Capital Expenditures

 Manufacturing Just Crashed And VCs Face A “Dismal Fundraising Climate”

Market indexes and recessions are two very different data series...

~ Doug Short

The recent release of the final estimate of Q2 GDP, and the September's Durable Goods Report, confirmed that indeed the economy was far weaker than the headline releases, and media spin, suggested. While the media quickly glossed over the surface of the report there were very important underlying variables that tell us much about the economy ahead. The problem is that there is little historical precedent in the U.S. as to whether maintaining ultra-low interest rate policies, and inducing liquidity, during a balance sheet deleveraging cycle, actually leads to an economic recovery.  This is particularly troublesome when looking at a large portion of the population rapidly heading towards retirement whom will become net drawers versus net contributors to the economic system. The important point for investors, who have a limited amount of time to plan and save for retirement, is that "hope" and "getting back to even" are not successful investment strategies.

Evoking the dark days of 2009 - after a steep and bumpy slide

Most people know that during this year's Coachella festival, Tupac made a surprising appearance, if not in the flesh for obvious reasons, then in hologram form. What fewer people know is that the firm that created Holo-Tupac is special effects producer Digital Domain Media, which after years of failed attempts to do so, finally went public in November with Roth Capital as underwriter (there is now an Urban Dictionary definition for 'Rothed') at a price of $8.50 (well below the preliminary range of $10-12/share) and at a time when its burn rate was well above 50% of revenues, and which filed for bankruptcy hours ago. In other words, the company destroyed over $400 million in market cap in under 10 months. What is known by very few is that this is yet another public equity disaster of this administration: as filed in the bankruptcy Affidavit, "the Company has worked closely with State and local government authorities in Florida to execute economic stimulus contracts designed to create jobs and stimulate Florida’s economy. As of the Petition Date, the Company had contracted to receive a total of approximately $135 million in such government stimulus financing, including $19.9 million in tax credits. This financing consists of cash grants, land grants, low-interest financing, and tax incentives." In other words, in addition to the government's remarkable track record in the alternative energy field, public equity is now in the digital movie studio subsidization business. End result: bankruptcy, of a publicly funded company, shortly after IPO and sadly the realization that US capital markets are now so broken that the combination of private and public funding can sustain a company for less than one year.

The X-12/13-ARIMA seasonal adjustments on today's data were not quite up to snuff as both the CPI, printing at 0.0% (or 1.4% Y/Y) on expectations of 0.2%, the biggest CPI miss since January and the Empire Manufacturing index, at -5.85 on expectations of a +7.00 print, posting the biggest miss in 14 months. Notably, the number of employees declined in August from 18.52 to 16.47, while margins got crushed as Priced Paid soared from 7.41 to 16.47 as Prices Received slide from 3.70 to 2.35. And so baffle with bullshit returns, as following several weeks of better than expected, if largely seasonally adjusted, the speculation that NEW QE may be coming back is here again. In other words, yesterdays scorching retail data was good, but today's horrible NY manufacturing miss is better. At least to the complete idiocy that the market, and its "discounting mechanism" have become. Sure enough both EURUSD and gold spike on the weak news as the ghost of Bernanke's printing press is back in the room. Finally, how CPI could be unchanged when crude alone posted a 20% increase in July, and gas prices are back to doing their vertical thing, will always remain a mystery.

With expectations for a muddle-through slight positive print, the headline Dallas Fed index just printed at -13.2 (exp. 1.9). This is its lowest level since September of last year and the biggest miss of expectations since May of last year. The headline index is teetering on the edge of its worst levels since 2009 as the month to month change in the general business activity index dropped a massive 19pts - its largest drop since April 2005. Specifically it appears the outlook for capital expenditures was among the largest sub-index to have its hope crushed - and this strongly suggests (and confirms) a sub-50 ISM print.

The first estimate of the 2nd Quarter GDP was released at a 1.5% annualized growth rate which was just a smidgen better than the 1.4% general consensus. There has been a rising chorus of calls as of late that the economy is already in a recession.  For all intents and purposes that may well be the case but the GDP numbers do not currently reveal that.   What we are fairly confident of is that with the weakness that we have seen in the recent swath of economic reports is that the 2nd quarter GDP will likely be weaker than reported in the first estimate. It is this environment, combined with the continued Euro Zone crisis and weaker stock markets, as the recent rumor induced bump fades, that will give the Federal Reserve the latitude to launch a third round of bond buying later this year.  While the impact of such a program is likely to be muted - it will likely push off an outright recession into next year.

In a first for Moody's, the rating agency, traditionally about a month after Egan Jones (whose rationale and burdensharing text was virtually copied by Moody's: here and here), has decided to cut Europe's untouchable core, while still at Aaa, to Outlook negative, in the process implicitly downgrading Germany, Netherlands and Luxembourg, and putting them in line with Austria and France which have been on a negative outlook since February 13, 2012.The only good news goes to Finland, whose outlook is kept at stable for one simple reason: the country's attempts to collateralize its European bailout exposure, a move which will now be copied by all the suddenly more precarious core European countries.

...But at least housing has bottomed (it so difficult to even write that with a straight face). Our two economic indicators today continued the tradition of the last 2 months and both missed, with the Richmond Fed sliding to -3 on expectations of a +2 print, and down from +4: the lowest number since October 2011. And the other data point hinting to the Fed that it is needs to do something now, was the June Consumer Confidence number, which was lower 4 months in a row (for the first time since May 2008), and which declined from 64.4 to 62.0, missing expectations of 63.0, and the lowest since January, undoing all transitory, S&P500 driven gains of the year.

Last September we were delighted to bring you the following great news:

DAVID BIANCO NO LONGER WORKS AT BOFA, SPOKESWOMAN SAYS

Now, we are even more delighted to bring you the following breaking news:

BLACKROCK CHIEF EQUITY STRATEGIST BOB DOLL TO RETIRE

And then there were three...

By now everyone knows that Chesapeake is a slow motion trainwreck: whether it is internal management issues, which eventually will culminate with the long overdue termination of the company's head (something the company had much control over and could avoid, but didn't, and should result in the sacking of the entire board for gross negligence), or plunging gas prices (something it had far less control over, but could have hedged properly, yet didn't), what is absolutely certain is that the firm's cash flow just isn't what it used to be. In fact, according to some, it is quite, quite negative. What, however, people do not know is that under ZIRP, when every basis point of debt return over 0% is praised, and an epic scramble ensues among hedge for any yielding paper no matter how worthless, the balance sheets of companies just do not matter. In other words, for companies that have massive leverage, high interest rates, negative cash flow, which all were corporate death knells as recently as 2008, the capitalization structure is completely irrelevant. We said this a month ago when we cautioned, precisely about Chesapeake, that "to all those scrambling to short the company: beware. CHK has a history of being able to fund itself with HY bonds and other unsecured debt come hell or high water. If and when the stock tanks, the short interest will surge on expectations of a funding shortfall. Alas, courtesy of the Fed's malevolent capital misallocation enabling, we are more than confident that the firm will be able to issue as much HY debt (unsustainably at 10%+, but that is irrelevant for the short-term) as it needs, crushing all short theses. What this means, simply, is that anyone who believes traditional fundamental analysis will and should work in the CHK case is likely to get burned." Sure enough, we were again proven right: Chesapeake just announced, following today's epic drubbing, that it is refinancing its secured debt facility (with its numerous restrictive covenants) with $3 billion in brand new Libor+7.00% unsecured paper (courtesy of Goldman and Jefferies). In doing so, CHK just got at least a one year reprieve.

In the span of 30 minutes CHK managed to crush both longs and shorts in the name.

Before even taking into account the aftermath of the “unexpected” NFP result, it has been amazing to see over these past few months the number of experts, especially those that reside solely within the “science” of economics, proclaiming a successful engineering of the long sought-after recovery.  That this has been the third such claim in as many years is lost in the noise of confusing “headwinds” that are somehow beyond the control of those that now control most everything within the financial arena.  Stock speculators are beneficial components to the healthy financial transmission mechanism into the real economy (even when all they are supposed to do is provide liquidity 20,000 times per second), but anybody that dares speculate in the far more vital energy sector (or any real commodity) is the pure incarnation of evil.  That these two apparently disconnected speculative classes are really one and the same shows just how obtuse (not always intentionally) economists and the pandering classes really are.

A warning by the SEC in mid-March 2011 regarding repo-to-maturity trades suggests otherwise.