Consumer Psychology In Recessions

Have to give a big hat tip to Value Plays for posting this up a while ago. Harvard Business School has a video out regarding consumer psychology during recessions. Watch the video below (RSS & Email readers will need to come to the blog to view it).



In the video, they discuss how both marketing and consumer behavior can be impacted by recessions and they bring up interesting points. In the past, we've highlighted that consumer spending during recessions is not quite what you'd think it would be.

Head over to Todd's site to check out his example of how Walmart has used the economic situation to refine their message while Target has suffered. Hedge fund manager Bill Ackman of course has confronted Target (read: gone activist), as he pushes for major changes in the company.

Downgrading the American Consumer's Credit Rating

Downgrading the American Consumer's Credit Rating:
A Potential FICO Score Nightmare
by market folly

We're here to point out a potential unforeseen consequence of credit cards as the next credit crunch. The developments of credit card companies raising interest rates, cutting credit lines, and closing inactive accounts altogether has many consequences: Firstly, consumer confidence and consumer spending could drop off. Secondly, as such, the economy as a whole would continue to suffer. Lastly, and most unforeseen, FICO (credit) scores most likely will be reduced and many American consumers will essentially be 'downgraded' by way of their new, lower credit scores, further inhibiting their access to future credit. Many people are focused on how these actions will affect consumer spending (and this could be a legitimate concern). But, we also want to turn the focus to the decrease in consumer liquidity and how overly reliant consumers are on credit cards for cash-flow management.

Credit Cards Are the Next Credit Crunch

We'll break this down in the piece below, but first, some background. If you don't know who Meredith Whitney is, then shame on you. She has been one of the best analysts on all things financial, nailing the trouble at Citigroup (C) when no one wanted to believe it. She is the dominatrix of doom and she has recently put out a report on credit card companies, stating that financial institutions could cut up to $2.7 trillion in lines of credit that have been typically available to consumers. The bulk of her message was that this could happen by 2010 and that it would severely dampen consumer spending. Not only would it affect consumers, but it would affect small businesses as well, who often rely on credit cards to actively finance their day to day activities.

We've been harping on this issue for a while under the notion that credit cards are the next credit crunch. Companies like Bank of America (BAC), American Express (AXP), and Capital One (COF) have reported increase after increase in charge-offs and delinquencies in their credit card units. Obviously, rising unemployment and a hell of a recession are only going to add to that. Head of JPMorgan (JPM) Jamie Dimon has even flat out admitted that credit cards are going to be a house of pain for his company in 2009 and possibly beyond. We've posted on this issue back in August of 2008 and will continue to harp on it until we see material improvement. But, while more people seem to be coming around to the fact that credit cards will indeed be a big problem going forward, the possible magnitude of the issues still needs to be highlighted.

Many American consumers were living on a debt binge by purchasing everything on credit cards and slowly paying them off over time (or not paying them off at all). America = consumerism. You also have a second tier of consumers who would typically pay with cash or debit card, who have now been struck by hard times. When push comes to shove and you've got to make the essential purchase of food, you fall on the credit card for emergencies. And, with this economy, there are a lot of consumers pushing the big red 'emergency' button. The problem here is that the credit card companies are trying to fight off rampant delinquencies and non-payers by all means necessary. The best example of this would be American Express offering you $300 to pay off your bills and close your account (to a limited number of accounts). This is the deleveraging world. Markets are deleveraging, hedge funds are deleveraging, and consumers are deleveraging. The credit card companies are no different. They simply took on too many customers (especially of poor credit quality) and offered everyone credit lines that were much larger than necessary. They are now correcting their errors.

But, as such, the consumer suffers and their purchasing power now decreases exponentially. If you didn't have enough money for that flat screen TV, you put it on your credit card with your $10,000 line of credit. But now, that $10,000 line of credit might be chopped down to only $4,000 and you've already racked up a lot of charges on there. Where do you turn now? How do you purchase your sacred flat screen TV? You can't. (In the end, that might not necessarily be such a bad thing as it brings consumers back to a realistic level of spending, as well as a realistic level of saving. But that's a topic for a whole 'nother post).

Available lines of credit were cut by almost $500 billion in Q4 of 2008. Whitney acknowledged that and says her estimate might be too conservative given how fast credit lines are shrinking. In the US there is about $5 trillion in credit card lines and $800 billion or so of that is being drawn upon right now. This affects overall consumer liquidity as consumers become even more squeezed in an already penny pinching environment. And, its not the reduction in credit lines that affects things. Creditors are also shutting down credit card accounts completely, due to inactivity (which, by the way, is their legal right). Additionally, they are raising interest rates on numerous accounts in an attempt to recoup whatever losses they can. Unfortunately, this move will put many borrowers even further underwater, decreasing the chances they pay off their cards. But, there is also something else that could be an unforeseen consequence: a nightmarish decrease in consumer credit ratings (FICO scores).

What is a FICO Score?

We should preface this section with a disclaimer: We're by no means FICO experts and FICO calculation is almost like a mad-science. We've simply done a ton of research and are presenting theoretical examples that could potentially lower credit scores of many consumers. Feel free to chime in if you're an über-expert on the matter. If you are unfamiliar with FICO scores, it is essentially your credit rating as a consumer; a number slapped across your forehead that tells creditors how likely you are to pay them back. The pure definition of a FICO score:

"A FICO score is a credit score developed by Fair Isaac & Co. Credit scoring is a method of determining the likelihood that credit users will pay their bills. Fair, Isaac began its pioneering work with credit scoring in the late 1950s and, since then, scoring has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrowers credit history into a single number. Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed. The Federal Trade Commission has ruled this to be acceptable. (And more info per mtg-net if you want it)"

Why FICO Scores Matter

Quite literally, your FICO score is one of the biggest factors determining your access to credit. The FICO score ranges from 300 to 850; the higher the score, the better (with 850 being the ideal score). You can essentially break down the FICO score range into four tiers:

1. Excellent credit: 700-850. People with this score will receive the best interest rates, aren't likely to default, and should have no problems accessing future credit.
2. Good/Decent credit: 600-699. People with scores in this range will pretty much get a normal loan and usually won't be denied.
3. Poor credit: 500-599. This is not the worst part to be on the ladder, but banks start to get you in their back pocket here and credit availability could be an issue.
   
4. Dismal credit: 499 and below. Terms for people with these scores will be absolutely brutal, if they are even given credit at all.
   

We've kind of generalized the list of tiers, but you get the picture. So, why do FICO scores matter here? Well, if you look closely, you'll see some big differences in terms of interest rates offered on loans and overall availability of credit as you move from one FICO score category to another. After all, don't forget that a sub-600 credit score was deemed as sub-prime by many. Let's take a look at a theoretical $200,000 30-year fixed mortgage (national average as of March 24th) across the range of credit scores to see the various APR's offered thanks to a graphic from myfico.com.

(click to enlarge)

Keep in mind that this graphic only encompasses an 'upper tier' of FICO scores. You'll notice that they only go down to a score of 62o on their list. And, even so, a consumer who has a score of 620 is paying 1.589% more in APR than someone with a 760 score. You can only imagine what the APRs are going to be like on FICO scores lower than 620 as you fall into the 'fair' and 'poor' credit ratings. So, not only does a lower FICO score mean you'll be paying a higher APR, but you'll also have less overall access to future credit as lenders will be more inclined to turn you down in this environment of tightening credit standards.

Why FICO Scores Will Decrease

Now that you've got an overview of how a lower FICO score is "bad-news-bears," let's examine why cutting consumer credit lines will essentially downgrade consumers' credit ratings. Your FICO score is determined by a myriad of factors. But, this chart breaks down just how the score is calculated:

(click to enlarge)

Now, as you can see, the two biggest pieces of the pie are 'on-time payments' (35% of the FICO score) and 'capacity used' (30% of the score). On-time payments are obviously in the hands of the consumer themselves. And, many pundits have already accounted for the fact that consumers will be delinquent on their bills or flat-out won't pay them due to economic hardship, etc. This is the well known part of the credit card crunch. What hasn't really been talked about is the second biggest piece of the pie: capacity used.

Capacity used is simply a calculation of how much of your available credit lines you are using. This utilization ratio can be affected by two inputs: how much you're charging to your cards and how high your credit limits are. So, a lower ratio of capacity used is obviously better. The lower your utilization ratio, the better your FICO score can be. You can achieve such a ratio by having either lower balances or increasing your available credit; or both. Now, we've already seen from above that creditors will be cutting available credit lines all over the place and even closing down some accounts completely. This immediately increases a consumer's utilization ratio even if their rate of spending remains constant.

An example: You spend $1,000 on your credit card each month and your available credit line is $10,000. Currently, your utilization ratio (capacity used) is only 0.1, or 10% each month. Fast forward to next month and you're still spending $1,000 on your credit card. Then, the credit card company comes through and axes your available credit down to only $4,000. Even though your spending rate has stayed the same, your utilization rate is now .25, or 25%. Once again, even though your spending was constant, the credit card company's actions have now just sent your utilization rate up 2.5x. And, as such, that 30% of your FICO score determined by capacity used (the second largest component in computing your score) has just sent your score down (possibly even to a lower-tier of ratings).

Next, look at the same example wherein the consumer ramps up the amount they charge to their credit card due to emergency and economic hardship. Before, they were spending $1,000 on a $10,000 credit line. Now, their line has been chopped down to $4,000 and their spending has doubled to $2,000 due to hardship brought on by the recession. Purchases they would normally pay for in cash now have to be put on the 'emergency card.' In this scenario, their utilization rate has now risen to .5, or 50%. Their utilization ratio has now increased five-fold! Such a large increase in capacity used will undoubtedly affect their FICO score in a negative way.

So, while others may be focused on the "amount charged" input in the capacity used equation, we are focused on the "available credit" portion of the equation. The amount charged on a card is a variable input as it can fluctuate on any given month. Available credit though, is more often than not static as consumers have their credit lines in place (with a few exceptions like opening new cards). The problem is, though, that credit card companies are no longer leaving credit availability relatively static. Creditors have already started cutting available credit and they will only continue to do so, as they struggle with rising charge-offs and delinquencies. This 'fad' has already run rampant, as I can't even begin to tell you how many people I've read about that have had available lines clipped and have even had cards closed down altogether due to inactivity.

Think about that for a second. If they close down a card completely, not only have you lost that available credit line which affects the 30% of the FICO equation, but you've also lost a portion of the 15% 'length of credit history' part of the equation in the pie chart above (or all of that history if its your only card). So, when they completely close an account, you now have negative readings on up to 45% of the inputs used to calculate your FICO score, rather than just the 30% in the theoretical scenarios we've outlined above. And, this is all on top of the negative scores many consumers will receive on the 35% allocation of the score for "on-time payments" since many have missed payments and delinquencies are continually rising. If you take all of these factors into consideration, the categories with the highest weighting in FICO scoring most likely have and will be negatively affected, leaving consumers with lower scores. Just how much lower could credit scores go? Ultimately, all we can do is guess. The degree of severity lies buried within the madness known as FICO. Our inclination is that it could very well have an impact though, depending on scale.

The Crux of the Credit Card Crunch

Utilization ratios (capacity used) could potentially skyrocket and thus negatively affect the 2nd largest input (30%) in calculating consumers' FICO scores. Additionally, closed accounts could negatively affect up to 45% of the FICO calculation, possibly bringing down one's score that much more. As such, FICO scores could possibly decrease, landing Americans in a credit tier below their current status, thus further restraining their access to credit. Why does this all matter? Well, we are just recently working off the effects of a defaulting sub-prime borrower. If FICO scores decrease en masse, we could shift a whole new batch of American consumers from the 'fair' tier to the 'sub-prime' tier. Not to mention, the liquidity crunch consumers are facing becomes that much tighter as companies put the squeeze on consumers, increasing the probability that said consumers will default.

The ultimate question becomes, 'Will FICO scores decrease en masse?' That's tough to answer, given the complexities of the FICO score itself and the vast variety of household balance sheets found around the nation. And, even if credit scores decreased en masse, FICO could possibly alter the way they compute scores to take this into consideration. So, the affects of a massive theoretical downard shift in FICO scores could be overstated. But, if you take this outcome on a slightly smaller scale, its still a very real scenario. We're simply trying to provide a counter-argument to our thoughts.

So, to recap: Credit card lines drying up is bad for the consumer because it takes away their liquidity and ability to spend since many potentially use cards for cash-flow management. This decrease in consumer spending would, in turn, obviously bad for the economy. Lastly, such a reduction in available credit could negatively impact consumers' credit ratings (FICO scores), 'downgrading' consumers to lower credit tiers, raising the interest rates they are charged, and decreasing their overall access to future credit. And, all of the above can increase the probability they will default. The creditors quite literally own consumers with bad credit; it's as simple as that. We're mainly worried about the consumers who are currently teetering on the edge in terms of their credit score and tier. While they might not have 'poor' credit yet, a slight decrease in their score could shift them into that category. Add up the cumulative effect of all those who are teetering on the edge, and there could be serious implications.

While things might not turn out to be as extreme as we've laid out above, there will nonetheless be consequences. In an environment where companies are being downgraded left and right, we're downgrading the credit ratings of the American consumer. Credit just got that much harder to procure.

Nouriel Roubini's Portfolio

In a shocking development, Nouriel Roubini, a.k.a. the harbinger of doom himself has been thrust in the spotlight yet again. And by shocking, we mean not shocking at all. Anyways, the FT recently gave us a glimpse into what Roubini himself invests in,

"Just ask Nouriel Roubini of New York University, who has a reputation as the most pessimistic economist in academe. He deserves it. His most recent paper, published last week, is entitled: “Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not.”

Nobody is more aware of the gravity of the financial situation, and nobody has done more to point out the risks of a systemic crisis.

So how are Roubini’s own funds invested? They are 100 per cent in equities. In the long run stocks do best and he is not yet close to retirement, so he keeps putting more money into index funds each month.

Fully aware of the gravity of the financial situation, he is also aware of the futility of trying to take action or to time the market. Those tempted to make the investing equivalent of a goalkeeper’s depairing dive should take note."

Felix Salmon of Portfolio went one step further and then notes that while Roubini's 401k is in equities, he has his interests in his firm as well as a lot of cash on the sidelines. So, while Roubini has cash on hand, you'd have to think that he would be inclined to put more of it to work at some point. But, maybe the fact that he is so incredibly pessimistic will blind him from his own contrarian indicators... who knows. I have yet to decide whether or not Roubini turning bullish (if that ever happens) is a good or bad thing. I'm actually scared for that day. The point is, though, that Roubini is human. He has a 401k just like practically everyone else out there. And, he is invested in the markets for the long-term. So, if you were to extract a positive from all of this, there you have it. And, if I were you, I would savor it. Because after all, don't forget that Roubini's picture is listed under 'doom' in the dictionary.

We recently noted that Roubini's estimate for the S&P 500 is 600 on the dot. At that level, he suggests that the S&P companies will earn $50 a share and trade at 12x. He also did not rule out the possibility of seeing 500. Considering we are getting relatively close to his targets, you have to wonder if he is starting to get slightly more constructive deep down. You would assume that he would possibly be investing his own money if/when we reach those levels. But, that is pure speculation on our part. We're mainly making this point to show that while he is not apt to time the market, he has identified a level of valuation he deems acceptable.

Just remember that now you, too, can be Nouriel Roubini by printing off this Roubini Halloween mask and proceeding to talk about doom and destruction nonstop.

Summary of Jim Rogers' Recent Portfolio

Jim Rogers has been in the media a lot over the past couple weeks and we wanted to provide a summary of these thoughts. He is a noted investor and founder of the highly successful yet now defunct Quantum Fund (with George Soros). Rogers has been out providing his opinion on various topics and giving us a deeper glance at some of his portfolio plays. We've compiled a list of some of his major positions below. Firstly, we'll examine some of the plays he's revealed just over this past week.

The rally we've been seeing in equity markets is a bear market rally that can last anywhere from days to months, according to Rogers. He sees the economy as getting worse before it gets better, citing more bankruptcies to come. It might be 'a bottom,' but its not 'the bottom,' Rogers said. He's very bearish on a macro level and thinks it could take 7 to 8 years to really clean out the system. He's noted that all the bailouts have added to the risks of an economic depression. His displeasure with the US government is no secret, as he thinks they are 'throwing money' at the wrong things.

In terms of the US financials, Rogers has covered his Citigroup (C), which was a short that had paid him off handsomely. He has also mentioned that he has covered most of his short positions in stocks. But, he is now short JP Morgan Chase (JPM), as he sees negative 'off balance sheet' exposure, along with derivatives exposure, and large exposure to the credit card business. Rogers has noted something that we here at MarketFolly have been talking about for some time: credit cards as the next credit crunch. And, head of JPMorgan Jamie Dimon even acknowledges this as well. Rogers has chosen to short JPM for a myriad of reasons, but credit cards are certainly one of them. Even the 'good house' in the 'bad neighborhood' can't escape. While he has that short position in the financial space, he has no positions in the insurers. He notes that sure, financial institutions can rally back from their lows, but that they still aren't financially sound. He thinks that financials won't be an attractive investment for years to come. Additionally, while not a financial, he mentioned he was short IBM (IBM), presumably due to their large financial services exposure.

Rogers has again re-voiced his concern with government debt, which has recently expanded five-fold. He was previously short the long-dated treasuries, but had to cover back in the fourth quarter. He has been patiently evaluating for a time to re-enter this position for the longer trend he forecasts. In the midterm, he won't fight the government though, as e expects them to buy treasuries in an effort to stem borrowing costs. Governments around the world are printing a ton of money and borrowing insane amounts. Rogers cites this as the reason for his desire to short the bonds eventually. We agree with Rogers on this point, and are willing to have extreme patience before entering this trade in size. It undoubtedly will take much longer to play out than many realize, especially when the Federal Reserve is still active and busy. We laid out our basic rationale for shorting treasuries down the road as well. Again, as Rogers emphasizes, patience is key.

Additionally, he has been waiting to establish a short position in the US dollar. He has been long the Dollar, which he says is rallying artificially, and is looking for this unwind to continue before he unloads the rest of his Dollar position, as he believes the US is trying to devalue its currency. He also currently owns some Japanese Yen and has elaborated on currencies recently. Considering his distaste for some of these paper currencies, he has a small gold position. But, he prefers silver and agriculture to gold.

We already know that he is bullish on commodities, and very bullish on agriculture. He has re-hashed this view numerous times. He might be early, but he has always claimed that he is not a market timer. He feels this trend will eventually arrive and he is poised to benefit from it. Raw materials and commodities are the only sectors with improving fundamentals according to Rogers. He expects low inventories and tons of shortages in the longer term (10-20 years). You have to keep in mind that Rogers is not a market timer and instead positions himself for broad, longer-term trends. He favors the commodities themselves over commodity resource stocks. And, he has even gone out and bought physical farmland. He has active investments in Agcapita Farmland Investment Partnerships (in Canada) and Agrifirma Brazil. As we noted in our hedge fund portfolio tracking series, Rogers' ex-Quantum Fund buddy George Soros has also bought a ton of Potash. So, they definitely share a bullish stance on agriculture. Lastly, its also worth noting that respected investment strategist Don Coxe is also an ag bull.

Overall, Rogers has a bearish macro view and expects bear market rallies, as they are just part of the cycle. And, while certain toxic companies like the financials may rally, he notes that they still have big problems ahead of them. He isn't a market timer and expects rampant inflation as well as bull markets in agriculture and commodities. He has placed bets to the tune of these forecasts and will continue to monitor the investment landscape for broad macro trends he can capitalize on in the future. If you enjoyed this post, please consider getting our free updates via email or for free via RSS reader. We cover gurus like Jim Rogers as well as other prominent hedge fund managers on a daily basis.

Lastly, if you've missed them, you can also see Rogers thoughts on the topics of:

• China, inflation, & the recession
• Agriculture
• Commodities
• The British Pound
• Other Currencies
• Long-term US bonds
  

Sources: Bloomberg, (again), CNBC, and various other media appearances

Nouriel Roubini & Robert Shiller's S&P 500 Price Targets

Well, you guessed it. I'm here to post up even more bullish news! And, by bullish news, I obviously mean bearish news. After all, its Nouriel Roubini and Robert Shiller. Here's the deal, Shiller has a set of S&P earnings and P/E ratios available in spreadsheet format here. Big hat tip to Cliff Küle for flagging this Schiller data and graphs to our attention. Cliff posts up some historical info, illustrated below. First, real S&P composite earnings:

(click to enlarge)

And secondly, historical P/E ratios and interest rates.

(click to enlarge)

By that historical data, you'd think that a 5 P/E could be achieved given the severity of everything that's happened. But, if you're not that apocalyptic, then maybe somewhere around 10x would be more appropriate. And, 'Dr. Doom' himself, Nouriel Roubini thinks that the S&P500 will see 600, which could be somewhat close to 10x by his measurement. Taken from Bloomberg,

"

The benchmark index for U.S. stocks would have to slump 12 percent from last week’s closing level to meet his forecast. Roubini is assuming that companies in the S&P 500 will report profit of $50 a share this year and investors will pay 12 times that for equities.

'My main scenario is that it’s highly likely it goes to 600 or below,' Roubini said today in an interview at the Chicago Board Options Exchange Risk Management Conference in Dana Point, California. A level of '500 is less likely, but there is some possibility you get there.'

"

What One Trillion Dollars Looks Like

Wow, this is insane. With what seems like a bailout every month in this crazy crisis, we thought it'd be interesting to find an illustration of just how much money is being tossed around like chips in a poker game. Seriously though, isn't everyone just numb when the terms "billions" and "trillions" get tossed around now? We've been talking about such large sums for so long that it doesn't even faze me anymore, which is concerning. Billion is the new million, and trillion is the new billion.

With the help of PageTutor, we can put this into perspective. First, for a frame of reference. This is a pallet of some dollar packets. This pallet below represents $100 million.

(click to enlarge)

So, now that you know what $100 million looks like. Here's what One Trillion Dollars looks like.

(click to enlarge)

Notice the little person in the bottom left hand corner for a frame of reference. Also note that each little stack in the picture is actually 2 pallets. So, each little stack is $200 million. Add up that field of double-stacked pallets and you've got a grand total of $1 trillion. No big deal. Make sure to head to Page Tutor for the full pictorial.

Rick Santelli CNBC Rant

If you've missed it, Rick Santelli of CNBC recently had a rant about capitalism which has been seen as a rallying cry. He's even talked about arranging a 'Chicago Tea Party' for capitalism. Santelli is one of the few/only brightspots on that channel.

The rant:



(RSS & Email readers might have to come to the blog to view the video)

Doug Kass Market Indicators: Signs Needed for Market Recovery

Doug Kass' recent piece, 'Fear and Loathing on Wall Street,' highlights some excellent points. In it, he creates a list of things the markets need to see to begin their return to normality:

"

• Bank balance sheets must be recapitalized. We await a bank rescue package in the week ahead.
• Bank lending must be restored. Bank lending standards remain tight. For now, we are in a liquidity trap.
• Financial stocks' performance must improve. We are not yet there. Financials' performance is still drek.
• Commodity prices must rise as confirmation of worldwide economic growth. There has been some recent evidence of higher commodities, but it's still inconclusive.
• Credit spreads and credit availability must improve. While credit spreads are improving, the yield curve is rising and interest rates have rebounded, the transmission of credit remains poor. Time will tell whether monetary and fiscal policies will serve to unclog credit.
• We need evidence of a bottom in the economy, housing markets and housing prices. The economy's downturn continues apace. Months of inventory of unsold homes are declining and so are mortgage rates, but home prices have yet to stabilize despite an improvement in affordability indices.
• We also need evidence of more favorable reactions to disappointing earnings and weak guidance. We are not yet there, but this will tell us a lot about the state of the stock market's discounting process.
• Emerging markets must improve. China's economy (PMI and retail sales) and the performance of its year-to-date stock market have turned decidedly more constructive.
• Market volatility must decline. The world's stock markets remain more volatile than a Mexican jumping bean.
• Hedge fund and mutual fund redemptions must ease. While I am comfortable in writing that most of the forced redemptions have likely passed, we will find out more over the next few months. Regardless, the disintermediation and disarray of hedge funds and fund of funds have a ways to go.
• A marginal buyer must emerge. Pension funds seem to be the likely marginal buyer as they reallocate out of fixed income into equities, but we have not yet seen the emergence of this trend."

Read the entire piece.

Comparing Job Losses During Recessions

(click to enlarge)

(From Time)


And expanded:

(click to enlarge)

And condensed:

(click to enlarge)

(From Big Picture)


See also our post on comparing historical unemployment rates during recessions.

25 People to Blame for the Financial Crisis

Time has an interesting list of they think is to blame for the Financial Crisis. Here's their list:

1. 1. Angelo Mozilo – Co-founder and former head of Countrywide
   2. Phil Gramm – Chairman of the Senate Banking Committee from 1995 through 2000
   3. Alan Greenspan – Former chairman, Federal Reserve
   4. Chris Cox – Former chairman, Securities and Exchange Commission
   5. American Consumers
   6. Hank Paulson – Former Secretary of the Treasury
   7. Joe Cassano – Founding member, AIG’s financial-products unit
   8. Ian McCarthy – CEO, Beazer Homes
   9. Frank Raines - Former chairman and CEO, Fannie Mae
   10. Kathleen Corbet – Former CEO, Standard & Poor’s
   11. Dick Fuld – Former CEO, Lehman Brothers
   12. Marion and Herb Sandler – Former heads, World Savings Bank
   13. Bill Clinton – Former U.S. President
   14. George W. Bush – Former U.S. President
   15. Stan O’Neal – Former CEO, Merrill Lynch
   16. Wen Jiabao – Premier, China
   17. David Lereah – Former chief economist, National Association of Realtors
   18. John Devaney – Hedge fund manager
   19. Bernie Madoff – Ponzi scheme orchestrator
   20. Lew Ranieri – Father of mortgage-backed securities
   21. Burton Jablin – Programmer at Scripps Networks, which owns HGTV
   22. Fred Goodwin – Former chairman and CEO, Royal Bank of Scotland
   23. Sandy Weill – Former chairman and CEO, Citigroup
   24. David Oddsson – Former Prime Minister, Iceland
   25. Jimmy Cayne – Former chairman and CEO, Bear Stearns

Read the article here.

Consumer Loans & Credit Cards = House of Pain in 2009

Head of JPMorgan Jamie Dimon is not too optimistic for 2009. And, understandably so. He's right in the middle of the financial tsunami. After a year of re-shaping the industry, there is more pain ahead for financial institutions as consumer loans start to kick the financial landscape's collective ass.

Per the FT, Dimon goes on to say that,

“The worst of the economic situation is not yet behind us. It looks as if it will continue to deteriorate for most of 2009. In terms of our sector, we expect consumer loans and credit cards to continue to get worse. When we look back at industry excesses in areas such as highly leveraged lending and securitisation, it is clear that some of these markets will never come back.”

This is clearly not good news for institutions who have been trying to weather the year-long storm. They've faced waves of a credit crisis, subprime, and leverage. Now, a whole new tidal wave is about to hit their shores: consumer loans. The economic malaise that has plagued Wall Street for some time now has also been hitting Main Street. Consumers are not only defaulting on their mortgages, but also on their car loans and credit cards.

We've harped on this issue for a while now on the blog, as the warning signs have always been there. As the consumer deleverages, their savings rate will have to rise in order to get out of this mess. One of our darling shorts from the past year, Capital One (COF), has been quietly licking their wounds, hoping the eye of the storm passes them by. Unfortunately for them, it may now be time for them to face the storm head on. Here are some highlights from December:

• Credit Default: Annual net charge-offs were 7.71% in December, up from 6.98% in November.
  
• Loans 30 days delinquent increased from 4.7% in November to 4.78% in December.
  
• Auto loan segment saw charge-offs of 5.93% in December, up from 5.6% in November.
  
• Auto loan delinquencies were up from 9.48% in November to now 9.91% in December.
• International charge-offs were 6.2% in December, up from 5.17% the month prior.
• International delinquencies rose to 5.51%, up from 5.44%
  

As you can see, charge-offs are rising. And, they have been for many months now. This is very problematic for a company that derives 75% of its earnings from credit card operations. As delinquencies and charge off rates continue to rise, the Economy is certainly not on their side. However, if the past is any indication, they do have the Government on their side, who has graciously given them a capital infusion in the past. Something to keep an eye on. Overall though, the environment in 2009 doesn't necessarily get any easier for financial institutions.

The credit card squeeze is upon us.

Peter Schiff Talks Treasury Bubble

Peter Schiff is out with a piece discussing treasuries, entitled 'The Fed's Bubble Trouble.' Here are some of his thoughts:

"If it is well known that Fed will be a big purchaser of Treasuries, those buying now will be positioned to unload their holdings when the buying spree begins. If the Fed pays higher prices in the future, traders can earn riskless speculative profits. If the traders lever up their positions, as many are likely doing, even small profits can turn unto huge windfalls.



The downside of course, is that all of the demand for Treasuries is artificial. Treasuries are now in the hands of speculators looking to sell, not investors looking to hold. These players are analogous to the mid-decade condo-flippers who flocked to new developments for quick profits. They did not intend to occupy their properties, but rather flip them to future buyers. Once these properties came back on the market, condo prices collapsed, as developers were forced to compete for new sales with their former customers.



This is precisely what will happen with Treasuries. Just as the U.S. government issues mountains of new debt to finance the multi-trillion annual deficits planned by the Obama Administration, speculative holders of existing debt will be offering their bonds for sale as well. In order to prevent a complete collapse in the bond prices the Fed will be forced to significantly increase its buying.



However, since the only way the Fed can buy bonds is by printing money, the more bonds they buy the more inflation they will create. As inflation diminishes the investment value of low-yielding Treasuries, such a scenario will kick off a downward spiral. But the more active the Fed becomes in their quest to prop up bond prices, the bigger the incentive to hit the Fed?s bid. The result will be that all Treasuries sold will be purchased by the Fed. But with the resulting frenzy in the Treasury market, and with inflation kicking into high gear, we can expect that demand for other debt classes that the Fed is not backstopping, such as corporate, municipal and agency debt, to fall through the floor, pushing up interest rates across the board."

You can catch the rest of his thoughts here. Also, although we're in no big hurry to put on the full position, make sure to read our rationale behind shorting treasuries.

Consumer Deleveraging & December Retail Sales

We've mentioned many times before that the consumer has a rough 2009 ahead of them and that discretionary retailers could be in the house of pain. The following data simply backs up this thesis. We recently looked at consumer spending during recessions, and you might be slightly surprised at the findings. Courtesy of the NY Times, we see that retail sales in December were weak, especially at discretionary retailers.

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You'll also take note that Walmart (WMT) continues to be one of the lone bright spots in a dark consumer world. All along, we have advocated getting short discretionary retailers and going long the likes of Walmart (WMT) and McDonald's (MCD) as a hedge. The thesis here has always been that the consumer will trade down to cheaper alternatives and thus those companies will not suffer as much as normal, non discount retailers. And, after all, its merely a hedge to our overall bearish consumer bias.

Then, courtesy of the Big Picture, we see that consumer deleveraging has actually just really begun. As this trend continues, look for things to possibly get even worse in the retail world.

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As a result of the deleveraging, we've said that the consumer savings rate will have to rise. And, lastly, as the consumer struggles along, they'll turn to their credit cards to get by once they run out of cash. Thus, the credit card squeeze begins and companies with a lot of credit card/consumer debt exposure, like Capital One (COF), will continue to see a rise in delinquencies and charge-offs.

Peter Schiff Comments: 2008 Video of the Year?

Back in November, the PE Wire had mentioned that the following Peter Schiff Video could very well be the video of the year. Why you ask? Well, Schiff was one of the first people to 'predict' the crisis so clearly.

Now, the only problem with this, is the fact that some of his investment decisions were not the best and he did not profit from the crisis like he truly should of. Pretty ironic. But, we're mainly here to give him props for calling things so early and correctly. Call him what you may: a perma-bear, a self-promoter. He is what he is. But, this video definitely deserves some credit.

Consumer Spending During Recessions

Todd Sullivan over at Value Plays takes a quick look at consumer spending from the 1990-91 and 2001-02 recessions. Surprisingly, Tobacco spending was down. We only point this one because in recessionary times, people are quick to point out plays like Altria (MO) and Philip Morris International (PM). When, in reality, the spending in their product category is down. The increase in education spending has already played out again this recession, as the number of MBA program applicants has been very high, if not at historical highs. Lastly, we want to highlight the massive decrease in the category: food away from home. This illustrates perfectly our thesis for shorting casualty dining restaurants in a deteriorating consumer environment and going long McDonald's (MCD) as a hedge. Because, after all, if people do go out to eat, they are going to the cheapest place out there, the golden arches.

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Top 10 Worst Recessions

Blain over at StockTradingToGo has a nice post up comparing the longevity of past recessions to the one we find ourselves in currently.

1. 1929-1933, 43 months in duration (Great depression).
2. 1981-1982, 16 months in duration.
3. 1973-1975, 16 months in duration.
4. 1937-1938, 13 months in duration.
5. 1926-1927, 13 months in duration.
6. 2007-2008, 12 months in duration.*
7. 1970, 11 months in duration.
8. 1948-1949, 11 months in duration.
9. 1960-1961, 10 months in duration.
10. 1953-1954, 10 months in duration.

Now, the question ultimately becomes: how long does the current recession last? Well, for one thing, this recession only needs to last 4 more months to become the second longest recession. With the current auto bailout nonsense still going on, and no real relief for consumers coming anytime soon, we could easily see this recession moving up into 2nd place. We've got real issues to deal with here and these are certainly unprecedented times.

We recently wrote about how the consumer savings will have to rise in order for things to stabilize. Such a deteriorating consumer environment will definitely play a large part in the longevity of the current recession. The destruction of wealth that many "main street" Americans have and will experience should reach astounding levels and will impact many psychologically. An overleveraged American consumer was the backbone of the American for quite some time. But, times change.

See also Paul Kedrosky's recent Economic predictions, as well as a comparison between the current crisis, the Nordic crisis, and the Great Depression.

Activision (ATVI): A Bright Light in the Dark Consumer World?

I am long a specialty retail play. I had to slap myself out of the stupor for owning one in an environment I have dubbed as a consumer recession. What am I long? Well, how about some Activision Blizzard (ATVI). I was fortunate/unfortunate enough (we'll know later) to get filled on some of my orders in the $10.xx region and I had a few more orders down in the $9.xx that did not get filled.

So, why am I long a retail name, much less a specialty retail name. Well, first and foremost, it is mainly as a hedge to some of my other retail shorts. So, let's make that abundantly clear. I am bearish on the consumer and the economy. But, such bearishness must be given protection to any rampant rallies that might occur and I've selected ATVI, as they are currently dominating competitors such as Electronic Arts (ERTS) and THQ (THQI).

Secondly, I would propose that video games are by no means recession resistant, but they are less affected by a recession than other types of specialty retail. Why? Gamers are hardcore. Many are addicts. A game costs a measly $40-60 bucks and gives you hours upon hours of entertainment. And, ATVI has some of the best titles out there right now, including the Guitar Hero franchise, Call of Duty (4th installment out for the holidays), World of Warcraft (new expansion pack out for the holidays), among many others. They offer relatively cheap products and this benefits them in an environment where the consumer is struggling. When that new game hits, most people gotta have it, especially if its an installment in an already proven franchise such as the games mentioned above.

Thirdly, in addition to the strong products set to hit for the holiday season, ATVI has some very highly anticipated games in the pipeline for the future as well. If anyone is a fan of Blizzard's games (now a part of Activision Blizzard), then you already know what I'm talking about: Diablo 3 and Starcraft 2. These are highly proven franchises and are long awaited sequels (especially Starcraft 2). The entire nation of Korea will probably pick up a copy of SC2, I'm not even kidding. The game's prequel, Starcraft, was that big of a hit over there. So, future revenue streams are well in place.

Fourthly, even in a weak consumer environment, ATVI was still able to deliver solid earnings and stick to their forecast. And, they even announced plans to buy-back $1 billion of stock. After all, they have $3 billion in cash. Some takeaways from the quarter,

"For the September quarter, Activision Blizzard had two of the top-10 titles in dollars on all console platforms in the U.S., according to The NPD Group. For the September quarter, Activision Blizzard had two of the top-five PC titles worldwide -- Blizzard Entertainment's World of Warcraft: Battle Chest(R) and Call of Duty 4: Modern Warfare, according to Charttrack, Gfk and The NPD Group."

And, some data from the recent quarter courtesy of Barron's Tech Trader Daily,

"For the quarter, the video game company posted non-GAAP revenue of $770 million, well ahead of the company’s previous forecast of $620 million. ATVI posted non-GAAP EPS of 7 cents a share, better than the company’s forecast of 4 cents. For Q4, the company sees non-GAAP revenue of $2.2 billion, with profits of 29 cents a share."

So, as you can see, the company is holding up fine so far in this environment. Yes, the consumer should theoretically weaken as we move forward, but ATVI has solid titles, is selling cheaper items, and is selling to a consumer who is not likely to give up their products, despite the recession. If you want any evidence that ATVI has a comparative advantage in titles, then simply compare ATVI's most recent quarter to rival THQ's quarter. Yea, that wasn't pretty.

Lastly, I want to highlight that $10 billion hedge fund Caxton Associates ran by Bruce Kovner was out adding ATVI as a new position in their portfolio last quarter. And, not only did they just 'add it,' they really loaded up. They brought it up all the way to their 3rd largest portfolio holding. I wrote about Caxton's purchase earlier, where I detailed their portfolio holdings. Caxton is one of the many hedge funds I track on Marketfolly.com.

ATVI is best of breed in the gaming space and I am happy to be long the name as a hedge to my other specialty retail shorts. (See my post on the deteriorating consumer environment for short ideas). But, more importantly, the company definitely has a bright near-term future with all the anxiously awaited titles they have lined up.

I would be remiss if I did not end this piece with a 'proceed with caution' label. Specialty retail is easily going to be the hardest hit in the retail space. This is simply going to be a case of "who loses the least." If you do not want to take on the risk involved with this name, I would highly suggest checking out cheap retail plays on the "trading down" of the consumer to cheaper alternatives. These names include the masters of the cheap domain: Walmart (WMT) and McDonalds (MCD). And, you can read my thoughts about MCD's dominance here. Apart from those, playing retail names from the long side will be a very uphill battle.

Peter Schiff's Latest Comments

Last week, Peter Schiff, president of Euro Pacific Capital, sat down on CNBC to discuss how he thinks Obama taking office will not necessarily help the crisis. Schiff has notoriously predicted much of what we've already seen in the markets and economy thus far. And, he thinks the dollar gets obliterated as we move forward (as do I).

Visa (V) Consumer Spending Trends

Earnings Breakout has some important highlights/takeaways from the most recent Visa (V) earnings report/conference call.

"-Debit is now 53% of payments
-All disputes with major competitors now resolved
-Further slowdown in U.S. (10%) and cross-border volumes. Debit low-to-mid double digits. Credit got weaker through September
-Additional moderation from September to October. U.S. credit volume +1-2% in September turned NEGATIVE first few weeks of October. Debit still low double-digits
-Seeing shift to non-discretionary purchases. More credit worthy are driving purchases
-53% of debit spend is non-discretionary. >40% overall. Last recession it was 30%"

Those last 2 bullet points re-affirm the fact that the consumer will be in a pinch for a while to come and consumer recessions can be brutal. That will of course drive down consumer spending and thus corporate profits, which in turn reduces earnings estimates. But, that's a no-brainer given that earnings estimates are too high to begin with. The trends that Visa is seeing are of course a result of a rising unemployment rate and sluggish housing market, among other things.

I like to use Visa (V) and Mastercard (MA) as gauges on the economy simply because they are purely payment processors. They process both debit and credit spending as more and more people are using less cash and more plastic to pay for their purchases. They essentially are our eye on the consumer. So, when the aggregators like MA and V notice big spending trends, you better pay attention. And, although the consumer recession is upon us and will likely worsen, I still like MA and V as much longer-term plays. Like I said, they are purely payment processors and the world is shifting away from cash. Legendary investor and former Tiger Management hedge fund manager Julian Robertson agrees and recently bought both MA and V. This investment will almost have to be treated as a value play given the fact that they will face near-term headwinds with the credit crunch and a consumer slowdown. But, long-term, I think these are solid businesses to own, and I detailed why here.

Check out the rest of the Visa (V) earnings/conference call summary at Earnings Breakout.

Half the Globe in Recession? Goldman Sachs Thinks So

A few weeks old, but still relevant. Some nice weekend reading here.