Martin Armstrong Is Free

You know you’re facing desperate times when an old man, wrongfully imprisoned for over ten years becomes a financial prophet on the Internet using just an old Remington typewriter.  Ironically, the man was tried in court for a financial fraud that could not be proved, while the entire financial world crumbled from the multitude of frauds committed by bankers, lawyers, mortgage brokers, central bankers and government officials.

But that’s exactly happened during the financial crisis of 2008.  Martin Armstrong’s story couldn’t be written in a Hollywood script because it’s just too unbelievable.

As tragic as it has been, hopefully his story will turn out to have an acceptable ending as Mr. Armstrong was released from prison early and is now serving the remainder of his sentence under house arrest.

Here is his letter published yesterday by a friend:

 

And Martin has also published his first piece of March 2011:

Contrahour wishes Martin Armstrong all the best and sincerely hopes that his typewriter gets upgraded to a new MacBook Pro.

If you have missed any of Mr. Armstrongs writings, they can be found here (http://www.scribd.com/kzuur58) and here (http://armstrongeconomics.com/).

Bond Market Lessons From The Days Of Yore

Facts do not cease to exist because they are ignored.
—  Aldous Huxley

Before theglobe.com IPO, talking trader babies, moral hazards and internet bubbles…before 0% interest rates, option-ARMs, house flipping hair dressers and housing bubbles…before TARPs, 10% unemployment rates, QE 2.0s and commodity bubbles, the United States had a stock market would generally rise and fall with the normal ebbs and flows of the business cycle.

In these days of yore, bond yields directly competed with stock returns for the attention of investor affection.  In those days, the bond market was thought to be smarter and more attuned to the business cycle.  And since stock prices followed the business cycle, bonds could often fore-tell the future for stocks.  Old, grizzled stock pros who had survived the 1970s bear markets, would often look to the bond market for guidance on the future of stock prices.

These veterans knew that falling interest rates were bullish for stocks as they were in 1982, when after several false starts, one of the greatest bull markets in history kicked off.


Souce: Stockcharts.com

Likewise, these veterans understood that rising interest rates would have the opposite affect and generally spell trouble for stocks.  For instance, in October of 1993, the veteran stock investors got a well-telegraphed warning when bond yields suddenly began rising as interest rates anticipated a Fed tightening.  Stocks continued higher on their merrily way for  several months until they snapped to attention and promptly fell four months after bond yields had bottomed.

Source: Stockcharts.com

And again, just a year later, bonds again telegraphed highs and lows in the stock market.

Source: Stockcharts.com

The grizzled veterans also understood what would happen if the stock market ignored the message of the bond market too long. They had gone through the October 1987 crash, when stocks closed their eyes, covered their ears and started yelling LALALALAL!, launching themselves to the sky.

Source: Stockcharts.com

Most of these veterans are long gone now, having been ridden out of town by high flying internet stocks, gravity defying home builders or other phenomenon that they could no longer understand. But just because they aren’t around to warn young gun hedge fund managers or high frequency trading computers of the risks of rising interest rates, doesn’t mean bonds won’t have an affect on stocks.

As the veteran stock traders learned so well in 1987, the stock market can only ignore the bond market so long.   And stocks have ignored the bond market for five months now as investors plowed back into the risk trade.  But those rising rates will bite at some time.  And as the wiley veteran would say, it will probably happen sooner than anyone expects.

Source: Stockcharts.com

The lessons of the bond market have long been lost among the circus of high frequency trading, put-selling hedge funds, activist Fed chairmen and single stock ETFs but they have not been forgotten.  The bond market might yet show the stock market a thing or two about forecasting the the future.

Windows Was Counterfeited: Why Steve Ballmer Needs To Go

Lee Ainslie of Maverick Capital recently pitched Microsoft (MSFT) as a good investment at the Value Investing Congress.  Unless Whitney Tilson has changed the name of the conference to the Value Trap Congress, I can’t imagine why you would be enamored with the stock right now.

In Texas Hold’em, when you have a leading hand on the flop but don’t play your cards right you can often be “counterfeited.”  For instance, if you hold 9-10 and the board flops 5-9-10 you will be leading against even a pair of A-A.  However, if you don’t protect your hand and get your opponent to fold with a big bet, you might end up losing.  If a 5 falls on the turn, your winning hand will have turned into a losing one.  You will now be holding middle two pair vs top two pair.

Microsoft let its winning hand, Windows, become counterfeited because of its poor management.  The only two business lessons Bill Gates preaches are

1) always hire the best lawyers you can afford (a reference to the contract which gave Microsoft control of the operating system it wrote for IBM personal computers in the 1980s) and

2) always control the ‘choke’ point of a system.  The choke point in the computing world is the operating system.  Hardware is a commodity because it is worthless without an operating system to run it.

When Bill Gates ran Microsoft, the company owned the choke point of the computing world with Windows.  Gates was ruthless in defending his turf.  When Netscape threatened to own the internet access choke point with its browser, Microsoft dropped everything to destroy its upstart competitor.  When PDAs became all the rage in the late 1990s, Gates created an operating system for PDAs to combat Palm OS.  Palm never recovered after Microsoft entered the PDA market because Microsoft always had the best hand – the company owned the PC and the PDA had to integrate with the PC to be useful.  When Sony threatened to invade people’s living rooms with Playstation and control their entertainment flow, Microsoft backed the Xbox.

But now, under the leadership of Steve Ballmer, Microsoft has lost the choke point.  The choke point has moved from the PC to mobile devices.  Microsoft’s winning hand has been counterfeited by both Apple (AAPL) and Google (GOOG).

Apple has been a thorn in Microsoft’s side for the better part of the past decade but never a huge threat because most businesses and many consumers would never dump their PCs to buy slower, more expensive Apple computers, no matter how good the user interface.  Steve Jobs was selling Lexus compared to Microsoft’s Camry.  It was basically two different markets.

The iPhone, however, was a direct threat to Microsoft’s control of the ‘choke’ point.  The iPhone was revolutionary not because of it’s interface, which was brilliantly designed, but because Apple opened up the code to allow third party developers to create new applications outside of the traditional Windows platform. Microsoft should have seen the threat immediately because it was a direct copy of the threat Palm posed with its operating system.  Yet Microsoft’s response was slow and disorganized.  It didn’t introduce a phone until 2010 and the KIN was a weak response to Palm’s phone, not to the threat Apple was posing.

So weak, in fact, that it allowed the unimaginable to happen.  It allowed another dominant competitor into the market: Google (GOOG).  The Android operating system, which was introduced in late 2007, should never have gained as much traction as it has.  Android was open design developed by a consortium of companies  specifically aimed at combating both the iPhone and any future Microsoft entry.  However, Microsoft should have been able to use its clout, cash war-chest and expertise to muscle into the market, just as it had with its PDA operating system.

Both the iPhone OS 4.0 and the Android are now working themselves backward to the PC from the newly introduced tablet computers.  Both allow third party developers to create applications that basically mimic the dominant Windows Office environment. Not only that, but in many cases, the targeted applications are easier to use than Microsoft’s increasingly bloated software.

Microsoft is now running behind with the introduction of Windows Mobile 7.0.  To continue the poker analogy, while Ballmer was trying to beat Google’s hand in search with his pursuite of Yahoo, Google hit an set on the turn with Android.  Microsoft didn’t bet big enough and fast enough on Mobile and Google stole the pot from under its nose.

This is clearly management’s fault.  Allocating resources and putting in place the correct division managers are strategic decisions that need to come from the CEO.  While KIN management was clearly incompetent, Ballmer should have realized this much earlier than 2008, when work on Windows Mobile 7.0 began.

Unless the Board replaces Ballmer with more competent management, I believe Microsoft’s stock will always trade at a discount to its competitors.  On paper, Microsoft looks like a value investors dream.  The company trades at a steep discount to Google and Apple, even though Microsoft’s margins and growth stack up equally or better.

         Click image to enlargen
In addition, Microsoft’s earnings have been growing steadily over the past two years.  In the chart below, you can see that the forward estimates indicated by the dotted line have been rising even though the stock has been stuck in the mud.

           Source: Baseline

And the stock’s Price/Earnings ratio is basically at the lowest level ever.


Source: Baseline

Since the introduction of Windows 7.0 and the resultant earnings boost from it the stock has basically gone nowhere.  I believe the market realizes that Microsoft has lost its dominant hand.  It no longer owns the choke point since that point has moved from the PC to mobile devices.

If the introduction of the biggest software upgrade since Windows XP in 2001 can’t move the stock higher, what will? Will it be Windows Mobile 7.0, a hopelessly late, fourth-place entry into the wireless market?  Will it be the rise of Bing, which costs Microsoft about $1 billion in losses every year to operate?  Will it be the Xbox which saw no growth and represents only 12% of Microsoft’s revenues?  Will it be the corporate upgrade cycle in PCs, which is being cannibalized by the introduction of tablet computers?

My answer is none of these will make the stock move higher.  Microsoft has relegated itself to a dying utility through its slow and inept management.  They have lost their dominating starting hand of pocket aces to a couple of upstart players that were playing a much weaker cards.  I believe much like IBM, which lost the operating system to Microsoft in the 1990s, Microsoft’s stock will trade at a forward P/E of the mid to low teens for the foreseeable futures.  The stock is, in my opinion, a value trap.  There’s no doubt the stock is cheap at 11x earnings and could move back to the high $20s.  And an increase in the dividend could make it more attractive to yield hungry investors.  However, I don’t see a sustainable advance back to $30 or higher until the Board cuts its losses and replaces the CEO who played his cards so poorly.

Disclosure: Contrahour is long Microsoft (MSFT) but for the life of it can’t figure out why.

What Fundamental Factors Make A Stock Move

A lot of investors are confused because of the extreme volatility in the stock market.  However, the fundamental factors that actually make a stock move up or down over the long term haven’t changed despite the advent of high-frequency trading, the ‘great recession’ or government intervention.  They’ve just made stocks more volatile in the short term.  In the following presentation, I’m going to get back to basics and try to explain what fundamental factors actually make a stock move. You’ll need the Adobe Flash player to view the video.

 

 

 

Martin Armstrong Updated Market Outlook

I received a very nice note from Martin Armstrong which I wanted to share.  Now that every central bank in the world as managed to re-flate itself out of the economic collapse, Martin's work might fade into the background.  However, it shouldn't.  His work is all about cycles and we will find ourselves back were we came from soon enough.   

In his note, Martin writes that he believes a market top could arrive after Labor Day with a retest of support in 2010.  New highs could follow by 2015. 

Letter From Marty082309   

Martin also notes that he continues to wait for a response from the Supreme Court on his case.  However, it sounds like little progress is being made.  Please contact Martin with any thoughts or well wishes at armstrongeconomics@gmail.com

Cash For Clunkers: A Shining Example of How Government-Run Programs Work

Joan McCullough, the incomprable market analyst at East Shore Partners, has a great riff about the government managing health care.  If you were on the fence about this issue, McCullough will shove you over to her side with her description of how the "Cash For Clunkers" program is going:

Hey. Are you sure you really want the government runnin’ healthcare? You do? One trip to any US Post Office oughta’ relieve you of that sentiment. But if that didn’t “cure you” and you need further evidence of why the last place Uncle Sam oughta’ be pokin’ his nose is up a proctoscope, how about considering the Mongolian Bluster Duck they’ve made of the cash-for-clunkers program before coming to such an ill-fated decision?

Ahem. You probably won’t believe what’s goin’ on with this puppy. Nevertheless, here goes:

We’ll start with the bottomline. There is a fixed amount of do-re-mi to be doled out by the NHTSA (National Highway Transportation Safety Administration). It’s $1 bil LESS $50 mil for “administration”. That $50 mil, I guess, is to pay for the 30 employees being hired by the new agency the NHTSA has created, the Office of the Car Allowance Rebate System. And also for the 200 “contractors” to whom most of the work will be farmed out.

*contractors: There is something unclear here. The press all talks about “contractors” in the plural, all 200 of them. But the text issued by the NHTSA, cited below, talks of “the contractor”, singular. I can only find reference to one contractor so far. And it’s none other than Citigroup. Perhaps Citi’s division handling the request for  reimbursements is 200-workers strong. We’ll find out eventually, I guess.

Perhaps you will be as edified as I was to learn that this new agency with the clever acronym CARS is, like “All Gaul”, divided into three parts.

Like so (highlighting is mine):

The Transaction Oversight Division which will work closely with the outside contractor NHTSA has retained to review incoming request for payment from dealers to ensure that those requests are reviewed correctly and in a timely way.

The Data Analysis and Reporting Division will review data generated in connection with the program to help ensure the system's efficiency and detect problems with the process or indications of potential compliance issues.

The Compliance Division will work to detect and deter problems related to the program and coordinate closely with NHTSA's Office of Chief Counsel when possible violations are found. It will also work with the Transportation Department's Office of Inspector General on allegations of fraud. [Ref.: www.cars.gov/files/TheRule.pdf This is the 136-page handbook released Friday.]

Lemme stop right now and ask you a question. Do you have a headache just thinkin’ about this bureaucratic nightmare or what? I thought so. Take an Excedrin and keep readin’.

Compounding the Bluster Duck, the program ends on November 1. Or until the money runs out. Whichever comes first. Got that? Okay. For starters, customers were comin’ into the dealerships starting on July 1 which was the official kick-off date. But the government wasn’t ready to allow any dealers to “register” with the program until July 24 which is the date that CARS finally published its 136-page handbook. Thus, right off the bat, there is a bottle-neck and a lot of uncertainty. And guess what else? They changed some of the original parameters that Congress had cobbled together.

Isn’t that amazing? Dealers had been accepting trade-ins since July 1 and on July 24, they made alterations! If you really wanna’ go nuts, go here:

http://www.edmunds.com/help/about/press/153567/article.html

Car buffs are familiar with the above website, Edmunds. On Monday, they put out a press release, part of which reads like this:

… “As if Cash for Clunkers wasn't complicated enough, Edmunds. com has learned that the qualifications are a moving target. The EPA confirmed with Edmunds.com that last Friday the agency "refreshed" its combined mileage ratings for older vehicles and that the new data often gives potential trade-ins a higher mileage rating. Edmunds.com learned of these changes over the weekend from consumers who had checked that their trade's mileage rating qualified for the program up until Thursday. When shopping for a new vehicle for new vehicle over the weekend, they learned they no longer qualified.” …

Isn’t that a hot, steamin’ deal from the government? J, M and J. They didn’t notify anybody. They just changed some numbers on the website. I guess you hadda’ be there when they did it or you were left in the dust. Meanwhile on balance, the major glitch goes like this:

Joe SixPack goes into the dealership and they accept his trade-in and sell him an upgrade at the discounted amount. This puts the dealer on the hook to collect the $4500 back from the government. Sounds easy enough, right? Here’s the problem: at the time the dealer passes the discount to the consumer, he does not know how much if any clunker money is still left in the kitty or if his paperwork will be rejected (some times for ridiculous reasons) or accepted … or when he can expect to get his money back.

Some dealers are already complaining that the paperwork is next to impossible to complete. That sounds about right, eh? And that given the time and the myriad of BUREAUCRATIC STIPULATIONS, there are thousands of cars that could be sold but which cannot be, owing to the frustrations of the process itself. … “"I have over $300,000 outstanding," says Gordon Stewart, who owns Chevrolet and Toyota dealerships in Michigan, Florida, Alabama and Georgia. Stewart has sold close to 80 vehicles to customers under the program. Despite many efforts, his staff has been successful in applying for rebates on only three sales. “ … [Ref.: Autonews] That kinda’ says it all, eh? 80 request for reimbursement; 3 approvals.

The government spokesperson said that there was “not a huge backlog”. However, he had no idea how many reimbursement applications were waiting in line for approval. Typical government baloney. He did promise, though, that “eventually” on the website they have set up for the dealers to register and submit paperwork, they will have a “ticker” which will show how much money is left of the $1 bil. Lemme ask you something: If you don’t know what the request pipeline looks like or the time it takes for an average reimbursement to be approved, what the heck good does it do to signal how much money is left in the kitty?

Last, lemme lay this one on you; consider it the “icing on the cake”:

Also on an as/of basis, the government is now demanding as follows:

… “Dealers will have to remove the engine oil from the crankcase, replacing it with a 40 percent solution of sodium silicate (a substance used in similar concentrations in many common vehicle applications, including patching mufflers and radiators), and (run) the engine for a short period of time at low speeds (rendering) the engine inoperable," NHTSA said. "Generally, this will require just two quarts of the sodium silicate solution." … [Ref.: Detroit News]

Unfortunately, nobody so far has made any provision to pay the dealers for this work. Isn’t this hot stuff?

Are you sure you want this crew handlin’ your request for an MRI? I thought you’d come to your senses. Good show.

If you’re bearish: 1991 Nikkei Redux

The last great hope for the bears is that the US is actually just like Japan in the 1990s after that country's real estate bubble burst.  The chart of the current NDX and the Nikkie in 1991 look very similar.  After a strong 23% rally off the bottom, the Nikkie looked like it would run higher after piercing the 200-day moving average.  However, the breakout failed. 

NDX vs Nikkei 

That breakout in the Nikkei turned instead into a head and shoulders top.  The Nikkei subsequently retested the lows later that year. 

Nikkei 1991

GM Went Bankrupt Years Ago

Although the headlines today all proclaim today as the day that General Motors declared bankruptcy, the company has actually been bankrupt for years.  Much like a small private company, General Motors has been run for the benefit of the management and employees, not shareholders.  Shareholders have not been the actual owners of the company for over a decade, as management and employees have staked claims to the companies future cash flows through pension and medical claims. 

In 2005, I published a post about an "imminent" GM bankruptcy.  I republish the post, not to congratulate my clairvoyance but rather to point out two key lessons that investors can use to analyze any situation.  First, the markets are not "efficient".  As late as October 2007, you could have sold short the stock of General Motors at over $40.  Even in the past several weeks, when bankruptcy was all but certain after Chrysler's announcement, you could have bought puts on the stock (you couldn't have sold short because there was no more stock to borrow.)  This opportunity arose because the market is made up of many investors who are hopeful, uninformed, conflicted, unsophisticated, or just plain lazy.  Therefore, securities are often mispriced, not the other way around.  It takes time for information to be disseminated and understood by the market.  If you can get ahead of the mass of investors in your understanding of a company you already have a huge advantage.

Second, you didn't need any insider information to conclude that General Motors was bankrupt years ago.  All you had to do was do some homework and read the footnotes of the financial statements.  Understanding the company's pension and medical liabilities made it clear that equity holders had virtually no chance of seeing any of the company's cash flows return to them.  Reading footnotes and listening to conference calls is tedious work and even most professional investors don't do it.  However, that's how you can get an advantage over most participants in the market. 

So with that, I bid adui to some great American classics – the Chevy Malibu, Buick Lucerne, and Pontiac G5 - three stupid cars with all the style, panache and innovation of a washing machine.   You won't be missed. 

Chevy malibu  

Buick Lucerne

Pontiac G5 

From Contrahour, March 21, 2005

(Scene: At Play Now – in the bosses office)

Thomassoulo: George, I’ve realized we’ve signed a one-year contract with you, but at this point I think it’s best that we both go our separate ways.
George: I don’t understand.
Thomassoulo: We don’t like you. We want you to leave.
George: Clearer

(Scene: At Monks Café)
Jerry: So you’re staying at Play Now?
George: Why not? Pay is good. I got dental, private access to one of the great handicapped toilets in the city.
Jerry: But they not you aren’t handicapped, aren’t you ashamed?
George: They’re the ones who should be ashamed. They signed me to a one-year contract. As long as I show up for work every day, they have to pay me.

(Scene: At Play Now – in the bosses office)
Thomassoulo: You win George. We’ve had it. If you leave right now, Play Now will give you six months pay. That’s half of your entire contract. Please…just go.
George: You see if I stay th e whole year, I get it all.
Thomassoulo: Want to play hand ball huh? Fine. (calls on intercom) Attention Play Now employees, George Costanza’s handicapped bathroom is now open on the sixteenth floor to all employees and their families.
George: Well played.
Thomassoulo: I’ll see you in hell Costanza.

— Seinfeld Episode 158 "The Voice"

General Motors CEO, Richard Wagoner, probably never watched Seinfeld regularly but if he had, he might have been able to save his company.  His strategy of appeasing the union and waiting for employee attrition to reduce the company's payroll has backfired.  As it stands, I believe that employees will be able to outlast GM's precarious liquidity position.   The company is currently being run to fund current and former employee benefits, not for shareholders or creditors.  Therefore, I believe GM will have to file for bankruptcy to restructure the company's crushing pension and healthcare obligations. 

With the GM fiasco on the front pages, it's an opportune time to look at how I analyzed this situation.   At first glance, GM might seem to be a reasonable speculative bet.  The stock is trading at about 1x trailing EBITDA, 2x trailing cash flow, .09x sales, 4.5x trailing earnings and has a 7% yield.   

In other words, the company's horrible fundamentals are probably priced into the stock at these levels. Among the well know problems are the company's short-sighted strategy of providing 0% financing and additional incentives for new car buyers.  This pulled demand for the company's cars into the present, leaving future demand very low.  The company's line up of brands and cars also gives you an insight into the company's problems.  Aside from Cadillac and Hummer, none of the company's cars offer a distinctive marketing angle or economic benefit.  If you want reliability you buy Japanese, and if you to show off, you buy German, if you want cool, you certainly don't buy a Pontiac.  In fact, 4 of the company's 10 brands should probably be killed – Pontiac, Oldsmobile, Buick and Opel – because they are so tired and have no cache left.   

These problems could be resolved by aggressively managing the company's operations.  If the operational issues were all that plagued GM, I would probably be tempted to buy the stock rather than run for the hills. 

The real problem is the company's onerous expense and liquidity position which is the result of the financial obligations owed to current and former employees.  There are several aspects to this problem. 

First, the company is not capable of cutting expenses aggressively because of its union contract.  According to the Detroit Free Press, the big three U.S. auto makers and the largest auto-parts supplier are paying about 10,000 hourly workers in the U.S. and Canada full wages and benefits not to work, despite falling U.S. market shares, shuttered plants and production cutbacks.   These workers are essentially in a holding tank for hourly employees who are off work a long time, a system devised by the auto makers and the United Auto Workers union.

While most of the companies refused to say how much they are spending to pay these workers, a Free Press survey suggests it is likely well over $1 billion this year, given the number of workers and typical union wage-and-benefit packages. Auto supplier Delphi has told Wall Street that it will spend $300 million in 2005 to pay the salaries and benefits for about 2,300 union workers who currently don't have jobs, and it says that cost is "as high as it has ever been for us."  GM's 2004 10-K states that the average hourly wage for its employees is about $74/hour.  I'm guessing few employees are actually getting paid that but once you add in the healthcare expense and "excess" workers, it's probably close.

Second, closer examination of the footnotes to the company's pension and other obligations, reveals that the company cannot survive with its current expense structure.   The obligations due to current and former employees are a drain on the company's resources. 

This table from the company's 2004 10-K from Footnote 16 reveals many of the issues.  The colored items represent areas of interest:

Gmpension

Lets first analyze the pension plan, which is actually in reasonable shape. GM has historically had an underfunded pension plan but it is currently overfunded by $1.9 billion in the US. The plan is in good shape because the company funded it with a $10 billion contribution from the largest corporate debt offering ever in 2003. This essentially shifted the risk from employees (who might not get their pension), to creditors (who might not get full value of the bonds if GM goes into bankruptcy).

The foreign pension plan, which the company inherited when GM bought Saab, is in worse shape as it is underfunded by about $9 billion. This could cause a problem since GM will have to fund it from ongoing operations or existing cash on the balance sheet. And the company will probably be unable to raise capital at a reasonable price unless investors become more comfortable with the operations.

A minor side note is the company's assumption on the discount rate used to calculate its pension plan obligations. The company looks like it makes a slightly aggressive but still reasonable assumption that the pension plan will return 9% over the foreseeable future. That's down from 10% in the past year – which was clearly too aggressive. I think a more reasonable assumption would be 8%, and which would make the plan look underfunded again, but I can live with 9%.

The real problem for General Motors comes in the form of the Other Post Retirement Employee Benefits lines. These amounts refer to the retirement benefits provided by a company to its employees other than those from its pension plan – for the most part "healthcare expense". A look at the Other Post Retirement Employee Benefits from the table shows why this is the key issue for GM – the company's future obligations in this segment amount to $77 billion, while the company's plan to fund those obligations only contains $16 billion – leaving the company on the hook for about $61 billion in future healthcare expenses.

CSFB analyst David Zion, who has done an outstanding job analyzing retirement obligations, succinctly explains the problem with the Other Post Retirement Employee Benefits for existing and potential shareholders – "In many cases, in particular among large companies, the risk of rising benefit costs is absorbed directly by the company if the OPEB plan is self-insured. Investors need to take this risk into account when valuing a company with an OPEB plan, as they are not only investing in an operating company, but they may also be purchasing a healthcare insurance company, and, for those with pension plans, an asset manager, all rolled into one."

The Company paid out $3.8 billion in 2004 for expenses related to retiree healthcare. In addition, GM used $5 billion to fund the OPEB plan in the hopes that one day the plan will be fully funded and the company will no longer have to use cash from operations to pay for retiree expenses. I believe the $3.8 billion expense will probably rise at a faster rate as employees continue to retire and grow older. It seems unlikely that GM will be able to get the OPEB plan fully funded at any time in the near future.

The under-funded OPEB plan is essentially a cash flow problem. The $3.8 billion in expense and $5 billion in plan contribution is a high price to pay for a company that will only be breakeven on a "cash from operations" basis according to its own forecast.  This is cash flow that could be used to pay down debt or pay a dividend is essentially diverted to paying for retiree healthcare.

There are two ways out of this predicament for GM – 1) fund the obligations with outside capital, as it did in 2003 when it issued $10 billion in debt or 2) renegotiate the extent of its obligations.

Given the state of GM’s balance sheet, I don’t believe the company will be able to float additional debt at reasonable rates to fund its obligations. The company’s balance sheet has deteriorated significantly in the past 15 years as the company has relied more on finance operations to boost the auto division’s results:

That’s right! Debt has tripled while stockholder’s equity has actually gone down over the past 15 years. Again, this is not a company being run for stockhoders – its being run for current and former employees. In addition, GM has $56 billion of debt coming due between now and 2007. It seems unlikely to me that the debt market will allow the company to issue additional debt on top of the existing amounts it already has to roll over. Therefore, it seems that the company could issue equity at these prices but I view that as unlikely given that the stock would collapse even further. I believe the only other choice for GM is to try to renegotiate its obligations.

However, I believe the company will be unable to negotiate with much leverage given that GM is locked into its current union contract until 2007. Therefore, the only way I see for GM to remain a competitive force in the auto industry is to enter into bankruptcy.  From bankruptcy the union should feel pressure to come to a more reasonable compromise on healthcare obligations to help the company exit bankruptcy. Otherwise, neither the shareholders nor the employees will have anything – just like Play Now –

(Scene: At Monk’s Café)

Jerry: Gee, Play Now is filing for bankruptcy. I guess you’re not going in anymore.

George: Yeah.

Jerry: So they’re not paying you your…

George: No.

Jerry: So you’re pretty much…

George: Yeah.


At The Intersection of Wall Street and Washington

Just in case you are still confused by what is going on at the intersection of Washington and Wall Street, Matt Taibbi at Rollingstone.com has written one of the best explanations of the financial destruction the United States now faces.  He points out, as I believe, that the solutions the Fed and Treasury are now implementing are going to be far worse than the problems that would have occurred.  And he points the finger squarely at Congress, which was in Wall Street's back pocket, for allowing the financial services industry to deregulate in the late 1990s.  In its greed, Congress forgot the lessons of the 1930s, when all the original regulations were implemented.  Now, the same people that got us into this mess are trying to get us out, and, most likely, it will end badly.  

Matt Taibbi explains…   

It's over — we're officially, royally fucked. No empire can survive being rendered a permanent laughingstock, which is what happened as of a few weeks ago, when the buffoons who have been running things in this country finally went one step too far. It happened when Treasury Secretary Timothy Geithner was forced to admit that he was once again going to have to stuff billions of taxpayer dollars into a dying insurance giant called AIG, itself a profound symbol of our national decline — a corporation that got rich insuring the concrete and steel of American industry in the country's heyday, only to destroy itself chasing phantom fortunes at the Wall Street card tables, like a dissolute nobleman gambling away the family estate in the waning days of the British Empire.

The latest bailout came as AIG admitted to having just posted the largest quarterly loss in American corporate history — some $61.7 billion. In the final three months of last year, the company lost more than $27 million every hour. That's $465,000 a minute, a yearly income for a median American household every six seconds, roughly $7,750 a second. And all this happened at the end of eight straight years that America devoted to frantically chasing the shadow of a terrorist threat to no avail, eight years spent stopping every citizen at every airport to search every purse, bag, crotch and briefcase for juice boxes and explosive tubes of toothpaste. Yet in the end, our government had no mechanism for searching the balance sheets of companies that held life-or-death power over our society and was unable to spot holes in the national economy the size of Libya (whose entire GDP last year was smaller than AIG's 2008 losses).

So it's time to admit it: We're fools, protagonists in a kind of gruesome comedy about the marriage of greed and stupidity. And the worst part about it is that we're still in denial — we still think this is some kind of unfortunate accident, not something that was created by the group of psychopaths on Wall Street whom we allowed to gang-rape the American Dream. When Geithner announced the new $30 billion bailout, the party line was that poor AIG was just a victim of a lot of shitty luck — bad year for business, you know, what with the financial crisis and all. Edward Liddy, the company's CEO, actually compared it to catching a cold: "The marketplace is a pretty crummy place to be right now," he said. "When the world catches pneumonia, we get it too." In a pathetic attempt at name-dropping, he even whined that AIG was being "consumed by the same issues that are driving house prices down and 401K statements down and Warren Buffet's investment portfolio down."

Read the rest of the article here.

Current Market A Mirror Image Of 2002 Bottom

Over the last couple months, I've seen more historical market overlays than ever.  The current market has been compared to everything from the 1970s market to the 1930s, from the 1987 crash to the 1990s financial crisis.  But you don't have to go back very far to find an analogue to the current bottoming formation.  The current market looks a lot like the bottom formed between July and October of 2002. 

2002 vs 2009 Market Bottoms 

After the October bottom and surge, the market drifted higher for two months before rolling over to make a final bottom in March 2003.

SPX 2003 Bottom

The current market could certainly move higher into the Summer before rolling over again.  A plausible scenario is that the current rally turns into a trading range between 840 and 940 on the S&P 500, which was an area of consolidation prior to the most recent decline.  After a consolidation, the market could get spooked lower again by poor first quarter earnings which will begin to hit in late April and early May. 

Whether the next retest of the bottom holds at that point would depend on whether earnings estimates have bottomed and whether the financials begin to stabilize.   In March 2003, earnings estimates for many companies were already moving higher and fundamentals were already improving.  The only issue weighing on the market in March of 2003 was the upcoming Iraq war.   

This time, if earnings estimates begin rising after the first quarter is reported because investors have gotten too pessimistic, then I think we could see a similar bottom play out.  However, if another crisis hits or earnings estimates continue to fall then I think the bottoming scenario won't play out like in 2002-2003.  The next three months will be key in determining the longer term outlook.