Multiple Disasters at WCI

There are disasters in the making at WCI. Let's takes a look.
On February 27th WCI reported wider-than-expected quarterly loss.

WCI Communities Inc. a Florida upscale home and condominium builder that may put itself up for sale, on Tuesday reported a wider-than-expected quarterly net loss, amid the weak U.S. housing market.

The company posted a quarterly net loss of $64.6 million, or $1.52 per share, versus a profit of $54.6 million, or $1.20 per share, in the year-earlier quarter.

Analysts had expected a net loss of $1.37 per share, according to Reuters Estimates.

Excluding the impact of $118.3 million for the write-off for deteriorating values of its land holdings and residential towers, WCI's income was $6.6 million or 18 cents per share.

Fourth-quarter revenue fell 37.6 percent to $526.3 million, the result of lower sales, higher cancellations of both homes and condominiums, the Bonita Springs, Florida company said.

Gross margins as a percentage of revenue were negative during the quarter, WCI said, a result of write-offs and greater sales cuts.

Earlier this month, WCI said it hired Goldman Sachs & Co. to explore strategic options, which included a possible sale, selling some assets or repurchasing stock. The move was viewed as a response to pressure from investors such as Carl Icahn, Hotchkiss & Wiley Capital Management and SAC Capital Advisors.

WCI last month adopted a shareholder rights plan, commonly known as a "poison pill" after investor Carl Icahn said he had boosted his stake in the company to 14.6 percent.

Meanwhile, billionaire investor Icahn said he and nine others will seek seats on the WCI board. WCI said Icahn's hand-picked slate would further his personal objectives and would be highly disruptive to the company.

A Realistic Look

1. No one in their right mind would want to but this company. Of course that does not exclude it from happening as insane leveraged buyouts of all sorts have been happening recently. However, I suspect the widening of credit spreads and recent global stock market action will put an end to such absurdities sooner rather than later.
2. Poison pills are an act of desperation.
3. The threat of repurchasing stock is a bluff. WCI has a serious cash flow problem and wasting money repurchasing stock would compound it.

Forecast Withdrawn

Later in the day WCI withdrew its 2007 earnings forecast.

Feb 27 WCI Communities Inc. a builder of upscale homes and high-rise apartment buildings, chiefly in Florida, withdrew its 2007 earnings forecast on Tuesday, citing difficulty in forecasting regional housing demand.

In November the company forecast 2007 earnings of $1 to $2 per share.

"Because of the lack of visibility on demand, cancellations that we've experienced ... we're withdrawing the guidance that we provided previously and believe that the most important metrics for WCI to focus on during 2007 is cash flow and debt reduction," Jerry Starkey, president and chief executive, said during a conference call with analysts.

Reasons for withdrawing forecast

• No visibility
• Cancellations exceeding closings
• Difficulty in forecasting regional demand
• Wants to focus on cash flow and debt reduction

Liquidity Crunch

Is there a liquidity crunch at WCI? Rodger Rafter on The Market Traders offered these thoughts:

WCI wants to generate $1 billion in cash flow from operations this year. Last year they burned $490 million, and they burned smaller amounts in 2004 and 2005, so that would be quite a turn around. Indeed, for many years builders were content to pile up inventory of land and homes for sale, along with mountatins of debt. They didn't care about cash from operations when there was plenty of cash from financing to be had.

Why the sudden need to generate cash?

My take is that the financing is drying up. If builders can't raise cash from operations while the losses are mounting, then they'll have an especially hard time getting lenders to extend their credit agreements. With today's write-offs, WCI is already in violation of their credit covenants. DHOM violated theirs last year and had to renegotiate at significantly higher interest rates. OHB is also on a mission to generate cash from operations.

WCI Releases Fourth Quarter and Full Year 2006 Earnings

Financial Highlights

• Full year 2006 net income: $9.0 million
• Full year 2006 diluted EPS: $0.21
• Full year 2006 figures include $139.5 million of pre-tax asset impairments & write-offs
• Full-year 2006 diluted EPS before impairments and write-downs: $2.16
• Fourth quarter net income: loss of $64.6 million
• Fourth quarter diluted EPS: loss of $1.52
• Fourth quarter figures include $118.3 million of pre-tax asset impairments & write-offs
• Fourth quarter diluted EPS before impairments and write-offs: $0.18
• 2006 year-end backlog: $911.2 million vs. $2.05 billion in 2005
• Projected 2007 cash flow from operations of approximately $1 billion
• Projected year-end 2007 net debt to capital ratio of approximately 50%

click on chart for a better view


"Our principle business focus in 2007 is on maximizing cash flow, reducing debt, and improving our financial flexibility. We expect to generate approximately $1 billion of cash flow from operations during 2007. While all aspects of our business will contribute to this cash flow objective, completing and closing nine towers during the year is the primary driver. We expect around $1 billion in collections from the closing of those nine towers and from the closing of the remaining sold units from three towers that were completed in December 2006."

WCI has not made its numbers for a year, the economy is headed into a recession, they have negative new orders for their latest quarter, and demand for condos is in the gutter. In addition they have "lack of visibility on demand" and are "withdrawing the guidance provided previously" yet somehow we are supposed to believe they are going to "complete and close nine towers" and that will be the "primary driver" enabling them to "generate approximately $1 billion of cash flow from operations during 2007." As ridiculous as it sounds, someone must believe that story or their stock would be trading closer to $2 than $20.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

German Unemployment May 2008

German unemployment unexpectedly rose in May for the first time in more than two years as record oil prices and the euro's appreciation weighed on exports. The figures however do need to be treated with caution, since computer glitches at the labour office, the reclassification of some categories of unemployed and the simple fact that Easter was in March and not April have all, to some extent, been playing around with the data.

The number of people out of work, adjusted for seasonal swings, rose 4,000 from April to 3.31 million (although the unadjusted number was still down a bit - see chart below) according to the Nuremberg-based Federal Labor Agency today. Up to May unemployment had fallen every month since January 2006.

With oil close to a record and the euro's 16 percent increase against the dollar in the past year making exports of goods like cars less competitive, companies may well be becoming more reluctant to hire workers. The European Central Bank has indicated its unwillingness to lower interest rates while inflation and money supply continue to surge strongly in the 15 country eurozone.

Exports unexpectedly fell for a second month in March as a global slowdown and the rising euro weighed on orders, according to the Federal Statistics Office in their monthly report.



In Europe, Germany's main export market, service and manufacturing industries expanded at the slowest pace in five years in May, according to the PMI flash estimates.

Data from NTC Economics gave a preliminary estimate for the Eurozone services PMI which slumped to 50.6 in May from 52.0 in April, way below forecasts for a much more moderate fall to 51.8. The level equals January's four and a half year low and takes the index closer to the 50 level below which the index would be indicating a contraction in activity. The equivalent index for manufacturing dropped to 50.5 from 50.7, slightly above forecasts, which were expecting a slightly weaker reading of 50.4, but still marking the lowest reading since August 2005.

The flash Purchasing Managers Index for Germany's service sector fell to 53.7 in May from 54.9 in April, while in the manufacturing sector activity dipped to 53.5 from 53.6 a month earlier. So basically we have the impression that things are slowing all round.

However, Frank Weise, head of the Federal Labour Agency which released the employment figures, warned that this months drop in the rate of employment creation “should not be interpreted as the first sign of a slowdown in the labour market.”

The agency said statistical effects and changes in the law also played their part. The seasonally-corrected figures, it said, were being distorted by unseasonably warm weather during the winter while changes in the legal status of jobseekers over 58 alone accounted for a 10,000 increase in the number of unemployed.

The mild weather, in particular, meant fewer jobs had been lost during the winter than in previous years, resulting in a lower reduction in unemployment during the spring season, the agency said. The statistical agency also pointed to employment figures – whose publication lags one month behind the jobless data – showing an 54,000 increase in job creations in April.


As reported by the Federal Statistical Office on the basis of first calculations for April 2008, the number of persons in employment whose place of residence was in Germany was 40.08 million. That was an increase by 650,000 persons (+1.6%) on April 2007. Compared with March 2008, the number of persons in employment rose by 153,000 (+0.4%) in April 2008.

So the positive trend in overall employment creation which has existed in Germany over the last two years certainly continued into April. It is true however that in April the increase in employment was somewhat smaller against the previous year than in earlier months (both in March and February 2008 the rate of increase had been + 1.8% compared with the same month one year earlier). One explanation being offered for this is that particularly favourable employment figures had been recorded for the earlier months (and this is, incidentally, also reflected in the particularly favourable GDP numbers). The mild winter on the one hand and an increased utilisation of the seasonal short-time working allowance on the other will have contributed to this result. The allowance is available only during the period 1 December to 31 March.

In April 2008, the number of persons in employment in Germany was 40.25 million after seasonal adjustment, that is after elimination of the typical seasonal variations. That was a seasonally adjusted increase by 27,000 (+0.1%) on March 2008.

Based on the labour force survey the Federal statistics Office reported a seasonally adjusted 3.19 million unemployed for April 2008. That figure, which is a provisional estimate, was calculated according to the concept of the International Labour Organization (ILO). Compared with the same month a year earlier (April 2007), the number of unemployed was down by 480,000 persons or 13.1%. The seasonally adjusted unemployment rate – which is harmonised across the EU and measured as the share of unemployed in the total labour force – amounted to 7.4% in Germany and was thus considerably below the level of the corresponding month of the previous year (8.5%).

The raw, unadjusted figures showed a 131,000-strong drop in unemployment in May – smaller than the fall observed in May last year - down to a total of 3.28m jobseekers. Internationally comparable figures using International Labour Organisation methodology put the number of jobseekers at 3.39m in April and the unemployment rate at 7.8 per cent.

Whither Spain – Towards Finland or Argentina?

Well, here I am spending my last day in Sitges, attending the annual meeting of the Circulo de Economía (which is why I have been so silent of late). This annual meet-up tends to attract many of the leading participants in Spanish economic and political life. To give you some idea, in the session before mine the Industry Minister Miguel Sebastian gave his version of where we are (which was in fact the toughest statement I have heard from any PSOE representative in recent years), while I shared the platform with Cristobal Montoro (who is PP candidate for Economy Minister). I have been here since Thursday, and in my presentation stressed the need for some sort of internal devaluation. This in fact got me a lot of headlines in the Spanish press the next day (or here, or here, or here). These have been interesting days for me, meeting and talking to a lot of people. I even got to meet the legendary Catalan President Jordi Pujol for the first time in my life. In the lift on my way to bed last night I found myself in the company of Banc Sabadell CEO Josep Oliu. I was tempted to share with him my views on the problems facing Spain's banking system (which I am sure he is only all too well aware of), but decided discretion was the better part of valour, and limited myself to a simple "bona nit" as he got out of the lift.

As a sign of the times, Alfredo Pastor (who introduced me) pointed out, "what Edward was arguing six months ago seemed to be "catastrophist", now it has become the consensus". And indeed if you look at the arguments presented by Fitch for their latest downgrade - including the demographic ones - they are not that far from arguing what I am arguing: the fiscal measures may work, but where the hell is the growth going to come from!

Interestingly, Dani Roderik, who has also been here, and spoke yesterday, has come to very similar conclusions: "Spain's needs a 20 % internal devaluation" (or in his opinion should leave the Eurozone - I don't agree with this part), and he basically arrived here by a process of steady elimination, examining all the other options and deciding they wouldn't work quickly enough. Keeping ahead of the curve, I am now starting to argue - as previewed in my latest AFOE post - that either we move soon on this, or Germany will inevitably have to go back (hopefully only temporarily) to the Mark. The system won't hold otherwise. Given that opinions have changed so radically here in Spain in just six months, nothing can be ruled out at this point.

Not even Zapatero stepping down. It is interesting to note that CiU gave him till the end of the year - he will not be able to pass a budget for 2011 - to do this, or there will be elections. So let's see if the leaders of PSOE are able to "factor in" what will inevitably happen, and take a decision now.

Spain does not need elections. Spain needs a change at the top, a consensus government supported by all the main parties, and a swift internal devaluation.

Interestingly a lot of people have spoken to me here over the last few days, and all the comments have been positive. Many of the people here seem to read me in La Vaguardia (Dinero supplement) on Sundays. I never realised I was so popular, in fact I had quite the opposite impression.

Below you will find the English version of my press release. I entitled my presentation "Spain - Finland or Argentina". I think the reason for this should be fairly clear. Back in the early 1990s, following an uncontrolled credit boom, Finland underwent a deep depression as its GDP dropped by around 14% and unemployment rose dramatically from 3 to almost 20%. Initially the Finish government refused to recognise the severity of the situation, and the economy failed to recover. Then they took the “bull by the horns”, carried out a series of deep structural reforms and as a result the country is now widely recognised as a model of flexibility and good practice.

The other path is to do very little, live in hope, and expect the worst. This is the road to ruin and decay. The Argentine path.

The Finnish case was of course a little different from the situation Spain now faces, since Finland had its own currency, and was thus able to restore competitiveness through a substantial devaluation, a devaluation which then required the creation of a bad bank to relieve lenders of toxic assets produced by the rapid rise in non perforing foreign currency loans.

To many in Spain this kind of radical price and wage adjustment proposal is simply unrealistic. But at this point there are few remaining alternatives. Spain is gradually replacing Greece as the focus of global investor concern, and while people in Spain may have little appetite for such drastic changes, they should never forget that across in Germany, where people are now being asked to authorise funding for substantial loans to be used on Europe’s periphery, support for proposals that the country return to the Deutsche Mark is growing by the day. As the IMF point out, any comprehensive strategy to move the Spanish train along the track which leads to the Finland station requires broad political and social support, while time is of the essence.

------------------------------------------------------------------------------------------------


Spain - Finland or Argentina?

“Spain’s economy needs far-reaching and comprehensive reforms. The challenges are severe: a dysfunctional labor market, the deflating property bubble, a large fiscal deficit, heavy private sector and external indebtedness, anemic productivity growth, weak competitiveness, and a banking sector with pockets of weakness. Ambitious fiscal consolidation is underway, recently reinforced and front-loaded. This needs to be complemented with growth-enhancing structural reforms, building on the progress made on product markets and the housing sector, especially overhauling the labor market. A bold pension reform, along the lines proposed by the government, should be quickly adopted. Consolidation and reform of the banking system needs to be accelerated. Such a comprehensive strategy would be helped by broad political and social support, and time is of the essence”.
IMF 2010 Article IV Consultation Spain Mission Statement

Following a decade long housing “boom” Spain now has an enormous debt problem. The combined debt level of Spain’s households, companies and government now amounts to some 265% of GDP.



However, in contrast to the situation in countries like Greece and Italy, Spain’s endebtedness problem is not principally one of massive public sector debt. The main component of Spanish debt is private – between households and companies accumulated debt amounts to some 210% of GDP.


Spain is not, by a long stretch, the only country to suffer from such a high level of private indebtedness. There is, for instance, the example of the United States, where total indebtedness now significantly exceeds the 300% of GDP level, a threshold which many consider to be highly structurally significant. The sheer fact of knowing you share this problem with other larger, and richer, countries may be soothing, but it should also give an indication of the kinds of difficulty Spain may experience in interacting with the external environment, since solutions will need to be found which fit the needs not of one isolated country, but of various countries, all at one and the same time.

Stabilisation....But At A Price


After an extremely severe recession the Spanish economy has now been stabilised.



Industrial output has stopped falling, and retail sales have even started to rise slightly.



Output in the bloated construction sector, as was to be expected, continues to fall, as do house prices. Unemployment has stopped rising, although employment, and participation in the Social Security system continues to fall.



At the same time the previously large migration flows have now all but dried up.



But this stabilisation comes at a price, given that is the result of a dramatic surge in current government spending and a huge liquidity support operation for the financial system being supplied by the ECB.

Deficit and Debt Dynamics

As is by now well known, this increase in public spending has produced a further problem – one of a large government fiscal deficit – and this development has served to attract the attention of the international investors on whom Spain depends for its financing at precisely the time that the issue of sovereign debt in the ageing societies of the economically developed world is starting to become a cause for concern in the financial markets.

The principal difficulty facing the Spanish economy at the present time is that while the emergency measures have served to buy time, this time has not been wisely employed, and the measures have simply served to exaccerbate the underlying structural problems rather than resolve them.

According to the National Statistics Office (INE), the slight economic expansion that was achieved in the first quarter of 2010 (0.1% growth) was the combined result of an increase in internal demand and a worsening of the net impact of external demand – precisely the opposite of what you would want to achieve. In other words, while Spain’s exports did increase, the growth in domestic demand in conditions of limited international competitiveness meant that imports increased even more. On an interannual basis the negative impact of national demand reduced (from -5.3 percentage points to -2.5 percentage points – see chart below) while the positive impact of external demand fell (from 2.2 percentage points to 1.2 percentage points). To be clear, growth in the first quarter of 2010 was due to rising domestic demand, and not rising exports, which means the real impact of the increase in government spending and the liquidity measures applied by the ECB since June 2009 has been to reverse the positive trend in the goods trade deficit which had been seen in earlier quarters.



As the Spanish government stresses, the country’s share in world exports has remained more or less constant since the start of the century, but at the same time Spain’s share of world imports has increased. Put another way, thanks to the foreign funds which flowed in to finance the housing boom Spain became a major imports powerhouse, with the consequence that both the trade and the current account deficits deteriorated sharply, while a significant part of Spanish industry simple died. One of the major tasks of any recovery programme is to bring this industry back to life. In this sense what Spain’s economy needs is not rejuvenation but resurrection.

With a highly integrated global economy as the background, Spain’s seemingly insatiable demand to build and buy ever more housing units was satisfied via the massive entry of migrant labour (5 million immigrants in 10 years), and substantial ongoing capital inflows (a current account deficit of around 10% of GDP), which both served to raise the short term capacity of the economy, but lead to the consequence that Spain today is a highly over-indebted country – net external debt is around 90% of GDP – while a large part of the manufacturing base which would have facilitated paying down the debt now no longer exists.



As a result – and as Mr Zapatero repeatedly stresses – it is the case that the accumulated debt of the Spanish government is not (yet) inordinately large when compared to that of its peers, although as a share of GDP it has been increasing rapidly in recent quarters.

To reduce this debt burden the Spanish economy needs two things: inflation and growth, although it should be stressed that competitiveness can only be restored by some form of price and wage deflation.

In a modern, mature, economy growth in aggregate demand only comes either via an increase in the level of credit, or through an increase in exports. The problem that Spain faces is that, on the one hand all sectors of the economy (households, companies and government) are now heavily over-endebted and deleveraging as fast as they can, with the result that – on aggregate – they are demanding less (not more) credit. On the other hand, the Spanish economy is not sufficiently competitive to be able to grow simply by relying on exports.

In addition, systematic dependency on external financing is never a good thing, since your creditors can always impose conditions on you which may not be to your liking. Despite the fact that the commitment to reduce Spain’s fiscal deficit by 5% of GDP in 2 years is, in and of itself, a very strong one, the country actually has to make a far greater fiscal effort than it seems, due to the commitment contained in the recent Ley de Economía Sostenible to reduce substantially the quantity of unpaid receiveables on the public sector account books. Spain’s Autonomous Communities alone have some 30 billion (or around 3% of GDP ) in payments oustanding as of the last quarter of 2010 – which means there will need to be a reduction in spending of something like a additional 1% of GDP a year over the adjustment period under this heading alone.




The need to restore order to Spain’s public finances will mean that the adjustment will be even more painful than generally envisaged, and that the impact of the correction on the economy generally will be more severe. Thus, it is rather unlikely that the Spanish economy will grow in 2011 as many expect. Weighed down by a heavy fiscal correction, an unacceptably high level of unemployment, private demand in slight contraction and a weak growth rate in exports, it is probable that the economy will once more contract, possibly by between 1% and 2%.

To conclude, Spain stands at a crossroads, and important decisions need to be taken. A fiscal adjustment is necessary, but the country also needs a competitiveness adjustment in the form of a substantial reduction in the wage and price level (possibly by 20%). If this is not implemented the dynamic of Spain’s debt will surely become unsustainable. Spain has two – and only – choices at this point. It can follow Finland’s example in the 1990s, take the bull by the horns and use the present crisis as an opportunity to transform the Spanish economy into a new economic miracle, or it can remain in denial about the severity of the problem, let things drift until they can do so no longer, and then follow Argentina down the road of ruin and despair.

To cite the words of the latest IMF report: “Such a comprehensive strategy would be helped by broad political and social support, and time is of the essence.” Ladies and gentlemen, enough is enough. Nearly three years have now been wasted, and it is time to act.

Fed Is Ready and Willing To Act

Market Watch is reporting Fed ready to act in a financial crisis.

The Federal Reserve stands ready to lower interest rates if a financial crisis erupts, said Tim Geithner, the president of the New York Fed, on Wednesday. "As always, central banks need to stand prepared to make appropriate monetary policy adjustments if changes in financial conditions would otherwise threaten the achievement of the goals of price stability and sustainable economic growth," Geithner said in a speech about liquidity in financial markets to a business group.

Geithner said his remarks were general in nature and not related to "the specific conditions of the moment" where the stock prices plunged around the world. Geithner said liquidity, like market confidence, is very difficult to measure and a reversal of both liquidity and confidence play a critical role in leading to financial shocks. Geithner said financial regulators have a difficult time in predicting when liquidity may reverse.

The best way to limit the risk of crisis is shock absorbers in the financial system. "These shock absorbers are substantially stronger today that they have been even in the relatively recent past," Geithner said.

Exactly who does Geithner think he is fooling when he said his comments were general in nature and not related to the "specific conditions of the moment". Even if by some miracle those were planned comments that just happened to come when they did, Geithner without a doubt proved he is just another Fed charlatan.

One of the reasons bubbles keep getting bigger and bigger is because the Fed has a history of being ready and willing to act. Market participants know the fed is ready and willing and plan on the Fed bailing them out when risk gets blown out of the water.

Geithner is now openly bragging "These shock absorbers are substantially stronger today that they have been even in the relatively recent past". There is a curious thing about those shock absorbers, though: It seems they have get stronger and stronger to work. The last "shock absorber" took interest rates down to 1% while creating the mother of all bubbles in credit lending and housing. What's next ye great wizards?

The best way to limit risk is to not let asset bubbles and risky conditions foment in the first place. Instead, the charlatans at the Fed are depending on shock absorbers to cover up their own mistakes. Eventually (perhaps it has started already, perhaps not), one of those shock absorbers will fail. That is when the charlatans at the Fed will be exposed for what they are.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Exports And Investment Drag German GDP Down In First Quarter

German exports and investment spending plunged in the first quarter, dragging Europe’s largest economy into its deepest economic slump on record.

Exports were down 9.7 percent from the fourth quarter and company investment declined 7.9 percent, according to the Federal Statistics Office. The Office reported that gross domestic product fell a seasonally adjusted 3.8 percent from the previous three months, confirming an initial estimate from May 15. That’s the largest drop since quarterly data were first compiled in 1970.



From October to December 2008, the German economy had already contracted by 2.2%, and by 0.5% in each of the the second and third quarters.

According to the statistics office, the decline in economic performance was mainly due to movements in the balance between exports and imports of both goods and services. As in the fourth quarter of 2008, German exports fell much more than German imports in the first three months of this year. While exports declined 9.7 % year on year, imports were down 5.4%, so that the chnaged balance of exports and imports contributed minus 2.2 percentage points to the decline of GDP.



The negative first quarter evolution was also characterised by a notable decline in investments (– 7.9%, quarter on quarter). Capital formation in machinery and equipment, in particular, was much lower than in the last quarter of 2008. Companies invested 16.2% less in machinery, equipment and vehicles than in the last quarter of 2008.


The decline in capital formation in construction was small in comparison with a drop of 2.6% on the quarter. Inventories were also run down considerably during the quarter, thus reducing growth by 0.5 percentage points. Growth was positive only only for household consumption and government consumption, which up by 0.5% and 0.3% respectively.


Year on year, German GDP was down by 6.7% in the first quarter of 2009. After calendar-adjusted, the figure is 6.9% , since there was half a working day more in the first quarter of 2009 than there was in 2008 (easter impact minus the leap year effect).

39.9 million people were employed in Germany during the first quarter, an increase by 48 000 persons (or 0.1%) on a year earlier. The number of unemployed (ILO definition) was just under 3.4 million, 7.8% of the entire economically active population.

The recession in Germany has hit industrial activity (including energy) particularly hard, and output was down 20.2% over the first quarter of 2008. Marked declines in real gross value added were recorded also by construction (– 8.9%) and by trade, transport and communications (– 6.4%). Financial, real estate, renting and business activities fell much less - by 0.9% compared with the first quarter of 2008.

In contrast to the bleak picture for investment, fixed capital formation and German exports, final consumption expenditure was ever so slightly up quarter on quarter - by 0.1% - and even did slightly better than in the last quarter of 2008 (– 0.0%).

On a year on year basis, household consumption was marginally down though - by 0.1% (following a 0.5% drop in the fourth quarter of 2008), but general government consumption expenditure was up by 0.8%.

The Long Term Outlook

The first-quarter drop in GDP marked an unprecedented fourth successive quarterly contraction for Germany’s economy. The government expects the economy to contract 6 percent this year, while ECB council member Axel Weber said earlier that while “rays of light” are positive, there’s “no reliable indication that the global economy is past the worst.” The euro-region economy may only “gradually stabilize during the latter part of 2009.”

The longer term decline in German GDP performance is now pretty clear (see chart below).

According to the Federal Statistics Office:

Measured in terms of gross domestic product changes at 1995 prices, the rates of economic growth in the former territory of the Federal Republic of Germany and - since 1991 - in Germany have continuously declined since 1970. While the average annual change was 2.8% between 1970 and 1980, it amounted to 2.6% between 1980 and 1991 and to 1.5% between 1991 and 2001.

Since 2001 the performance of the German economy has in fact been worse rather than better, much to the consternation of those who hoped that many years of sacrifice in the form of wage deflation and structural reform would lead to a rebirth of the country's former economic prowess. In reality the German economy shrank (0.2%) in 2003, and grew by only around 1% in both 2004 and 2005. And while the German economy picked up notably in 2006 and 2007 (with growth rates of 3.2% and 2.6% respectively) and many talking in terms of such grandiose notions as global uncoupling and "Goldilocks" type sustainable recoveries, the most striking feature of the recent German dynamic has been the way that internal demand failed to respond to the externally driven export stimulus. Of course, all the speculation came to an abrupt end in 2008 when the German economy once more entered recession as world trade expansion slowed and exports collapsed (with GDP only growing by 1% over the year), while 2009 looks set to be a lot worse (with the IMF currently forecasting a contraction somewhere in the region of 5%, and forecasts of up to minus 7% not seeming exaggerated).

What we seem to have here is "engine faliure" rather than mere "magneto problems" (using Claus Vistesen's memorable phrase for a very similar situation in the Japanese economy, and it would be nice if the current crisis could serve as the stimulus for an open, and "in the real world" debate about why this is. So some part of the traditional mechanism of economic transmission seems to have been broken, and the "second leg" of the economic cycle, the domestic consumtion driven one, seems no longer to work. Long term GDP growth rates in the German economy are clearly falling, and the decline looks clearly set to continue. Now falling and ageing population couldn't have anything to do with it, could it?

The Science of the Free Market

The question of integrity concerning academic institutions’ involvement with outside donors seems to be a topic of interest these last couple of weeks. It has been suggested that academic institutions have sold out to outside donors and further that these donors have unprecedented and unwarranted involvement in the selection process of faculty. Of course the specific donors in question are the Koch brothers, or more accurately the Charles G. Koch Charitable Foundation, and the subject of the work they support is economic freedom.

I am an assistant professor of economics, and I have received a grant from the Koch Foundation. I have also participated in workshops on Koch’s Market-Based Management, a management philosophy based on the principles of a market economy and fully explained in Charles Koch’s book The Science of Success. This work is an important aspect of my professional development, and I am sharing my intellectual discoveries with my students, my colleagues and members of my community. I thought this was my job.

To that end, the Koch Foundation is interested in supporting teacher-scholars devoted to advancing individual well-being and in turn social progress by incorporating the principles of economic freedom in their work. It isn’t a big secret, and it shouldn’t be appalling. One can read about their mission right on the front page of their website.

I teach entrepreneurship in addition to economics. I use MBM in my classroom, by my own choice. It helps me drive home the relevance and linkages of individual integrity, value-creation for the customer and in turn the company, long-term profit maximization and the betterment of society in contrast to the short-sighted approach to business that is the focus of traditional business ethics education (I choose to let my students learn the habits and practices of winners rather than losers). For those not familiar with MBM, the five dimensions are:

1. Vision
2. Virtue and Talents
3. Knowledge Processes
4. Decision Rights
5. Incentives

Compare these five dimensions with the cornerstones of economic freedom:

1. Private ownership of resources or property
2. Personal choice
3. Voluntary exchange
4. Free entry into markets or competition.

An economist or a student at the introductory level immediately recognizes these four cornerstones of economic freedom as nothing more than underlying characteristics of a market economy, taught in every Principles textbook I have ever read. These are relatively simple, basic notions. Yet, society has managed to abstract from these basic principles, as success so often has the tendency to cause. Some argue of course, Joseph Stiglitz comes to mind, that we can’t assume these principles are strong enough to override the problem of imperfect information. Yet, technology is removing information barriers with amazing leaps, so much so that much of society is now more concerned with privacy rights than ever before – a recent WSJ article about researching human behavior through cell phone records comes to mind. Yet, looked at from another perspective, market innovations in science and technology are helping disseminate better, more complete information. On the basis of economic principles, this should suggest that the free market is becoming better able to deal with resource allocation and efficiency in production, not less able.

So in conclusion the Koch Foundation supports research and scholarship on economic freedom. I wonder if we would witness a media uproar over an energy firm, other than Koch of course – maybe BP before the big spill, supporting a chemistry department’s research into alternative fuels. Would there be outrage to find a Fortune 500 company supporting marketing research and learning activities? Would there be outrage to find that the EPA supports student competitions to come up with all the reasons regulation is good, which the EPA has actually done.

From the perspective of economic freedom, this is just more competition. But then, it shouldn’t be a surprise that opponents of the free market are opposed to competition.

Seeing is Believing, But Stabilising is NOT Recovering

This is one of the key points I have been hammering here on this blog for some weeks now. There is clear evidence of most economies globally "stabilising" at this point, you could even stretch it to say that the "worst is over" - since I doubt we will go back to the dreadful days of December and January (see German manufacturing PMI chart below) - when it was like someone had given a very sharp knock to the whole industrial sector with a large sledgehammer, and of course ultimately the vibrations settle down even if the damage remains.



But to go from this evident fact to drawing the conclusion that a full recovery is now in the works would be a very fast and loose use of both logic and economic theory. Production is falling less slowly (on an annual basis) and even increasing slightly (on a monthly basis) in some countries as orders can no longer simply be met from what are now very depleted inventories.

But as I suggest in this post, upping output to meet current orders is not a recovery, for the win-win dynamic to move us back into a new cycle investment activity has to increase. And on this front there is precious little actual evidence to back the more positive discourse, and indeed the data we are seeing indicate rather the contrary.

When I last wrote we did not have detailed data for Q1 GDP for the eurozone economies , so I took a look at the evidence from Japan, where investment activity slumped massively between January and March (pointing out that there was no good reason why we should expect the situation to be very different in Europe). Japanese business investment was down a record 10.4 percent year on year in the first three months, and a massive 35.5% over the last quarter.

But now we have detailed German Q1 GDP results from the Federal Statistics Office, and we find a very similar picture. Total investment was strongly down (– 7.9% quarter on quarter), while capital formation in machinery and equipment, was 16.2% lower than in the last quarter of 2008, and 19.6% lower than in the first three months of last year.



But all of that is to some extent history. Much more preoccupying - certainly for the "onward-annd-upward-we-go" thesis - is that German plant and machinery orders declined the most on record in April from a year earlier. Orders dropped an annual 58 percent, the most since data collection started in 1950, after falling an annual 35 percent in March, according to the Frankfurt-based VDMA machine makers association in a statement today. Export orders slumped 60 percent while domestic demand dropped 52 percent. So things actually seem to have deteriorated in April with respect to March. No good news this.

Especially when you read the same day an interview with Hans-Joachim Dübel - CEO of Berlin based FinPolConsult, one of the leading and few relatively independent voices in the German housing finance community - where he says: "My guess is that the Landesbanken alone will cause ultimate losses of 8-10% of German GDP, which is real money. Compare that sum with the 5% of GDP costs for the US S&L crisis".

France Consumer Confidence May 2008

Consumer confidence in France dropped to a record low in May after fuel, gasoline and food costs soared. The French consumer sentiment index fell to minus 41, the lowest level since the index was introduced in 1987, from a revised minus 38 in April, Insee, the Paris-based national statistics office, said today.



France's inflation rate fell to 3.4 percent in April after reaching 3.5 percent in March, the highest in at least 12 years. As a result, consumer spending on manufactured goods fell 0.8 percent in April from March, the third drop in four months, Insee reported last week.

Spain Mortgages March 2008

According to data from the National Statistics Office (INE), the value of mortgages constituted on urban buildings in Spain was approximately 16,575 million euros in March, representing a year on year decrease of 36.7%. In housing, the capital loaned exceeded 9,975 million euros, 41.9% less than in March 2007. 105,608 properties were mortgaged in March 2008, a decrease of 37.77% over March 2007.



During the month of March the average amount per mortgage constituted was 164,637 euros, 1.5% more than for the same month in 2007 and 2.8% lower than that recorded in February 2008. In the case of mortgages constituted for housing, the average amount was 141,725 euros, 3.8% less than the same month in 2007, and 4.9% lower than the figure registered in February 2008.

97.9% of the mortgages constituted in March used a variable interest rate, as opposed to the 2.1% that used a fixed rate. Within the variables, the Euribor was the reference interest rate most used in constituting mortgages, specifically in 86.8% of new contracts.


The average value of the mortgages signed in March increased by 1.5% on a year on year basis and reached 164,637 euros. The number of mortgages changing conditions increased by 1.6% and registered cancellations decreased by 33.8%.

Advance / Decline & Volatility Charts 2007-02-27

Following are a few charts of interest for February 27, 2007.
Click on any chart for a better view.

NYSE Declining Volume



NYSE Advancing Volume



NYSE Declining Issues



NYSE Advancing Issues



$Nasdaq Declining Volume



$Nasdaq Advancing Volume



Nasdaq Declining Issues



Nasdaq Advancing Issues



VIX



VXN

Quick Observations

Following are a few quick observations by 3 astute observers of today's stock and commodity market action.

Trotsky on The Market Traders:

I've seen something very unusual today - market-on-close bidding for index puts. I have a feeling this doesn't bode well for tomorrow.

There must be a load of open derivatives positions that have suddenly turned sour. e.g. I noticed a big put seller getting active just before the plunge accelerated, apparently on a 'this is business as usual' assumption. Maybe it is, but the odds chart-wise are that it isn't. Also, this has the typical feel of a sudden turn in sentiment from totally complacent to full of fear - and the fear has not found full expression just yet.

Please note, market 'liquidity' is largely a psychological phenomenon. It is those sudden turns when liquidity evaporates the fastest.

Professor John Succo on Minyanville:

Interestingly, I've only seen option sellers. Vega is up a little but not much. There's no panic put buying--the VXO is up only because correlation between stocks is up.

Professor Kevin Depew on Minyanville

Tomorrow has the potential to be an even more severe day. For one thing, unlike May when a partial carry trade unwind began mid-month, this "event" has occurred at the end of the month, beginning in Asia and spreading across the globe.

There are many risk models that will need to be de-leveraged tomorrow - portfolios that most likely were not even considered at risk going into today. With the VIX up more than 62% today models that adjust on month's end will require some fine-tuning tonight... to say the least.

What is most interesting as a tell is weakness today in gold and gold shares. Leverage is everywhere.

Leverage is indeed everywhere and today is just a down payment on the unwinding of that leverage. Whether or not tomorrow is "business as usual" remains to be seen but the risk of a "sustained event" is certainly not going away.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

GFK Consumer Climate Survey May 2008

German consumer confidence fell more than economists forecast in May, as inflation sapped purchasing power. GfK AG's foward looking index for June, based on a survey of about 2,000 people, declined to 4.9 from a revised 5.6 in May.

Rising inflation in May of this year has clouded the mood among consumers. The economic outlook indicator, income expectations and the propensity to buy all suffered considerable losses. As a result, the consumer climate indicator for June is forecasting a value of 4.9 points after a revised 5.6 points in May.

GFK emphasised that with oil and petrol prices constantly hitting new record highs and further looming price increases in areas like food, German consumers are becoming increasingly preoccupied by the constraints on their purchasing power. This has led to income expectations being assessed less positively than in April. Price increase expectations also meant that the propensity to buy fell sharply in May. Concerns about price stability and uncertainty resulting from the crisis on the financial markets and the flagging US economy are currently fueling economic fear amongst German consumers. This has resulted in the economic downturn becoming somewhat more pronounced than at the beginning of the year.

Turning to the sub-components, these are all sharply down this month.





Economic expectations

The significant gains in economic expectations last month could not be maintained in May. The indicator dropped back by almost 10 points to stand at 13.4 points.

GFK suggest that despite the fact the German economy did surprisingly well in the first quarter of the year, German consumers are looking towrads further economic development much more cautiously. It is becoming increasingly apparent that the crisis on the financial market is far from over and the current developments of the US economy while not being disastrous are also far from encouraging in the short term. Evidently, Germans are assuming that the strong GDP growth recorded in the first quarter of 2008 is not likely to continue and as a result, an economic slowdown is being anticipated. The continuing strength of the euro and the high rates of inflation are only intensifying this feeling.

In this light, economically positive developments, such as the good conditions on the job market, are currently taking more of a back seat.

Income expectations

After three months of successive growth, income expectations incurred marked losses in May. The indicator fell by 14.8 points to stand at -4.3 points. As a consequence, the gains made over the previous three months were almost completely negated.

In addition to a general concern about household purchasing power, the particularly high energy prices seem to be a major factor behind the current pessimism concerning future personal finances. Beyond this, discussions of price increases are currently drowning out the positive effects of the wage agreements concluded at the beginning of the year. Positive developments in the job market and the knock-on positive effects for income development are presently being eclipsed by strong inflation expectations.

Propensity to buy

In the wake of falling income and economic expectations, the propensity to buy also suffered major losses in May. The indicator dropped back 15.7 points, to now stand at -20.4 points.

The drop in buying propensity is mainly attributable to the increased fears of inflation. In light of soaring energy and food prices and the fear of further price hikes, any funds allotted to cover these increases can obviously not be used for other purchases.

German GDP Q1 2008 Detailed Results

As already reported here following the first release of data from the Federal Statistics Office on 15 May 2008, the German economy started 2008 with what seemed on the surface to be considerable momentum since on a price, seasonal and calendar adjustmented basis gross domestic product (GDP) was up by 1.5% higher in the first quarter of 2008 over the level achieved in the last three months of 2007.




Economic growth in the first quarter of 2008 was supported primarily by gross fixed capital formation, which continued to increase at a fair clip. Compared with the fourth quarter of 2007, investment in machinery and equipment was up by 4%, and capital formation in construction rose by even 4.5% owing to the comparatively mild winter. Overall final consumption expenditure, increased by 0.5%, the first such rise in over a year, however breaking this down we find that government final consumption expenditure was up markedly (+1.3%), while the final consumption expenditure of households showed a smaller increase (+0.3%) against. Inventory building, on the other hand, added a substantial 0.7% points to growth in the first quarter. Exports continued to grow (+2.4%) but in fact since imports rose even more strongly (+3.5%), foreign trade actually had a downward effect on gross domestic product in Q1 2008 when compared with the preceding quarter (see chart below).



So the bottom line is that the of the 1.5% increase in q-o-q GDP, nearly half (0.7% points) was accounted for by a growth in inventories, while 0.4% was accounted for by a growth in construction which was in part the result of better weather in January and February and scheduled work being advanced (although you can't simply add these numbers since some of the construction work may well have accumulated in inventories), while the net impact of external trade slowed, and household consumption only accounted for 0.2% points.

So basically it would be far from in order to announce this result as strong evidence for anything about the Germany economy at this point, other than that the economy resisted a strong slowdown in Q1. The data from Q2 should make all of this much clearer, I think, we will see what gets to happen to the inventories, and we will see what happens to construction.

Year on year a slight increase (+0.1%) was recorded for the final consumption expenditure of households following a decline in the four preceding quarters (see chart below). According to the statistics office this slight improvement is primarily due to a recovery in private car purchases (follwoing the VAT impact in Q1 2007), since expenditure on transport and communications, which includes also private car purchases, rose by an annual price-adjusted 2.2%.



In the first quarter of 2008, GDP was a price-adjusted 1.8% higher than in the same quarter one year earlier. The growth rate was a calendar-adjusted 2.6% as there had been two working days less in the reference quarter than in the first three months of 2007.



Q1 2008 gross domestic product was achieved by about 39.8 million persons in employment - 686 000 persons or 1.8% more than one year earlier. The number of unemployed (ILO definition) amounted to just under 3.5 million, having a share in the entire economically active population of 8.0%.

Overall labour productivity (price-adjusted gross domestic product per person in employment) rose only very slightly by 0.1% (another bad sign), although as measured per hour worked, there was an increase by 0.8% since the number of hours worked by those in employment rose much less than the number of persons in employment. This is a reflection of how Germany has been creating a lot of part time and temporary work in recent quarters.

Italy Business Confidence May 2008

Italian business confidence rose for the first time in seven months in May after Silvio Berlusconi's victory in the April national election resolved political uncertaintly to some extent and manufacturers' orders improved, raising slightly the short term prospects for higher production. The Isae Institute's business confidence index rose to 89.6, the highest since February, from a revised 87.6 in April, the Rome-based research center said today. That was the biggest monthly increase in more than a year.

``Confidence is bouncing back a little, but it won't be sustainable,'' said Paolo Pizzoli, an economist at ING Bank NV in Milan. ``When Germany's economy slows, it's going to hurt Italy.''

German growth is helping to offset the effect of a strong euro and rising energy costs. Germany's Ifo survey also rose slightly to 103.5 in May from 102.4, according to a May 21 report.

``The data is in line with what recently emerged from the Ifo survey of German manufacturers,'' Isae said in a statement. ``Businessmen are more optimistic about demand, especially foreign demand, and the outlook for production.''

In terms of the sub indexes, the measure of total orders rose to minus 16 from minus 18 in April, and the three-month outlook for production rose to 14, the highest since November, from 9 in April. An index of foreign orders rose to minus 16 from minus 20.

Understatement of the Month Award

The understatement of the month award goes to Garry Evans at HSBC for his comment on the Shanghai Composite Index "I think the market had gotten a little too expensive".

China's leading stock index tumbled nearly 9% Tuesday, marking its biggest plunge in a decade, on concerns of more economic tightening measures as China's parliament prepares for its annual session next week.

The Shanghai Composite Index, which tracks shares listed on the larger of China's two stock exchanges, tumbled 8.8% to 2,771.79. The declines rank as its biggest single-day drop since the benchmark plunged 9.4% on Feb. 18, 1997, which reportedly came after the death of reformist Communist Party elder Deng Xiaoping.
The Shenzhen Composite, a gauge of shares on China's smaller exchange, shed 8.5% to 709.81.

Analysts said the declines, which came a day after the Shanghai Composite ended at an all-time high, were sparked by concerns the government may implement new measures to cool speculative behavior.

Market watchers said investors in China were spooked by rumors the government may impose a 20% capital gains tax, while comments by People's Bank of China Governor Zhou Xiaochuan, published in a Chinese-language publication Tuesday, also stirred unease about the prospect for further rate hikes.

"If inflationary pressure increases the central bank should consider monetary policy action, including interest rate policy," the Xinhua Finance news service reported Zhou as saying in the interview, which was published in the Hong Kong Commercial Daily.

Investors were also wary that additional macro-tightening policies could be in the works after the annual session of the China's National People's Congress, which gets underway March 5. China's central bank lifted the reserve requirement on domestic banks by 50 basis points from Sunday.

"I think the market had gotten a little too expensive and had reached about 26 times forward price earnings, at the top of what we see as a fair value range," Evans said. Prior to Tuesday's decline the Shanghai Composite had risen 14% year to date, following on from a 130% gain in 2006.

Chart Defining "A Little Too Expensive"



How did this happen?

Inquiring minds might be wondering just how the market got "A Little Too Expensive". That's a good question. For the answer we turn to Eager Chinese grab bull market by the horns.

February 16, 2007

SHANGHAI — After emptying his savings account, Lu Gang borrowed funds from his mother, relatives and friends. Now he's planning to mortgage his home.

Where's all the money going? Into China's booming stock market.

"Both of my parents think it's crazy, but I think it is OK," said the 26-year-old investment company manager, who's already sunk about $15,000 into stocks since getting in on the action last summer. "If there is opportunity, you have to grasp it."

Millions of Chinese have entered the trading frenzy in the last year amid the strongest bull market in the nation's young capitalist history. The Shanghai composite stock index has doubled since August after four years of dismal performance. On Thursday, the Shanghai index set a fresh record, gaining 3% to finish at a whisker below 3,000.

Many individual investors have reaped handsome profits, but a growing number of them are tapping their credit cards and using their homes as collateral for cash to buy more stock, say bankers and analysts. That has stoked government concerns about excessive speculation.

China prohibits banks from giving consumers home-equity loans to play the stock market. So many people are hocking their homes with pawn shop dealers, who typically front borrowers as much as 60% of the value of their homes — but charge an annual interest rate of 36%.

China's Pawn Assn. recently warned its members about the risks of making such loans, saying that although it is quick and easy to advance cash to clients, collecting on loans in default is another matter. "It's quite complicated and troublesome to transfer ownership," said Wu Xianda, director of the association, which has about 100 members.

At Jinbao Pawn Shop in Beijing, manager Hu Bo usually sees a surge in business this time of year. Before the lunar New Year, which falls on Sunday, bosses seek extra cash to settle debts and pay bonuses to employees. But Hu estimates that the stock mania has helped push up Jinbao's mortgage loans by at least 30% this year.

He recalled one client in particular, a man in his 40s who mortgaged his 800-square-foot apartment in Beijing for $40,000. "I told him that he might suffer losses, but he insisted anyway. He was very confident. He said, 'I have targeted one good stock and I just need the money for one month.' "

"I just need the money for a month". Oops. It seems the market gave you less than two weeks. The unanswered questions of the month are as follows: "How many homes is Jinbao's Pawn Shop going to own at the end of the month, and what will manager Hu Bo do with them?"

Durable Goods

Meanwhile back in the states Core capital-equipment orders post biggest drop since January 2004.

New orders for U.S.-made durable goods plunged 7.8% in January as nearly every category of manufactured goods declined, the Commerce Department reported Tuesday. Transportation orders fell 18% in January after rising 3.1% in December. Aircraft orders fell 60.3% in January. But the weakness in January's durable-goods orders extended well beyond the aircraft sector. Orders excluding transportation fell 3.1% in January. This is the third drop in the past four months and the sharpest decline since July 2005.

Orders for core capital equipment, the kind of goods producers invest in to build their productive capacity, fell 6.0% in January, the biggest drop since January 2004. Core capital equipment orders (which exclude aircraft and non-defense goods) are the best monthly indicator of capital expenditures.
Economists said the drop raised questions about how strong business spending will be this year.

"With capital spending having been down in the fourth quarter, this trend is not something that makes one comfortable about the strength of the economy," said Joel Naroff, president of Naroff Economic Advisors. Ian Shepherdson, chief U.S. economist at High Frequency Economics, went so far as to say the factory rector was in a "recession."

The Yen

The weak capital goods report and the implosion in Asia seems to have gotten the carry trade players a bit nervous. Here is a chart of the Yen.


The Euro



The combination of the Euro, Yen, and Pound all being up means the US$ is sinking. But guess what? Treasuries are continuing their rally and the yield curve is further inverting.



Thanks to Bloomberg for the above chart. Click to refresh.

Yesterday, in Does anything mean what it used to? I noted that Bernanke thinks that the data suggests a "somewhat firmer economy" and Greenspan thinks housing has bottomed, and neither thinks the inverted yield curve means what it used to. Meanwhile fresh off the presses today The Boston Globe is reporting Massachusetts foreclosure filings smash record.

January had the highest number of monthly Massachusetts foreclosure filings in at least two decades as local consumers struggled to hang onto their homes, according to a new report.

Last month, 2,207 foreclosure filings - or 110 every business day - were submitted in Massachusetts, more than double the number of a year ago; filings in January 2007 were up 105 percent from 1,076 filings in January 2006, according to ForeclosuresMass.com, a Framingham firm that provides online Massachusetts foreclosure data to investors, real estate agents, and lenders.

"The flood of foreclosures in Massachusetts is not only continuing; it has reached a new high," company president Jeremy Shapiro said in a statement. "The fact we are starting the year with the highest number of foreclosures we've ever recorded for a single month is more than significant - it's ominous."

Message to Ben Bernanke: It's high time for you and Greenspan to leave Wonderland and face the real economy.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/