The last week was one of extremes. On a positive note, five straight days of rising stock prices, driven primarily by optimism over President-elect Obama’s confidence-building announcements of his economic team led by Timothy Geithner, Larry Summers and Paul Volcker, coupled with strong signals of a moderate course on foreign policy issues through expected nominations of Hillary Clinton, Robert Gates and James Jones to key posts.
The wisdom of keeping Gates in place as Defense Secretary was underscored by the horror in Mumbai, which served as a worrisome reminder of the unpredictability and disruptive potential of terrorist attacks both to political and financial stability.
Back to the positive, the outgoing administration’s latest measures to resolve the credit crisis were generally well received, but the smorgasbord of government interventions is racking up a massive liability and looks increasingly ad hoc, piecemeal and reactive. Perhaps this is part of the reason Obama’s measured approach to everything is reassuring to the markets.
Visitors to Research Recap appear concerned that the crisis is far from over: our most popular posts this week focused on growing problems with credit card and not-quite-prime mortgage loans: Moody’s US Credit Card Performance Indicators Continue to Weaken highlighted the increase in delinquencies and chargeoffs in credit-card debt, while CreditSights warned that the “Dramatic Rise” in Alt-A Loan Delinquencies May Continue. The International Monetary Fund’s paper confirming the all-too-apparent interconnectedness of the financial world also was popular. The paper found that a Major Bank Failure Could Spur Losses of Over $1,500 Billion.
More gloomy news was featured in Moody’s Expects 20-30% Decline in Commercial Real Estate and Capgemini’s Oil Price Decline Bad News for Future Supplies. A glimmer of home came from a popular MIT paper Cap-and-Trade Can Cut Emissions Without Major Economic Hit.
Research Recap Quote of the Week:
Everything Obama is doing with his appointments is signaling continuity in U.S. policy.- Stratfor
President-elect Obama soon may be forced to address agricultural policy issues, even though the topic was not high on his campaign agenda.
Agricultural policy is one of the least likely candidates for the ‘change agenda’ that President-elect Barack Obama has promised to implement, says Oxford Analytica. “The 2008 Farm Bill extends well beyond Obama’s first term, and he supported that legislation.”
The president-elect also backs ethanol from corn (and other domestic feedstocks) and is likely to nominate a secretary of agriculture who is sympathetic to Mid-western agricultural interests.
Therefore, a major shift in US agricultural policy appears unlikely — although there are gathering pressures that may force Obama to consider change, even though it is not on his agenda.
Obama signaled his interest in attacking some of the excesses of farm subsidies at a press conference Wednesday, reports ABC News:
“There’s a report today that from 2003 to 2006, millionaire farmers received $49 million in crop subsidies even though they were earning more than the $2.5 million cutoff for such subsidies. If this is true, it is a prime example of the kind of waste I intend to end as president.”
OxAn notes that The 2008 Farm Bill was passed before the full impact of the financial crisis was apparent:
- Booming commodity prices promised record farm incomes and low anticipated programme expenditures.
- The Doha Round of global trade talks was collapsing, and in any case it would have had little impact if prices remained high.
- Sustained growth in emerging markets, particularly in Asia, gave farmers favourable export prospects regardless of the trade policies followed by those countries.
All these ‘assumptions’ on which the Farm Bill was premised are now in question. Moreover, the strain on federal budgets caused by the rescue packages for financial institutions could well lead to pressure for agricultural spending and subsidies to be reduced.
One specific issue that may appeal to the incoming president is the pressing need to reinvigorate African agriculture. However, it is difficult to see how Washington could avoid making changes to its domestic cotton policy — even without a completed Doha Round — if it is to be credible as a driver of agricultural reform in Africa.
A prolonged global recession could add to the challenges faced by US farmers, thereby increasing the pressure to reform the Farm Bill. If Chinese GDP growth slows to a rate of 5-6%, US farm exports to this market could slump sharply. Coupled with a stronger dollar, this could have a major impact on US farm sector profits.
Agricultural exports could come down from their recent record high points and add to the weaker domestic market for farm products.
Even if none of these factors emerge to threaten the stability of the Farm Bill, there will still be domestic pressures to improve the oversight of food safety, to incorporate farming more fully into environmental stewardship strategies, and to strike the right balance between production of biofuels and food and feed use for the major crops. Climate change legislation will face the dilemma as to whether agriculture is to be treated the same way as other sectors when it comes to capping and trading emission permits.
Cross-listing of shares on different exchanges no longer makes sense, according to McKinsey.
Conventional wisdom has long held that companies cross-listing their shares on exchanges in London, Tokyo, and the United States buy access to more investors, greater liquidity, a higher share price, and a lower cost of capital. In the 1980s and 1990s, hundreds of companies from around the world duly cross-listed their shares, McKinsey says. “Yet this strategy no longer appears to make sense—perhaps because capital markets have become more liquid and integrated and investors more global, or perhaps because the benefits of cross-listing were overstated from the start”
From May 2007 to May 2008, 35 large European companies, including household names such as Ahold, Air France, Bayer, British Airways, Danone, and Fiat, terminated their cross-listings on stock exchanges in New York as the requirements for deregistering from US markets became less stringent. These moves represent the acceleration of an existing trend: over the past five years, the number of cross-listings by companies based in the developed world has been steadily declining in key capital markets both in New York and London. On the Tokyo Stock Exchange, too, some well-known companies, such as Boeing and BP, have recently withdrawn their listings.
Whatever benefits companies might once have derived from cross-listing, our analysis shows that in general it brings few gains but significant costs, at least for most companies in the developed markets of Australia, Europe, and Japan.
Maintaining an additional listing generates extra service costs—for example, fees for the stock exchanges—and additional reporting requirements, such as 20-F statements for ADRs. Although these service costs tend to be minor compared with the cost of compliance (particularly with US regulations such as Sarbanes–Oxley), they have grown enormously over the last few years.
“As for the creation of value, we haven’t found that cross-listings promote it in any material way. Our analysis of stock market reactions to 229 delistings since 2002 on UK and US stock exchanges found no negative share price response from the announcement of a voluntary delisting. Our comparative analysis of the 2006 valuation levels of some 200 cross-listed companies, on the one hand, and more than 1,500 comparable companies without foreign listings, on the other, confirmed that the key drivers of valuation are growth and return on invested capital (ROIC), together with sector and region. A cross-listing has no impact.”
comScore is forecasting flat US online shopping during the holiday season, which would require a pickup from the 4-percent decline to $8.2 billion estimated for the first three weeks of November.
With consumer confidence low and disposable income tight, the first weeks of November have been very disappointing, with online retail spending declining versus year ago. It’s also likely that some budget-conscious consumers are planning to wait to buy until later in the season to take advantage of retailers’ even more aggressive discounting.
comScore’s forecast is that holiday online retail spending for the November – December period will be flat versus year ago at $29.2 billion, significantly lower than last year’s growth rate of 19 percent and below the retail e-commerce growth rate of 9 percent that has been observed for 2008 year-to-date.
Alongside its reporting of behaviorally monitored e-commerce spending, comScore is also conducting weekly surveys of approximately 500 consumers to determine attitudes and sentiment in regard to the holiday shopping season.
In the most recent survey, conducted between Friday, November 21 and Monday, November 24, 33 percent of consumers said they had not even begun their holiday shopping yet. They also indicated they intended to cut back on holiday spending in several ways, most notably by buying fewer gifts (47 percent of respondents) and buying less expensive gifts (46 percent of respondents). Respondents also said they planned to employ the Internet to help cut costs, by taking advantage of free shipping and/or no sales tax (39 percent).
A recent survey by Deloitte indicated that more consumers plan to spend at least part of their holiday budgets on the Internet. Online retailing will continue to grow this holiday season, with a record 71 percent of consumers planning to do some online shopping, according to Deloitte’s 23rd Annual Holiday Survey of retail spending and trends. This figure is up 5 percentage points from 2004.
More than one in five consumers (21 percent) surveyed plan to shop primarily or entirely online this holiday season (up from 19 percent last year), and almost one-quarter (24 percent) of total dollars are expected to be spent on the Internet, compared with 22 percent last year and only 19 percent in 2004.
The series of events that have led to the shutting down of the credit markets and eroded confidence in the global financial system will lead to the most profound changes in the banking system since the Great Depression, according to Standard & Poor’s Ratings Services.
In a new report How The Credit-Market Crisis Is Changing The World Of Banking, S&P says the outlook for the global economy is worsening, and the changes resulting from these recent events are leading to a reassessment of the creditworthiness of financial institutions. “Despite the unprecedented government actions to bring order to the banking sector and to help stabilize capital markets, in Standard & Poor’s view, there will still be an impact on the real economy from the contraction in financing and asset price declines, which will likely cause more delinquencies and defaults on loans.”
As a result, an increased call for regulation and a wave of bank consolidations, as seriously weakened institutions are acquired by stronger ones, along with this newfound coordination of global regulatory and central banking initiatives, appear likely to significantly alter the nature of the financial services industry.
S&P believes several factors will combine to change the face of the banking industry:
- Increased regulation;
- Consolidation of weaker entities;
- Fundamental reconsideration of the “originate to distribute” model;
- Adaptation to higher volatility; and
- Higher losses for this economic cycle.
“It appears the level of losses for banks will be much greater,” said Standard & Poor’s credit analyst Tanya Azarchs. “Although governments have demonstrated a willingness to provide extraordinary support to a degree we have not previously seen, we now believe credit markets may be prone to bouts of illiquidity in the future. We are therefore reassessing the vulnerability of the wholesale-funded banking model and will conduct a global review of major mature market-financial institutions, which will consider all factors, including government support and deteriorating financial performance.”
Multiple drug patents begin expiring in 2010 and pharmaceutical companies may be tempted to maintain growth through acquisitions, both of which are likely to negatively impact balance sheets, according to Moody’s Investors Service.
Profits and cash flow have remained strong, but cash flow will come under pressure in the next 18 months as exclusive rights to top-selling drugs expire starting in 2010 and running through 2012. At the same time, Food and Drug Administration approval of new drugs has slowed to about 20 approvals per year, Moody’s said.
Patent expirations are not a new phenomenon. However, credit profiles weakened during such periods in the past. .. As the industry’s approaching revenue shortfall looks even more challenging to replenish, we expect that some U.S. pharmaceutical companies will pursue growth through more-aggressive M&A strategies.
Between 2003 and 2006, Moody’s noted, patent expirations led to lowered ratings for a number of large drug companies, including Schering-Plough Corp. (NYSE:SGP), Merck and Co. (NYSE:MRK), Bristol-Myers Squibb Co. (NYSE:BMY) and Pfizer, Inc. (NYSE:PFE).
For details, see “U.S. Pharmaceutical Industry Six-Month Update.”
So much for the slowing rate of decline in US home sales prices over the past few months: the pace of decline in the S&P/Case-Shiller Home Price Indices accelerated in September. The 10-City and 20- City Composites continued to set new records, with annual declines of 18.6% and 17.4%, respectively.
Looking at the returns of the U.S. National Index, prices are back to where they were in early 2004.
As of September 2008, the 10-City Composite is down 23.4% from its peak, the 20-City Composite is down 21.8% and the National Composite is down 21.0%.
Phoenix was the weakest market, reporting an annual decline of 31.9%, followed by Las Vegas, down 31.3%, and San Francisco at -29.5%. Miami, Los Angeles, and San Diego did not fare much better with annual declines of 28.4%, 27.6% and 26.3%, respectively.
Dallas and Charlotte fared the best in September in terms of relative year-over-year returns. While also in negative territory, their declines remained in single digits of -2.7% and -3.5%, respectively. However, both are at rates of decline lower than those reported in August’s numbers. In addition, Charlotte also reported its largest monthly decline on record, down 1.3%. Monthly returns were negative across the board. Cleveland was the one market that showed any improvement in its year-over-year returns reporting -6.4% compared to the -6.6% reported for August.
Early signs from President-elect Barack Obama’s cabinet nominations are that he will be conducting foreign policy from the center, says Stratfor’s George Friedman.
Freidman notes that Obama’s anticipated nominee for Secretary of State, Hilary Clinton, voted to authorize the Iraq war — a major bone of contention between Obama and her during the primaries. She is also a committed free trade advocate, as was her husband, and strongly supports continuity in U.S. policy toward Israel and Iran. Treasury Secretary nominee Timothy Geithner comes from the Federal Reserve Bank of New York, where he participated in crafting the strategies currently being implemented by U.S. Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson.
Everything Obama is doing with his appointments is signaling continuity in U.S. policy.
Obama supporters believed that Obama’s position on Iraq was profoundly at odds with the Bush administration’s. We could never clearly locate the difference. The brilliance of Obama’s presidential campaign was that he convinced his hard-core supporters that he intended to make a radical shift in policies across the board, without ever specifying what policies he was planning to shift, and never locking out the possibility of a flexible interpretation of his commitments. His supporters heard what they wanted to hear while a careful reading of the language, written and spoken, gave Obama extensive room for maneuver.
To those who celebrate Obama as a conciliator, these appointments will resonate. For those supporters who saw him as a fellow ideologue, he can point to position papers far more moderate and nuanced than what those supporters believed they were hearing (and were meant to hear).
His appointments match the evolving realities. On the financial bailout, Obama has not at all challenged the general strategy of Paulson and Bernanke, and therefore of the Bush administration. Obama’s position on Iraq has fairly well merged with the pending Status of Forces Agreement in Iraq.
One point we have made repeatedly is that a presidential candidate’s positions during a campaign matter relatively little, because there is only a minimal connection between the issues a president thinks he will face in office and the ones that he actually has to deal with.
As for policies, they come and go. As George W. Bush demonstrated, an inflexible president is a failed president. He can call it principle, but if his principles result in failure, he will be judged by his failure and not by his principles. Obama has clearly learned this lesson.
As consumers rejoice over sub-$2-a gallon gasoline, Capgemini points out that the decline in oil prices is very bad news for future oil supplies. In its annual European Energy Markets Observatory, Capgemini ticks of a litany of worrying developments:
- Long term investments in exploration projects require stability in oil prices. Price volatility increases investment risks.
- A big drop in oil price will render expensive projects no longer financially viable. $90 per barrel is about the threshold below which production from the extra heavy oil sand in Canada would not give a satisfactory Return on Investment. At the same time, this heavy oil is needed for the future, and investment needs to start now.
- Even if economies of Western countries slow down or even go into recession, pushing down their oil consumption, it will not be enough to offset the steady consumption growth in the developing world.
- Technical difficulties to replace current oil production with new discoveries will remain.
- Unfortunately, there is little hope that geopolitical tensions between some oil and gas producing countries, notably Russia and Iran, and the western import countries, will ease soon.
In order to comply with the forecasted energy demand growth and replace aging infrastructure, huge investments are needed Capgemini notes:
At 2% global economic growth rate, the world would need about $22 trillion cumulative investments in energy (oil, gas and electricity) infrastructure between 2006 and 20304, half of them in developing countries.
“In the previous EEMO editions, we estimated that €1 trillion investment is needed in electricity and gas infrastructures in Europe. Our report cautioned that without a vigorous construction program, security of energy supply would be threatened. Since then, raw material cost growth and difficulties in finding qualified human resources have pushed investment amounts up and delayed commissioning dates of some much needed plants, electrical grids and pipelines.”
Fortune’s Allan Sloan gets out of the coop early with his list of turkeys for Thanksgiving. There’s no shortage of candidates. Top of his list: letting Lehman Brothers fail.
Letting Lehman Brothers go into bankruptcy in September is the turkey of the year, if not the decade, for the Federal Reserve and the Treasury Department.
Other prime turkeys:
Yahoo spurns Microsoft: Yahoo CEO Jerry Yang gets thecredit for this one, with an honorable mention to Carl Icahn, who bought into Yahoo on the assumption that he could get a deal done with Microsoft. “By our estimate, he’s down more than $1 billion on his $1.8 billion Yahoo investment.”
SuperSIV: Last fall Treasury Secretary Hank Paulson announced a superfund in which banks would combine to buy securities from “structured investment vehicles” they had left off their balance sheets. “Amid a lack of interest, the superfund was canceled. Next came the $700 billion Troubled Asset Relief Program, which has now decided not to buy troubled assets. Hello?”
Zell buys Tribune. “This $13 billion deal, which gave Sam Zell control of the nation’s second-biggest newspaper firm last year, has resulted in cuts this year that are disastrous for anyone who cares about having an informed public.”
Raiding the Times. “Philip Falcone’s Harbinger hedge fund gobbled up enough New York Times Co. stock to scare the company into giving him two seats on its board. Alas for his investors, he’s down about 60 percent on a $512 million investment”
“There are plenty of other candidates: Merrill Lynch (yesterday’s price: $11.53) spending $5.27 billion in 2007 buying its own stock at an average of $84.88 per share. Or a group led by the normally sure-footed TPG buyout house (formerly Texas Pacific Group) putting $7 billion into Washington Mutual five months before regulators seized it and wiped out shareholders. Then there are Fannie Mae and Freddie Mac and American International Group.”
We’re going to need a bigger coop.