Five Things You Need to Know: Inside the PPI; Quick Note On Demand and Debt; Fed's "Other" Tools; Burnt Ciena; It's a Record!
What you need to know (and what it means)!
Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. Inside the PPI
Producer Prices surged 3.2% month-over-month in November, the headline fed by a huge increase in energy prices. And suddenly the Fed's inflation hawks no longer look so out of touch.
- Even core PPI (the number that is calculated to exclude food and energy) rose 0.4%, well above expectations for a 0.2% increase.
- What's so weird is the 3.2% headline increase was the largest one-month gain since 1973, the year the Miami Dolphins completed the only perfect season.
- So it's no coincidence that in some strange and terrible inversion of reality the Miami Dolphins are on track this year to complete the exact opposite of their perfect season.
- So is this the return of 70s style inflation/stagflation?
- No. It's that strange and terrible inversion thing again.
- What may look like stagflation now is the transition from excessive risk-seeking behavior, a seemingly endless appetite for credit, and the correction to the Federal Reserve-engineered credit expansion.
- What we see as stagflation looming in our side-view mirror today - note that removing the heavy influence of car and truck prices from core PPI, it was really only up a hair under 0.01% - could become full-blown deflation up-close as dollars are hoarded to pay down excessive debt as consumers reduce, reduce, reduce.
- Things will be clearer tomorrow with the Consumer Price Index release.
- What we are watching is for pass-through, companies passing on their increased costs to consumers.
- That will be trumpeted as the Return of Inflation, but in reality it will be the harbinger of deflation as demand collapses under what is perceived to be "excessive debt."
2. Quick Note On Demand and Debt
On my desk right now is a very depressing paperback book titled, "After the Crash." This book claims it will tell me everything I need to know about "how to survive and prosper during the depression." Wait, I left out the best part. This book claims it will tell me everything I need to know about how to survive and prosper during the depression... OF THE 1980s! Dang. Looks like I might be too late.
What is interesting about this book is the scenario it warns is coming:
- Money barely worth the paper it is printed on
- Cities in default
- Banks closing
- Social fabric coming apart
- Excessive debt
Hmm, check. Check. Check. Check. Check. Maybe I'm not too late; maybe the book was just way too early? But seriously, the questions raised by the mere existence of this decades-old book are legitimate. Among them, why should we worry about excessive debt and a collapse of demand that has been "on the horizon" for decades? And hasn't there always been "too much debt"?
The answer is that it is not about debt qua debt. It is about the perception of debt. If it were simply a matter of looking at how much debt is in the economy, determining the point at which that debt becomes excessive, and then sitting back and watching as it is unwound then economics wouldn't be called the "dismal science."
How long can we continue the path of a credit-engineered economy? As long as we can maintain the appearance of the ability to service that debt. But the links in the chain are all interdependent. When one link weakens or breaks, the chain ceases to be a chain, it's functionality broken. Moreover, this chain's construction is not entirely physical. It's existence depends not only on raw materials - in this case credit, currency, assets - but on the observation of what those raw materials mean and the attribution of something tangible to them. If we're talking about a breakdown or weakening in the raw materials of this chain, it can be repaired and survive. But if we're talking about a breakdown or weakening in the observation of those materials and what they mean, well, at that point you might as well call the chain a unicorn. It's beyond repair.
3. Fed's "Other" Tools
Of course, it's never a good idea to underestimate the ingenuity of a central bank. New York Federal Reserve President Timothy Geithner this morning said central bankers are looking at "additional instruments'' to provide funds to banks.
- Central bankers around the world have begun a "coordinated review'' on liquidity risk and whether they need "additional instruments'' to "mitigate marketwide liquidity problems,'' Geithner said in a speech today that was appropriately titled, "Restoring Market Liquidity in a Financial Crisis."
- Alluding to precisely the dynamic we went over in today's Number Two, Geithner said, "The danger this [elevated risk premium - a fancy way of saying risk aversion] poses is the risk of an adverse, self-reinforcing dynamic in which concerns about overall liquidity magnify concerns about credit problems."
- In other words, Geithner is saying the real danger of risk aversion is its self-reinforcing nature.
- Risk aversion begets risk aversion.
- And just as excessive risk-taking overshoots on the upside, excessive risk aversion can overshoot on the downside.
- Perception is everything.
4. Burnt Ciena
Ciena (CIEN) supplies networking equipment and software to big clients like governments, telecom providers, etc., you know the drill. The headlines this morning look great: "CIEN Q4 Earnings Beat Expectations, Revenue Up 35.2%" So why is the stock off 10%?
In the conference call this morning the company noted they took a $13 million loss on marketable debt instruments. The loss stems from a $45.9 million investment in commercial paper issued by two structured investment vehicles (SIVs). The SIVs entered into receivership and failed to make payments at maturity.
How did this happen? Well, at the time of purchase the investments had the highest ratings available from S&P and Moody's. Now, they don't.
Ciena said that they may incur additional realized losses in fiscal 2008 "up to the aggregate amount of these investments."
Ciena noted it was moving some of their investments into pure cash and have seen a decrease in some of the rates they're getting as a result. This is how seemingly unrelated moves in credit markets impact a wide array of companies that have previously had success with investments and cash management programs as a boost to overall performance.
In the Q&A it was asked if the company was moving to cash because they need to be more conservative with where they park it or because they need quick liquidity with what they're doing with the company. The answer? Both.
The bottom line is the CIEN story is not about slowing business. The company has reasonable Q1 visibility and is fairly upbeat. It is about how small (and large) changes in credit market conditions affect earnings and earnings management.
5. It's a Record!
CDO Defaults and Downgrades Break New Records" the Financial Times noted this morning.
- Moody's says more than $45 billion of collateralized debt obligations of asset backed securities (CDOs of ABS), "a crucial link in the chain" that supplied funding for subprime mortgages, have now gone into default.
- This is up from about $5.5 billion at the end of October.
- According to Morgan Stanley, the number of CDOs that have suffered credit ratings downgrades was more than 2,000 in November alone.
- "November was the worst ever month for CDO downgrades since we have been tracking CDO rating actions," analysts at Morgan Stanley said.
- It was a record, but not a good one.
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