Charts in the Babson Style for Midweek 2 July 2008

Unless we get a major market move tomorrow there will be no updates until Monday because of the holiday weekend.

Meredith Bombs Merrill - the Bottom is Not in for Financials

The script for today was a short squeeze, but just before the open Meredith Whitney bombed da boyz with a serious earning estimate cut on Merrill Lynch.

This after a general pall of gloom was cast by the worse than expected ADP jobs estimate. The Street is edgy about the June Jobs Report coming to town tomorrow ahead of the US holiday weekend.

Look for the Street to try hard to shake all this off, as the fops of finance are sitting on a pile of cash and the shorts are leaning too heavily on the financials.

We wonder how long it will be before Meredith gets a fabulous offer from one of the bigger houses, and then gets assigned to cover something else. Thanks for 'telling it like it is' Meredith.

Merrill Lynch Estimates Cut by Oppenheimer's Whitney
By Josh Fineman
July 2, 2008 09:42 EDT

July 2 (Bloomberg) -- Merrill Lynch & Co. had its second- quarter earnings estimate cut by Oppenheimer & Co.'s Meredith Whitney on expectations subprime writedowns will be as large as $5.8 billion.

Merrill, the third-biggest U.S. securities firm, will probably lose $4.21 a share, Whitney said in a report today, compared with her earlier estimate for a profit of 20 cents for the New York-based company.

Analysts and investors are reversing their predictions that the worst of the credit-market contraction is over after more than $400 billion of writedowns and losses by the world's largest financial institutions. Lehman Brothers Holdings Inc. last month increased its loss estimate for Merrill and more than doubled its prediction for the firm's subprime writedown, to $5.4 billion.

``Given Merrill's headwinds of de-leveraging and the next disruptive step of restructuring, we believe Merrill's shares are expensive,'' said Whitney, who has an ``underperform'' rating on the shares.

Merrill, which reports second-quarter earnings in two weeks, fell 25 cents, or 0.8 percent, to $32 at 9:36 a.m. in composite trading on the New York Stock Exchange. The stock is down 40 percent this year.

Sanford Bernstein & Co.'s Brad Hintz last month reduced his estimate for Merrill to a loss of 93 cents a share from a profit of 82 cents and predicted a writedown of $3.5 billion. Goldman Sachs Group Inc. analyst William Tanona reduced his Merrill estimate to a loss of $2 from earnings of 25 cents and predicted a writedown of $4.2 billion.

Whitney estimated a wider 2008 loss of $5.37 compared with her earlier prediction for a loss of 45 cents. For 2009, she sees profit of $2.85, down from $4.05 previously.

Whitney also said she expects Merrill to announce an asset sale, probably involving its stakes in BlackRock Inc. or Bloomberg LP, the parent of Bloomberg News.

To contact the reporter on this story: Josh Fineman in New York at jfineman@bloomberg.net.

Here Comes Inflation Driven by Non-Wage Inputs

There is a rule of thumb in economic circles that a chronic price inflation cycle does not set in until wages start increasing, triggering a wage-price spiral.

That rule of thumb is going to be seriously tested in the upcoming months. US business has done almost all that is possible to cut costs on the wage front significantly through outsourcing.

However, given the extreme monetary inflation stressing almost all other inputs to the corporate product management income statements, prices look ready to start moving much higher across the board, in any business impacted by material and energy costs.


THE ECONOMIC TIMES
Surging costs catch up with corporate America
2 Jul, 2008, 0110 hrs IST
REUTERS

BOSTON: US manufacturers are turning to price increases as their only way to offset record-high energy bills and surging raw material costs, deciding that the risk of losing some sales is worth preserving profit margins. The moves are a sign that companies are running out of ways to offset the rise in key costs including oil, natural gas, steel and aluminum, while betting their customers will have little choice but to accept higher prices.

Manufacturers including Navistar International and OshKosh Corp over the past week have told investors they plan to raise prices. "Companies are definitely getting more aggressive in terms of raising prices," said Kurt Spieler, a fund manager at the Fort Collins, Colorado-based First Focus Growth Opportunities Fund, whose key industrial holdings include L-3 Communications Holdings Inc, Joy Global and Agco Corp.

"Initially they tried to manage their profitability through productivity improvements, becoming more efficient, some cost cutting. But now with the extent of the rise in raw material costs, that's just not sufficient," Spieler said.

"The interesting part will be how much the prices that they're increasing will stick in a pretty tough economic environment." The question of whether price increases will stick -- and will be phased in quickly enough -- was one that haunted investors in United Parcel Service Inc, the world's largest package delivery company, and its main US rival FedEx Corp last month.

Both companies cut their profit forecasts, citing higher oil prices, and analysts warned the fuel surcharges the companies were imposing did not seem to be coming in fast enough to offset more expensive energy costs.

'GET IT IN PRICE'

Navistar, a maker of trucks and engines, has locked in its pricing on steel and aluminum through the rest of this year, said Chief Executive David Ustian. The company expects its energy bills to go up again next year, and to offset that, he said it will have to raise prices as well as look for ways to trim other costs. To justify higher prices to customers, Navistar will offer more fuel-efficient products that will save them money in the long run.

"Commodities are a challenge for the entire country and certainly in the trucking industry," Ustian told investors on Monday. "The real answer to it ... is get it in price." Navistar is not alone in bracing for more cost pressures. A survey by consultant RSM McGladrey of 912 manufacturing and distribution companies, which will be released next week, found that more than 80 percent expected energy, raw materials and shipping costs to rise at least 6 percent over the course of the year.

"We continue to experience headwinds in our manufacturing costs that impact progress against our productivity targets," Rich Kramer, who heads Goodyear's North American tire operations told investors. "We continue to attack all of our costs aggressively." "There's a lot of things we can do in the factories to take variable labor (costs) out, to take actions around energy," Kramer said.

PUTTING THE BOTTOM LINE FIRST

OshKosh plans to raise prices on its fire trucks, concrete mixers and other large vehicles 3 percent to 9 percent, scale back capital spending and look for other ways to cut costs to cope with higher energy and steel prices. "We haven't had significant pushback from customers, our competitors seem to be similarly increasing prices," Robert Bohn, OshKosh's CEO, told investors last week. OshKosh's competitors include Navistar, Federal Signal Corp and Terex Corp.

But any time a business raises prices it runs the risk of losing sales. The fact that companies are moving to raise prices suggests they may be looking to protect profit margins in the face of a slowing U.S. economy. "Just as the perceptions of consumers can affect their spending decisions, the confidence of manufacturers can certainly have an impact on their behavior," said Michael Goodman, director of economic and public policy research at the University of Massachusetts' Donahue Institute.

"In a different economic environment, someone might take a loss-leader to gain market share or to open up a new avenue of business. But the willingness to do something like that is going to be directly related to confidence."

The Price of Oil Exposes the Monetary Inflation of the US Economy

This seems so obvious that we have been putting off the task of actually writing it out. Since several economists have been tripping over their own equations and assertions in order to prove a point in the mainstream media, producing nothing but confusion, we felt compelled to take the time to write out some thinking points for your consideration.

We would also like to preface this by saying that of course there is speculation in the oil market. There is a degree of speculation in all markets which are not purely mechanistic, centrally controlled, where variables are not certain. These are known as 'free markets.'

Speculation is nothing more than the arbitrage of information. The better question is: is this market being manipulated? That is another question better answered by the power of subpoena and a good hard look at the market regulation and significant players who tend to have access and control of important market information. That question often goes unasked and unanswered. An unregulated or loosely regulated market is likely to be corrupted over time. This is the way of the world except in the eyes of ardent romanticists, and some academic papers.

The most commonly observed condition in US commodity markets is called contango. That means that prices in future delivery months are progressively higher than in the nearest delivery months. Why is this so common?

The reason for this is simple: the Federal Reserve is creating an often gradual but persistent monetary inflation which we have seen for almost the last 100 years.

This is same reasoning behind the mechanism of most discounted cashflow analyses so commonly used in finance. There is also the 'perceptual' element. As the perception of future inflation increases increasingly the current prices of things begin to reflect that inflationary bias in their future prices.

Let's suppose you own some 'commodity,' something like a rare coin.

Lets assume that market perception and pricing seems to reflect a steady increase in the price of your coin for a variety of reasons including demand and simple inflation.

As the perception of inflation increases, the 'demand' for your coin may start increasing more geometrically, because it is viewed as protection from that monetary inflation. The price increases for such coins can become rather dramatic as a result, as we saw in the last flight from monetary inflation in the US back in the 1970s-1980s.

How does one make a decision then to sell that coin?

There are two motivations at least: the 'need' to sell to obtain short term funds and the desire for a optimum or 'fair' price from your point of view. If you do not need the money for some urgent reason, like a child's tuition or the gasoline bills, then you can ignore that impulse for a sale. If not, if you do need to exchange the rare coin for money urgently, then there is a range price dampening motivations from discretion to distress.

For now let us take the urgent need for cash out of our equations.

We are left then with the determination of a fair price, or profit maximization. How do we determine such a price target?

One common way to do this is to at price history. But even recent history may be stale news in active markets. The other way is to investigate offered prices, from the near term demand driven prices, perhaps with less regard to other factors, and further out to a calmer waters in the months and years out, depending on one's timeframes. The way this has been expressed is that today's prices are a voting machine, while future prices are a discounting machine.

A rational investor will look out at the broad market perception of prices in the future, run a kind of discounted cashflow on the basis of THEIR own inflationary expectations and other assumptions, and then arrive at something approximating a fair price for the near term. That discounting needs to include storage costs, opportunity costs, probability of exogenous events, etc.

This is the price at which the market will clear for those not under duress, personal factors such as a short term need for cash aside. If the market is making a fair price is will clear, and there will be little hoarding of supply. If for some reason the market is presenting sellers with an artificially low price that is determined to be so, such as in the case of wage and price controls or rigged statistics, then hoarding will occur. Hoarding will only occur as prices increase if they are being held down artificially despite the increases, all other things being equal.

Hoarding would be more probable in a market with artificial price controls, and/or no futures market which would make current price more subject to near term duress. Why hoard, when one can 'sell it forward' in a futures market. This involves more than just storage costs, but the 'half life' of the products and their fungibility to future sales, their utility towards storage.

In a prior blog we attempted to explain how there really is no 'spot market' but just the price at which transactions are occurring on an individual basis. The real mechanism for price discovery is in the near term futures markets, and the 'front month.'

Monetary inflation is a clear input to oil prices for oil prices in US dollars, besides supply and demand. There are also the opportunities for exogenous events to disrupt supply, as in the case of war or accidents or natural disasters. Or demand, as in the growth of new economies and demand for oil.

The probability of these events becomes an opportunity for speculators to calculate their like impact on the future price of a commodity, and then take positions accordingly. This is 'betting.'

The net of all this is that what the oil market is telling us is that the published government inflation numbers are bunk, and that in discounting the expectations of future prices, the market is demanding higher prices. There is also a perception that oil demand will increase, and supply may be disrupted.

Does this involve speculation? Of course, since the probability of exogenous events is not a 'knowable' variable, with any degree of certainty, unless you cheat, in the case of certain well known market equations, and assume a 'normal distribution.'

Commodity and currency markets are notorious for overshooting or overrunning trends. Why is this? It is because of the speculative element, but that may be a discussion for another day.

There is an undeniable increase in demand from the developing economies, who may actually be subsidizing the price of oil to their own people to stimulate growth, as in the case of China. There is also the potential for 'peak oil' and the debate surrounding that macro event. But these are all inputs into prices with degrees of probability, fruitful for speculation, all made more likely by a surfeit of money with no better productive outlets for its use.

We hope this helps. It is not that complex. But for some reason the establishment does not find itself capable of discussing the perception of the current monetary inflation, refusing to discuss broad monetary measures like M3 and the manipulation of common Consumer Price Index number with simply outrageous assumptions and changes.

This meets and exceeds 'no-brainer' status because not only is oil increasing in price in US dollars, but so too are almost all commodities. We also wonder if a sustained distortion of inflation statistics does not in fact mimic artificial wage and price controls, ultimately leading to supply shocks and shortages?

You can usually tell when an 'expert' doesn't know, does not wish to say, or does not wish to admit an error because they tend to retreat into equations and technical jargon. Trust us on this one. In this case, economists are badly failing to fulfill their role in society, as is the broad news media. The reasons for this are also a good topic for another day's discussion