Planet Yelnick

BRICs-A-Bracked

The BRICs are a' breaking, with three of four sharply down and below their 200 DMA, indicating a trend change to a protracted bear market. Russia is now largely an oil-bearing State, and belies the trend down of the manufacturing States, but would follow if when the oil bubble echo breaks. From Bespoke:

This speaks to a shift from investing in emerging markets - a major theme of the past few years - back to developed markets. Emerging markets are down 3% in January, with India down over 10%, South Africa down 9%, Indonesia -7% and Brazil -4%. Inflation, arguably exported from the US be QE2, has thrown them all a curve ball.  

Markets Shrug Off Egypt, Look to Economic Data

Markets are generally up even as the Egyptian situation worsens. This makes the financial press look pretty foolish for attributing the fall on Friday to Egypt. I commented in my weekend post that all the time a market move is said to be caused by a news event when instead it was driven by technical factors, and this is just another of a myriad of examples. Yet the punditry persist in this error. 

Much more important today were some good economic reports, including the Chicago PMI at really high levels. Tomorrow the national ISM report comes out and should show an increase in production. Also income was up, although income less transfer payments was essentially flat, meaning much of the increase is government life support. Spending was up much more than income, meaning it came out of savings, and seems to have been largely driven by rising food and energy costs, not an increase in core demand.  

Over the weekend a lot of commentary on the GDP Report came in. The most interesting is from Econophile, a former bear who has been ahead of the curve on noticing a bottoming and the start of a recovery. His take on this GDP report is that it too is due to government life support, in this case largely a consequence  of QE. He thinks the positives are largely a "mirage" and may be revised away next month 

Three Things to Know About the GDP Report

Pre-market GDP disappointed at 3.2%, below expectations (3.5%) and whisper (4%) although above Q3 (2.6%). GDP hit an important milestone: we have recovered from the drop and are back at 2007 levels. The Great Recession is over! So why did the market react so badly?

The consensus opinion points to Egypt, not GDP, but Egypt had been in turmoil for several days as the market kept blissfully rising. The financial press always try to pin a market rise or fall on some news event, when technical conditions are the more likely culprit. Lost in the noise were disappointing earnings from Microsoft, Ford and Amazon, which may have had more to do with the fall. 

The best line was that the market that was looking for a reason to correct and got it in the form of Egypt's public protests. This market had been peaking since Monday and was showing signs of exhaustion. The past few days show a Fractal Finance plateau that was bifurcated to the downside by the close (see chart, courtesy SlopeofHope):

The pattern looks ominously like last April, right before the Flash Crash. As one bear pundit put it, if the market gets smoked Monday at the open, the hedge funds may short with a vengeance.

Past Monday, the question is: does the GDP report give guidance as to the future direction of the market? Is this just a momentary overreaction to a spike in oil prices and fears of a widening Arab revolt, in which case stocks will resume their upwards trajectory, or does the GDP Report throw doubt on the recovery and thereby corporate earnings? Three key things to watch:

1. Final Sales vs Growth. Final sales were up strongly, a good sign, but overall growth is mediocre at 2.8% YoY, meaning the consumption-driven Q4 is not sustainable. The trajectory is for less growth in 2011, a warning flag for a recovery, where we should be accelerating growth right now. 
2. GDP Deflator vs Inflation. The inflation indicator the BEA uses came in very light at 0.3%, with the core PCE component at 0.4%, the lowest level since 1959! If it had come in at expectations (1.6%), real GDP would have been almost halved to 1.9%. It may be it was light due to rising imported oil, which gets subtracted; but the core GDP deflator (which the Fed prefers) also declined. This very low inflation seems inexplicable given rising food and energy prices, and is likely to be revised up, lowering GDP. 
3. Inventories vs Imports. Inventories were down, lowering GDP, and imports were down too, helping GDP. Usually nventory drawdowns are good, as they presage future production to refill, but in this recoveryless recovery, Econbrowser observes that we seem to be substituting imports for inventories. As a consequence, while they expect inventories will be less a drag on GDP as they have recently, imports should go up and exert a drag of their own. See final chart for the inverse relationship.

This report looks inexplicable, with a ying/yang across those three things to watch, and is likely to be revised downwards. Karl Denninger took a look at the core conundrum in this report (I paraphrase):

how do you get an acceleration in spending with a decrease in imports, since we are not suddenly moving all those electronic gadgets back to being manufactured in the US?

He concludes that consumption number is driven up by inflation, an increase in energy and food costs, not a large increase in units. The inflation indicator for personal consumption increased to 2.1% compared with 0.7% in Q3. (The GDP core PCE deflator mentioned above excludes energy and food.) Use that 2.1% instead of the 0.4% of the report and GDP would be less than 2% again. 

My take: the year-end optimistic reports by Goldman Sachs and others of an increase in 2011 GDP as compared with 2010, to 3.5% or higher, looks at risk. Instead, it looks like the period from 4Q2009 to 4Q2010 may have been the high water mark, and we are beginning to slow down as stimulus abates.

Yesterday's op-ed in the WSJ from economist John Taylor (who would make a really great Fed chairman), which was adopted from his testimony last week to Congress, is the best I have seen to explain the conundrum we are in: the very ad-hoc and one-time efforts to jump-start the economy has kept it in a funk, unable to heal itself:

The one-time stimulus payments to people did not jump-start consumption. The stimulus grants to states did not increase infrastructure spending. Cash for clunkers merely shifted consumption a few months forward. The Fed's purchases did not have a material impact on mortgage interest rates once changes in risks are taken into account. At best these actions had a small temporary effect that dissipated quickly, leaving a legacy of higher debt, a bloated Fed balance sheet and uncertainty—all of which slow growth and job creation.

An economy on life-support is not an economy in recovery.

QE2, Inflation and the Great Margin Squeeze

Don't confuse speculation with inflation

Global food prices are soaring. Market speculation fueled by QE2 as well as one-off events like the Great Queensland Floods in Australia and US subsidies for ethanol have driven up prices from coffee beans to prime beef, from coal to corn, and just about everything else. The WSJ reports that eateries have little pricing power, so they have to scramble to avoid a big margin squeeze.

Mish takes it a step further, noting how commodity prices have increased across most industries, especially driven by oil and energy prices. Finished goods prices rose 1.1% in December, driven primarily by a 3.7% increase in energy inputs. Finished food rose 0.8% while wholesale inputs rose 23%. Mish concludes that "every step of the way, a decreasing portion of costs are passed along."

• prices are up 15.5% for crude goods
• prices are up 6.5% for intermediate goods
• prices are up only 4% for finished goods

Even less gets to consumer prices. The great margins squeeze is on. And the rise in oil could scuttle the recoveryless recovery. (Picture courtesy Pierre du Plessis.)

This is NOT inflation. Inflation is a general rise of prices, whereas this is a rise among commodities but not end prices or wages.

Let me use an analogy. A while back I discussed "good" deflation vs "bad" deflation. The steady drop in HDTV or PC prices is an exemplar of good deflation - price drops due to the ruthless pursuit of productivity and efficiency. A general drop in prices is a symptom of bad deflation - the rise in the purchasing power of the currency. Good deflation can continue for years in certain factors of production - such as oil in the 1890s, autos in the 1910s, PCs in the 1990s and HDTVs in the 2000s - without in any way presaging or sparking bad deflation.  

Similarly, a rise in classes of prices, such as commodities, is not the same as a general rise in prices. The commodities rise is likely to spill over into inflation gauges, such as the CPI, as energy and food prices tend to get passed through. But the core CPI - excluding food and energy - is unlikely to budge much. This commodities bubble echo (an echo of 2008) can continue for months without causing or presaging any general inflation.

When it bursts, it might paradoxically accelerate deflation. In our economy, debt creates money, and commodities speculation that uses margin piles on more debt. As the positions unwind, the margin is paid off and money disappears. If the effect is large enough, it can lead to deflationary pressure. 

This is not to downplay very real inflation outside the US. China in particular is seeing the inflation monster threaten to swallow their economic miracle. Some argue this Godzilla is caused by Bernanke and QE2, and certainly the commodities bubble contributes to inflationary pressure inside of China, but the source of Chinese inflation is much more prosaic: their money supply is growing too fast, fueled by a credit bubble from Chinese banks, not the Fed. Chinese M2 is up 55% in two years, and its PPI is up 5.5% year over year. Chinese steps to quell inflation have been tentative so far, as they seek that elusive "soft landing." If inflation crests double digits, they may need to find their own Chairman Volcker to slay the inflation beast. Andy Xie, one of the best observers of Chinese financial markets, suggests that China may need to devalue the Yuan, slowing capital inflows and likely causing internal interest rates to rise. 

What the Great Margin Squeeze means going forward is pressure on domestic US profits, headwinds from rising oil prices, and the possibility of a bursting Chinese credit bubble shocking world markets.

Demand Media Kicks Off Social IPO Season With a Bang

Amidst a nice little Obama SOTU Rally since late in yesterday's session, Demand Media (DMD) priced at $17, above the range, and is now trading around $23, a fine opening to Social OPO Season. DMD is now valued at $1.5B and is the largest Internet IPO since Google. The offering was also super-sized, from 7.5M shares to 8.9M. 

DMD has about the same market cap as the venerable New York Times. 

DMD has a different model than the NYT: it creates on-demand websites based on expected hot search keywords rather than create news stories based on, well, news. It covers topics that are of current interest, and should be compared to Time-Life or McGraw-Hill rather than a newspaper. This sites are a new form of the sort of special-interest magazines that McGraw-Hill used to cherish. Some of the most popular are ehow.com, livestrong.com, trails.com and the guy site cracked.com. 

A popular term in the websphere these days is "curation", the use of a human editor to organize and select content. DMD is a hybrid of machine-generated and curated, where the keywords help guide DMD to construct a site that matches how prospective readers are trying to find information on the web, and the human curators construct and update the site. In effect, they are using keywords to drive editorial content, and humans to make the site interesting. Although DMD is the subject of derision from old-fashioned editorial sites, it is better thought of as using modern, social techniques to determine suitable groupings of editorial content.

Its bet is the crowdsourced keyword editorial context drives better editorial content. So far its sites collectively are the 17th most watched sites on the Internet, an incredible achievement. The most read is ehow.com. 

If you wish to play this new category, a good read is this TradingIPOs analysis by Bill Simpson. He says to watch the operating expense ratio, essentially the spread between paying contributors and monetizing the sites. DMD uses freelancers for the most part. In an accounting decision which is controversial, DMD amortizes the cost of content over five years, rather than expensing; this turns a loss into a profit. He thinks fair value is $14-16, below the current trading range. 

The other issue to watch is Google's steps to rank search results differently, which could lower DMD sites in the search stack. Right now 41% of DMD readers come in from search results. The initial move of Google is to encourage searchers to report poor results, which I do not expect to lead to much of a response and therefore to have little impact on DMD. The war between quality results and synthetic sites from DMD will continue. 

The Social IPO Onslaught is About to Commence

The new wave of tech is the Social Mobile Web, and its leading companies are lining up to go public. We haven't seen such a lineup since 1995, when Netscape went out and rang the bell on the dot-com mania. Further back, this happened in 1980 when Apple went out (in an overall poor market climate) and set off the PC bubble. Will lightening strike a third time?

The first out is Demand Media (to be Nasdaq: DMD), run by Richard Rosenblatt, who had been CEO of the parent company to MySpace. DMD is a next generation style content site, which mass-produces sites based on hot keywords. Google search begats synthetic content, designed to rise to the top of search results and skim clicks.  Blogger Paul Kedrosky describes DMD's business as: “find some popular keywords that lead to traffic and transactions, wrap some anodyne and regularly-changing content around the keywords so Google doesn’t kick you out of search results, and watch the dollars roll in.” This modern way to produce content has produced hockey-stick growth, but Google just announced modifications to search results to undermine these synthetic web sites. DMD is highly dependent on search optimization and will quickly modify what it needs to to stay ahead of Google.

How this business dynamic plays out is anyone's guess.

How this IPO dynamic plays out will set a tone for the coming IPO Season. DMD should go out at over a $1B valuation, and be the largest Internet IPO since Google itself. It is supposed to price at the close on Tuesday (tonight) and begin trading Wed. 

On its heel are LinkedIn, Zynga, Groupon and eventually Facebook. LinkedIn is now trading at a $3B valuation. Yes, trading, even though it is not yet public. Markets fill gaps, and a secondary trading market for private shares has evolved for these social IPO candidates. Demand for these shares is hot hot hot, and Facebook ticked to a $70B valuation even as Goldman Sachs did an organized sale of $1.5B at a $50B value. 

You might wonder why they have to subject themselves to Sarbanes-Oxley and other nefarious regulatory schemes when they can raise and trade effortlessly in private markets. Well, the Empire eventually strikes back, and the SEC has put pressure on Facebook to go out as its tradeable shares close in on the 1934 Act limit of 500 shareholders.  

Until the Empire shuts it down, SecondMarket is a great resource. Here is its current hot list, showing which social IPOs should be hot:

Tech Stock Smackdown

Uncertainty creeps into the tech world on soft cat's paws. Last week was full of surprises: Eric, Steve, some guy at AMD, half the HP board, gone. Apple has tremendous momentum and had blow-out earnings, but maybe it is all priced in? Google still beat, but a close look suggests it barely made it, and largely on currency hedging, not core business. AMD beat and the stock gets hammered the next day on chip pricing weakness. And maybe it is over for the PC-centic Intel Architecture? The sharp reaction suggests the stock was priced to perfection.

Perhaps next week will be a general tech stock smackdown, as the whole market is priced to perfection. 

Small caps have taken a dive (see chart). 

The major indicies didn't fare much better, other than the Dow, driven up by GE and strong earnings, plus a hint of crony capitalism. We have a clear divergence which will resolve one or the other:

Tech is where the action is. First AAPL. Casey Research had done a bearish number on them last June, but reconsidered this weekend as the iPad has blown past all expectations. AAPL is poised to be the WinTel of the tablet era; it might garner the combo value of Intel+Microsoft as of the 2000 peak. They find the current stock price in line with expected earnings. And add this:

Now that Jobs might be gone for good, would we recommend shorting the company?

Apple had its Q1 2011 earnings call yesterday, and results were again better than anybody could have expected. Revenue for the quarter of $26.7 billion reflected an increase of 31% from the previous quarter and 70% from the same quarter a year ago. Earnings per share came in at $6.43, a full $1.79, or 38%, increase from last quarter. What’s more, iPad unit sales came in at 7.3 million, indicating an average of 2.43 million per month – more than 20% higher than the 2 million units we assumed for the conservative earnings forecast above.

So, for now, Apple is running like a well-oiled growth machine. An amazing feat given its size (with a market cap over $320 billion). And we expect this to continue for at least the next several quarters whether Jobs is at the helm or not.

The test for AAPL will come when it hits the 50 DMA, which has provided support during prior Whither-Steve-Jobs episodes:

Over to GOOG. Larry Page was the initial Google CEO, and he stepped aside for Eric Schmidt for a decade. Now he has gone back into the drivers seat.

Is the second coming of Larry Page the return of a Steve Jobs, or of a Jerry Yang (YHOO)?

Other founders have returned to run their company and done middling, such as Michael Dell right now. At moments of market transition a successful tech CEO needs to bet the company on a new vision. Google is at such a moment, losing momentum to Facebook and the whole social mobile web phenom.

Most tech companies fail to come up with a second act: IBM, DEC, Lotus, Yahoo, to name a few. Consider the fate of Microsoft since the departure of Bill Gates:

Ballmer completely fumbled the transition for PC to mobile. Compare MSFT to AAPL during the Ballmer era:

Will there be a general tech selloff next week, bring the broader market down? It seems much more likely afer this past week. Uncertainty begats profit taking. 

QE2 Working the Wrong Way - Has the Fed Redefined the Mission?

 Monetary policy responsibility cannot substitute for government irresponsibility - Jean-Claude Trichet

A funny thing happened on the way to QE2: rates rose rather then fall. It appears The Ben Bernank has now redefined the mission from keeping long rates down to pushing stock prices up. He says he wants to create a "wealth effect" among investors that pulls the economy out of the slump. Never mind that rising commodities prices (especially oil) create a corresponding "poverty effect" for the middle class. How will this end?

John Mauldin's latest, Thinking the Unthinkable, is a must read. (Also available here.) He notes how Bernanke in 2002 believed that the Fed could target an inflation rate such as 2%, raising short rates to stifle inflation and lowering long rates to fight deflation by buying forward in the Treasury curve. This buying forward is what Ben means by Quantitative Easing (QE). John's comment on QE2:

Then a funny thing happened on the way to QE2: long-term rates began to rise all over the developed world. As Yogi Berra noted, "In theory, there is no difference between theory and practice. In practice, there is." It’s got to be driving Fed types nuts to see the theory of QE, so lovingly advanced and believed in by so many economists, be relegated to the trash heap, along with so many other economic theories (like that of efficient markets). The market has a way of doing that.

So, Liesman asked Bernanke about one minute into the clip (link here) about the little snafu that, following QE2, both interest rates and commodity prices have risen. How can that be a success? Ben’s answer (paraphrased):

“We have seen the stock market go up and the small-cap stock indexes go up even more.”

Really? Is it the third mandate of the Fed now to foster a rising stock market? I wonder what the Fed’s target for the S&P is for the end of the year? That would be an interesting bit of information. Are we going to target other asset classes? 

So isn't rising stocks goodness? What could go wrong? Richard Fisher of the Dallas Fed has been plainspoken about the risks:

The new Congress and the new staff in the White House have their work cut out for them. You cannot overstate the gravity of their duty on the economic front. Over the years, their predecessors — Republicans and Democrats together — have dug a fiscal sinkhole so deep and so wide that, left unrepaired, it will swallow up the economic future of our children, our grandchildren and their children. They must now engineer a way out of that frightful predicament without thwarting the nascent economic recovery.

So far the new Congress does not appear serious. Only three House members joined the Tea Party Caucus. The first major action is to try to repeal ObamaCare - a futile and symbolic effort at best. The stated goal is to reduce $100B from spending - a drop in the bucket. 

What has gone wrong for Bernanke is the rise in rates. The 10 yr is approaching a record spread with the 2 yr: 273 bp where the record is 283 reached in Feb 2010. Normally this spread is goodness for banks, as they can borrow short and lend long in the spread; but most of their mojo would come from mortgage lending, and new mortgage applications are "plumbing" 15 year lows. So instead of profiting, they are seeing the value of homes drop, pressuring the asset values for their carried mortgage base. At this point either he has to reconsider steps to reduce long rates, or hope Mother Market takes care of it for him.

What may go wrong next for Bernanke is a drop in stocks. A stock fall would show that the Fed Emperor has no clothes, that his justification for QE2 is baseless. A serious correction eradicates the wealth effect, and the continuing rise in commodities extenuates the poverty effect from high oil prices. In any event, the purported wealth effect has been studied and found wanting - not much there, and very little trickle down to the middle class. 

The biggest risk comes from theory hitting reality. Niall Ferguson (economic historian) decries the economic theorists for believing in some form of neo-classical equilibrium, that things tend to stay in balance. Neo-classicists, including Bernanke, completely missed the 2008 crisis because it was outside their view of how the world works. They thought markets were self-correcting and changes incremental. The history of booms & busts, however, says that change can be rapid and dramatic - crashes not slow slides.

In other words, QE could spiral out of control. Already it is not working as Bernanke expected. As Niall concludes:

Complex systems look like they are in equilibrium, but they are not: they are constantly adapting, highly decentralized, interdependent systems and this process of adaptation can continue for quite a long time. And you think to yourself when you look at it, that's in a wonderful equilibrium. That's how we think about the economy. That is how economists teach economics. They talk about it in terms of equilibrium.The bad news is that in fact we inhabit a complex system that has virtually nothing to do with the neoclassical model that you are taught in Econ 101. And that's why the economists failed to predict the financial crisis ...

For me American power if you generalize beyond the realm of finance through the geopolitical system is a perfect example of a highly complex system which looks like it is in equilibrium but like all the great empires of the past is quite close to the edge of chaos. And our nightmare scenario should be that something happens to us like happened to the Soviet Union... It suddenly just falls apart.

And I think the trigger, the catalyst if you want to switch to chaos theory the butterfly in the tropical rainforest that flaps its wings and posits the distant thunderstorm is going to be the credibility of fiscal policy. That just seems to me like the obvious place where things can turn nasty, and they turn nasty with amazing speed."

Oil Approaches the Breaking Point

Oil has three cracking points: when it gets refined, when it stops rising, and when it breaks the economy. Econbrowser analyzed oil prices and the economy and concludes: 

Every recession (with one exception) was preceded by an increase in oil prices, and every oil market disruption (with one exception) was followed by an economic recession.

Merrill Lynch’s Sabine Schels, a commodity analyst, calculates that $120/bbl will break this recoveryless recovery. This price makes the energy sector 9% of the economy, and she says we saw that in the 1980s and in 2008. Since oil tends to rise into the summer, this puts the cracking point out in Q2.

Might oil peak before $120? Oil's price is approaching a key level at $105/bbl (see chart, courtesy Market Oracle), the 61.8% retracement (this is the Brent Crude level; in the US WTI, oil fell a bit more on a cash basis, to $32, so the US level is just above $101/bbl.)  You can see how it oscillated around the 38% level for a while before testing the 50% level at $90/bbl and falling back. It has now crushed through $90 and fallen off a bit, but stayed above $90. Watch to see if it falls back below in short order, indicating a false break. Otherwise we seem headed above $100 in short order. 

 

The Fed Follows The Market, Usually

It is commonly asserted that the Fed sets interest rates. Instead, history shows the Fed follows the market - and gets the economy into trouble when it diverges too long from what the market is saying. Tony Caldaro has an excellent piece on the Fed and rates in the 'Oughts. He shows how the Fed sets the Fed Funds rate (red line) based on movement in the 1-year Treasury Bill rate (black line):

In 2003 the Fed held rates too low compared with the 1-yr, and the Greenspan Bubble of excessively easy credit was on. In 2006 the Fed held rates too high, and the Housing Bubble was burst. The signal for being too low or too high appears to be 50 bp - when the 1-yr is 50bp or more out of alignment, the Fed Funds rate needs to be changed.

Given this correlation, wouldn't it be more consistent policy if the Fed Funds rate were simply set by the market, and not the Fed? Or the Fed behaved by rule and not discretion?

Right now the Fed Funds rate and the 1-yr are very close. No short term rate increase is on the horizon. The 1-yr would need to crest 0.75% to spark a possible change. With a commodities-based inflation emerging due to QE2, this may happen sooner than investors, and the Fed, think.

Great stuff by Tony!

Will Steve Jobs Bring Down the Market?

It is difficult to imagine a world without Steve - he has been the prime driver for three generations of computing: Apple // begat PC and MSDOS; Mac begat Windows; and iPod begat a whole new mobile experience, with iPhones and iPads. This is an unparalleled achievement. Whither technology if Steve really retires, or his illness worsens?

His leave was announced a day before earnings, which suggests Steve's situation is too serious to wait even a day. 

Apple is expected to announce blow-out earnings tomorrow, but AAPL is down 7% in German markets, and the Nasdaq 100 futures are down hard (see next chart from SlopeofHope). Apple has had such a run that stories are beginning to emerge that the stock has no place more to go. The next frontier would be to conquer TV, but Steve has insisted the Apple TV offering is but a hobby - which means his vaunted Steveness has not yet figured out how to conquer the world of Mad Men. Most likely it is his failure to negotiate deals that would enable Apple to offer a $30 cable TV bundle over the Internet within iTunes. It could be this is the time to sell AAPL, not buy the coming dip.

Of course, last time this happened, the stock dipped 10% and then tripled. This time Steve's condition may be worse. 

This drop started before the Steve announcement, which suggests the expected January correction has begun. This event could trigger a series of falls. Investors are best described as jittery. 

One Interesting Insight From CES

The public side of CES was very incremental. Nosing around the floor can sometimes unveil that which is hidden. I spent some time with a very well-connected character in mobile and he laid out the case that Oracle will have to enter the smartphone race, and may be in the best position to challenge Apple and Android. 

When HP bought Palm I commented on their logic: rather than be a box supplier for Windows or Android, they believe they need to have architectural control. Palm's new WebOS is the most developed alternative to Apple and Android, and gave HP the best starting point. They intend to eschew the mobile handset space (at first) and race ahead in tablets. WebOS is easy to program in for web designers, giving HP a possible developer community to leverage. (Apple's iPhone leveraged the Mac base, and now has a whole new base; and Android leveraged Java). How well they do will now depend on execution and great apps.

HP seems a bit slow to get out of the starting gates, however, which opens up room for another challenger. Nokia's Symbian seems out of it. RIM's Blackberry is making their play right now with their new touch line, and it still has a strong following, as you can see from this recent Nielsen market survey:

What remains is a huge Java phone installed base, estimated at 3B feature phones, all of which rely on Java. That base dwarfs the smartphone market. Sun (now Oracle) is the prime licensor of Java, and Java gets into handsets via 'stack' suppliers like Aplix and Esmertec (now Myriad). The world remains firmly Java even as the high-end is going Apple or Android. 

Oracle bought Sun and now is in a series of battles to maintain royalties for Java. Esmertic (Myriad) has defected and sued Oracle, claiming excessive royalties; Android modified its Java engine and claims not to owe to Sun. Oracle has sued Google and counterclaimed against Myriad. 

Rather than play defense, their next move is to go on offense and launch a Java-based smartphone OS (or embedded java stack that the handset makers can add on top of their proprietary OSes). They have a 3B user market to convert, scads of handset makers to sign up (all left a little high-and-dry by the onslaught of Apple), and a huge Java developer base to keep in the fold and out of the clutches of Android. My source says they are already making moves:

From the directions that Oracle is taking (and deeply investing in) it is clear that they are making a large client move with embedded Java. They have made it clear to the JCP executive committee that JSE 7 will be their technical competition for Android. They are setting up to support the eco-system and willing to make the moves needed to recapture and grow the Java market share. They will be pushing JSE 7 changes into OpenJDK that they have partnered with IBM on. ... This will exceed the openness of Android, but they will still need to meet the service value of Android.

Watch and see whether Oracle goes a step further into a branded Java smartphone community with an apps store, mimicking Android. Investors take note that an apps store for Java already exists in a company called GetJar, which might be snarfed up by Oracle as their strategy gains substance. Game on!

Australian Real Estate At The Brink

While Northern Australia suffers from floods of Biblical proportions, the Southern (big city) property market seems poised for a devilish fall as the Oz Tulip Mania is about to crash. The Aussie answer to David Rosenberg, Steve Keen, has been on this for two years, and last summer Jeremy Grantham weighed in as well. Now Mish piles on, noting that the purported eternal housing shortage is a myth of Biblical proportions: property listings have surged in a flood tide by 44% last year, an indication of panic listing at the peak. 

Steve Keen noted before Christmas that a large Australian bank, Westpac, had been dumbing down its lending standards to keep the bubble afloat. He commented on Mish's post, adding to his series that explains the recent bubble in simple terms:

One factor that I'm following closely in all this is what Biggs, Meyer, and Pick called "The Credit Impulse": This is the change in the change in debt.

[A]ggregate demand in a credit-driven economy is the sum of GDP plus the change in debt, [and it] follows that change in aggregate demand is the sum of the change in GDP plus the acceleration of debt.

Australia got out of the crisis in 2009 by exploiting the upside of this factor: if you can encourage people into debt, then aggregate demand grows as debt accelerates--so even slowing down the rate of deleveraging gives a positive boost to demand. ...

That's how the USA looked a bit better in recent months--you slowed down deleveraging. But since Australia went from marginal deleveraging to releveraging, the acceleration in debt was all the more extreme--and we had a apparent boom.

That appears to be ending now, since though the Credit Impulse is still positive on a yearly basis, it's turned negative in the last few months.

Mish gives the following recommendations, and expects they will also soon apply to Canda, China and the UK:

• Exit the Australian stock market
• Get out of the Australian dollar
• Pick up some popcorn
• Stay on the sidelines and watch the collapse unfold

Our Hollow GDP

"Weak Hiring Casts a Cloud" -  WSJ
"For Jobs, Signs of Recovery" - USAToday

Is the recovery finally on? Or is it all an illusion, where the increase in spending is due to transfer payments from big deficits? Let's explore the reality and the illusion. 

A lot of pundits have caught the optimism. Consider these factoids:

• Holiday retail sales highest in years
  • but it turns out it wasn't - it was a dud
• Q3 GDP revised up
• Q4 GDP on track for even higher
• GDP in 2011 revised upwards due to Tax Deal
• Latest ISM report up showing increased business activity
• Job openings rebounding (see chart)
• Commercial lending *may* be picking up

The best green shoot of them all is the WSJ story that bank lending may finally be picking up. Commercial lending to finance growth is the real key to a recovery. Yet if there is an uptick, it is barely discernable (see second chart).

The other big positive news is the Tax Deal, which puts off the dreaded double-dip by not hammering the economy with a massive tax increase.

Yet at the same time the recoveryless recovery faces severe headwinds:

• Housing - double-dipping
• Jobs - growing too slow 
• Oil - rising to dangerous levels
• Debt - used for transfer payments, not growth

Make no mistake, there are signs of improvement, and they have been trending better for the past four months - ever since QE2 was announced in late August. We saw a similar burst of optimism last year at this time. Is it real this time, or another illusion, driven by massive transfer payments, which boost GDP but not the real economy, and pile on more debt for transient spending?

Let's walk through all four headwinds.

Predictions 2011

That time of year again.  I did surprisingly well in 2009, with 7 of 9, including predicting the Dow would exceed 10500 at a time when it was in free fall below 8000 heading to 6400. Not as well in 2010. Where 2009 was Hope, 2010 was to be Change, and it was, with an historic election and the emergence of the Tea Party. Got that right, and a few others, such as 2010 being the Summer of Disillusionment, which it was, and no double-dip until 2011; but while I was directionally right I was too bearish in the predicted levels. Thought stocks would top in Q1 and bounce, and they did, but did not go as low as I predicted. Thought bond rates would rise then fall, which they did, but not as much a rise as I thought. Expected the Dollar Index to break 90, and it got to 89. Close but no cigar. Let's see about this year:

1. 2011 is the year of Chickens (coming home to roost) - kicking the can down the road is ending. The Tea Party really has an impact to stop Keynesian stimulus and cut the growth of government. But you never know - the GOP may screw it up. 

2. Housing will drop 20%, if not all in 2011, over the next three years

3. Margins get squeezed as inputs (commodities) rise but pricing power is not there, causing a flattening of domestic profit growth. PEs go up! Stocks go down! Timing dependent on how long oil stays up.

4. Commodity Bubble Echo peaks and then drops hard - it is already at the 50% retrace and could drop from here, but more likely goes a bit longer to the 62% retrace (another 10% higher in the CRB)

5. China slows enough that the Chinese bubble is said to burst. Already growth is slowing and the Shanghai index is showing weakness. China raised rates again to stem an inflation that is at least at 5% and rising. NIxon imposed wage/price controls in 1971 and junked the entire world financial system (Bretton Woods) when US inflation got to those levels. 

6. Dollar surprises by rising. This year it really does break DX90.

7. Stocks move sideways all year. We may see a peak in January but will rebound and head to new highs, above Sp1300. The Hope Rally may end in 2011 but more likely limps into 2012. If we get a double-dip in Q2, October could be a cruel month. 

8. Muni bonds do not face the sort of disaster predicted by Whitney among others

9. GDP starts strongly but heads south by end of year. We might get a negative quarter if oil stays high for the first half of the year. If not, 2012 will have the dreaded double-dip. 

10. The Social Mobile Web boom continues, with high-profile IPOs. The Nasdaq100 should therefore outpace the broader indexes. 

11. The world gets colder. Climate Change becomes a joke. Every weather event that is blamed on "global warming" is now done with tongue in cheek. Political support chills for subsidies for green technologies, whether carbon taxes, cap & trade schemes, cheap loans or outright subsidies. CleanTech VCs switch focus to real breakthroughs which can compete without subsidy. 

KIndle Safe From CES Tablet Mania

iPad Not a Kindle Killer, TechCrunch survey says. Good thing too. CES is full of tablets but my family is full of Kindle lovers.

Margin Debt Outpaces S&P

Margin debt - borrowing to buy stocks - has shot ahead of the S&P. It normally follows the index up and down. When margined stock gets ahead of the market, any significant drop is in danger of snowballing as stock is sold to cover the margin. Call it the old fashioned type of Flash Crash, of the sort we saw in 1929 when stock was bought with subprime margin (90% margin on 10% cash), or right after the Lehman debacle when TARP was pronounced (see chart, courtesy PragCap). How the 'bots might handle that we may find out - technicians are all over themselves with expectations of a 5-7% drop as early as tomorrow.

With 3D a Bust, TV Gets Smart

CES approacheth, and so do video dreams. Last year the industry bet on 3D, with Sony going all in. As I reported after the 2010 show, it was not ready for prime time. It flopped.

This year hope changes to "smart TV" - the boob tube turned into a smartphone, with apps galore. Clever, certainly, but smart? Wait 'til you see the remote! Will immediately fail the Wife Acceptance Factor (WAF). 

Smart is not well-thought-through yet, but starts with an Internet-connected TV that accesses television online. The onslaught of Netflix continues unabated. Stories fly through the blogosphere about cord-cutting away from cable and into online TV. Cable is indeed losing customers, and about at the pace we saw a decade ago from landline to mobile telephony. 

I bought two networked blu-ray players that were simple enough to pass the WAF and yet provide Netflix, Vudu and YouTUbe on the telly. Both came from LG and were powered by Widevine, one of my investments that recently got bought by Google. I believe in online TV and have placed bets. 

Stepping beyond "online TV" to "Smart TV" and into the land of apps, and the future gets murky. TV remains a lean-back experience. For TV makers, the cost and complexity to enable an apps layer (typically powered by Google's Android) may be quickly wrung out of the profits in the hyper-competitive TV market. The advantage will inure to Google, Netflix and the new intermediaries who provide the content & apps services. 

Let's see what they cook up at CES. More when I return.