Mish's Global Economic Trend Analysis

Cisco Misses Estimates, Warns of Dwindling Public Spending; CEO Chambers Not Worth a Cent; Lather, Rinse, Repeat
Ireland's Finance Minister Seeks "Substantial Discount" on Senior Bank Debt
Ron Paul slams Fed’s bond-buying program; Political Pressure on Fed Mounts
Republicans Attack Dual Mandate; Bernanke Defends QE Yet Again, Says Unemployment will "Remain Elevated", Chastises Congress on Fiscal Policy
Money Heaven

Cisco Misses Estimates, Warns of Dwindling Public Spending; CEO Chambers Not Worth a Cent; Lather, Rinse, Repeat

Posted: 09 Feb 2011 06:17 PM PST

I do not often comment on individual stocks, especially technology stocks. However, I want to point out a couple of things that I have been saying for quite some time that came up in Cisco's second-quarter results announced this evening.

Margin compression will start affecting corporate earnings.
Cutbacks at state and local governments will have a bigger impact than most think.

Cisco managed to tie those two themes together. CEO John Chambers blamed the public sector for a miss on profits and competition for a miss on margins. Please consider Cisco spooks Street again with weak outlook, margins

Network equipment maker Cisco Systems Inc's CEO John Chambers spooked investors for the third time in as many quarters, warning of dwindling public spending and weaker margins from tough competition.

Chambers upset investors last August with a warning of "unusual uncertainty," and followed up last quarter with a weaker-than-expected outlook that he blamed on weak orders from debt-burdened government agencies.

He offered no relief this quarter.

"Unfortunately, we believe that our concerns in the public sector will continue to be challenging in the developed world for the next several quarters," he said, adding that Cisco's government accounts in the United States, Europe and Japan had all been hit in the fiscal second quarter.

"The challenges at state, local, and eventually federal level in our opinion will worsen over the next several quarters," he said of the U.S. market.

Cisco's second-quarter gross margin fell to 62.4 percent from 64.3 percent in the previous quarter, raising analysts' concerns that growing competition may be forcing the company to cut prices to protect market share.

The company forecast margins to be around 62 to 63 percent for the rest of the fiscal year, which ends in July.

Cisco also let down investors with a third-quarter outlook of earnings excluding items of 35 cents to 38 cents per share, below Wall Street expectations for 40 cents. And it said sales growth for the full year would likely be at the mid- to low-end of a previous 9 to 12 percent outlook.

Analysts said the outlook and low margins, a signal it may be cutting prices in response to tough pressure from competitors like Hewlett-Packard Co, overshadowed stronger-than-expected results for the second quarter.

"I think that's a way to cover up that they are facing competition in their more mature business lines and that they are most likely going to use price as a weapon to hold market share, and this is going to pressure earnings and margins," said Channing Smith, managing director and co-manager of Capital Advisors.

Cisco and HP used to be resale partners, but turned rivals after Cisco in 2009 unveiled plans to enter HP's territory of data center servers. HP in turn challenged Cisco by buying network equipment maker 3Com for around $3 billion.

Both sides have lately been raising the stakes with discounts, zero-interest leasing and pay-later schemes.

"We believe long-term investors should ride out the storm. If your time-frame is longer than the next six months, we believe Cisco's growth opportunities rival that of Apple and Google," said Smith.

Growth at What Price?

Channing Smith's idea that Cisco's growth rivals Apple or Google seems rather preposterous. Regardless, the important question is "How much you want to pay for the growth at Apple or Google, vs. Cisco?"

I suppose one can make a case many ways on that, but it is important to phrase the issue properly.

John Chambers 2010 Stock Sales

Inquiring minds just may be interested in Cisco Insider Sales. Here are the transactions for John Chambers alone.

Sep 16, 2010 285,000 Acquisition (Non Open Market) at $0 per share.
Aug 18, 2010 243,178 Automatic Sale at $22.50 per share - $5,471,505
May 18, 2010 22,273 Automatic Sale at $25 per share $556,825
May 17, 2010 1,000,000 Option Exercise at $16.01 per share.
May 17, 2010 1,250,000 Automatic Sale at $24.61 per share - $30,762,500
Mar 05, 2010 1,800,000 Option Exercise at $16.01 - $20.53 per share.
Mar 05, 2010 1,800,000 Automatic Sale at $25 per share - $45,000,000
Feb 08, 2010 2,000,000 Option Exercise at $18.57 per share.
Feb 08, 2010 2,000,000 Automatic Sale at $23.73 per share - $52,206,000

Lather, Rinse, Repeat

Cisco Monthly Chart

Chambers has not done a damn thing for shareholders for 10 years, cashing out hundreds of millions of dollars along the way. From the perspective of a shareholder of a publicly traded company, Chambers is not worth a damn cent.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Ireland's Finance Minister Seeks "Substantial Discount" on Senior Bank Debt

Posted: 09 Feb 2011 01:07 PM PST

In a series of wishy-washy statements Ireland's Lenihan Wants Senior Bank Debt Discounts

Irish Finance Minister Brian Lenihan said the government is pressing for a "substantial discount" on 20 billion euros ($27.2 billion) of unsecured senior bank bonds, a push resisted by the European Central Bank.

"We put the 20 billion euros on the table in the EU-IMF negotiations, and the ECB ruled it out," Lenihan said in a debate on RTE television late last night. "But it's still there in debate, it's still there in discussions. We're pressing for substantial discounts and burden sharing."

ECB President Jean-Claude Trichet said yesterday that Ireland needs to press ahead with its fiscal austerity measures and imposing "haircuts" on investors isn't part of the plan. Lenihan told reporters today he "couldn't see the European Central Bank contemplating" discounts on senior bondholders.

"But again in the context of the winding up of an institution or the gradual winding down of an institution these options can be put on the table," Lenihan said at a press conference in Dublin. "It is an issue and we have an ongoing dialogue with the bank and with the European authorities."

The government raised the issue of discounts on some senior debt with the European Union during negotiations for its 85 billion-euro rescue package in November only to be rebuffed by the ECB, according to Lenihan. Ireland has already injected about 46 billion euros into its banks.

Arrogance of Trichet

Note the arrogance of ECB president Jean-Claude Trichet - "Haircuts on investors isn't part of the plan."

The idea that bondholders should have no risk is preposterous. If investment had no risk it would be called "winning" not investing, and everyone would be plowing into Greek bonds right now at huge guaranteed rates.

Well I do not believe those guarantees, and more importantly, neither does the market. If the market thought there will not be haircuts, then there would be no difference in yields on Greek bonds vs. German bonds.

Going About This The Wrong Way

Lenihan is going about this the wrong way. Ireland should not be asking for "substantial discounts" or haircuts. Rather, Ireland should be telling the ECB and Jean-Claude Trichet that haircuts are coming. The correct starting point for negotiation is default, a 100% haircut.

Instead, Lenihan made wishy-washy statements, begging for a "substantial discount" while also stating "he couldn't see the European Central Bank contemplating discounts on senior bondholders."

What kind of nonsense is that?

Fortunately, Lenihan will be out on his ass after the next election. For the sake of the Irish citizens, let's hope the next prime minister and finance minister are more willing to tell the ECB just where to stuff it.

This is not about what the ECB wants, but rather how much Ireland is willing to make its citizens debt slaves to the senior bondholders, in other words, the UK, German, French, and US Banks.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Ron Paul slams Fed’s bond-buying program; Political Pressure on Fed Mounts

Posted: 09 Feb 2011 11:49 AM PST

MarketWatch reports Paul slams Fed's bond-buying program

Outspoken Federal Reserve critic Rep. Ron Paul, R-Texas, slammed the central bank's latest $600 billion bond-buying program on Wednesday, saying it and near-zero interest rates haven't led to job creation in the United States.

"Over $4 trillion in bailout facilities and outright debt monetization, combined with interest rates near zero for over two years, have not and will not contribute to increased employment," Paul said at a hearing of a House Financial Services subcommittee he heads.

"Debt monetization" is a reference by Paul and other Fed critics to the Fed's latest bond-buying program — a characterization rejected by Fed Chairman Ben Bernanke.

In essence, Paul is charging that the central bank is enabling profligate spending by the government. The term "debt monetization" is a buzzword for how some poorer countries conducted policies in the post-World War II era.

Political Pressure on Fed Mounts

WSJ's Sudeep Reddy reports on concerns the Federal Reserve could be facing political pressure from Congress, as Rep. Ron Paul holds the first hearing of a new Fed oversight committee. Separately, Fed Chairman Bernanke updates Congress on the economy.

If the above YouTube does not play here is a link: Rep. Ron Paul Ignites Fed Worry

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Republicans Attack Dual Mandate; Bernanke Defends QE Yet Again, Says Unemployment will "Remain Elevated", Chastises Congress on Fiscal Policy

Posted: 09 Feb 2011 10:25 AM PST

Like a broken record, Bernanke keeps playing the same tune, this time to the House Budget Committee. Please consider Bernanke Says Unemployment to `Remain Elevated'

Federal Reserve Chairman Ben S. Bernanke said the unemployment rate is likely to remain high "for some time" even after the biggest two-month drop in the jobless rate since 1958.

Bernanke told the House Budget Committee today that while the declines in the jobless rate in December and January "do provide some grounds for optimism," he cautioned that "with output growth likely to be moderate for a while and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level."

Representative Paul Ryan, the Wisconsin Republican who chairs the budget panel, reiterated his criticism of the Fed's Treasury purchases, saying they risk asset-price bubbles and faster inflation. The increase in long-term bond yields this week "certainly adds to these concerns and fuels some of this speculation," he said.

Ryan has said he supports legislation proposed by fellow Republicans, Tennessee Senator Bob Corker and Indiana Representative Mike Pence, that would remove the Fed's employment mandate and have it focus solely on keeping prices stable.

Bernanke said "inflation is expected to persist below the levels that Fed policy makers have judged to be consistent" with their dual mandate from congress for stable prices and maximum employment.

The Fed's preferred gauge of inflation, the personal consumption expenditures index excluding food and energy, rose 0.7 percent in December from a year earlier, the lowest level in more than 50 years.

As in his appearance before the National Press Club, Bernanke said the low rate of core inflation provided a better guide to where overall inflation was headed. He noted that wages, which increased 1.7 percent on an average hourly basis last year, have acted as a constraint on inflation.

Full Text of Bernanke's Remarks

Fox News has the full text of Bernanke's Remarks to House Budget Committee for those who are interested. Here are a few snips.

The economic recovery that began in the middle of 2009 appears to have strengthened in the past few months, although the unemployment rate remains high. The initial phase of the recovery, which occurred in the second half of 2009 and in early 2010, was in large part attributable to the stabilization of the financial system, the effects of expansionary monetary and fiscal policies, and the strong boost to production from businesses rebuilding their depleted inventories.

More recently, however, we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold. Notably, real consumer spending rose at an annual rate of more than 4 percent in the fourth quarter. Although strong sales of motor vehicles accounted for a significant portion of this pickup, the recent gains in consumer spending appear reasonably broad based. Business investment in new equipment and software increased robustly throughout much of last year, as firms replaced aging equipment and as the demand for their products and services expanded. Construction remains weak, though, reflecting an overhang of vacant and foreclosed homes and continued poor fundamentals for most types of commercial real estate. Overall, improving household and business confidence, accommodative monetary policy, and more-supportive financial conditions, including an apparently increasing willingness of banks to lend, seem likely to result in a more rapid pace of economic recovery in 2011 than we saw last year.

While indicators of spending and production have been encouraging on balance, the job market has improved only slowly. Following the loss of about 8-3/4 million jobs from 2008 through 2009, private- sector employment expanded by a little more than 1 million in 2010. However, this gain was barely sufficient to accommodate the inflow of recent graduates and other new entrants to the labor force and, therefore, not enough to significantly erode the wide margin of slack that remains in our labor market. Notable declines in the unemployment rate in December and January, together with improvement in indicators of job openings and firms' hiring plans, do provide some grounds for optimism on the employment front. Even so, with output growth likely to be moderate for a while and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level. Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.

On the inflation front, we have recently seen increases in some highly visible prices, notably for gasoline. Indeed, prices of many industrial and agricultural commodities have risen lately, largely as a result of the very strong demand from fast-growing emerging market economies, coupled, in some cases, with constraints on supply. Nonetheless, overall inflation is still quite low and longer-term inflation expectations have remained stable.

To assess underlying trends in inflation, economists also follow several alternative measures of inflation; one such measure is so-called core inflation, which excludes the more volatile food and energy components and therefore can be a better predictor of where overall inflation is headed. Core inflation was only 0.7 percent in 2010, compared with around 2-1/2 percent in 2007, the year before the recession began. Wage growth has slowed as well, with average hourly earnings increasing only 1.7 percent last year. These downward trends in wage and price inflation are not surprising, given the substantial slack in the economy.

The Federal Reserve's purchases of longer-term securities do not affect very short-term interest rates, which remain close to zero, but instead put downward pressure directly on longer-term interest rates. By easing conditions in credit and financial markets, these actions encourage spending by households and businesses through essentially the same channels as conventional monetary policy, thereby strengthening the economic recovery. Indeed, a wide range of market indicators suggest that the Federal Reserve's securities purchases have been effective at easing financial conditions, lending credence to the view that these actions are providing significant support to job creation and economic growth.

My colleagues and I have said that we will review the asset purchase program regularly in light of incoming information and will adjust it as needed to promote maximum employment and stable prices. In particular, we remain unwaveringly committed to price stability, and we are confident that we have the tools to be able to smoothly and effectively exit from the current highly accommodative policy stance at the appropriate time. Our ability to pay interest on reserve balances held at the Federal Reserve Banks will allow us to put upward pressure on short-term market interest rates and thus to tighten monetary policy when needed, even if bank reserves remain high. Moreover, we have developed additional tools that will allow us to drain or immobilize bank reserves as needed to facilitate the smooth withdrawal of policy accommodation when conditions warrant. If necessary, we could also tighten policy by redeeming or selling securities.

As I am appearing before the Budget Committee, it is worth emphasizing that the Fed's purchases of longer-term securities are not comparable to ordinary government spending. In executing these transactions, the Federal Reserve acquires financial assets, not goods and services; thus, these purchases do not add to the government's deficit or debt. Ultimately, at the appropriate time, the Federal Reserve will normalize its balance sheet by selling these assets back into the market or by allowing them to run off. In the interim, the interest that the Federal Reserve earns from its securities holdings adds to the Fed's remittances to the Treasury; in 2009 and 2010, those remittances totaled about $125 billion.

Bernanke on Fiscal Policy

The above snips addressed monetary policy. Bernanke also yapped about fiscal policy. Here is one small but noteworthy clip:

"The unsustainable trajectories of deficits and debt that the CBO outlines cannot actually happen, because creditors would never be willing to lend to a government with debt, relative to national income, that is rising without limit. One way or the other, fiscal adjustments sufficient to stabilize the federal budget must occur at some point."

Bernanke went on preaching to the House Budget Committee about various things including , debt-to-GDP ratios, but of course he does not want them to do anything now.

No one ever wants to do anything "now". Should by some miracle the recovery pick up steam they will not want to do anything "then" either, for fear of killing the recovery. Such is the nature of Keynesian and Monetarist clowns.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Money Heaven

Posted: 08 Feb 2011 11:58 PM PST

Via email, reader Denis wonders "Where did the Money go?"

Hello Mish

I read many times on your blog how bubbles created by the Fed led to the overpricing of assets such as real estate and stocks. Someone paid those overpriced valuations. So, where is the money? At some point will that money be used to mitigate the economic doom?

Denis

Illusion of Wealth

Let's take a look at a real estate example, then the stock market. Please consider home ownership rates.

In 2002 there were 71,278,000 owner occupied homes. In 2006 there were 75,380,000 owner occupied homes. The difference is 4,102,000 homes.

Thus, the overwhelming percent of the population did not buy a house in the biggest bubble years 2003-2006. Most had a house for many years and millions of others rented throughout.

Therefore it's safe to say that most homeowners rode home valuations up, then down, feeling rather wealthy in 2005-2006, and decidedly less wealthy now.

Anywhere, USA

Consider a typical subdivision of 200 houses, Anywhere USA where the homes are all relatively similar in size and value. Assume those homes were worth $250,000 in 2002 and $450,000 in 2006, with a few of sales at varying prices, but no sales since 2006.

Now let's assume one person has to sell now and all he can get is $220,000. Poof. Conceptually, the entire subdivision was just repriced on one sale.

Disregarding that sale, no money went anywhere (except of course via rising property taxes over the years to pay overly generous wages and pension benefits to police, fire department and other government workers).

On a percentage basis, few bought or sold during the years in question.

In general terms, the winners were those who sold at or near the top (and those benefiting from rising property taxes). The losers were those who bought near the top (along with taxpayers under the burden of rising property taxes).

Of course, many millions took out home equity lines and bought boats or made home improvements. However, those loans (except for loans in foreclosure or default) are still on the books of banks, most likely not marked-to-market.

Repricing Events

In the example above, 1 house out of 200 sold, yet that lone sale set the price for the entire neighborhood. Given that current buyers will not pay 2006 prices, repricing occurs whether any transactions take place or not.

Such repricing events happen all the time in the stock market as well.

For example, in premarket trading of as little as 100 shares, stocks can rise or fall 5% or more easily. Money does not go anywhere per se. Rather valuations change, just as happened in my housing example above.

To understand how valuations change over long periods of time, please consider Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think

Cycles of PE Compression and Expansion

Over long periods of time PE ratios tend to compress and expand. Unless "it's different this time", history says that we are in a secular downtrend in PEs. From 1983 until 2000, investors had the tailwinds PE expansion at their back. Since 2000, PEs fluctuated but the stock market never returned to valuations that typically mark a bear market bottom.

Of course, there are hedge fund managers who made $5 billion or more in the crash, but that pales in comparison to the valuation of the stock market which changed by $trillions on the way up and the same amount on the way down.

On an ongoing basis, broker-dealers and CEOs take their cut (and huge bonuses as well). Here is a case-in-point: Anthony Mozilo, CEO of Countrywide Financial, single-handedly cashed out over $1 billion in shares and options (but that was over the course of a decade).

Will Mozilo use his $billion to help mitigate the economic doom?

How far would it go, even if he did? $1 billion is extremely tiny compared to the total stock market valuation and housing bubble bust.

So Where Did the Money Go?

Clearly, Wall Street took a tiny percentage (and continues to do so). Those CEOs and broker-dealers take their cut whether the market goes up or down. They don't care what happens to anyone in the process.

A few big hedge funds betting the stock market would drop made out very well. However, the stock market would have plunged whether anyone bet against it or not.

At the housing and stock market peaks, presumed wealth was nothing but an illusion caused by the Fed's serial bubble blowing policies. It would have been impossible for everyone to cash out then, or cash out now.

Thus, most of the money went to "money heaven" which is to say nowhere at all. It was not really "money" in the first place, but rather unrealistic valuations (and in regards to real estate, a mountain of debt that cannot be paid back).

Valuations went up, then down, repriced over time (with Wall Street siphoning off a bit in both directions). This helps explain why the rich get richer and the middle-class continually shrinks.

Millions of lives, late to each bubble-blowing party, take on too much debt and are destroyed in the process. Bernanke's policies ensure it's going to happen again.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Wednesday, February 9, 2011

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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