Tuesday, April 28, 2009

ARE WE THERE YET ? : Main Street vs. Wall Street

Market Observations:

Shipping Slowdown: The ‘Baltic Freight Index’ reflects the current state of slowdown in world trade. As an industry executive said ‘Too many ships chasing too little cargo’.
The Suez Canal Authority and the Panama Canal Authority are renegotiating and thinking of reducing passage fees.

Auto Industry: Just like the real estate sector, the auto industry expanded rapidly on the surge of easy credit over the last few years. The sector is now facing a situation of massive inventory levels and sluggish sales. Unemployment figures will rise, if auto giants like GM and Chrysler file for bankruptcy.

Consumer Consumption: The end of the road for Goldilocks:
Faced with job losses, home foreclosures and banks that are unwilling to lend, individuals are cutting back on expenditure.
Instead, they are resorting to paying back debt and saving a bit more.

Here are the results of my ‘Consumer Stress Test’
Hotel Occupancy
remains low, and room rates are expected to fall still further. ‘Mega’ hotel plans in Asia by large hotel groups are being shelved!!
Airlines too are complaining of the continued fall in passenger traffic.

Student Loans – are getting hard to come by, and graduates are struggling to find jobs in an ‘impossible’ job market. If 'parents' lose their jobs, students will need to take on more debt, but I expect further tightening in lending to students!

Credit Cards – Credit Card debt is getting more expensive. Even creditworthy borrowers are having a hard time. Credit Card related losses will be the next big source of write downs at the banks.

Retail Sales are struggling. As consumers are cutting back on brands and luxury items, retailers are cutting back on new store launches.

Media – Television and newspaper firms are faced with declining advertising revenues.
Companies are cutting back on ad spends as advertising budgets are being rationalized.
Apparently consumers are even cutting back on satellite TV subscription budgets

Lastly, US Bankruptcy filings are still increasing!

Unemployment: Government announced figures could be understated!
The continuing credit crisis has resulted in job losses across sectors.
If GM or Chrysler file for bankruptcy – unemployment numbers will surge.

Commercial Real Estate: We’ve all heard a lot about the collapse in home prices. As jobs are lost and vacancies arise in office space and retail malls, this sector could face quite a challenging time. Most REITS are highly leveraged and they will struggle to refinance loans and raise further equity. These REITS purchased these properties at high valuations (backed up with easy credit), and are now struggling service their debt as vacancies at their properties are on the rise.

Banking Sector: Surprise! Surprise! The US Banking sector is profitable again, albeit artificially supported by the FED, AIG handouts and proprietary trading activity. Let’s hope they are not underestimating risks taken on their proprietary trading books. It’s a crisis of solvency and not of liquidity, but I expect they will pass their stress tests with flying colours!

Pension Funds and Savers: These have been badly affected by the actions of the FED and the collapse in prices across asset classes.
Imagine a pension fund losing 30% or more over the last year, because the fund invested in private equity funds and hedge funds; that were not as ‘safe and liquid’ as first estimated.
Or the Saver who now gets nothing on his bank deposits/ CDs because the FED is trying to save ‘big business’
A short while ago, I wrote of the losses at University Endowment funds and University retirement funds. Funding and grants for research programmes will also be affected.
Until recently, student tuition fees at US universities have been rising rapidly; a trend that may not continue. Massive falls in endowment fund values combined with declining income will hurt spending activities at universities.

Work VISAs and Student VISAs:
Given the state of the US job market, campus hiring is suffering badly.
Even US work VISA applications by the Indian IT sector have failed to match the incredible demand of previous years. The IT sector is not hiring agressively anymore.
Well known educational institutes in India such as the IITs and the IIMs have noticed a marked drop in campus recruitments by Investment Banks and Multinationals.
(One positive upside from all this is that large Indian firms will be able to hire excellent talent at attractive rates, whereas up until a few years ago, they were being outbid by foreign banks and MNCs.)

Business Outlook of Non Banking CEOs - It’s a classic ‘ Emperor’s new clothes’ story! Only the Banking CEOs claim to see an improvement!!!
Manufacturing sector CEOs are still cutting back on capex plans, trimming workforces and cutting inventory levels.
Banking Ceos are so eager to get back to the heady days of mega bonuses and irrational risk taking, that they are only too ready to claim that things are back to normal again.

The ‘Let them eat cake’ attitude: In a recent post, Jim Kunstler (Clusterfuck Nation by Jim Kunstler) wrote of the possibility of rising inequality and the possibility of a breakdown in law and order.
It’s important to remember that most blue collar workers didn’t get a share of the massive profits and bonuses enjoyed by the upper management and equity shareholders over the past few years. Now they are being forced to share the losses of a system they did not control or understand. Governments may soon be battling both a financial crisis and a ‘law and order crisis’ if things really get out of hand!

To conclude,

Wall Street is far more optimistic than Main Street.

The main drivers needed for a sustainable economic recovery at this stage are ‘earnings’ and ‘employment’, but I’m seeing no improvement just yet. As the process of deleveraging continues, many 'marginal' players will fail and many more jobs will be lost.

I’m not a permabear, but I don’t want to pay the penalty of jumping in too early. While we may have made a medium term bottom, for now it may be wiser to wait for things to clear before jumping back in.

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