are coming in well below already-diminished expectations, and some reports have been downright depressing – including The Neiman Marcus Group Inc. -26.8%; The Gap Inc. (NYSE:GPS) –16%; The Nordstrom Group (NYSE:JWN) -15.7%; J.C. Penny Co. Inc. (NYSE:JCP) -13%; Kohl’s Corp. (NYSE:KSS) -9%;  Ltd. Brands Inc. (NYSE:LTD) -9%; Target Corp. Inc. (NYSE:TGT) -4.8%; and Wal-Mart Stores Inc. (NYSE:WMT) +2.4%. In a report last week, Moody’s Investors Service (NYSE:MCO) projected that the retail sector’s woes will continue into 2009 as consumers cut back on buying apparel, footwear and accessories “in order to save money for essentials.” The credit rating firm said in a separate report that holiday spending “will prove even weaker than expected,” amid October’s financial-market swoon. Verdict: Recession.

If U.S. exports are taken out of the GDP calculations going back to January, it’s apparent that there has been very little domestic growth in the economy. And when revisions are finalized in the next few months, we’ll be looking back at the recession that we’re all but certain is upon us right now. Until the credit markets are freed up and borrowers are extended credit at reasonable rates, it’s unlikely that credit, the centerpiece of the economy, will be anything other than a major cog in the wheel.

There are some signs of a thaw, but not anytime soon. The U.S. Federal Reserve’s lowering of the Fed Funds target rate to 1.0%, and coordinated rate reductions by the Bank of England and the European Central Bank, as well as other major world-wide central banks, may start to ease the stranglehold gripping the worldwide credit markets. The London interbank offered rate (Libor), a critical interest rate against which trillions of dollars of mortgages, bank loans and derivatives are priced, dropped to 2.39% last week from a high of 4.82% on Oct. 10.

The prospect of President-elect Obama’s choosing a different means of attacking the credit crisis will be closely watched and, by itself, may create an air of confidence that perceptions will change. But changed perceptions will not be enough.
The truth about our economic outlook is that it is predicated on demonstrably better transparency. If U.S. banks follow the lead of their European counterparts, which have recently been freed from fair-value, mark-to-market accounting, and which may retroactively mark assets to “internal models” back to July, then balance-sheet clarity will continue to be cloaked in darkness. Lack of confidence in the banking system will persist, especially among the banks themselves. The first order of attack needs to be the creation of a fundamental leadership position that leads to an open, transparent and accountable measure of balance sheet assets and liabilities. As long as failing banks are being propped up, this cycle of credit contraction will persist.

The outlook for the economy is inextricably tied to the price of oil. The run-up of benchmark crude this summer to the record $145 a barrel level, and its subsequent fall to half that level, has wreaked havoc throughout the economy. Similarly, the run-up in commodity prices, and their subsequent fall, also has caused a lot of damage. Together, the dramatic rise and fall in the pricde of oil and other commodities is a harbinger of greater volatility in the future.

Follow the Money

Follow the money. Capital rapidly inflated the tech-stock bubble. When that bubble burst, capital flowed into and flooded the hard-asset world of real estate. When that bubble burst fast, speculative money dove into oil and commodities. When the U.S. and world economies looked weak, those bubbles burst. The looming threat of inflation this past summer instantly gave way after the drop of oil, gold, metals and agricultural commodities. And now, deflation is seen as the looming threat on the horizon.

Which threat should we worry about?

The answer is – both. The prospect for near-term deflation seems all too real. As raw material prices fall and finished good prices fall due to a lack of purchasing power resulting from lack of credit and world-wide recessionary fears, the U.S. consumer has fundamentally changed his or her collective psychology. Is U.S. consumerism, which is responsible for 70% of GDP, in full retreat? If it is, as all measures project, then it’s likely that government stimulus efforts will overshoot their intended mark.
Just look at what the United States has done already as it battles this financial crisis. It has:

• Handed out more than $150 billion in stimulus rebate checks.
• Floated a $700 billion financial bailout rescue plan – almost $160 billion of which has already been placed.
• Bailed out American International Group Inc. (AIG), to the tune of $125 billion.
• Covered JP Morgan Chase & Co.’s bet on taking over The Bear Stearns Cos. – to the tune of $29 billion.
• Looked to lend struggling automakers $25 billion.
• Agreed to guarantee depositors at all banks.
• Stepped in to buy commercial paper that no one else will buy.
• Guaranteed money-market-fund investors.
• And backstopped the Federal Deposit Insurance Corp. (FDIC), Fannie Mae (FNM) and Freddie Mac (FRE).

And now we’re getting wind of another stimulus package and more help for everyone.

If, in six months to a year, the credit markets are facilitating borrowers again, the massive buildup of U.S. debt will result in a falling dollar and higher interest rates.

That spells inflation.

A massive re-inflation of the economy portends another flood of speculative money into oil and commodities. The cycles are increasingly condensed, more volatile and will be increasingly more disruptive.

Welcome to the brave new world of global finance and speculation.

The Federal Reserve’s balance sheet has ballooned from $900 billion to more than $1.8 trillion. That’s 13% of GDP. The Treasury Department has telegraphed its intention to float $550 billion of debt in the fourth quarter and estimates it will have to float another $368 billion in the first quarter of 2009. Our national debt will then be close to 49% of GDP.

If there is an easing of credit in the economy, and borrowers come to market with the pent-up demand that has not been met for the past year, the competition for funds will raise interest rates. Higher interest rates will counter any stimulus effect from government programs.

Who will buy U.S. Treasury debt if the world is less apprehensive about credit quality? Lenders will once again seek higher returns, potentially forcing the Treasury Department to increase its rates. The potential of this event may sink the dollar if investors perceive that the U.S. economy is stagnant and the world is awash in dollars. The yield curve – the spread between the Treasury’s two-year and the 10-year paper – has been steepening. A steepening yield curve, where short-term borrowing costs are low and long-term rates considerably higher, is good for banks that borrow short and lend long.

But if the perception of risk diminishes, and the perception of future inflation increases, the yield curve will invert and the threat of rising rates will cause a sell-off in the short end of the curve and a rush into longer-dated maturities. Any increase in short-term interest rates would be painful for struggling banks. An inverted yield curve would be devastating, and inevitably would lead to more bank failures.

Always a Silver Lining – My Forecast

The outlook for the economy is not rosy – and that’s an understatement. But there is a silver lining. Even in the near term, the stock market will present innumerable wealth-creation opportunities.

• First, there are plenty of shorting opportunities out there now, and more will present themselves in the future.
• Second, in due course – in perhaps 12-18 months – we will be presented with the investment opportunity of our generation. If President-elect Obama gets it right, and I believe he’s got the potential to bring us all together and get the country through this (and if you’re reading this Mr. President-elect, I’d like to put in my vote for [New York Fed President] Timothy Geithner as next U.S. treasury secretary), American companies will be able to be purchased so cheaply that fortunes will be made. The recovery will not only make us whole, it will make our people and our nation rich again.

I have absolutely no doubt that the United States will lead the world back into balance. The sea change that has arrived is the result of the conservative experiment having lost its true moorings, pushing the economy into disaster. Not that a wholesale swinging of the pendulum to the other side would be good. In fact, it would be disastrous. We have the potential to end up with a new, fair, transparent and judiciously regulated environment where capital formation can again spread its wings and the U.S. economy can fly.

There are new hands reaching into the colorful box of beads that comprise the American landscape and economy. From any human perspective, the United States is more than a microcosm of the universe; it is the center of the world as we know it. It will take time to construct the new mandala. We all need to meditate on the process to ensure that the design we embrace will ultimately be inclusive, forward-looking and – like all great art – an inspiration to all who view it.

PS. This is a cut-down version of the original Money Morning article, which can be read by clikcing the link below.

Source: For the U.S. Economy in the New Year, the Pain Will Precede the Promise

Companies with large distribution networks have redesigned their shipping schedules, crafting more efficient routes that accommodated larger truckloads.

The upshot: Gasoline sales tumbled during the first half of the year as domestic demand fell to its lowest level in five years.  In fact, the U.S. Department of Transportation reported that Americans drove almost 5% less in June than a year ago, and also said that the buses, subways and light-rail systems that make up the nation’s public/mass-transit systems climbed by 3.4% in the first quarter of the year.

Lately, U.S. gasoline stations have been forced to adjust their prices (again) after prices at the pump dropped below $3.80 a gallon – a hefty decline from the prices of $4 a gallon and higher that motorists were forced to deal with as the summer driving season began.

Even in China, oil imports dropped substantially in July on shrinking global demand. (It will be interesting to see if – and by how much – the Summer Olympic Games affect these numbers. And even if the games prompt a spike in demand, some analysts are now predicting that a post-Olympic economic “lull” will afflict Mainland China – watch for our analysis of that theory in an upcoming issue of Money Morning).

This energy-price conundrum doesn’t stop there, either, as such geopolitical “wild cards” as the Russian invasion of Georgia continue to whipsaw prices. Even with such tensions, however, energy traders brushed aside concerns about major supply disruptions – not the response we would’ve seen just a few months back. Late last week, in fact, oil prices took cues from the newfound strength in the dollar and dropped below $112 a barrel, a number not even imaginable in mid-July, when crude-oil prices reached a record level of $147.

All’s well on the Energy Front, it seems.

Don’t you believe it (as we’ve said on more than one occasion during the past year).  In the near term, crude-oil prices could well keep declining … but it’s only going to take one “real” scare – a terrorist attack, or some sort of event that creates protracted supply worries – to cause oil prices to spike in a big way.

And in the long run, demand is going to keep rising in such emerging-market countries as China and India. That can only send oil prices higher. [For a related story on oil prices in today’s issue of Money Morning, please click here].

On the Horizon

The July inflation report (Part II) will be reported tomorrow (Tuesday), with the release of the wholesale price gauge, the Producer Price Index (PPI).  Since energy prices have declined in recent weeks, analysts should take these numbers with a grain of salt, as the July data still will reflect the previously higher levels.

Of greater relevance, perhaps, is the Index of Leading Economic Indicators, due out Thursday. The leading indicators often serve as a foreshadowing of future activity so U.S. Federal Reserve Chairman Ben S. Bernanke and friends should take note of that report.

More retailers post earnings this week, including Limited Brands Inc. (LTD), The Gap Inc. (GPS), AnnTaylor Stores Corp. (ANN), and The Home Depot Inc. (HD). By now, however, most investors realize that consumers remain cautious about the economy, and that most related companies (other than discounters) have continued to struggle.  Maybe the lower gas prices will help turn things around for these and other businesses in the coming months – that is, as long as the current trend in energy remains “friendly.” [For a related story on consumer sentiment in today’s issue of Money Morning, please click here.]

We’ve all watched as the once-pristine reputation of former Fed Chairman Alan Greenspan has been tarnished by the credit crisis, and by some of his recent public pronouncements that were aimed at putting the blame on others (possibly impacting book sales). But that’s okay, as investors are now eagerly awaiting the authorized biography of the “real” market maestro – Berkshire Hathaway Inc. (BRK.A, BRK.B) Chairman Warren Buffett. The book, “The Snowball: Warren Buffett and the Business of Life,” published by Bantam Dell Publishing Group, is due on bookstore shelves Sept. 29.

Market Matters

While certain optimistic analysts claimed that the worst of the credit crisis had ended, the latest news from the financial front indicated otherwise.  Swiss banking giant UBS AG (UBS), fresh off $5 billion in new mortgage write-downs, will divide its investment banking and wealth management operations into two separate units – and some analysts believe it may look to sell off the banking arm over the next few years.

On the other hand, threats of hurricanes in the Gulf of Mexico and geopolitical turmoil in Iraq, Turkey, Nigeria – and now the fireworks between Russia and Georgia – could spark a dramatic reversal in sentiment and renew fears of supply disruptions.

However, this week’s economic calendar contains the types of reports that will factor into the musings of Federal Reserve policymakers with regards to interest rates.

The report on the Consumer Price Index (CPI) for July – due out Thursday – gives economists another look into domestic price pressures, although the recent drop in energy prices will not yet be reflected in this data.  Then again, economists tend to focus only on so-called “core” inflation (which “excludes volatile food-and-energy prices,” anyway).

The July retail sales report gives us some additional insight into the consumer mindset, demonstrating that those tax rebates are virtually all gone. With gas prices on the decline, consumers should have a bit more available disposable income in the months ahead (though, again, the July numbers may not show any enhanced activity just yet).

Additional confirmation of the recent consumer cautiousness should come from the next round of earnings reports, which will feature reports from such retailers as Macy’s Inc. (M), J.C. Penney Co. Inc. (JCP), Nordstrom Inc. (JWN), and Wal-Mart Stores Inc. (WMT).  Should the gas trend continue, consumers could emerge from hibernation just in time for the holiday shopping season… wishful thinking?

Market Matters

Let the games begin. As host of the 2008 Summer Olympic Games, Mainland China takes center stage and gets the chance to show the rest of the world that it has arrived as a global player and an economic superpower. Of course, no event should be more apolitical than the Olympics.  That is, until China banned some participants for their support of Darfur.  And before U.S. President George W. Bush criticized China’s poor record of human rights on the eve of the games. And before China deported a few activists who were demonstrating against certain national policies. (Probably nothing that a few gold medals won’t cure.)

Speaking of having politics cross over into the economy: Last week, Democratic presidential candidate Barack Obama publicly lobbied for the sale of 70 million barrels of oil from the U.S. strategic reserve and also claimed to now support new offshore drilling (if his tire gauge idea fails to prove an effective policy).  As the presidential-election campaigns accelerate into the home stretch, investors can expect plenty of promises (and flip-flopping) from both sides of the aisle.  (How do you feel about those Bush tax cuts this week, Senator McCain?)

So just where are investors to turn these days?  Freddie Mac (FRE) and Fannie Mae (FNM) returned to the headlines last week, as both reported significant losses – far in excess of Wall Street expectations.  (Weren’t those analysts following the news?)  Likewise, insurance giant American International Group Inc. (AIG) reported its third consecutive quarterly loss as its mortgage portfolio remained deeply under water.  Citigroup Inc. (C), Merrill Lynch & Co. Inc. (MER) and UBS AG (UBS) each reached multi-billion settlements with the New York state attorney general over certain high-risk securities that the firms will buy back from affected investors. Outside of financials, Cisco Systems Inc. (CSCO) – the subject of a recent “Buy, Sell or Hold” feature in Money Morning – provided a boost to techs by announcing better-than-expected profits; likewise, The Procter & Gamble Co. (PG) proved that consumer companies could still thrive, despite surging commodity prices.

Institutional funds have garnered additional interest as of late as investors seek out non-traditional asset classes to help compensate for the challenges of the markets.  In July, Hedge Fund Research Inc. reported that the return on a basket of 60 funds designed to reflect the industry as a whole declined by about 3%, the worst monthly showing in six years.  Tutor Investment Corp. will be spinning off its Raptor fund at year-end after bad calls on the energy sector caused ongoing losses for the past two years.  Private equity firm, Fortress Investment Group LLC (FIG), reported a larger-than-expected quarterly loss and has seen its share price drop about 40% since its IPO in early 2007.  Bear in mind, not all hedge funds and non-traditional assets are created equal; plenty of “winners” have emerged lately.

Anyone remember when oil touched $147 a barrel on July 11?  Has the bubble officially burst?  Energy continued its downward spiral as oil fell below $117 barrel, its lowest level since early May.  Rising inventories eased supply/demand concerns and renewed strength in the dollar also helped support domestic securities (thanks to the European Central Bank – see below).  Equity market volatility remained as investors tried to weigh the negative Freddie/Fannie reports against the positive energy trend (and the inactivity of Federal Reserve policymakers with regards to interest rates – also see below). Stocks alternatively soared, plunged, and soared again as the major indexes moved considerably higher by end of last week.

Then there are the ongoing Beijing Summer Olympic Games (which opened Friday), a reminder that every investor should have a China investment strategy.

[Editor’s Note: Please click here to read the first part of our two-part research report -"Why Every Investor Should Have a China Investment Strategy." The second part of that report will appear later this week.]

Perhaps that jubilant Olympic spirit is contagious?  So let the games continue: “USA…USA…USA…!”

Economically Speaking

They came, they debated, they analyzed, and they left – with no action taken. The “they” we refer to here are the members of the Federal Open Market Committee (FOMC), the Federal Reserve policymakers responsible for setting interest rates.

With dueling economic dilemmas impacting the country (slow growth vs. inflation), Federal Reserve Chairman Ben S. Bernanke and his band of central bank policymakers chose to leave the benchmark Federal Funds rate unchanged at 2.00% at their policymaking meeting last week.

While most Fed-watchers still expect the next interest-rate move to be to the upside, some believe such an action is unlikely before the end of this year as reduced consumer activity continues to spark talks of recession.  The recent decline in commodity prices helped the Fed stay on the sidelines, given that inflationary pressures are slightly less than before (at least, for the time being).  The European Central Bank (ECB) and Bank of England both left their key rates unchanged as they also weigh ongoing economic concerns in their countries against continued price pressures.  They prompted a surge in the dollar and took additional pressure off of the Fed, as well.

On the retail front, same store sales in July were lackluster at best as consumer held off on back-to-school purchases and focused on necessities such as food and household goods. (Apparently, last year’s No. 2 pencils and lunchboxes still will work fine.

Even the afore-mentioned Wal-Mart’s sales came in slightly below expectations while mall chains – the Limited Brands Inc. (LTD) and The Gap Inc. (GPS) – and luxury retailers such as Saks Inc. (SKS) all struggled as consumers no longer had those tax rebates to spend.  Moving to housing, the Federal Deposit Insurance Corp. (FDIC) reported that just under 1% of all prime (not subprime) loans originated in early 2007 were at least 90 days delinquent, meaning that the mortgage crisis still has a ways to go before being resolved (and additional write-downs may be on the way).  The weekly jobless claims data showed that more unemployed folks are seeking government benefits than at any time since March 2002.

Weekly Economic Calendar

Source: Federal Reserve Policymakers Will Hold the Line on Interest Rates – At Least for Now

Sears’ Craftsmen tools are among the best. Sears’ appliances have always been great values. There was a time when you could go to Sears and get a pound of nails, pound of fudge and a prom dress in one easy trip. The catalog over the years weighed as much as 6 lbs and sold whatever America needed: watches, guitars, baby chicks, bedspreads, power saws, wedding rings, dolls and BB guns. It was an American icon. Sears had it all.

Yet Sears (SHLD) went bankrupt. It is barely limping back from complete oblivion along with Kmart.

Why does a company with good products and prime locations, a huge mail-order business, and status as an anchor store in very successful malls fall so badly it can hardly get to its knees? And why can’t it get back up no matter what it tries?

I think you know already. Remember the “Softer Side of Sears”? Television and print ads promoted the touchable joy of Sears’ fluffy towels, silky blouses and other home goods.

It didn’t work because Sears had long ago spoiled its own brands. The Crafstman tool quality stayed high, and that unit succeeded. But its department store goods like tee shirts, shoes and jewelry went from attractively average to below average over the years. By the 1980s, you could hardly find a clothing item in Sears that even came to the style level of competitors like JC Penney (JCP).

This is the downside of a strong brand. Let it sour enough to stand for something bad, and you will never get it back again.

I bring this up now because turnaround candidates are turning up all over the market thanks to a bad economy. One business after another has stumbled and promised that a new plan and change of management will make it all OK again. Some will make a success of their turnarounds. Some won’t.

Turnarounds are one of my favorite types of investments, but what goes into a good one is not as simple as cutting jobs, closing a few stores or plants and getting back on track.

Before all that… very first of all, you have to wonder if management even knows where the track is.

Talbot’s (ATLB) is a good case of management that did not know where it was headed or what its business was supposed to be. Any customer knew—Talbot’s sold conservative women’s clothes. That was it. While Sears had some lines of excellence going for it, Talbot’s did not have distinctly different departments. To a shopper, the lingerie, women’s casual and women’s dress clothes are all just clothes. If they weren’t all satisfying, the whole store was off. There were no Craftsman tools to be saved, only the core business.

In its women’s clothes niche, Talbot’s had an identity it aimed for—tailored classics. It did it in well-constructed clothes of good quality textiles. It stuck to that.

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But it had a design sense that was decidedly frumpy and constantly falling behind trends. It got worse and worse at being decidedly out of step as time went by. Talbot’s clothes could make Beyonce look thick-waisted and flat-chested. Sales slumped. Management decided to do something about this disaster…

It added men’s and children’s clothes.

Oh momma. If you can’t dress your primary customer, you aren’t going to make it trying to figure out an entirely different market.

For contrast, about three or four years ago, I recommended Abercrombie and Fitch (ANF), a company which mounted a spectacular turnaround. The differences between Abercrombie, Sears and Talbot’s is telling.

Abercrombie, like Sears, was a long-established, iconic American business with a big reputation. It was where the rich and famous shopped for safari, fishing and hunting gear and clothes. Teddy Roosevelt, Katherine Hepburn, Clark Gable… these were the Abercrombie customers. As was Ernest Hemingway, who killed himself with a gun he bought there.

Sales slid over the years and the stores dwindled. In 1976, Abercrombie filed for bankruptcy. Another sporting goods company bought the name and sold outdoor gear. Once again stores grew, but sales faltered. Forbes declared in 1986 that some great names were better off left to die.

But Forbes missed a big point. The name never suffered. Never.

Yes, Abercrombie’s business was badly managed, but the name never tarnished. It still stood for a store that catered to customers who “don’t care about cost but want top quality.” Then The Limited (LTD) bought the chain in 1988 and began repositioning it as an upper-tier teen brand.

That is why Abercrombie and Fitch could be revived … even with a huge change in its target clientele and its merchandise. The name never came to stand for trash. It never stood for unfashionable or cheap. It aimed for teen price ranges, but the very top of what a well-funded teen would pay. To this day, it hardly has sales except at the end of a season. It gets more full-price clothes through its stores than any of its competitors.

Think about reputation when you consider the next turnaround. There are lots of choices coming up. The economy, which is probably in recession, though economists disagree, is certifiably lousy. Lots of good businesses are feeling it. Some need a turnaround.

But some of those “turnarounds” are not victims of the economy. They were already dying businesses and ran out of ways to hide it when the mechanics of inflation or opening new stores (or the equivalent) could no longer create the illusion of growing sales.

Turnaround investing is fun, extremely challenging, and not a little bit dangerous. And the potential is wonderful—both in money and bragging rights. But it’s strictly for the brave and clear minded, because even successful turnarounds can misstep and go backwards before they go up and onwards. Abercrombie was a success story, but it took six years for Abercrombie to increase sales from $48 million to $50 million under The Limited. After that, it exploded upwards. Sales tripled over the next three years.

You can measure a lot of factors in sizing up a turnaround—credit quality, cash flow and burn rates, institutional support, inventory trends, sales per employee trends. They all matter. But the main things to measure before you drag out your calculator has to be done by a human, it is subjective. Ask these questions:

• Does this business now have a clear mission and idea what the business is?
• Does it own a clean brand or reputation in its field that has never been dragged in the mud?

Another important factor is the character of management itself. I liked Office Depot some years ago, another turnaround story, because its management set out a plan that made sense and they stuck to it. Keeping promises is very important.

Source: Looking for a Turnaround – Why Some Succeed Where Others Fail

Accompanied by that reassuring bit of alleged “certainty,” gasoline at $4 a gallon doesn’t sound quite so scary. In other words, we know that gas prices are headed higher, but we also know that there’s a limit, and we know exactly what that limit is.

Early last week, the U.S. Department of Energy said that it expects average monthly gasoline prices to peak at $3.60 a gallon this spring, since that high price will serve to curb demand and keep prices in check.[although even the Energy Department report said that before prices level off there could be interim price spikes that will take pump prices up over the $4 a gallon level].
With crude oil having spiked above the $112 a barrel level last week on reports of declining oil supplies, grandstanding politicos on both sides of the aisle took the opportunity to bash each other’s energy policies [Don’t tell me … it must be an election year]. Seeming to add credibility to the Energy Department’s prognostication was last week’s weekly inventory report that showed that demand is waning – ostensibly because record gas prices now stand more than 55 cents a gallon higher than they were at this time last year.

But here’s the problem.

The Energy Department is wrong.

Indeed, the federal agency is just the latest “expert” to make erroneous forecasts for energy prices. Thankfully, that’s not true of Money Morning.

Since its inception last year, Money Morning has repeatedly predicted incrementally higher prices for crude oil and gasoline. Invariably, these predictions have proved themselves correct. And we’ve done more than just make predictions: We’ve also outlined investment opportunities that would allow investors to capitalize on this advance in energy prices.

In December, for the first time ever, Money Morning Investment Director Keith Fitz-Gerald publicly predicted that oil prices would reach $187 a barrel within three years. In mid-March, he reiterated this projection [accompanied by several suggested ways for investors to profit from this powerful trend]. Not only has this forecast continued to receive widespread play on energy- and investment-related Web sites, we’re starting to see similar “me too” predictions being made by some the energy sector’s heavyweight experts: Literally only days after Money Morning reiterated its forecast, Wall Street giant Goldman Sachs Group Inc. (GS) said that crude oil prices would reach $175 a barrel in the next two years.

This underscores one of the key mandates for Money Morning. While it’s true that we’re the hottest global-investing news service in the market today, this case study demonstrates that we’re more than just a purveyor of news. Our role is to provide our regular readers and subscribers with the news, of course, but it’s more important for us to explain just what the news actually means. To that end, look for us to:

• Put the news in context.
• To describe how the issue at hand fits in with the handful of powerful global trends that we’ve ferreted out and identified as the top ones that you need to follow if you’re to succeed and profit.
• To stay ahead of the crowd by projecting the “end game” – the outcome – for these top trends.
• And, finally, to research and highlight investment opportunities that are the best-positioned to benefit from these trends, meaning these represent some of the best profit opportunities in the market today [Editor’s Note: If this investing strategy appeals to you, it’s well-worth checking out our affiliated monthly newsletter that maintains several portfolios of stocks and funds chosen using these guidelines. New subscribers get a free copy of investment guru Jim Rogers’ new best-seller, "A Bull in China."]

Stay tuned: We’ll continue to follow the oil-and-gasoline saga as it unfolds, and we’ll continue to find ways for investors to profit from this and other top global trends.

Last Week’s Market Action

If you’re of a certain age, surely you remember some of the marketing “slogans” airlines used to burnish their brand names and, hopefully, to attract passengers. attract passengers.

After all, whatever happened to: “We Earn our Wings Everyday,” or “Fly the Friendly Skies,” or even “Something Special in the Air?”

Last week, however, the more appropriate taglines may have well have been: “We No Longer Overlook Safety,” or “Enjoy Your Stay in the Updated Airport Concourse,” or even better “When the FAA Talks, We Now Listen.”

As if the escalating gasoline prices have not caused enough hardships for the airlines, in recent weeks, they seemed to realize that they actually are required to abide by government safety regulations. Just last week, American Airlines Inc. (AMR) canceled more than 3,000 flights, thus, inconveniencing an estimated 250,000 travelers because a little faulty wiring “may” cause fires in certain aircraft. While some analysts were astonished at the lapse in judgment exercised by AMR’s airline management, others believed this to be classic bureaucratic overreaction due to previous lax oversight. In any case, the airlines undoubtedly will see their future earnings suffer and ticketed customers will experience extended delays [forcing them to seek out the closest Chili’s Bar & Grill inside the airline terminal - at least perhaps representing a boon for the earnings for that company].

Early last week, the U.S. Department of Energy said that it expects average monthly gasoline prices to peak at $3.60 a gallon this spring, since that high price will serve to curb demand and keep prices in check.[although even the Energy Department report said that before prices level off there could be interim price spikes that will take pump prices up over the $4 a gallon level].

With crude oil having spiked above the $112 a barrel level last week on reports of declining oil supplies, grandstanding politicos on both sides of the aisle took the opportunity to bash each other’s energy policies [Don’t tell me … it must be an election year]. Seeming to add credibility to the Energy Department’s prognostication was last week’s weekly inventory report that showed that demand is waning – ostensibly because record gas prices now stand more than 55 cents a gallon higher than they were at this time last year.

But here’s the problem. The Energy Department is wrong. Thankfully, that’s not true of Money Morning. Since its inception last year, Money Morning has repeatedly predicted incrementally higher prices for crude oil and gasoline. Invariably, these predictions have proved themselves correct. And we’ve done more than just make predictions: We’ve also outlined investment opportunities that would allow investors to capitalize on this advance in energy prices.

In December, for the first time ever, Money Morning Investment Director Keith Fitz-Gerald publicly predicted that oil prices would reach $187 a barrel within three years. In mid-March, he reiterated this projection [accompanied by several suggested ways for investors to profit from this powerful trend]. Not only has this forecast continued to receive widespread play on energy- and investment-related Web sites, we’re starting to see similar “me too” predictions being made by some the energy sector’s heavyweight experts: Literally only days after Money Morning reiterated its forecast, Wall Street giant Goldman Sachs Group Inc. (GS) said that crude oil prices would reach $175 a barrel in the next two years.

This underscores one of the key mandates for Money Morning. While it’s true that we’re the hottest global-investing news service in the market today, this case study demonstrates that we’re more than just a purveyor of news. Our role is to provide our regular readers and subscribers with the news, of course, but it’s more important for us to explain just what the news actually means. To that end, look for us to:

• Put the news in context.
• To describe how the issue at hand fits in with the handful of powerful global trends that we’ve ferreted out and identified as the top ones that you need to follow if you’re to succeed and profit.
• To stay ahead of the crowd by projecting the “end game” – the outcome – for these top trends.
• And, finally, to research and highlight investment opportunities that are the best-positioned to benefit from these trends, meaning these represent some of the best profit opportunities in the market today [Editor’s Note: If this investing strategy appeals to you, it’s well-worth checking out our affiliated monthly newsletter that maintains several portfolios of stocks and funds chosen using these guidelines. New subscribers get a free copy of investment guru Jim Rogers’ new best-seller, "A Bull in China."]

Stay tuned: We’ll continue to follow the oil-and-gasoline saga as it unfolds, and we’ll continue to find ways for investors to profit from this and other top global trends.

Last Week’s Market Action

If you’re of a certain age, surely you remember some of the marketing “slogans” airlines used to burnish their brand names and, hopefully, to attract passengers. attract passengers.

After all, whatever happened to: “We Earn our Wings Everyday,” or “Fly the Friendly Skies,” or even “Something Special in the Air?”

Last week, however, the more appropriate taglines may have well have been: “We No Longer Overlook Safety,” or “Enjoy Your Stay in the Updated Airport Concourse,” or even better “When the FAA Talks, We Now Listen.”

As if the escalating gasoline prices have not caused enough hardships for the airlines, in recent weeks, they seemed to realize that they actually are required to abide by government safety regulations. Just last week, American Airlines Inc. (AMR) canceled more than 3,000 flights, thus, inconveniencing an estimated 250,000 travelers because a little faulty wiring “may” cause fires in certain aircraft. While some analysts were astonished at the lapse in judgment exercised by AMR’s airline management, others believed this to be classic bureaucratic overreaction due to previous lax oversight. In any case, the airlines undoubtedly will see their future earnings suffer and ticketed customers will experience extended delays [forcing them to seek out the closest Chili’s Bar & Grill inside the airline terminal - at least perhaps representing a boon for the earnings for that company].