No matter which path GM chooses – conventional restructuring or bankruptcy – the U.S. Big Three of GM, Ford Motor Co. (NYSE: F) and Chrysler LLC will have to adjust to the U.S. auto market’s post-financial-crisis “new reality.” Automakers will sell only 10 million cars and trucks in the U.S. market this year, the worst in at least 3 decades – and roughly 38% less than the 16 million vehicles that were sold in the United States annually in recent years before the financial collapse caused an accompanying collapse in auto sales.

Part of the reason for the slump in new vehicle sales is that consumers are increasingly turning to used cars. Pre-owned car sales are up 10% this year over last, as credit availability increases, but buyers focus on affordability. In fact, according to the most-recent report, used-car sales jumped in April, and the trend is expected to continue at least until the middle of the year as pent-up demand for affordable, pre-owned vehicles jacked up the used-vehicle segment of the auto marketplace.

Market Matters

U.S. Treasury Secretary Timothy F. Geithner put his most optimistic face forward in assessing the progress with the bank bailout plan. Geithner pointed out that the 19 stressed-tested banks have already raised $56 billion in capital [including Bank of America Corp.’s (NYSE: BAC) $13.5 billion stock offering] and several could begin to pay back Trouble Asset Relief Program (TARP) money shortly.  He also indicated that the public-private partnership to remove “toxic” assets from banks’ books should be up and running in the next month-and-a-half, a move that may instill greater confidence in the financial markets.

However, an analysis by The Wall Street Journal rained on Geithner’s parade by estimating that small and mid-sized banks could face losses on bad commercial real estate loans of $100 billion by year-end 2010. A Money Morning investigation of the looming commercial real estate crisis predicted that this sector of the real-estate market would pose major problems for the U.S. economic recovery.

Meanwhile, GMAC LLC may be close to receiving a fresh $7 billion in new (bailout) money as the government continues to seek ways to rescue the auto industry.  GM reached an agreement with its main union (UAW) that would reduce retiree benefits and overall labor costs to make them comparable to those of their foreign rivals.

As another negative earnings season comes to a close, investors searched long and hard for a bright spot – any bright spot.  With most Standard & Poor’s 500 Index companies reporting, earnings plunged more than 30% in the first quarter and are on track to fall 13% for the full year, the worst annual performance in six years.

Still, Thomson Reuters PLC (Nasdaq ADR: TRIN) says that a consensus of sell-side analysts projects a 29% increase in earnings in 2010 as cost-cutting measures pay off and relative results begin to look more attractive.

The Lowes Cos. Inc. (NYSE: LOW) reported better-than-expected quarterly profits and raised its outlook for the year, but The Home Depot Inc. (NYSE: HD) saw its numbers disappoint investors who were looking for stronger signs from the home improvement giant.  Likewise, Hewlett-Packard Co. (NYSE: HPQ) reported weaker earnings, and that spawned renewed pessimism for the high-tech sector.

On a brighter note, retailers Sears Holdings Corp. (Nasdaq: SHLD) and Aeropostale Inc. (NYSE: ARO) reported better-than-expected quarterly profits.  Ratings upgrades brought early promise as Citigroup Inc. (NYSE: C) boosted its forecast on homebuilder Lennar Corp. (NYSE: LEN); Deutsche Bank AG (NYSE: DB) raised its views on McDonalds Corp. (NYSE: MCD); and Goldman Sachs Group Inc. (NYSE: GS) made Bank of America a “Buy.”  However, S&P warned it may downgrade the United Kingdom’s debt below AAA due to ongoing economic obstacles, a development that prompted others to wonder if U.S. securities could face similar dire possibilities.

Crude oil surged past $62 a barrel on lower inventory data and gasoline climbed above $2.36 a gallon heading into the Memorial Day holiday weekend, a far cry from the $3.80 of this time last year – although it was 30 cents higher than late April levels.

Economically Speaking

While Geithner was “spinning” the bailout progress in the most favorable light possible, the U.S. Federal Reserve meeting minutes painted a picture of a more sluggish economy than most had predicted just three months ago.  In fact, the policymakers negatively revised their projections for economic contraction and warned that the unemployment rate could push toward 10% by the end of the year.  Still, central bank Chairman Ben S. Bernanke believes improvements are on the way as the impact of the Obama administration stimulus package aids in the recovery over the year’s second half. Furthermore, the Fed stands prepared to buy more U.S. Treasury and mortgage-related securities should such moves be deemed beneficial.

In the “it could be worse” category, Mexico (-21.5%), Japan (-15.2%), and Germany (-14.4%) each reported severe economic declines (as measured by gross domestic product, or GDP), as these three primary U.S. trading partners suffered the ill effects of the lower domestic demand for foreign-made goods and services.

Though the economic calendar was rather light during the week, some positive signs did emerge from deep within the numbers.  While analysts were surprised by a decline in April housing starts, the losses stemmed from a reduction in apartment activity, and single-family construction actually jumped by almost 3%, its second consecutive positive monthly showing.

Additionally, a private survey of the nation’s construction professionals depicted that homebuilder sentiment soared to its highest level in eight months, another sign that the prolonged housing slump may finally be nearing an end.

Finally, leading economic indicators, a predictive index that forecasts activity for the ensuing six months, turned positive after six straight down months.  Unfortunately, labor continued to struggle as the number of folks who have been receiving unemployment benefits for over a week hit a new record high.  While the economy definitely seems to be moving past the dreaded recession, any recovery will be limited as long as the labor picture remains weak and employees hold off on purchases until their job situations become more stable.  And the risk of a “double-dip” downturn remains somewhat high.

Weekly Economic Calendar

Source: As GM Cruises Toward Government Deadline, U.S. Automakers Must Learn to Deal With a Permanently Smaller Market

“How to earn 367% off American Retail’s “Seven-Ten Split.”

“Biggest jump in wholesale food prices in more than a year!”

– Associated Press, commenting on the Labor Department’s latest wholesale prices report

I know that Justice and I have gone on for some length now on the recent rise in agricultural prices. And I now am about to delve into that same topic – again.

By now, you are probably wondering if you have accidentally subscribed to the Farm Report. But hey – it beats another column on car companies, eh?

(Oh wait, here’s an item on cars after all. I was just perusing Chrysler’s list of doomed dealerships. No wonder they are going under: In my area, there are some 25 or 30 outfits on the list that are all within an hour’s drive of each other. Many are mere miles apart, and a few could probably throw rocks at each other on slow days. With that sort of insane saturation, sooner or later, something was bound to bust!)

And Now, Back to the Farm Report…

I have two reports on my desk right now with almost completely contradictory messages. I am talking a real “seven-ten split” here (a technical term I filched from the local bowling league).

The first lauds the fact that there was almost no drop in consumer prices in April. The Labor Department thinks that this is just peachy because it means that we are not locked in a hideous deflationary spiral.

Apparently this has been a real fear in some quarters of Washington, as over the past 12 months, consumer prices have fallen a whopping 0.7%, the largest such drop since late 1956-early 1957.

Be Careful What You Wish For

The same report also brags that there was not but so much inflation to be found either. Core prices (which exclude most everything you use on a daily basis, particularly food and gasoline) actually did rise 0.3% in April. And while this was the biggest such spike since last July, the bean counters reassure us that 40% of that rise resulted from a huge spike in the Fed’s tax on tobacco.

So far as Washington is concerned, “it’s the best of all possible worlds.”

You know, those guys in Washington really ought to re-read Voltaire’s Candide before putting out such jolly statements. By the end, the kind professor who coins that Pollyannic phrase suffers through bankruptcy, the Spanish Inquisition, the Lisbon earthquake, and syphilis.

The Dangerous Gap

Because the other report on my desk has the latest wholesale figures, and they are a tad disturbing for all sorts of reasons.

In April, we saw a 0.3% increase in overall wholesale costs. This gain was roughly three times higher than expected. Annualize this and you get a wholesale inflation rate of 3.6%. That’s more than enough to completely neutralize the 3.7% drop we’ve seen over the past 12 months.

What’s more, the actual extent of this rise has been disguised by certain internal disparities. Over that same stretch, wholesale crude oil fell 0.1%. (You could be forgiven for somehow missing this, as the refined gasoline sold to retailers actually went up 2.7%.)

The New Luxury Food: Eggs

It’s that old “non-core devil,” food, that is really soaring. Overall it went up 1.5% in April. If you annualize that, you get an 18% rate of climb. But wait – eggs alone went up some 44%. And that’s not annualized. That’s just the jump for April, making for the largest such increase in the past 17 years.

Oh, and just to dot the “I,” as it were, pharmaceuticals went up at an annualized rate of 12.6%, just as swine flu began sweeping through the nation. (What lovely people in that biz. Ah well, this is, after all a capitalist nation, and they certainly have the right to charge what the market will bear.)

The Worst of All Possible Choices

Going forward, those businesses must do one of three things. They must either lower costs further (not gonna happen), raise their prices (not gonna happen), or admit that they lost their shirts come the next round of quarterly reports (and unless something changes, that is sooo gonna happen).

A few companies that you particularly ought to keep an eye on: Sears (SHLD:NASDAQ) is particularly vulnerable to increases in cotton, wool and synthetic fabric costs, and also Safeway (SWY:NYSE), which will have to start posting “apologies” signs on the egg bins again.

You would be in good company in these positions. The former is already being played short in WaveStrength Options Weekly to the tune of 37% gains as I sit to write, with gains over 118% anticipated in the near future and a final target of 367% lurking just out over the horizon. The latter, I believe is being shorted by my cellmate, Chris DeHaemer.

Source: Costs Up, Sales Down – A Formula for Retail Disaster

With the U.S. unemployment rate jumping to its highest level  in a quarter century in February, it’s become abundantly clear that that the U.S. recession is much deeper than President Barack Obama anticipated, meaning it’s likely that additional measures will be undertaken to arrest the slide and restart growth.

Many experts are now calling for the Obama administration to focus on the fundamentals – fundamental economics, that is. They want him to drop some of its ancillary pet projects – such as healthcare reform – and are telling President Obama to focus all his time and the government’s resources on three things:

• Arresting the economy’s slide.
• Hastening its subsequent rebound.
• And fixing the U.S. banking system.

A focus on anything else is just a diversion and is a waste of time – especially because  there are questions about just how bad the economy actually is, says John Ryding, chief economist for RDQ Economics LLC in New York.

The Obama administration “should be focused on stabilization [of financial firms] and stimulus – and that should not only be ‘Job One,’ that should be the only job right now,” Ryding told Bloomberg Television. “The question is: Is it (a) recession or is it something worse than (a) recession” – like a depression?”

There’s definitely a cause for concern: The U.S. unemployment rate jumped to a higher-than-expected 8.1% percent in February, as employers reduced payrolls by 651,000, the U.S. Labor Department said Friday. Job losses have exceeded 600,000 for each of the last three straight months – something that hasn’t happened since the government started collecting jobless data all the way back in 1939.

As if that weren’t bad enough, consider this: Unemployment has already reached the average rate the White House had projected for the entire year, Bloomberg News reported.

Economists and other experts were already calling for the recession to last longer than had been expected; some are even calling for four more years of pain: a longer recession, followed by slow recovery that could have the malaise afflicting Americans until 2013. [For a related report on these revised views that appears elsewhere in today’s issue of Money Morning, please click here].

Experts don’t want the already dire situation to get even worse. But now there’s a growing concern that the Obama administration may be trying to do too much, and focus on too much – when the economy and its related ills should be – as Ryding said – “Job One.”

Market Matters

Just imagine what President Obama’s approval ratings would be if the country weren’t mired in the worst recession since the Great Depression?

With unemployment soaring to its worst level since 1983 and the U.S. Federal Reserve having declared that every sector of the economy is in the doldrums, President Obama moved into the 2nd month of his presidency with 41% of the American people believing that the country “is generally headed in the right direction.”  By comparison, 26% of those surveyed in January (and 12% in November before the election) expressed similar sentiment.

Though the economic data reveals more “challenges” ahead and the markets continue to move to much lower levels, two-thirds of Americans feel “hopeful” about Obama’s leadership.  In a small way, these results may be more telling than any earnings or economic report.  Consumer and business confidence will prove keys in moving the country back in the right direction.  Perhaps, these poll results indicate that such “optimism” may be returning to the American mindset (though ever so slowly)?

Although the administration’s $787 billion stimulus plan is designed to save or create a total of 3.5 million jobs, the American economy has already shed 4.4 million jobs since the recession “officially” began in December 2007. And experts say that more declines are coming.

Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. (DB) in New York, is one such expert. In a research note to clients, LaVorgna says he now sees the U.S. jobless rate reaching the 10% level by the end of this year. And he’s now abandoned his expectation that growth will emerge in the second half.

“Without any engines of growth, the labor market and the economy are likely to remain depressed for some time,” LaVorgna wrote.
Plunging domestic and overseas demand is inducing such firms as Sears Holdings Corp. (SHLD) and General Motors Corp. (GM) are stepping up their job cuts.

U.S. stocks posted their biggest weekly decline in three months last week after American International Group Inc. (AIG) reported a $61.7 billion loss – the biggest in history – and iconic billionaire investor Warren Buffett said the economy is in a “shambles.”

The Standard & Poor’s 500 Stock Index slumped 7% last week, meaning that broad index has plunged 20% since President Obama took office on Jan. 20. The Dow Jones Industrial Average tumbled below 7,000 and never looked back, hitting levels not seen since May 1997.  Other major indexes followed, with the Nasdaq Composite Index plummeting to a six-year low.

The Obama Administration and the Federal Reserve have rolled out two more measures designed to stabilize the credit markets and provide some much needed relief for struggling borrowers. The Term Asset-Backed  Securities Loan Facility is a $200 billion program that will stimulate lending activity for small businesses and consumers.  The $75 billion “Making Home Affordable” program is supposed  to assist 9 million homeowners with financial hardships to avoid foreclosure by modifying terms of their mortgages.

How long until Citigroup Inc. (C) is listed as a penny stock on the Pink Sheets?  With nationalization talks becoming more prevalent, the one-time banking giant fell below $1 a share last week and its market cap plunged to $5.4 billion (from $270 billion just two years ago).  Speaking of penny stocks, American  International Group Inc. (AIG) posted a $60+ billion quarterly loss, the largest in history, and stands prepared to accept another $30 billion in government funds.

US Bancorp (USB) and Wells Fargo & Co. (WFC) each took measures to shore up their financial positions as both cut their respective dividends by about 85% to a nominal nickel a share. Meanwhile, Wells’ management announced an additional $2 billion in expenditure reductions and claimed that the financial institution experienced “strong operating results” in early 2009.  The news outside of financials was not much better.  Computer shipments are projected to decrease by almost 12% in 2009, the worst level of activity ever reported.  Auto sales in February plummeted again and no one escaped the negativity: GM (-53%), Ford Motor Co. (F) (-48%), Toyota Motor Corp. (ADR: TM) (-40%).  GM also seemed to move a few steps closer to bankruptcy reorganization (and penny stock status).

Volatile oil prices settled above $45 a barrel as traders weighed the dire economic picture against inventory reports that showed an unexpected decline in crude supplies.  Prospects for a new stimulus plan from China brought short-lived optimism, though ultimately the pessimists won out as news about Citi and GM ruled the day.

Economically Speaking

With many countries mired in a global recession, China proclaimed that its $585 billion stimulus plan should produce about 8% annual growth for the world’s third largest economy.  Outsiders had hoped that China’s premier would announce a more robust package, but instead the government has adopted a “wait-and-see” attitude before determining if any further measures are needed.

Both the European Central Bank (1.5%) and the Bank of England (0.5%) reduced their key lending rates by 50 basis points, dropping those benchmarks to their lowest levels in their respective histories.

The Federal Reserve’s Beige Book reported that the prospects for recovery continue to look bleak for the short-term with any “pickup not expected before late 2009 or early 2010.”  Meanwhile, Fed Chairman Ben S. Bernanke confirmed that the recession is worsening as the labor market weakens; he also appeared to support the Obama administration’s stimulus package as the best hope to revive the domestic economy.

This week’s economic calendar is highlighted by the February retail sales report and some analysts are “cautiously” optimistic (which is really saying something in this environment).  The January report depicted the first monthly increase in seven months and the best showing for retailers in over a year.  After a dismal holiday season, perhaps folks are simply antsy to partake in the “Great American Pastime” of shopping again.

Remember, gift cards purchased for the holidays are still being redeemed and may have contributed to some additional activity last month.

And with equities facing their lowest valuations in 12 years, some investors may be becoming just as antsy to jump off the sidelines and take advantage of bargain-basement prices. Could this be the week?  Unfortunately, up to this point, there’s been far more talk than action.

Weekly Economic Calendar

Source: As the Economy Worsens, Experts Call for Obama to Focus on the Fundamentals

• U.S. sales in November fell 31% for Ford Motor Co. (F) and 34% for Toyota Motor Corp. (ADR:TM) Every line of Ford vehicle posted falling sales, and the company responded by slashing first-quarter North American output for 38% to 430,000 vehicles, Bloomberg reported.

• Crippled by global slowdown, British Airways plc (OTC:BAIRY) said it is in merger talks with Australian airliner Qantas Airways and Spain’s Iberia, Reuters reported. Should the three mesh together, it would create the largest airline company.

• U.S. conglomerate General Electric Co. (GE) said it is looking for ways to cut costs, including job cuts and its finance and industrial units, in order to reach the low end of its fourth-quarter profit forecast. “Obviously the macro environment remains very challenging,” Keith Sherin, GE’s chief financial officer, said in a briefing with investors, Reuter reported. “We know that we have to reduce our cost structure in this environment.”

• In the midst of a dour holiday shopping season, Sears Holdings Corp. (SHLD) posted a wider-than-expected third-quarter loss, as its Sears and K-Mart stores took a beating from the U.S. recession. The company also announced it would close more stores and buy back as much as $500 million of its stock, MarketWatch reported.

• Oil prices fell to a 3-year low yesterday (Tuesday) as mounting job losses and fears of a protracted recession continued to weigh on investor confidence. Light, sweet crude for January delivery fell $2.32 – more than 4% – to settle at $46.96 a barrel on the New York Mercantile Exchange. Prices touched $46.82 earlier in the day, the lowest level since 2005.

• U.S. credit card write-offs will continue to increase in 2009, as the unemployment rate continues to climb from the 6.5% reached in October, the top executive at Discover Financial Services (DFS), said yesterday (Tuesday) according to The Associated Press. David Nelms, Discover’s chief executive, said write-offs could be near 5% in the fourth quarter and 6% in the first quarter of 2009.

Source: Global Investing Roundups Wednesday, December 3rd, 2008

The bottom line is consumers are running scared, and that is bad news for retailers and manufacturers.

Adam says Whirlpool (NYSE:WHR) and Sherwin-Williams (NYSE:SHW) are in for a particularly rough ride. Even ’safe’ stocks such as Sears (NASDAQ:SHLD) or Kohl’s (NYSE:KSS) could seriously hurt your portfolio in the coming months.

Still, if you dig a little below the facile headlines, you’d learn that the bailout may be sucking up all the air in the room, but that trillion dollars is NOT really this week’s big story. That is reserved for a lowly zero.

Because zero is the change in consumer spending from July to August.

The bright guys over at the Commerce Department were kind of hoping that spending would go up about 0.2%. That’s not much, but it would at least have been double the increase between June and July.

The Economic Stimulus Act of 2008 (remember that?) was supposed to have one of those multiplied effects wherein Joe buys from Fred, who in turn hires Mike, who takes Sadie out to dinner etc., etc.

Instead, there was no gain whatsoever, demonstrating quite clearly that dumping $152 billion into a system already overburdened with excess dollars wasn’t quite the cure Washington thought it might be.

Here’s another “small” figure that dwarfs that trillion-dollar package Congress is screwing around with: Excluding “volatile food and fuel” (snicker), prices increased 0.2% July to August, and 2.6% between August 2007 and August 2008. The latter is the largest spike since January 1995.

Run these “ tiny fractions” all the way through the system, and American disposable income fell 0.8% in July and 0.9% in August. To paraphrase Ross Perot, that loud snapping sound you hear is millions of pocketbooks, wallets and checkbooks snapping closed.

And it’s not going to get any better anytime soon. According to the latest Bloomberg economist survey, the last quarter of 2008 should be the worst in almost 20 years.

In a nutshell, all this horse hockey going on in Washington this week isn’t touching the underlying economic problems we are facing. In fact, if anything, it is only making them worse. And it’s scaring consumers to death.

My advice? Forget about anyone who makes washing machines… I am thinking Whirlpool (NYSE:WHR) here. I am not a big fan of anyone who makes house paint either. Here’s a hint: Run — don’t walk — away from a big coatings manufacturer like Sherwin-Williams (NYSE:SHW).

And I know that some folks are still warm to certain outfits like Sears (NASDAQ:SHLD) or Kohl’s (NYSE:KSS) that sell washing machines and house paint, and sweaters and khakis, too, for that matter.

Maybe they are right. Heck, if you are buying for the next decade looking for $300, you won’t care if you bought for $100 or $50.

But right now, that sort of drop looks like a 50% loss to me.

And this week, -50% trumps a trillion easy.

Source: Zero Growth Trumps Washington’s Trillion Dollars

U.S. Federal Reserve Chairman Ben S. Bernanke didn’t use the “S” word – stagflation – but he might as well have. On Friday, the U.S. central bank chief said that the financial crisis that has hammered the U.S. market is combining with rising inflation to eviscerate American economy. Together, the two forces are making it extremely difficult for the Fed to restore economic stability in the U.S. market.

Bernanke apparently welcomed the recent drop-off in the prices of oil and other key commodities – and says that inflationary pressures will moderate over the next year and a half, but also cautioned that the current inflation outlook remains highly uncertain.

The upshot: The Fed will monitor the economic situation closely and will “act as necessary” to make sure that inflation doesn’t get out of hand. These dueling cross-currents – a sputtering economy and racing prices – is stagflation, the potentially ruinous manifestation that was once thought to be a theory only, meaning it couldn’t possibly show up in real life. That changed in the 1970s, when soaring energy costs and a collapsing U.S. global competitiveness combined to send the American economy into a tailspin. When the inflation rate peaked at 13.5% in 1981, then-Fed Chairman Paul A. Volcker had to put short-term interest rates up to more than 20% to finally break inflation’s back.

Let’s hope that’s not happening again.

With the afore-mentioned crosscurrents, most economists believe that Fed policymakers will leave short-term rates unchanged when they next meet Sept. 16 – if not for the rest of the year.

Unfortunately, the latest wholesale prices report is a cause for concern, and certainly didn’t put a stop to the recent inflationary fears. In July, the Producer Price Index (PPI) skyrocketed at its fastest rate in nearly 30 years, far exceeding most economists’ forecasts.  While some are keeping a “wait-until-next-month” attitude (when the lower energy prices will be reflected in the numbers), others point to the core data (which excludes the volatile food-and-energy component) as proof that inflation is here to stay – regardless of the shift in energy prices.  Core wholesale prices suffered the largest monthly increase since November 2006 as other sectors clearly have been impacted by the rise in commodities.

At week’s end, however, Bernanke seemed to be reveal that he is most concerned about the sluggish economy; he made his case for the current level of Fed Funds rate of 2.00% by projecting that inflationary “pressures should ease in the coming months as commodity prices fall and the economy slows.”

Despite the recent reprieve from record energy prices (and Bernanke’s comments notwithstanding), inflation definitely should remain high on the Fed’s radar screen (and Americans will still feel the pinch in their pocketbooks).  While some analysts expect food and energy prices to lead to lower overall inflation gauges (Consumer Price Index, PPI) in the months to come, the recent core numbers reveal that businesses and consumers will continue to be impacted by price pressures.

The upcoming release of the minutes from last month’s Fed policymaking (Federal Open Market Committee, or FOMC) meeting will delve a bit into the mindset of the policymakers as they continue to face the dual economic threats of sluggish economy vs. inflation.  On that note, the revised second quarter gross domestic product (GDP) estimate will be released and investors are hoping for an upward revision from the 1.9% reported in July.

Most experts had been counting on those tax rebates contributing more to the domestic economic growth.  Confidence and personal income/spending data will help dictate just how active the consumer will be in the months to come.  Retailers (discounter and luxury stores alike) will surely be watching to learn whether they can expect any positive news in time for the holidays.  Finally, two one-time industry leaders, Dell Inc. (DELL) and Sears Holdings Corp. (SHLD), report earnings, though such announcements do not carry the luster they once did.

Market Matters

Market/Index	Previous Week (08/15/08)	Current Week (08/22/08)	YTD Change
Dow Jones Industrial	11,659.90	11,628.06	-12.34%
NASDAQ	2,452.52	2,414.71	-8.96%
S&P 500	1,298.20	1,292.20	-12.00%
Russell 2000	753.37	737.60	-3.71%
Fed Funds	2.00%	2.00%	-225 bps
10 yr Treasury (Yield)	3.85%	3.87%	-17 bps

The latest business headlines are coming to us straight from China – the land that exports much of the world’s toys and other manufactured products and imports significant oil, natural gas and other commodities (greatly contributing to the prior surges in commodities-related prices). With Michael Phelps becoming an overnight hero at the Beijing Summer Olympics, a new corporate bidding war may soon begin as the record medalist prepares to be transformed into the next global marketing sensation (Whatever happened to just being featured on the cover of a Wheaties cereal box – you know, “the breakfast of champions?”).

Phelps currently maintains a contract with swimwear company, Speedo [The Warnaco Group Inc. (WRC)], and will collect a cool $1 million bonus for his gold medal accomplishments.  Enter Nike Inc. (NIKE), the sports apparel giant, with a limited swimwear presence.  Analysts project that Phelps could mean $50 million and a huge new market for Nike; the company may come calling with a blank check (Can you say Tiger Woods?  Michael Jordan?).

But here’s the issue as these companies prepare their bids and potentially increase their ad budgets during a period of economic uncertainty.  While Tiger and “MJ” participate(d) in sports that graced TV screens constantly, Phelps will drift into virtual athletic oblivion until London 2012.  Good luck, Michael.  Thanks for making us forget the global financial crisis – even if only for a couple of short days.

Speaking of the global financial crisis… just when it seemed that investors once again found it safe to hold Freddie Mac (FRE) and Fannie Mae (FNM) securities, a negative Barron’s article spooked shareholders that their stock prices were heading to zero amid an imminent government bailout.  Other analysts believed that full-fledged nationalization of the two government sponsored enterprises remains unlikely, and said that major loans from the U.S. Federal Reserve would seem the more logical path should capital infusions be needed.

Meanwhile, the respective stocks plunged to 18-year lows.  On the “lighter” side of the financial news, Goldman Sachs Group Inc. (GS), Merrill Lynch & Co. Inc. (MER), and Deutsche Bank AG (DB) joined UBS AG (UBS), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM), and Morgan Stanley (MS) in reaching settlements with New York Attorney General Andrew Cuomo (doing his best pre-scandal Elliot Spitzer imitation) over past sales of risky securities.  On an even more positive note, analysts at JPMorgan stated that the next two years would be more favorable for financial firms than for energy companies  (Anyone interested in a Lehman Brothers Holdings Inc. (LEH) hostile takeover?).  In earnings news, retailers Home Depot Inc. (HD), Target Corp. (TGT), Saks Inc. (SKS), and Staples Inc. (SPLS) each posted worse-than-expected quarters, revealing that consumers are steering clear of just about every type of store these days.  Techs, however, got a boost as Hewlett-Packard Co. (HPQ) reported surprisingly strong results.

As the week began, the Dow Jones Industrial Average plummeted more than 300 points in two days as the Freddie/Fannie scare resurfaced.  Fortunately, the eternal optimists pointed to the light volume, which often results in exaggerated price moves (either up or down).  With the summer winding down, traders and investors alike head to the Hamptons for some much-deserved R&R (at least, those who can still afford it).  Oil prices suffered through some excess volatility as traders (over)analyzed the growing tensions between Russia and the United States, the weekly inventory data, and threats of storms in the Gulf that could have disrupted production.  By week’s end, the major equity indexes had bounced back, but still ended in negative territory.

Economically Speaking

As inflation worries continue to escalate, housing continues to struggle, as July construction starts plunged to their lowest pace since March 1991 and new mortgage applications also declined to levels not seen in almost eight years.  On the bright side (if any really exists), residential sales in So-Cal (Southern California) climbed to a 16-month high as homebuyers and real estate investors (more likely, speculators) finally found some value in certain foreclosed properties.  The predictive index, leading economic indictors, fell far more than expected as the continued slump in building permits led the ongoing pessimism about future housing activity.

Well, at least, So-Cal may be on the mend?  Any other regions care to follow?

Source: Worrisome Stagflation Becomes More Real All the Time

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

I heard that statement when I was watching Fox business news on Friday. I waited to hear the name of the company, but it didn’t come up again. The broadcast moved on to another topic and my attention was diverted.

Was it Macy’s (M)? Exxon (XOM)? GM? Sears (SHLD)? All those companies slumped while making news on Friday.

With the market down, a lot of companies are sporting attractive price-to-earnings. The Dow’s forward P/E is only 12.5. The S&P 500’s is only 14.6.

Why not invest in some upscale names going for downscale prices? If you do, be careful. Sure, the market drags down the good companies along with the bad. But the cheapest buys may be basement bargains for a reason.

Take Sears, for example. The company has a proud tradition and a famous name, but the retailer is only a shadow of its former self. It was for several decades the mega-store of its day. The famous Sears catalog – as big as a phonebook – clued America in to the latest gadgets, fashions, tools, appliances, toys, and everything in between. America trusted the “solid as Sears” brand and flocked to its stores.

Seems like ancient history, doesn’t it? Sears lost its way but, it didn’t happen overnight. It took years. And during this period, many investors bought Sears for its cheap price and famous name. But the name couldn’t revive the price. Now both are diminished and will probably remain so.

Did it have to turn out that way? I don’t think so. With smarter management, Sears could have done much better.

But some sectors have no choice but to wither away. Their time has simply come and gone.

Take newspapers, for example. I loved reading newspapers when I was growing up in Salem, Massachusetts. My favorite journalist? It was William F. Buckley Jr. He was always spouting off.

I always had a dictionary beside me when I turned to the editorial pages to find his column. It was great. I picked up at least 3-4 new words every time I read his articles. (When I went to university in London, a highlight was watching Mr. Buckley debate the highly respected leftist intellectual and renowned orator, Mr. Tony Benn. Buckley held his own, but so did Benn.)

So, a few years ago, when a search engine (using some of my favorite value ratios) popped out the names of the New York Times, Washington Post, and the USA TODAY, I was more than intrigued. I was kicking myself with delight. With P/E ratios under 10, how could I not invest in them?

Of course, I checked them out but (in hindsight) with perhaps a little less rigor than usual. I ended up going with USA TODAY. It wasn’t one of my best decisions. The newspaper industry had changed. I knew that, of course. But I had underestimated by how much.

It was no longer the newspaper business I had grown up with. That was easy money. In his 2007 “Letter to Shareholders,” Warren Buffet explains it best:

“…the newspaper business was as easy a way to make huge returns as existed in America. As one not-too-bright publisher famously said, “I owe my fortune to two great American institutions: monopoly and nepotism.” No paper in a one-paper city, however bad the product or however inept the management, could avoid gushing profits.”

The Internet took all of that away. Newspapers lost their exclusivity, seemingly overnight. An almost infinite choice of media outlets on the Internet were vying with newspapers for a finite set of eyeballs. The newspaper business as we knew it faded away and bad management had nothing to do with it.

Newspapers were a trap for investors. Here are some other traps you should avoid:

• Banks. Do you think the sovereign wealth funds regret pouring billions into America’s biggest banks? They should. Slicing and dicing mortgage securities into so-called high-quality derivative instruments and then selling them throughout the world didn’t work out so well, did it? And right now, there’s nothing to replace this formerly lucrative practice that brought in trillions of dollars to the banks.

• Oil majors. Do they have a plan for the future? Exxon’s capital expenditures budget is smaller than the money it uses to buy back shares. Falling future production plus falling futures prices (2015 oil futures are lower than today’s prices for the first time in over a year) add up to falling profits. Big oil’s business model is broken.

• Any sector that depends on cheap oil is in trouble. Airlines? Their problems extend way beyond expensive jet fuel. But putting 2,000 airplanes out to pasture isn’t a sign of a healthy sector. Petrochemical companies? Trucking? Fertilizer companies (that use natural gas as their main raw material)? They’re all getting killed.

But not the auto sector. This sector isn’t broken. Even GM with its billions of losses isn’t broken. Auto companies have to give consumers what they want. That’s all. And what they want is smaller, gas-sipping cars.

Auto companies should be among the first group of companies to blast out of the recession and lead the market to higher ground. The real bargains will be the companies that give drivers what they want. And you can find them in the U.S., Japan, Korea and India.

Invest well,

Andrew Gordon

Source: The Business Behind the Big Name is What Counts

• Shareholders of The Bear Stearns Cos. Inc. (BSC) approved the government-assistant $2.3 billion acquisition by JPMorgan Chase & Co. (JPM), Bloomberg reported. The all-stock deal is expected to close today (Friday), though shareholders who sought more than the buyout’s price of $10-a-share may file suit.

• Shares of Sears Holdings Corp. (SHLD) – owner of Sears and K-Mart department stores – dropped 3.6% yesterday (Thursday) as the company posted a net loss of $56 million, or 43 cents a share, for the quarter ended May 3. “Given that we do not expect any significant near-term improvement in the overall retail environment, we believe that our sales and gross margin for the balance of fiscal 2008 will continue to be pressured,” the company said in a statement.

• Meanwhile, the same economic slump that’s crippling Sears has benefited warehouse retailer Costco Wholesale Corp. (COST), which posted a estimate-beating profit gain of 32% for its fiscal third quarter, Reuters reported. Net income was $295.1 million, or 67 cents a share, as shoppers took advantage of its members-only discounts on clothes, gasoline, food and big-ticket items such as televisions and furniture.

• Taiwan’s economy grew an estimate-beating 6.06% for the first quarter, as exports grew more than expected and consumer spending continued its strength. Bloomberg reported that Taiwan joins Japan, Hong Kong and Malaysia in having reported GDP growth that exceeded expectations.

• General Motors Corp. (GM) announced yesterday (Thursday) that 19,000 workers accepted voluntary buyouts, MarketWatch reported, as the struggling automaker looks to cut costs. The departing employees represent 24% of GM’s Auto Workers Union-represented staff.

Source: Global Investing Roundups Friday, May 30th, 2008