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Sunday, June 14, 2009

How's the Economy Doing? Let's Look Under the Hood

Our investment strategy focuses on bottom-up analysis of individual companies. Therefore, we try not to be absorbed or overly influenced by macroeconomic conditions. However, we can't operate in a vacuum unaware of trends that may impact certain companies or sectors. In this regard, we've received a few questions in recent weeks about our views on current conditions and where the U.S. economy is headed. The quick answer is: your forecast is probably as good as ours, but we can relay data that reveal challenging conditions all around.

Railroads - from Association of American Railroads : "U.S. railroads originated 260,282 cars during the week ended June 6, down 19.8 percent from the same week in 2008, with loadings down 16.5 percent in the West and 24.4 percent in the East. Intermodal volume of 188,801 trailers or containers was off 20.1 percent from the same period last year, with container volume falling 15.3 percent and trailer volume dropping 37.7 percent. Eighteen of 19 carload commodity groups were down from last year, with declines ranging from 6.7 percent for grain mill products to 68.2 percent for metallic ores. The lone group showing an increase was the catch-all category labeled “all other carloads” which was up 24.4 percent." Link here.

Trucking - from American Trucking Associations (yes, ATA is plural): "Compared with April 2008, tonnage contracted 13.2 percent, which was the worst year-over-year decrease of the current cycle and the largest drop in thirteen years. In March 2009, tonnage dropped 12.2 percent from a year earlier." Link here.

Air - from IATA: "The International Air Transport Association (IATA) released international traffic data for April showing a 3.1% decline in passenger demand and a 21.7% fall in cargo demand compared to April 2008. The average passenger load factor stood at 74.4%.... Freight demand appears to have found a solid floor with a fifth consecutive month at more than 20% below previous year levels." Link here.

Semiconductors - from SIA: "The Semiconductor Industry Association (SIA) today [6/5/09] released its annual mid-year forecast projecting worldwide sales of $195.6 billion for 2009, a decline of 21.3 percent from sales of $248.6 billion in 2008." Link here.

Residential Housing Permits and Starts - from US Department of Housing and Urban Development: "Privately-owned housing units authorized by building permits in April were at a seasonally adjusted annual rate of 494,000. This is 3.3 percent (±2.3%) below the revised March rate of 511,000 and is 50.2 percent (±1.4%) below the revised April 2008 estimate of 991,000.... Privately-owned housing starts in April were at a seasonally adjusted annual rate of 458,000. This is 12.8 percent (±13.0%)* below the revised March estimate of 525,000 and is 54.2 percent (±6.0%) below the revised April 2008 rate of 1,001,000." Link here.

Mortgage / Real Estate - from Annaly Capital Management monthly commentary: "Delinquencies on subprime mortgage loans rose to 24.95% [in 1Q09] from 21.88% in the fourth quarter of 2008, which should surprise no one. However, prime loan delinquencies rose to 6.06% from 5.06% one quarter ago, a significant and disconcerting increase from a group of borrowers that had previously been holding up much better. The percentage of loans in foreclosure increased 61 basis points to 2.49% for prime loans, and 63 basis points to 14.34% for subprime loans." Link here.

So, the longer answer is: the environment remains tough and most sectors are seemingly seeing 10 - 20% Y/Y declines as inventories are worked downward to adjust for slack aggregate demand. Also, real estate is still a big problem. The good news is that once we reach 4Q09 and 2010, Y/Y comparisons for the economy will be against very weak 4Q08 and 2009 figures, which could at least bring stability and set the stage for inventory restocking (growth) at some point (impossible to say exactly when, could be beyond 2010).

In recent months, we took advantage of certain asset plays in real estate -- Brandywine Realty Trust (BDN, $7.04) and Weingarten Realty Investors (WRI, $14.80) -- and in mining/retail -- Harry Winston Diamond Corporation (HWD, $6.59). However, we generally prefer well positioned franchise type businesses that are generating significant excess cash flow and that have limited to no debt. Examples in this category include eBay (EBAY, $17.80), Yahoo! (YHOO, $16.40), j2 Global Communications (JCOM, $23.37), and Youbet.com (UBET, $2.77), all of which we own. Further, we continue to believe that companies that are actually growing in this economy -- such as Youbet and Sonic Foundry (SOFO, $0.68) -- should outperform the broader market, although this hasn't necessarily been the case in the recent rally as some the highest risk names/sectors seem to be the big winners.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long BDN, WRI, HWD, EBAY, YHOO, JCOM, UBET, SOFO.

© 2009 Jeffrey Walkenhorst
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