Monday, November 01, 2010
An Open Letter to Ben Bernanke
Dear Mr. Bernanke,
Ours is not an economics column, nor do we profess to grasp the mechanics of how it is, exactly, that you do what you do.
Indeed, the truth is, Macroeconomics was, for us, a snooze-fest—and a fairly literal one at that.
Our impression of the dismal science from those, er, hazy days from 30 years ago, if you get our drift, includes mainly random lines on charts—red lines and green lines and blue lines—and equations of the “GDP = C+ I + G” type, which as best we can recall means Gross Domestic Product equals Consumption plus Ingestion plus Gastronomy, or something.
Nonetheless, while we admit to not being schooled enough to grasp the finer points of your job as Fed Chairman, we do have a strong opinion about your persistence in bemoaning the state of the current unemployment rate, as well as your determination to plow ahead with the purchase of billions of dollars of Federal debt at negligible interest rates in order to, somehow, cure that high unemployment rate.
Our opinion is that your plan it is doomed to look foolish thanks to an impending rise in employment, and corresponding drop in unemployment, that we think will happen even without you buying a single government bond.
How, you may ask, do we dare argue given our own lack of schooling in your own chosen field?
Well, we listen to a lot of earnings calls with companies that do business all over the world. And we think if you bothered to do the same, it would change your mind about the inevitable persistence of that “stubbornly high unemployment rate,” to quote the well-worn phrase.
The conference calls we speak of comprise the earnings calls that publicly-listed companies routinely hold on a quarterly basis with investors to review the previous three months’ worth of their business activities.
They are free of charge—your minions can find them archived on corporate websites—and only take an hour or so apiece.
If, however, you’re in a hurry and don’t have an hour to spare, you can fast forward past the usual CEO patter about “executing our strategic plan” and the frequently mind-numbing financial report from the CFO, and get right to the Q&A.
And if you did this, you would hear a few things you are not seeing in the muted employment numbers that seem to have your kickers in a proverbial twist.
For example, you would hear the CEO of one of the world’s largest outplacement firms, Manpower, say:
As I've stated before, as early as a year ago, we believed that the, slow but steady, demand for our clients' goods and services, coupled with uncertainty and a will to change the flexibility of their workforce, is creating sustainable positive secular trends for us. The growth we experienced in September, and to date in October, is also very important. As we stated in the past, the ability to see growth after the August break in Europe and the Labor Day break in the US was an extremely important indicator for us, for the health for the rest of the year.
For the most part, we picked up where we left off, with growth rates across all geographies quite strong.
And the CEO of the world’s largest private equity firm, Blackstone Group:
Our current portfolio is benefiting from the recovery. It's been underway in commercial real estate. We feel very good about the $15 billion of investments we made during the 2004 to 2008 period, which are now valued above cost including realized proceeds.
Our office markets have generally stabilized. And certain markets such as New York and London are seeing improvements in both leasing activity and asking rents.
New supply remains extremely limited with construction starts 80% below historical averages. In hospitality, RevPAR has been positive for six straight months, benefiting from both improving occupancy and more recently, higher room rates.
Indeed, you’d also hear the CEO of the world’s largest advertising group, WPP PLC, say:
So just in terms of summary of the regional growth, United States was the first to recover, and it has had five quarters of improving like-for-like revenues, with 9.7% in quarter three, more like an emerging market status.
Western Continental Europe is our second-largest region, with significant improvement in like-for-like growth, with quarter three up 4.7%. The UK and Asia Pacific, Latin America, Africa and the Middle East and Central and Eastern Europe were both up well over 7% on a like-for-like basis in the quarter.
And in Asia Pacific, Mainland China and India lead the region with like-for-like revenue growth of over 22% and 15%, respectively. Australia has recovered with like-for-like growth of almost 7%. And Japan was up in this quarter, as it was in quarter two. So we've had two quarters of growth from our Japanese business.
And the Chairman of a little railroad called Union Pacific:
As for the third quarter we are reporting record results….our most profitable quarter ever. Similar to last quarter, we achieved volume growth across each of our six business teams. Total third quarter car loadings were up about 14% to more than 2.3 million. That's our highest level in two years but still 9% below our peak in 2007.
Yes, it is a fact that business at the UP is still below peak levels, as is US employment. But things do not seem to be slowing down there, as the company’s head of marketing made clear:
Let me give you a quick overview of some the specific growth drivers that we expect to see in the fourth quarter. Our industrial products business look to have the most upside with the best opportunities in markets that are benefiting from improved product production, increasing drilling activity and hazardous waste disposal. International and domestic intermodal segments will continue to drive growth with some indication that the international peak may be slightly longer than we thought. Fall demand for fertilizer is expected to be stronger than last year and petroleum should post gains with crude -- growth of crude oil shipments to St. James and increased residual fuel oil moves.
Also looks like industrial chemicals and soda ash will hold their current run rates and that will close the rate stronger than a year ago. Increased electrical demand and expectation of inventory replenishment following a hot summer are expected to keep our coal trains moving and while feed grain exports will likely not be able to match last year's near record levels, wheat exports should supply a nice boost to our ag products business as we close the year and move into next.
Finally we expect our automotive run rate to hold -- our automotive run rate to hold steady but sales forecast to stay in the mid-$11 million range through the end of the year with production slightly ahead of the fourth quarter of last year. That's how we see the quarter shaping up…
Exactly how, Mr. Bernanke, do you expect to do push the Union Pacific to higher heights than it is achieving without your bond purchases?
Now, the good times are not limited to the western side of the country, from which the UP hails: its eastern counterpart, the Norfolk Southern, is also seeing good things in the heartland:
Volumes in the third quarter improved 15% year-over-year and 2% sequentially from the second quarter. We also posted 52-week highs in several commodity groups …. Against this strengthening economic back drop, we continue to improve productivity as we safely handled increasing traffic levels. As compared to the 15% volume increase, crew starts were up only 8% and total employment up a modest 2%.
We know what you’re thinking. You’re thinking: ‘See! There’s the problem! Employment at Norfolk Southern has not risen in line with revenues.’
But, again, we wonder, how exactly would your bond purchases make the good times any better than they are?
If two railroads that cover most of the United States can’t convince you that fundamental business conditions are quite decent, let’s look at one of the nation’s largest industrial distributors—W.W. Grainger:
All segments were up versus the prior year quarter. Specifically, reseller was up in the high 30s related to the Gulf of Mexico oil spill cleanup. Heavy manufacturing was up in the low 20s. Light manufacturing was up in the low double digits. Retail was up in the high single digits. Commercial was up in the mid-single digits. Government and contractor were up in the low single digits.
Not a weak spot in the joint.
Still, after listening to the repeated use of the term “up,” you may well wonder why, then, companies have been so slow to hire.
Caterpillar, the heavy equipment maker, sheds some light on that very question:
….we are seeing growth in the developed countries of North America and Europe, albeit off depressed levels from 2009. With weak economic recoveries in the US and Europe and with depressed construction activity, I know it is tough to understand why sales of Cat machines are up so much. And new machine sales in the United States are a good example that illustrates the point.
Here is what is happening - First, sales to users peaked in 2006, then declined in 2007, declined again in 2008 and then declined even more significantly in 2009. From the peak quarter in 2006 to the bottom in late 2009, dealer machine sales to end users in the US declined nearly 80%.
That’s right: Caterpillar equipment sales to end customers were off 80% from their peak at the apocalyptic bottom.
Is it any wonder that hiring has not come back as quickly as in years past? Wouldn’t you be a little gun-shy about adding FTEs until you were convinced things were trending in the right direction?
Here’s how advertising giant WPP PLC described the downdraft during the crisis, and the slow rebound in hiring:
On the other side, taking the headcount down by 12% in 2009 was very severe, and there had to be some bounce-back from what we had done. I think people responded to the challenge very well, but there probably -- there was too much tightness, if that is the right word, in the system. So it had to be -- we had to invest a bit more, particularly when we started to see revenue growth, not so much in the first quarter, but we saw a five-point shift in the second quarter, and we've seen another three-point shift upwards in the third quarter.
And it is not only advertising agencies and equipment makers that are hiring—the Union Pacific is hiring, too:
In terms of employees we have 1100 on furlough while recall rates have averaged better than 80% this year, the current furlough pool has been out of work since late 2008. So we expect only about half of these to return to service. Because of this we were ramping up our hiring efforts systemwide for 2011.
So is Norfolk Southern:
Turning to the next slide, train and engine employment increased by 501, or 4.8%, in the third quarter as we continue to strategically hire to support traffic growth where we had let attrition decrease in employee counts in 2008 and 2009. As I stated last quarter, all T&E employees have been returned from furlough status. To date we have authorized the hiring of 1,550 conductor trainees with the first of those trainees now starting to come off training program ready for placement.
And Manpower as well, albeit slowly:
We're continuing to see the benefits of strong momentum, as we moved into the third quarter. Across all areas our infrastructure is intact and we are quickly filling in the capacity. As you would suspect, not all areas are filling in at the same pace. So, even with excess capacity, we had to increase our staff in areas, adding just over 600 people in the third quarter.
Now, with all this business going around, you’d think hotels would be seeing more business—and they are. Here’s the CEO of Marriott International:
The business traveler is back. We're excited to see demand so strong in so many places with prices moving up. But we know what you want to know, essentially where do we go from here? According to the National Bureau of Economic Research, the recession officially ended in June 2009.
Notwithstanding that, many seemed to wonder whether the economic recovery has any strength and about the risk of a double dip. Let's be clear. There is nothing in our business which indicates that sort of weakness. Both business transient and leisure travel remain strong.
If travel is strong, airlines must be better—and here’s how Delta described things:
Turning to revenue, our revenue for the quarter was $9 billion, up $1.4 billion, or 18%, on a year-over-year basis against a 2% increase in capacity. Our consolidated passenger unit revenues increased over 16% year-over-year, driven by a higher corporate revenue and international mix. Corporate revenue was up 35% year-over-year, driven largely by a 27% increase in corporate volumes. Our domestic unit revenues increased 10% over the prior year on a two point increase in capacity. Our domestic yields were up 12%.
Turning to international markets, we are seeing continuing strength with unit revenues up 29% year-over-year, with both yields and load factors showing significant improvement. The Transatlantic business is above its 2007 run rates, with unit revenues up 25% year-over-year on a one point increase in capacity. Our Pacific routes have performed very well and we're seeing especially strong results in the beach markets, particularly between Japan and Hawaii. Our overall Pacific unit revenues have increased 45% year-over-year on a six point growth in capacity. Our Latin unit revenue increased 16% on an 8% increase in capacity. South America's performing well driven by the recovery of business traffic.
What is it, exactly, Ben, that are you so panicked about?
If it’s deflation, well, outside of the housing market, you won’t hear about that. Here’s what the Union Pacific had to say about your deflation:
As we close out the year, we continue to feel very positive about our future pricing opportunities and are committed to achieving real pricing gains that will drive higher returns. Let's discuss the expense details starting with compensation and benefits at $1.1 billion in the third quarter, a 9% increase versus last year. Roughly half of the higher year-over-year expense relates to wage and benefit inflation. We also seeing higher costs as train starts increase generating more starts per employee as well as paying more for overtime and training expenses. In addition, equity and incentive compensation was a little higher year-over-year driving about 10% of the increase. Offsetting a portion of these higher costs is our strong employee productivity…
In fact, the UP is starting to see exactly what you’d expect to see at this point in the cycle: upward wage pressure as existing employees work overtime:
We had a lot of overtime. We have been pushing the overtime curve here in terms of absorbing some of the volume. That's out of here. Our health care costs have jumped up pretty substantially here in third quarter. You look out to the future. Our inflation number that we look at is in that 3.5% to 4% range. That's what you have to think about.
Norfolk Southern is seeing higher labor costs:
Slide five reflects the components of the 14% increase in compensation and benefits. First volume related payroll increased $34 million including $18 million for train and engine employees. Second, medical benefits increased $20 million largely related to higher agreement employee health and welfare premiums coupled with increased retiree medical costs. Third, incentive compensation was up $13 million due primarily to stronger financial results. Pension expenses were $8 million higher and payroll taxes increased $7 million. Finally, increased agreement wage rates and other compensation expenses were offset by lower stock based compensation which reflected last year's strong improvement in performance metrics.
And so is Caterpillar:
Before I move on to the full-year outlook, I would like to cover employee incentive compensation in just a little more depth. As you may be aware, a portion of the compensation for management support and some of our hourly employees is at risk and it varies based on the financial performance of the Company. Given the economic environment in 2009, the profit target related to our short-term incentive plan was aggressive and it did not trigger.
Financial performance in 2010 has been much better and based on the newly-revised and higher profit outlook for 2010, we expect incentive compensation to be higher. Our practice is to accrue the expense as we go through the year based on our full-year expectations. That means when we change the outlook, we have a year-to-date catch-up in the provision. And that happened this quarter.
The outlook we provided with our second-quarter release included $600 million in incentive compensation. $300 million of that was in the first half and we had an expectation of about $150 million in each of the third and fourth quarters.
And so is Marriott:
Our corporate G&A spending increased 4% in the third quarter, reflecting higher incentive compensation. There isn't much more to cut but we continue to look for ways of doing things more efficiently.
In fact, we’re hearing more about inflation than deflation. Here’s what Marriott said:
The recovery is here and we're doing things differently. First, we're reducing discounting and improving our mix. For example, in the third quarter the Marriott Hotels and Resorts brand reduced the availability of rooms at discount and transient rates such as packages, wholesale, government and other similar programs. While we reduced these room nights by 16% in the quarter, they were more than replaced by a 16% increase in corporate and special corporate guests paying $57 more on average than the discounted business. We expect to continue to improve our mix in 2011. And we're raising room rates.
Even in the capital markets, inflation is back. Here’s how serial-acquirer WPP PLC put it when discussing acquisition targets:
But I think pricing is an issue. There is a lot of aggressive dealmaking. Investment banking advisers and brokers are being very aggressive on process, and that's a little bit disturbing. It would make the Guy Hands' Citibank-EMI process look relatively pedestrian.
“Disturbing” indeed—especially when a certain Fed Chairman wants to buy half a trillion in Treasury paper at all-time high prices.
Now, we are well aware that you may perceive that the quotes above have merely been selected to prove a point, and thus are likely to view them with suspicion, especially since they do not seem to gibe with months-old economics statistics.
So we wondered if there was a way to somehow put numbers on what we heard.
After minutes of tinkering with our Bloomberg, we came up with the following statistical summary of this conference call season that might help put a less subjective face on the previous body of evidence: it is the first ever NotMakingThisUp Conference Call Survey.
The results of this survey, we think, are illuminating.
For example, in the previous nine weeks (the heart of third quarter earnings season), the phrase “Very weak” appeared in 91 earnings calls—a 29% decline from last year, when the phrase appeared during 150 earnings calls.
Furthermore, the phrase “Very strong growth” appeared in 132 calls this year compared to 112 last year—an 18% increase.
As far as your concern about deflation goes, well, the term “deflation” was used in 61 calls this year, compared to 101 calls last year—a 40% drop.
Meanwhile, “inflation” was spoken of on 399 conference calls, compared to 385 last year—a modest and perhaps statistically insignificant gain of nearly 4%, but more than six-times the number in which “deflation” reared its ugly head.
Encouragingly, too, the use of “layoffs” collapsed, from 78 last year to 48 this year—a 38.5% drop.
Finally, we note with absolutely no surprise that the use of the phrase “executing our strategic plan” did not materially change this year versus last. If you read “My Dog Charles, Executing His Yadda-Yadda”
you would know there is always a bull market in, well, bull.
And so, Mr. Bernanke, we here at NotMakingThisUp sincerely hope you skip today’s reading of statistical reports at your quiet lunch in some nuclear-attack-protected bunker deep within the bowels of Washington, and get out and listen to real people discuss real business, before you go and “execute your strategic plan” of buying half a trillion in Treasuries to somehow make employment start to go up at the very moment it looks like it may well start to be moving that way anyhow.
If, however, in the course doing so, you become nauseous at the recurring use of the phrase “executing our strategic plan” by America’s CEOs, well, don’t say we didn’t warn you.
I Am Not Making This Up
© 2010 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.
Posted by Jeff Matthews at 9:11 AM