June 2005 Archives

An article in the Wall Street Journal Acquittal Casts Cloud Over Sarbanes-Oxley Law (subscription required) discusses acquittal Richard M. Scrushy, the former CEO of HealthSouth, under the new Sarbox law.

The certification provisions of Sarbanes-Oxley were intended to prevent the type of defense that Mr. Scrushy's attorneys mounted, in which they said he had no knowledge of the accounting improprieties that occurred while he ran the company. Congress, responding to a wave of financial fraud at companies such as Enron Corp. and WorldCom Inc., included the provision in the 2002 corporate-overhaul law to make it easier for authorities to hold executives responsible for fraud that happened on their watch.

While I am certainly supportive of the aims of Sarbox, I am cautious about its use for smaller companies because the enormous associated costs. And if Sarbox proves to be a paper tiger, then I am even more cautious about its use for companies of all sizes.

Update: Thursday, 29 June 2005.

A bad day for the prosecution in The Economist is an excellent article on this topic.

In Sunday's NY Times Daniel Gross writes an interesting article How Home Prices Can Be Hot but Inflation Cool (free registration required) discussing housing prices and inflation.

In other words, a home isn't just where you hang your hat or an investment in the future (or, in the case of visitors to CondoFlip.com, for two days). It's something that is consumed, the way potato chips, gasoline or a barber's skills are. So the bureau decided to track a measure that represents only the consumption of housing: rent. And rents had much to recommend themselves as a long-term inflationary yardstick - they don't jump significantly from month to month - and as a proxy for home prices. Over time, after all, rents correlated very closely to home prices.

As the article points out, rents have decoupled from housing prices. And as the article further points out, more and more people own homes, thus making "rent" less significant. As rates decreased, housing prices increased, which in turn encouraged a strong housing building boom. The building boom drove rents down as people left their rental accommodation to gain home ownership. As rents went down, inflation was reduced because of the reliance upon the rental input. But in reality, inflation was rampaging along as housing prices and commodities (cement, lumber, copper, and others) went ever higher. Oddly enough, the more extreme this cycle became, the more tame inflation appeared.

What would happen if Greenspan were to suddenly raise interest rates much beyond people's expectations? The overall economy would slow because of increased interest rates. Because of rising interest rates many of those who have ARM mortgages would be forced to liquidate, perhaps at a substantial loss. Housing prices would decline because some people could no longer afford their mortgages and because of declining housing speculation. Those who would lose their homes because of expensive mortgages would become renters again. And because of increased demand, the rental market would tighten and rents would rise. Oddly enough in this scenario, higher rents would result in higher inflation, even though housing prices might be plummeting and the economy slowing.

Both situations seem counterintuitive. The first situation arises because lower rates cause renter to purchase homes, driving up home prices. In this situation, rental rates drop. The second situation arises because interest rates force many people out of their homes and back into the rental market again. Housing prices drop, perhaps significantly, but rental markets strengthen.

So when you hear inflation numbers being low, remember that roughly one quarter of the inflation figure results from the rental market and that rental market might be moving in the opposite direction to the prevailing change in inflation.

In Its Different This Time Redux Barry Ritholtz discusses the shape of the yield curve. The Deustche Bank believes that the shape of the yield curve, the slope between the Feds fund rate and the 10-year Treasury note, no longer accurately predicts the growth in real GDP. Barry's main focus, however, is not to worry about whether or not the yield curve accurately predicts growth in real GDP, but rather to note when the yield curve becomes inverted, because that is an indication of a coming recession. And when there is a coming recession: Sell.

I have bookmarked an interesting website Dynamic Yield Curve. Hit the animate button and you can see how the yield curve has changed over the past seven or eight years. Note how the yield curve has begun to flatten recently. Will it soon invert, however, is the real question.

The Online Wall Street Journal has two interesting articles today concerning Ford and GM. Ford Plans Deeper Cuts as Sales (subscription required) indicates that Ford is reducing its outlook amid slumping sales and a difficult environment.

Ford Motor Co., blaming a worse-than-expected sales slump among its core sport-utility vehicles amid rising gasoline prices, slashed its full-year earnings outlook for 2005 for the second time this year and said it would make deeper job and cost cuts than originally announced.

The No. 2 U.S. auto maker in terms of production said it would terminate 5% of its salaried work force in North America automotive operations, or 1,700 jobs, to cut costs. Those job cuts, to be made by Oct. 1, will come in addition to actions announced in April aimed at reducing about 1,000 salaried positions in North America.

News of Ford job cuts comes as its cross-town rival, General Motors Corp., is negotiating health-care cost reductions with the United Auto Workers union. Yesterday, a top union official indicated in a meeting with UAW leaders that no agreement with GM was likely until at least mid-July, after GM's annual summer shutdown.

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Ford said it now expects to earn $1 to $1.25 a share this year, excluding special items, down from its previous forecast of $1.25 to $1.50 a share, which was announced several weeks ago.

The article goes on to discuss the negative effects of high consumer incentives from competitors and of high gas prices. Recall the GM is presently using the "GM Employee Discount" to sell vehicles, and we are all aware how high gas prices are adversely affecting SUV sales.

In the other WSJ article UAW Wants Time for Team To Examine GM's Health Costs the UAW appears to taking a firm stance with regard to healthcare cuts.

DETROIT -- United Auto Workers President Ron Gettelfinger said Wednesday the union isn't yet persuaded by General Motors Corp.'s argument that it must cut union members' health-care benefits to be competitive, and said the UAW wants time for teams of experts to study the No. 1 auto maker's costs.

"We are trying to wrap our arms around the magnitude of the issue," Mr. Gettelfinger said during an interview Wednesday at the UAW's Detroit headquarters. "I wouldn't refer to it as a problem. I will say there are issues we are looking at. We want to know exactly where we're at. ...We can't be expected to buy a pig in a poke."

I expect the negotiations between GM and the UAW to be very difficult. There will be some days when the news will be favorable to GM and other days when it will be favorable to the UAW, but I suspect it will be a difficult challenge for both parties.

Earlier this year WSJ had an ominous article on April 22, 2005 Cars Made in China Are Headed to the West where it suggests that China is considering sending cars to Eurpose and America because of the surplus capacity in China. Even more ominous is China's wage rate.

Once seen as a market of vast opportunity, China is becoming a tough place for global auto makers -- and that is prompting some of them to ready plans to export China-made cars to America and Europe for the first time.

Sales of cars to Chinese consumers had been soaring the past few years as the country opened up and Western auto makers rushed in to set up joint ventures with local companies to satisfy domestic demand. But now the market is encountering some of the same ills that plague more mature markets, including bitter price competition, excess production capacity and falling profits. China's government intensified the trend by turning off some of the cheap financing that had promoted vehicle sales.

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Mr. Grube said he would expect little protest over Chrysler selling a Chinese-made car in the U.S. because it would be a new model and would not replace a vehicle now made in U.S. plants. He added that China offers "big, big" cost advantages because of its low wages. In China, car makers generally pay about $1.95 an hour in wages and benefits. By comparison, DaimlerChrysler pays its German workers about $49.50 an hour, and its U.S. workers about $36.50 an hour.

Compounding these problems are a slowing economic environment in Europe, and possibly in China and America. For Ford and GM, this is certainly a difficult time.

Looking at the Yahoo!Finance, we see that Ford's forward P/E (fye 31-Dec-06) is 8.75. We also see that GM's forward P/E (fye 31-Dec-06) is 22.18, which is almost three times larger than that of Ford's. I suspect that a substantial portion, if not the entirety, of the P/E premium is attributable to the involvement of Kerkorian. But given the severity of the challenges that the automobile industry in North America faces, I am doubtful that even he can effect much positive change in the short-term. Instead, I anticipate a difficult readjustment period while the automotive sector restructures itself. And thus I remain short GM.

The Wall Street Journal has an excellent article on eBay Threatening eBay's Dominance, More Online Sellers Go It Alone (subscription required).

So Mr. Wieber revamped his Web site and began selling through other online companies, such as Amazon.com Inc. and Yahoo Inc. Last year, his sales neared $5 million, but his eBay revenue grew at a much slower pace, making up only a quarter of the total. It will likely fall still lower. Of the auction site, where he got his start, Mr. Wieber says: "Too many sellers, not enough buyers."

EBay, with more than 147 million users world-wide, has long been regarded as the dot-com survivor that could do no wrong. Mr. Wieber's story shows why the company may be losing some of that luster. Setting up an online store is so easy these days that sellers needn't rely on eBay as a source of customers. Advertising is simple and inexpensive, thanks to new technology from companies such as Google Inc. And multiple competitors, including Amazon and Yahoo, are pulling once-loyal eBay sellers into their orbit.

On his weblog Infectious Greed Paul Kedrosky writes in his post Google Sez PayPal is Safe. It Isn't. that once Google experiences success with its on-line payment service it will it face immense pressure to broaden its product offering, which will put it squarely in PayPal's territory.

And over on Street Insight (a subscription site related to TheStreet.com), fund manager Scott Rothbort wrote on Monday:

I thought the most interesting story today was that of Google (GOOG) replicating eBay's (EBAY) PayPal platform. Slowly but surely, eBay is getting picked off left, right and center by other Internet companies. eBay no longer deserves the lofty growth and P/E ratios the stock sports.

These are certainly challenging and interesting times for eBay. I wonder which company is more challenging to lead: eBay or Disney?