Econ 2009

[ewmayer]

Stock rally loses traction: Markets slip after Fed chairman Bernanke says the economic recovery is going to be slow and gradual.

NEW YORK (CNNMoney.com) -- Wall Street gave up earlier gains Tuesday after Federal Reserve Chairman Ben Bernanke warned that the economic recovery would be slow and gradual.

Midway through the session, the Dow Jones industrial average (INDU) was nearly unchanged, flipping on either side of the breakeven mark. Meanwhile, the broader S&P 500 (SPX) index fell 4 points, or 0.4% and the tech-laden Nasdaq Composite (COMP) gave up 10 points, or 0.5%.

Earlier in the session, the Dow led a charge on the back of a strong report from component Caterpillar and optimism about better-than-expected second-quarter earnings.

My Comment: The wording "Strong report from Caterpillar" elicited a loud "WTF?" from me, until I realized that the article author had apparently carefully chosen his words - notice he didn't say strong *earnings*, rather strong "report", the latter in reference to CAT's earnings "outlook", i.e. "highly-improbable-V-shaped-recovery-based-fantasy-earnings". "Why the sleight of hand?", you ask. Because actual *earnings* (i.e. stuff you can measure, with a not-significant but somewhat limited ability to be manipulated) were terrible. The same bias can be seen in CNN/Money's accompanying article about CAT's earnings - four full paragraphs of better-than-expected "hope" propaganda [underlined by me] before they get to the actual *numbers* [boldfaced by me]:

Caterpillar beats estimates, shares jump: Heavy equipment maker says it sees 'signs of stabilization' and raises its full-year profit outlook.

CHICAGO (Reuters) -- Machinery maker Caterpillar Inc. posted stronger-than-expected quarterly earnings Tuesday and raised its full-year outlook, citing what it said were growing signs of stability in the world's credit markets and economies.

The company, the world's largest maker of construction and mining equipment and a closely watched component of the Dow Jones industrial average, said fiscal stimulus programs, especially in China, were beginning to pay off and commodity prices were holding in a range that was positive for investment.

The upbeat outlook, which Caterpillar's chief executive said "set the foundation for an eventual recovery," sent the company's shares surging as much as 13% in early trading on the New York Stock Exchange.

"There is still a great deal of economic uncertainty in the world," Chairman and Chief Executive Jim Owens said in a statement. "But we are seeing signs of stabilization ... Credit markets have improved significantly. Fiscal policy and monetary stimulus have been introduced around the world, and we are seeing signs, particularly in China, that they are beginning to work."

Caterpillar (CAT) reported a second-quarter net profit of $371 million, or 60 cents a share, compared with $1.11 billion, or $1.74 a share, last year.

Sales and revenue fell 41% to $7.98 billion.

My Comment: A two-thirds plunge in earnings is "better than expected"? Here can I get some of that magic weed y'all are smoking? How much ya wanna bet that CAT quietly lowers its full-year outlook sometime befgore the next quarterly earnings report, thus allowing themselves the win-win of a boost in their share price from "positive outlook" now and once-again "better than expected earnings" next Q doe to lowering the bar? works every time, and the MSFM just lap it up.

[Fusion_power]

In this case, I will agree that Caterpillers outlook is favorable. They are in the pits. There is every indication that they will benefit significantly from infrastructure projects linked to stimulus dollars. So they climb out of the pits and maybe get up to the point of just being in a big mudhole.

This brings on an issue you should consider carefully ewmayer. Even in a terrible economy, there are some businesses that are thriving and expanding. Not to offer this as a general trend, but perhaps as an analogy, my business growing and selling tomato plants doubled this year. That is gross dollars. Net profit was significantly better because my expenses are relatively fixed. Now I have a terrible problem. I'm going to have to pay a duke's ransom in taxes. Note that is NOT a kings ransom, just a duke.

I love gardening. Starting a business growing and selling tomato plants seemed like a natural extension of something I already enjoy. Now it is starting to seem more like running a business. That takes most of the fun out of something that I enjoy. I still get a lot of pleasure out of emails from customers who have the first good tasting tomato they have ever tasted in their lives.

And just as an aside more in line with the thread intent, my hobby business can't quite replace my income from Nortel, but if it grows as expected for the next 2 years, I will make more than enough to leave Nortel.

DarJones

[ewmayer]

Originally Posted by Fusion_power

In this case, I will agree that Caterpillers outlook is favorable. They are in the pits. There is every indication that they will benefit significantly from infrastructure projects linked to stimulus dollars. So they climb out of the pits and maybe get up to the point of just being in a big mudhole.

This brings on an issue you should consider carefully ewmayer. Even in a terrible economy, there are some businesses that are thriving and expanding. Not to offer this as a general trend, but perhaps as an analogy, my business growing and selling tomato plants doubled this year. That is gross dollars. Net profit was significantly better because my expenses are relatively fixed. Now I have a terrible problem. I'm going to have to pay a duke's ransom in taxes.

I have no problem with a well-run company making great products which people are buying even in the recession - for example Apple - having that fact reflected in their share price. That`s the way it`s supposed to work. I *do* have a problem with a company attempting to gloss over factually dismal earnings (and I mean "dismal" not in the oh-so-easy-manipulable "versus expectations" sense, I mean QoQ, YoY, real compared-with-past-performance numbers) using overly rosy "guidance". Based on actual earnings (even ignoring the fact that those got a big boost from CAT selling $800M worth of stuff already in its inventory, i.e. they previously booked the cost of manufacture, and this quarter got to book the pure revenue - otherwise they would have actually reported a *loss* for the quarter), CAT`s P/E now stands at a whopping multiple of around 50. OK, so let`s instead look at forward earnings as a basis for P/E:

The company earned 72 cents a share, excluding redundancy costs, on revenue of $8.0 billion. That compares to earnings of $1.74 on revenues of $13.6 billion in the year ago quarter. Revenues were off 41% and 44% in Caterpillar`s core machinery and engines segment. EPS beat estimates of 22 cents a share on heavy cost cutting.

Caterpillar raised its full year 2009 EPS outlook to between $1.15 and $2.25 a share from $1.25 the company gave in its first quarter report. At today’s close of $39.46, the midpoint of that range represents a 23 forward multiple.

The stock was off to the races today, up 7.7% on heavy volume.

But, seriously, is this kind of report really indicative of an economic recovery? A 43% drop in machinery and engines sales shows recovery or stabilization?

We’ve seen this before: groupthink in the stock market with everybody buying into the premise of recovery until finally the facts intrude and end the party.

My Comment: Forward P/E of over 20 even if CAT`s rosy-glasses V-shaped economic-recovery scenario plays out - yeah, right. Also note that "U.S. and China stimulus spending" is not *nearly* enough to justify those kinds of earnings estimates - there would need to be a major rebound in the U.S. construction business, real soon. Does anyone think that likely, given the huge glut of unsold homes left over from the past decade`s insanity, and the ongoing implosion of commercial real estate? But hey, feel free to load up on CAT shares if you believe their guidance - as far as I`m concerned, the recent action and any further rise in the share price simply make it a better shorting opportunity.

And speaking of the ongoing collapse of the CRE securitization market...

Overheard on the World Wild Web:

In response to Standard & Poors' shameless about-about-face ("We rate this crap-mortgage-backed goop AAA ... oh wait, we meant BBB- ... whoops, changed our mind, we meant AAA...") in their ratings of certain commercial-real-estate-backed bonds, there was a lively discussion on ZeroHedge.com which included this exchange:

by Anonymous
on Wed, 07/22/2009 - 02:34
#11711

guys I live in former communist country in the middle of europe, I thought that we are way too far from normal markets, corruption etc. But what shit is in the USA, I could not believe. If someone told me two zears ago that all this will happen iun US, in terms of corruption and manipulation people will be in the streets..but nothing is happening.

* reply

by Anonymous
on Wed, 07/22/2009 - 07:31
#11756

You do not understand that almost all Americans hold the dream of getting rich through asset inflation, especially real estate. George Washington was a land speculator. America exists essentially to inflate assets. There was always a distrust of this among the populace and for one brief moment in the 30's political power turned against it but that passed. The populace now understands that if we don't reinflate assets, all assets real and financial, then America is broke and broken-. Any and all lies going to the purpose of boosting asset prices is a patriotic duty.

Oh, glad to hear your Plan B with the tomato-growing business seems to be doing well ... home vegetable gardening is definitely an area that tends to do well in deep economic downturns.

[Fusion_power]

Again I disagree with you Ewmayer. Your complaint is that Caterpillar is overpriced re its P/E. That I agree with and I would not under any conditions buy stock at current prices. But you are painting the company totally black when in fact prospects over the next year are relatively good. Sales have been terrible for the past year. The overall housing and commercial real estate markets are indeed in extremely weak condition. What you gloss over is that at least 60% of Caterpillar's sales are to infrastructure businesses. These are the businesses that will benefit most from stimulus dollars and they will have to buy equipment. That translates to sales for Caterpillar. Now comparing apples to apples, Caterpillar has had very poor sales for the last year, but now there is a real prospect of improving sales over the next year at least. The question to ask is "Will it last"?

Did the company overstate prospects? Sure they did. Are the prospects actually improved compared to this time last year? They surely are, just not up to the level the company indicated. The weakest part of this picture is overseas sales which will continue to stagnate. As I said above, they were in the pits, now maybe they are in a big mudhole.

DarJones

[garo]

Originally Posted by Fusion_power

As I said above, they were in the pits, now maybe they are in a big mudhole.

But the stock is being priced as if they are already out of the hole and racing halfway up the hill. Less bad does not mean good. So yes, CAT's prospects are less bad but they are certainly not great.

Ernst, re Apple, have you taken a look at their forward P/E? How can you compare them favorably to CAT? Great products which people are still buying in a recession? You would think that 16% unemployment would crimp iPhone sales somewhat.

[cheesehead]

Originally Posted by ewmayer

This next one - a fascinating tour of the psychology of hubris, from Gallipoli 1915 to Bear Stearns 2007 - could almost find a home in the Evolution: The Scientific Evidence thread:

Yes, indeed.

The psychology of overconfidence | The New Yorker

My Comment: The people who make the best liars are the ones who can convince themselves that they are telling the truth ... Note that "optimal" here does not mean "all people, in all circumstances" - in fact there will be (as with other cognitive and behavioral traits) wide variations in "margin of illusion" (or better, of self-delusion) between people, and a level of self-delusion which works well in some circumstances may prove maladaptive in others: The level of cockiness that helps you bluff successfully much of the time in your poker games with your college buddies may get you shot in East L.A. But in a very broad, averaged-over-all-people-over-the-course-of-humanoid-evolution sense,

Cockiness is a superiority only when the underlying objective truth is not as important as the subjective impression. Poker games and East L.A. differ in this regard.

In science, it is the objective truth that matters more than the subjective. There, self-deception is not an advantage, but instead is a primary pitfall to guard against.

[ewmayer]

Originally Posted by garo

But the stock is being priced as if they are already out of the hole and racing halfway up the hill. Less bad does not mean good. So yes, CAT's prospects are less bad but they are certainly not great.

Ernst, re Apple, have you taken a look at their forward P/E? How can you compare them favorably to CAT? Great products which people are still buying in a recession? You would think that 16% unemployment would crimp iPhone sales somewhat.

Garo, while I agree that Apple`s P/E is high in absolute terms, the fact is, they have been one of the very few major companies in any market sector to have shown consistent sales and earnings - and in absolute terms, not just relative to arbitrarily-low-balled "expectations" - during the recession, which is all the more surprising given that most of their business counts as "consumer discretionary". Instead of people holding on to their old iPhones and MacBooks longer during the downturn or turning to lower-priced alternatives, Apple's new products are selling better than ever, which justifies a hefty forward-looking P/E. Also impressive to me is that Apple tends to give very cautious (often deliberately downbeat) guidance, i.e. they are relying on actual *performance* to boost their share price. I must say I thought the stock was extremely overpriced when it briefly hit $200 at the end of 2007 and was very skeptical about their prospects during a deep recession (based on the fact that their sales and profits are based in no small part on what I would classify as "consumer discretionary" electronics), but they have flat-out proved me wrong; credit where credit is due. Based on results since, $200 again seems a distinct near-term possibility, which will have me eating a bit of crow, as I told a friend who works at Apple last year that I doubted the shares would see $200 again for a very long time. (Note that I personally don't rate AAPL as a "buy" at the current level ... just saying I judge the odds of the stock going to $200 by EOY to be roughly as great as of slipping backward by a similar amount). Based on their best-in-class performance, I'd say a P/E of ~30 is justified. That`s still only half the P/E of that other similar recession-beating performer, Amazon.com, whose stock price seemed frothy a couple years ago, and still does, though (again based on outperformance during the recession) perhaps to a lesser extent. Also note that companies like these may be getting the benefit of a flight-to-quality effect.

iPhone, Mac sales lead Apple earnings rise

Apple said it earned $1.23 billion, or $1.35 a share, on revenue of $8.34 billion. During the comparable period a year ago, Apple earned $1.07 billion, or $1.19 a share, on $7.46 billion in sales.

The results beat the estimate of analysts surveyed by Thomson Reuters, who on average forecast earnings of $1.17 a share on revenue of $8.16 billion.

Gross margins as a percentage of revenue rose to 36.3% from 34.8% in the year-ago quarter.

Apple said its results were led by sales of 2.6 million Mac computers -- up 4% from last year's third quarter -- and 5.2 million iPhones. Sales of the company's digital media players totaled 10.2 million units -- down 7% from the same period last year. However, the quarter is typically the slowest one for Apple's iPod business.

It was also the first earnings report for Apple since Chief Executive Steve Jobs returned to the company after a medical leave of almost six months. Jobs received a liver transplant during his time away from the company.

"The big surprises were the strong Mac units, as well as the gross margins," said Shaw Wu, who covers Apple for Kaufman Bros.

The upbeat results, coming ahead of Apple's back-to-school quarter, suggest that while consumers may be reining in some of their spending, when it comes to Apple's products, they aren't holding back.

[ewmayer]

ZeroHedge has been blogging about the "legal" scam that is High-Frequency Trading (HFT) for months now ... looks like some of the mainstream media are finally picking up the scent:

Stock Traders Find Speed Pays, in Milliseconds

It is the hot new thing on Wall Street, a way for a handful of traders to master the stock market, peek at investors’ orders and, critics say, even subtly manipulate share prices.

It is called high-frequency trading — and it is suddenly one of the most talked-about and mysterious forces in the markets.

Powerful computers, some housed right next to the machines that drive marketplaces like the New York Stock Exchange, enable high-frequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense.

These systems are so fast they can outsmart or outrun other investors, humans and computers alike. And after growing in the shadows for years, they are generating lots of talk.

Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.

And when a former Goldman Sachs programmer was accused this month of stealing secret computer codes — software that a federal prosecutor said could “manipulate markets in unfair ways” — it only added to the mystery. Goldman acknowledges that it profits from high-frequency trading, but disputes that it has an unfair advantage.

Yet high-frequency specialists clearly have an edge over typical traders, let alone ordinary investors. The Securities and Exchange Commission says it is examining certain aspects of the strategy...

My Comment: LOL, "The SEC is on the case!" Let me guess, Mary Schapiro calls Lloyd "Blankenstein" Blankfein, croons, "Lloyd, honey, sorry to harsh your buzz with this, but we`re getting complaints from a bunch of li`l pricks in the blogosphere about how Goldman et al are using HFT to front-run their clients` trades and manipulate the markets ... now I know you`d never do anything illegal, sweetie, but I`ve gotta make some kind of show of 'taking these complaints very seriously', blah, blah, you know, the usual bullshit dog and pony show to calm the Great Unwashed. So I`ll just ask you 'To the best of your knowledge, has Goldman Sachs or any other brokerage used HFT to illegally manipulate the markets?', and you answer like I know you will, sweetie, and we`ll do lunch sometime next month, `kay?"

LB pretends to consider the question for a moment, then replies robotically, "To the best of my knowledge, neither Goldman Sachs nor any other brokerage has used HFT to illegally manipulate the markets ... though I can`t be certain about the other brokerages, since I don`t have access to their trading software." (And mentally appends a "...yet" to his reply).

Seriously, in their latest earnings report, GS reported an average value-at-risk (VAR) of $275 million, and an average profit on that VAR of $100 million per trading DAY from their proprietary trading operations. You do the math.

The article continues with a nice example of HFT in action ... tell me if this doesn`t amount to a form of market-rigging:

The rise of high-frequency trading helps explain why activity on the nation’s stock exchanges has exploded. Average daily volume has soared by 164 percent since 2005, according to data from NYSE. Although precise figures are elusive, stock exchanges say that a handful of high-frequency traders now account for a more than half of all trades. To understand this high-speed world, consider what happened when slow-moving traders went up against high-frequency robots earlier this month, and ended up handing spoils to lightning-fast computers.

It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: the hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors’ upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.

Multiply such trades across thousands of stocks a day, and the profits are substantial. High-frequency traders generated about $21 billion in profits last year, the Tabb Group, a research firm, estimates.

My Comment: And the beauty of the whole scam is that it`s entirely risk-free ... pay the exchanges what amounts to an insider-trading-permit fee which allows you to "packet sniff" orders in the queue, then use that to in effect skim a small percentage of every retail order. Doing this all day, every day, is what allows the prop trading desks at companies like GS to make such outsized returns on such a (relatively) low VAR ... the "Risk" part of "VAR" is in fact a joke for them, since the only risk they suffer is that their computer systems might crash, costing them their daily skim.

To use (entirely apt, IMO) casino analogy: HFT is as if a Vegas casino allowed wealthy gamblers to get a peek at all the cards being dealt to the other players at a blackjack table in exchange for a fee. Wall Street has always been a casino, and now here is crystal-clear proof that the casino is actively being rigged to benefit the large investment banks, who can afford both the HFT fee (where I come from we call that a "bribe") and the computer equipment and exchange-adjoining real estate in which to house it so as to minimize latency. And they say Bernie Madoff was crooked...


Friday Funny

ZeroHedge has a hilarious spoof of the CNBC.com website front page. They also have a slightly less-funny Open Letter To the Financial Media.

[cheesehead]

Originally Posted by ewmayer

Stock Traders Find Speed Pays, in Milliseconds

That's what happens when homo sapiens investorensis competes with a cyborg.

[ewmayer]

Originally Posted by cheesehead

That's what happens when homo sapiens investorensis competes with a cyborg.

No - I would have less of a problem if there were any kind of chance for actual "competition" (except in the sense of "one insider's algos compete versus another's to see who can screw the retail investor first") occurring. Paying the exchange for the privilege of front-running eliminates any pretense of fair competition, even of the human-intelligence-versus-machine-power kind. Imagine playing a high-powered computer chess program, but in a game where the program gets to replace one or more of its pawns with a queen at start of the game. No chance of any real competition there.

"That's what happens when the exchanges collude with the big investment banks to rig the markets in the IB's favor" is more apt.

[cheesehead]

That's like what happens when homo sapiens investorensis competes with a cyborg.