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Thursday, August 20, 2009

How's the Economy Doing - Under the Hood in August

This is an update of our "How's the Economy Doing" post from June. As a reminder, while our our investment strategy focuses on bottom-up analysis of individual companies, we think awareness of overall macroeconomic conditions is helpful since trends that may impact certain companies or sectors. On 8/12/09, we wrote about the many mixed views regarding what happens next in the Market and the economy. Rather than speculate on which view is correct -- we can't say for sure and the market will do what it does, often detached from fundamentals in the short-run -- let's look at some hard data:
  • Railroads - from Association of American Railroads: "For the week ended Aug. 8, 2009, U.S. railroads reported originating 274,633 cars, down 16 percent compared with the same week in 2008. Regionally, carloadings were down 14.1 percent in the West and 18.8 percent in the East. Intermodal volume of 195,014 trailers or containers on U.S. railroads was down 16.6 percent from the same week last year. Container volume fell 10.8 percent and trailer volume dropped 38.1 percent. Total volume on U.S. railroads for the week ending August 8 was estimated at 29.3 billion ton-miles, off 14.8 percent from the same week last year. All 19 carload freight commodity groups were down from last year, with declines ranging from 6.1 percent for chemicals to 48.3 percent for metals and metal products. For the first 31 weeks of 2009, U.S. railroads reported cumulative volume of 8,159,672 carloads, down 18.9 percent from 2008; 5,764,816 trailers or containers, down 17.1 percent, and total volume of an estimated 868.3 billion ton-miles, down 18 percent. Combined North American rail volume for the first 31 weeks of 2009 on 14 reporting U.S., Canadian and Mexican railroads totaled 10,357,235 carloads, down 19.8 percent from last year, and 7,158,845 trailers and containers, down 17.1 percent from last year." Link here.
  • Trucking - from American Trucking Associations (yes, ATA is plural) for the month of June (reporting lag): "Compared with June 2008, tonnage fell 13.6 percent, which surpassed May’s 11 percent year-over-year drop. June’s contraction was the largest year-over-year decrease of the current cycle, exceeding the 13.2 percent drop in April. ATA Chief Economist Bob Costello said truck tonnage is likely to be choppy in the months ahead. “While I am hopeful that the worst is behind us, I just don’t see anything on the economic horizon that suggests freight tonnage is about to rise significantly or consistently,” Costello said. “The consumer is still facing too many headwinds, including employment losses, tight credit, and falling home values, to name a few, that will make it very difficult for household spending to jump in the near term.” He also noted that inventories, relative to sales, are still too high in much of the supply chain, especially in the manufacturing and wholesale industries. “As a result, this is likely to be the first time in memory that truck tonnage doesn’t lead the macro economy out of a recession. Today, many new product orders can be fulfilled with current inventories, not new production, thus suppressing truck tonnage.” Link here.
  • Air - from IATA: "The International Air Transport Association (IATA) announced international scheduled traffic results for June showing passenger demand declining 7.2% compared to the same month in the previous year while freight demand was down 16.5%. International passenger load factors stood at 75.3%, down from 77.6% recorded in June 2008. The 7.2% drop in international passenger demand was a slight improvement on the 9.3% fall in May. The capacity adjustment of -4.3% did not keep pace with the fall in demand leaving average fares and yields under significant pressure. As a result, June revenue on international markets fell by a shocking 25-30%. Cargo demand remained weak at 16.5% below June 2008 levels. This is a moderate improvement, albeit from extremely weak levels, over May, which was 17.4% below 2008 levels. There has been some improvement in world trade and, after adjusting for seasonal fluctuations, freight volumes rose 6% from the low point recorded in December 2008. However, the utilization of air freight capacity on international routes remained very weak (47.3%) in June due to unbalanced trade flows with Asia and some market share loss to ocean transport." Link here.
  • Semiconductors - from SIA: "Worldwide sales of semiconductors for the second quarter of 2009 were $51.7 billion, a 17 percent increase from the first quarter when sales were $44.2 billion, the Semiconductor Industry Association (SIA) reported today [8/3/09]. Second-quarter sales declined by 20 percent from the $64.7 billion recorded in the like period of 2008. Worldwide sales in June were $17.2 billion, an increase of 3.7 percent from May when sales were $16.6 billion, but 20 percent lower than the $21.6 billion reported for June 2008. Year-to-date sales of $95.9 billion were 25 percent below the first six months of 2008, when sales were $127.5 billion. All monthly sales numbers represent a three-month moving average of global semiconductor sales." Link here.
  • Residential Housing Permits and Starts - from US Department of Housing and Urban Development: "Privately-owned housing units authorized by building permits in June were at a seasonally adjusted annual rate of 563,000. This is 8.7 percent (±3.0%) above the revised May rate of 518,000, but is 52.0 percent (±3.6%) below the June 2008 estimate of 1,174,000. Single-family authorizations in June were at a rate of 430,000; this is 5.9 percent (±1.4%) above the revised May figure of 406,000. Privately-owned housing starts in June were at a seasonally adjusted annual rate of 582,000. This is 3.6 percent (±11.3%)* above the revised May estimate of 562,000, but is 46.0 percent (±4.3%) below the June 2008 rate of 1,078,000. Single-family housing starts in June were at a rate of 470,000; this is 14.4 percent (±11.8%) above the revised May figure of 411,000." Link here.
  • Commercial Real Estate - from Annaly Capital Management monthly commentary: "On Friday July 31, Property and Portfolio Research (“PPR”) issued their Q209 forecast entitled “Keep Your Eyes Shut; It’s Scary Out There.” The picture painted by the report is not pretty. Vacancies have not peaked and occupancies have not hit bottom. This observation was confirmed through the release of the Fed’s beige book on July 29 reflecting data through July 20. All twelve districts reported that leasing of commercial real estate was either “slow” or “weak.” Transactions are at a near standstill reflecting a combination of frozen capital markets and wide “bid/asks” in terms of pricing. Cushman & Wakefield Inc. reported that overall asking rental rates for prime Park Ave, NY office locations have dropped on average 35% to approximately $76 psf. over the past 18 month. Contributing to the eroding rentals is a fourfold increase in sublet space." Link here. As a sidebar, this view is similar to what we wrote in June about commercial real estate -- we think fundamentals remain challenged.
Thus, as relayed above, the hard data is decidedly negative on a Y/Y basis and jibes with anecdotal information we've collected:
  • the job market for white and blue collar workers is extremely difficult around the country
  • like commercial real estate, residential real estate activity is very slow with plenty of for sale signs in most suburban neighborhoods (in particular, we can vouch for the Greater NYC area) -- we think prices will continue to fall well into 2010, especially since real estate typically runs in very long cycles (i.e. seven years up, seven years down, seven years up, etc.) and the last up-cycle lasted approximately ten years (ending in mid-2006)
  • all kinds of services are being impacted by the downturn, including barbers (our NYC barber: "business is slow and we're losing customers because they're moving out of the city")
  • the hatches remain mostly battened up in venture capital community and poor returns over the past decade leave many investors scratching their heads over future capital allocations
Of course, the Market is forward looking, and, what we call "the hope rally" since March is based on the hope that things will surely soon get better on the back of government stimulus packages in the U.S. and elsewhere. We're natural optimists and also hope so, however, we're inclined to remain in the cautious camp. Now and always, we need to pick our spots with a preference for very low multiples of current earnings and growth.

Fortunately, we do see some reasons for hope: inventories are being worked downward to adjust for slack aggregate demand and, as noted in June, once we reach 4Q09 and 2010, Y/Y comparisons for all sectors of 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. We should no longer see negative 10 to 20% Y/Y declines in 2010 and could even see areas of growth (which largely explains the hope rally).

Unfortunately, we've missed a number of incredible stock moves -- four to five times March lows -- by being in the cautious camp and avoiding most cyclical companies with still horrendous fundamentals. Yet, we've done well with select cyclical plays where we saw a margin of safety, such as Harry Winston Diamond Corporation (HWD, $5.60), Brandywine Realty ($10.00), Sun Communities (SUI, $17.50), and Wiengarten Realty Investors (WRI, $18.00). In addition, we continue to sleep well owning franchise type businesses that are currently generating significant excess cash flow and have limited to no debt. As before, examples in this category include eBay (EBAY, $21.37), Yahoo! (YHOO, $14.87), j2 Global Communications (JCOM, $22.91), PetMed Express ($18.00), and Youbet.com (UBET, $2.39). Finally, given our quick post on Y/Y retail sales declines yesterday, people may think we're crazy for owning Bidz (BIDZ, $3.06), yet we see reasons to own the bombed out online retailer. At the more speculative end, we still like Sonic Foundry (SOFO, $0.57) given the company's leading market position and continuing growth.

Happy investing,

Jeffrey Walkenhorst


© 2009 Jeffrey Walkenhorst
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