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Jeff Saut Presents: So Goes GM, So Goes the Country

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Collateral damage indeed...

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Greetings from Detroit, where I grew-up as a "kid" and often heard the axiom, "So goes GM, so goes the country." It was a heady time following WW II when folks "flocked" to the Motor City in search of high paying auto jobs. Back then General Motors (GM) was the employer of choice, for as my father used to say, "GM builds the best cars in the world!" Unfortunately, most car rating services no longer concur, causing my Dad to lament, "How times have changed." I can still remember my childhood escapades in the Fisher Building directly across from the now defunct General Motors world headquarters . . . indeed, how times have changed. Clearly, GM was in the media last week given its decision to sell a majority stake in its "prized" financing division GMAC. While I have absolutely no opinion on the stock of GM, over the years I have seen other companies sell-off the "family jewels" and most of the time that strategy has been questionable. Manifestly, selling-off profitable corporate divisions in an attempt to support money-losing divisions has tended to be a mistake. In GM's case they don't need to sell various divisions, like they are doing, they need to sell more CARS. Yet, GM has more problems than that.

While not selling enough cars is GM's biggest problem, its pensions and other post-retirement benefits are not far behind. Consider this: according to the King Report, there are more GM retirees than there are GM workers. Obviously, that puts a strain on GM's pension plan. Further, it appears as if the Financial Accounting Standards Board (FASB) is going to make corporate America move pension plans from the "foot notes" (off the balance sheet) of a company's financial statement onto the company's balance sheet. If this occurs it will obviously have negative implications for the cash balances of companies with pension plan deficits . . . hello GM ($68 billion in unrecorded liabilities). Troubling as these pension concerns are, even more troubling are the post-retirement benefit obligations (read: healthcare), which certain savvy seers put at two to three times the size of the pension crisis. No wonder GM is pulling out all the "stops" as reprised in a February 8, 2006 Wall Street Journal (WSJ) article titled, "At GM, Cuts in Pay and Benefits." The subtitles revealed even more as they read, "Board Halves Dividend as Cost, Competition Gang Up on Auto Giant" . . . "Curb on Pensions Follows Other Companies' Path; 'System Is Collapsing' . . . The End of Retirement?"

Last week GM pulled out another "stop" with the announced sale of 51% of GMAC. While that event grabbed headlines, the deal was best summed-up by Morningstar analyst John Novak who said, "The deal doesn't do anything to fix their auto operations." Indeed, if Alfred Sloan and Boss Kettering were alive, and still at GM, our guess is they would advise the company to work at becoming a "platform company," which is a term lionized by the astute folks at the GaveKal organization. Indeed, like platform-company Dell (DELL), GM should work toward focusing on design, marketing, and financing while outsourcing auto manufacturing to the "Chinas" of the world. Interestingly, that exact strategy was featured in last Wednesday's WSJ in an article titled, "In a Rare Bright Spot for GM, Its Korean Unit is on a Tear."

Unsurprisingly, we focused on GM this morning because of last week's news and because we are in Detroit speaking at seminars and to institutions. Yet, while what is/has happened to GM is a Harvard case study, we are particularly concerned with the "collateral damage" that is occurring from Detroit's woes. That damage was highlighted in yet another WSJ article titled, "Down and Out in Bloomfield Hills." Now for those who don't know, Bloomfield Hills, and Birmingham, Michigan are two very upscale suburbs of Detroit, as well as where I grew up. The article's title read, "As Detroit Wobbles, Even its Toniest Suburbs Feel Ripples from the Woes of GM and Ford." To reprise the first paragraph of said article:

"Foreclosures are up and charitable giving is down. A local country club has a waiting list – for members who want to quit. The market for expensive homes is so slow that Michael Robbins, a divorce attorney here, says one of his clients is still living with his ex – three months after the divorce was final."

However, GM and Ford's (F) economic "fall out" is not just centered in Michigan. Dateline Anderson, Indiana, February 16, 2006; The New York Times, "General Motors once had so many plants here that it had to stagger their schedules so that the street would not be clogged with traffic when the workday ended. At the city's peak, of 35 years ago, one of every three people in Anderson worked for GM. Now there is not a single GM plant left. . . . But in many ways, Anderson is still just as dependent on GM as it once was. Only now, rather than being dependent on General Motors, the corporation, it is dependent on General Motors, the welfare state. The company's generous medical plans, prescription drug coverage, dental care and pension checks are a lifeline for the 10,000 GM retirees and untold number of surviving spouses and other family members who still live in the Anderson area. They in turn help to prop up the doctor's offices, hospitals, buffet restaurants, and shopping centers that might otherwise vanish. . . . 'When we all die off, this city will die,' Jesse Lollar, 83, said last week, as he finished an early dinner of lima beans and macaroni and cheese at the MCL Cafeteria in the Mounds Mall. Other communities will start to look more like Anderson as GM carries out its plan to close a dozen factories and cut 30,000 blue-collar jobs by the end of 2008, in part by offering buyouts and early retirement packages."

Collateral damage indeed, for as GM and Ford "shrink" themselves, their suppliers, and the suppliers to the suppliers should feel the ripple effect. We have a difficult time envisioning how this "domino effect," when combined with rising interest rates, will not eventually slow the economy. While we still don't see a recession on the horizon, a view we have held for the last five years, we do think the economy will slow more than most expect. In the near-term, however, we believe the economic numbers will remain perky, the Fed will continue to raise interest rates until there is a financial accident, cries will emerge about Bernanke overdoing the monetary tightening, fallacious recession concerns will sprout, and the stock market will decline by more than just a few percent.

Consistent with these views, we remain "predominately defensive," to borrow a line from Charlie Knott eponymous captain of Knott Capital Management. Verily, we believe the broadening-top discussed in these missives for weeks is still in the process of being formed. Whether last Friday's flop completes the "top" remains to be seen, but Friday's action was pretty ugly. For those disagreeing with our cautious stance, a screen of Raymond James' research universe searching for companies with rising returns on invested capital (ROIC), and attractive re-investment opportunities, produced the following list of stocks and their attendant ratings from our fundamental analysts: Jabil (JBL); Benchmark Electronics (BHE); Wesco (WCC); Investment Technology Group (ITG); Cbeyond Communication (CBEY); Ultra Petroleum (UPL); and CNX Gas (CNX).

The call for this week: Eliot Janeway once opined, "When the President is in trouble the stock market is in trouble." Regretfully, the President is in trouble . . .

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