Monday, June 30, 2008

Listen to the Companies; not the Government Reports - Brunswick Corp (BC) & Smithfield Foods (SFD)

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I have no idea what the market will be doing today, this week, this month, or this year. I have been saying the real economy is in serious trouble, and that was stated under an impression oil would be at $90-$110 or so. What we have now is ever more frightful. The market has been and continues to be in denial; I have pointed this out repeatedly even in the face of conventional wisdom as the market raced to new highs in fall 2007. I continue to stress most traders on Wall Street have been conditioned to corporate led recessions - not consumer led. This is the first consumer led recession since the late 70s/early 80s and it appears most market participants are not students of history. We still live in denial - only now in inflation. Inflation is a tax on all things - consumers and producers.

I outlined in mid April a theme I've been repeating since blog inception - avoid the (bottom 80%) U.S. consumer and his discretionary income stream; it is disappearing. Stock tied to said consumer, will sometimes bounce around earnings reports because instead of "putrid" earnings, they report "horrid" numbers. And since horrid is "better than expected" versus putrid - a bunch of shorts get squeezed and the stock rises 20% instantly. And bulls clap gleefully that the American consumer is back, and the "sign of strength" of the stock is a clear signal that the "market knows more than we do". Ignore these pundits. They live in a fantasy world. Once the shorts are chased out of a stock, the spike is (in 95% of cases) over, and the stocks begin a drift down. This will continue. For a long time. Consumer discretionary is going to be the new financials. In fact it has been nearly as bad as financials - but it's being under reported.

I used to write this early in the blog but I should start repeating it: regardless of income strata most surveys show 70% of Americans live paycheck to paycheck. That's at $30K, $60K or $120K. They've lived in a relatively low inflationary environment for much of the latter 80s to early 00s. When that changed they had their house ATM as their piggy bank to supplement their paycheck. Now we live in a high inflation world and we're running out of ATMs. That doesn't spell months of pain and then recovery - nor quarters. It's going to be years. It is worth repeating those points for newer readers, and I will post the growing evidence (which is almost contradictory by 180 degrees to the spin in government reports) in the bottom of this post.

I cannot continue to stress enough how wrong analysts are on 2008 estimates and any company with focus on the US consumer is simply going to be blown apart in due time - if not this earnings season - then in the future. We are told daily how "cheap" these stocks are; this is based on the fictional body of work called "analysts 2008 estimates". Don't believe the hype. The subprime nation (us) is in trouble. Consumers make 70% of GDP. Its a consumption culture where the consumer is being drowned in negative wealth effect from housing, inflation from the Federal Reserve/global forces, and underemployment if not outright unemployment. [Apr 2: The Underemployment Rate is Rising] It is bad out there in the bottom 60% and it's creeping up to the formerly immune 20-40 percentile as well. So now it "matters" because that starts cutting into the bottom part of CNBC's audience. It is the perfect storm and I will utter the most dangerous words a financial commentator can ever utter - it *IS* different this time. Or at least it's certainly not like it's been in a long time...

People were asking me for individual names for shorts - I continue to stress the same themes I've stated since last summer - anything consumer related or based on American conspicuous consumption - it will all go. I was looking at a chart of Whole Foods (WFMI) and that's a perfect candidate - its held up "ok" because it relies on the upper middle class who can afford to pay $7.00 for organic milk. Well, when economics start to hit, people are going to have to stop being so "healthy" and buy what they can afford. That's just reality. Hence this looks like the prototypical short. As is Harley Davidson (HOG) [Jan 25: I Can't Believe this Pig...err HOG was up Today] [Sep 7: More Retail Tells? Harley Davidson and Office Depot], as is just about every restaurant in America [Sep 19: Tough Times Ahead? Restaurants] - even magical Chipotle Mexican Grill (CMG), as if just about every retailer in America ex-Walmart (WMT), etc. These stocks bounce every time the bulls pass their... well bull... that the consumer will be back any moment now and just "trust us" because in 6 months they'll be back in the malls spending like mad. Just. Plain. Wrong. These are going to be shorts for a long time. It won't be so easy as when I first called it out in early fall because we were still in the "no recession at all" camp, and the stocks had just began to weaken from much much higher levels. Now you have to short in smaller time frames, realizing dead cat bounces occur every 3-5 weeks as a "hopeful rally" will ensue. At which point, once it tuckers itself out - you short again. Keep repeating until CNBC finally tells us "we're heading into a deep, long recession" - and then you'll probably want to go long since the bottom will be in.

Simple as that. Next to go on the food chain will be entertainment - think casinos - Wynn (WYNN), Las Vegas Sands (LVS), MGM (MGM) - it is all going to suffer [Nov 1: A Top in Casino Names? Wynn and Las Vegas Sands] - that's an "extra" you don't "need". Disney (DIS) will hold up ok due to our cheap US peso bringing in foreigners but regional amusement parks without that international name recognition are going to suffer the same fate. Sorry to sound alarmist but this is the coming reality of a strapped, indebted US consumer whose real wages have been pummeled for years (this has not suddenly happened 18 months ago; it's just now catching up to us without the house ATM to hide the pain), and now is taking it on the chin with the Fed policy to devalue their currency to the tune of 1:5 ratio. Each dollar they now own becomes even more worthless.

So when you ask for specific names from me - its simple - what can you do without? What would you give up first, second, and third as your budget closes in on you? What will you sacrifice to pay for food, gasoline, heating, and air conditioning? Whatever you will skip on - short that stock each time the "early cycle" proponents run them up for a 5-7 day cycle, on wishful thinking. Even cheap holey shoes that cost half a ticket to a professional ballgame are seeing the pullback. The only people immune and the only products immune are those catering to the top 1% - Porsche yes - Ford (F) no. 60' yacht - yes. 22' Sea Ray powerboat - no. Avoid the "no's" which frankly is almost everything facing the domestic consumer. We're heading into a long, drawn out recession... I've said it since last summer and as each month/week/quarter passes more denial will turn into acceptance and more earning cuts will have to happen across the board. The people in denial rely on government reports, which are for the most part another pile of fiction work.

So in the last paragraph of my April entry, I talked about boats as one example (the smaller ones, not the yachts that the upper 1% enjoy). I stumbled upon Brunswick Corp (BC) which ironically one of our holdings, Cabot Oil & Gas (COG) just replaced in the S&P 500. This is a perfect "pooring of America" play as it hits a 17 year low (that's nothing, General Motors (GM) is at a 53 year low). But just as we had a positive multiplier effect from spending over our heads in a consumer driven economy, so will the opposite happen - as shops/plants close, people are let go, as they are let go, they cannot spend, which leads to more shops/plants closing - it is vicious. Just as it was virtuous on the way up - but much of it the past decade has been based on a fantasy of cheap dollars (printed by the bushel) and "if you have a pulse, you deserve credit". That's changing. Quick. Toss in this "we're in denial that there is no" inflation, and it's even more devastating. Let's see this cycle play out in just this one press release.
  • Brunswick Corporation (NYSE: BC - News) announced today a set of comprehensive actions to resize the company to improve profitability during the current downturn in the U.S. marine market, including actions to reduce its fixed-cost structure by $300 million versus 2007 spending levels.
  • "Retail unit sales of power boats in the United States have been in decline since late 2005; however, the rate of decline has been accelerating," McCoy added. "Industry retail unit sales were down 13 percent in the fourth quarter of 2007 and down 21 percent in the first quarter of 2008 compared with the respective year-ago quarters. Further, these reductions were recorded off of an already low base. Total unit sales of power boats in the United States in 2007 were at their lowest in more than 40 years."
  • "An uncertain economy, high fuel and food prices, slumping home sales and values, rising unemployment and other factors continue to erode U.S. consumers' confidence and are reducing their ability and desire to purchase discretionary items such as boats, and billiards tables and fitness equipment for their homes.
  • Brunswick stated that its $300 million cost savings target will be achieved in part by further shrinking its North American manufacturing footprint. The company plans to have 17 or fewer boat plants by the end of 2009, compared with the 29 it had in 2007. (read: job losses) This will require the closure of four plants in addition to eight plant closures already completed or announced.
  • A reduction in production rates also results, unfortunately, in the need for fewer workers." The company said that it had notified employees today that it would be reducing its hourly and salaried work force at certain of its marine plants by 1,000. Further work force reductions of approximately 1,000 hourly and 700 salaried employees across the company's marine business units and staff functions are contemplated as additional plant closures and consolidations and other cost-cutting measures are completed. (that's 1000 newly minted Walmart/Costco/Big Lots workers, with another 1700 coming)
So in our government reports these people will magically appear in new healthcare jobs, new government jobs, and new "we cannot measure it, but we will create a new category called birth/death model" jobs. And we'll smile at our mid 5% (up from 5%) unemployment rate, and ask what all the fuss is about - this is still low by historical rates. Listen to the companies, not the government reports.

On we go to completely unrelated Smithfield Foods (SFD), a company (and sector) I've followed since fund inception since its an agriculture tell. They produce a lot of hogs - that require feed. Feed that is skyrocketing. [Feb 28: Smithfield Foods Continues to Struggle with Input Costs] Friday? Down 20%. Inflation - tax on all things producer and consumer. Keep repeating it to yourself while Uncle Ben tells you that inflation will dissipate as the economy slows. He has been browbeating that into us for 9 months now. He is going to be right eventually - after a full scale global slowdown.
  • Shares of Smithfield Foods Inc. hit a five-year low on Friday, as an analyst downgraded the company and Standard & Poor's cut its ratings amid a difficult environment. Shares fell $4.34, or 17.6 percent, to $20.31, during late-day trading, after earlier reaching a low of $20.12. The last time the stock traded that low was January 2003.
  • D.A. Davidson analyst Tim Ramey wrote in a note to investors that record-high corn prices make it difficult to predict when Smithfield's hog farming losses will end.
  • Grain prices have soared in the past year, driven by world demand for wheat, corn, oats and soybeans to feed people and livestock. Furthermore, crops have also been battered by bad weather around the globe.
  • "The combination of reduced earnings, deteriorating credit quality, surging working capital and no foreseeable peak in corn prices points to share price risk to the $14 level," Ramey wrote. (but other than that, things are going well)
  • Meanwhile, S&P lowered its ratings on the Smithfield, Va.-based company, including lowering its corporate credit rating two notches to 'BB-' from 'BB+'. S&P said it expects the company will face a "challenging" operating environment in its hog production segment through most of fiscal 2009 due to higher feed costs and soft hog prices.
Or we can check on near peer Sanderson Farms (SAFM), another company we like to watch for the same reasons as Smithfield. Nothing major here except a planned plant will not be going into operation because of same inflationary costs. That's 1500 future jobs NOT created (hey perhaps they could of used the former boat employees) Tyson Foods (TSN)? Same problem.
  • Sanderson Farms Inc. late Thursday indefinitely delayed construction of a new chicken-processing plant, underscoring the repercussions of skyrocketing corn and soybean costs on the chicken and meat industries. Sanderson had planned to break ground on the $126.5 million plant this summer. When running at full capacity, the plant was expected to boost the company's current supply of chickens to the retail market by 1.25 million birds per week, or 6.7 million pounds.
  • Sanderson's decision comes a day after Tyson Foods Inc. pulled the plug on its meat-processing business in Canada.
  • The Kinston, N.C. site is also to include a feed mill and hatchery, employing 1,500 workers and contract deals with 130 regional chicken growers.
  • Sanderson, which doesn't hedge its feed grain costs, will likely being paying more for corn to feed its chicken flocks. It bought 90% of its corn for prices between $5.50 and $6 a bushel; those supplies run out at end of July. Corn for July delivery is trading around $7.54.
So you see, when the inflation reports, already massively incorrect, go another step forward and say, exclude food and energy as well... because really what effect do those have on the real economy... you can see why their "predictions" have been so completely wrong, time after time. When you live in the Twilight Zone - your predictions are just as zany.

This is just the consumer story - the next layer will be the local government story - those zany high prices in steel and petrol... combined with sagging government revenues from both real estate price deflation and lowered sales tax receipts are going to mean a lot of very bad things for state budgets. And cutbacks. Lots of cutbacks (forced) by legislatures that did not save for a rainy day. Because that is so unAmerican. Because as 70% of Americans live paycheck to paycheck, I could guess 98% of governments do. And a new fiscal year begins in 24 hours. But that story that won't be hitting the mainstream until later in the year... probably by the time public schools start panicking.

It's going to be a very tough economy, and a stock pickers market for years to come. The days of throwing a dart and making money (I miss you 80s and 90s) are off to hibernation. Unfortunately the bubble allowed to form by Uncle Al in the housing market is going to make the NASDAQ tech bubble look like child's play. The reaches of this bubble are so much more pervasive.

If you want to know what is happening in the "real economy", listen to the companies; ignore the wizardry coming from behind the velvet curtain in Washington D.C.

Long iPath DJ Livestock ETN in fund, no personal position

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