Thursday, January 15, 2009

The Dow and the Economy

Let us look at the Dow Industrials that have reported earnings so far and what they indicate about the economy.

First, Alcoa reported. 'AA' lost money. Its working capital position is not strong. The stock continues to sell above tangible book value, and since it is a mature but money-losing company, with the economy definitely worse this quarter than last quarter, it is very possible if not likely for the stock to decline below tangible book, which is obviously declining due to the losses.

Next, J.P. Morgan Chase (+ Bear, Stearns Washington Mutual etc.) reported. Absent a one-time gain related to the WaMu acquisition, and other net gains such as $627 MM from dissolution of a joint venture (Paymentech) 'JPM' lost money. Tangible book value is about $18 per share, $8/share less than the stock price. Given the fragility of the financial system, the uncertainty of the value of Tier 3 assets, the certainty that this quarter will stink, the likelihood that the entire year will stink, it is easy to see the stock trading down to or below tangible book value. (The entire concept of a financial company having "tangible" assets is oxymoronic.)

Last, Intel announced virtually break-even earnings today. The stock has gone nowhere for over 12 years. Given prevailing risk-free interest rates in the late 1990s, it is clear that the stock was, with benefit of hindsight, drastically overpriced then. The Company trades at over two times sales per share. Sales growth has lagged nominal GDP for a decade or more. So, even the largest and most successful semiconductor company, which has destroyed its main competitor AMD, can't even grow sales as fast as nominal GDP. One can look for this stock to gradually trade down close to one times sales per share. The stock is $13-14 per share. The long-term chart shows 8-9 years of lower highs. The dividend was increased recently, just as operations were tanking. AIG did the same thing. That didn't reward shareholders well. This stock can go flat to down for years to come.


Here are 3 relatively well-run companies. All are large and highly cyclical. Alcoa and JP Morgan Chase are very old companies and Intel acts old and mature. None of them have any pizzazz. There is nothing new. These companies are reflective of the economy as a whole. It's creaky. They are at best marginally profitable going forward, smoothed over an "average" economic cycle.

Right now, things remind me most of the US economy in the early 1930s. There were 2 years, 1932 and 1933, when I believe that corporate America had no net profits. Could the same thing happen again? Oil companies are not going to make much at current oil prices and gasoline volumes; financials and GM are disasters; and Intel and Alcoa are collectively perhaps break-even going forward. Presumably IBM, HP and P&G will save the day, but Citi, BofA, and GM could lose many tens of billions of dollars.

The pattern is that unlike Intel's optimism that after the recession, there will be strong growth, I think that the U.S. is in a secular slow-growth phase. Corporate America can't keep promising growth year after year, not deliver it, and expect its stock price not to reflect the reality that this is a slow-growth economy at best. This is a Japan post-bubble flat-to-down stock price scenario if it is not a fast-crash 1929-32 scenario.

Copyright (C) Long Lake LLC

This could be Great Depression 2 from a profit standpoint.

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