The Simplified Investor

One of the lesser-known fundamentals underpinning the global economy is the Baltic Dry Index, a benchmark that measures dry-bulk shipping rates.  Dry bulk goods include the most commonly used raw materials, like grains, coal, and metals.  When global economies are booming, demand for these inputs (and the ships to transport them) fuels high day rates for companies like DryShips (NDAQ:DRYS) to transport these goods across the world’s oceans.  

The Baltic Dry Index (BDI) tracks rates in the 22 main shipping routes for these key inputs.  The BDI has plummeted in the past several months, as the U.S. financial crisis has snowballed into a global economic downturn and the consumption of raw materials has ground to a halt.  For example, China is the world’s biggest consumer of steel, but it has cut its consumption as infrastructure projects have slowed in response to slumping economic growth.  The same situation has played out with a host of other raw goods - and as demand for materials slows, so too does the earnings growth of a dry bulk shipper.

And there’s more to the story than a simple supply-demand curve.  Companies that ship goods overseas often use “letters of credit,” or contracts in which a bank will guarantee a company’s ability to pay back loans.  This way, a company can take delivery of orders immediately, but pay for them weeks or even months later.  When they pay, they’ve already turned the raw goods in the order into revenues by manufacturing products and selling to consumers. These letters of credit are an essential part of the shipping system - but they create risk for banks, which are on the hook for the balance owed by the company that shipped the goods in the event of a default.  In today’s lame economic climate, when banks are wary of all risk, it is increasingly harder for struggling companies to pay back loans - and it has also become quite difficult for companies to get letters of credit.  This means that companies can’t pay to have their goods shipped overseas - and their shipments simply sit at port, waiting for the voyage to be financed.  As the cargo languishes, so too do the companies that depend on shipping  orders for revenue growth.

But the credit crunch is just one reason why DryShips and its peers have seen their stock prices get hammered in recent weeks. There’s another force at play as well - shipping companies are being squeezed from both sides because while revenues dry up, the value of their assets (shipping vessels) are also declining.  Forbes reports that net asset values for dry bulk ships have fallen roughly 50% in the last four months, but outstanding loans for ships and contracts have remained static - creating a situation that has quite a few parallels to what happened to homeowners and property values during the subprime lending crisis.  

Shipping companies now owe more on the loans taken to build or buy a ship than the ship is currently worth. Furthermore, a company’s existing fleet is often used as the collateral to secure loans for new building projects - and as the value of these underlying assets declines, the company must post more collateral to secure a loan.  This could possibly lead to foreclosures by major shipping lenders like the Royal Bank of Scotland and HSBC and will certainly lead to a slow-down in the construction of new ships, as owners become wary of taking on these costs while struggling to make good on existing loans.

So what does this mean for the dry bulk shipping business?  Two things - ships sitting at anchor, with no cargo to transport (but no fuel or crew costs for a company to pay either); or, more ships hitting the scrap heap as companies downsize to stay efficient.  It’s unlikely that the turnaround for shippers will be quick, as revenue growth will depend on a revitalized global economy creating demand for raw materials.  It seems unlikely that stock prices (down 75% in this industry in the past six months) can fall any lower - but if 2008 has taught investors anything, its that you never know just how low we might go.

Last week, things looked bleak for equity investors. As the Dow Jones and S&P 500 slid to historic lows, and the TED spread soared to a historic high (more on that below), it looked to many like the thing to do was pull out of stocks entirely, and enter safer assets like gold, T-bills, and steady bank savings accounts. But on Monday, the market bounced, led by the news that the U.S. government will invest up to $250 billion to shore up the U.S. banking system in a plan similar to measures taken by several European powers, including Germany and the U.K.
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The Dow Jones Industrial Average fell below 8600 today - bleeding another 7% to continue the incredible losses that have take place all week. It seems like the much anticipated bailout has not had the effect that many anticipated - rather than assuading investor concerns that the worst of the financial crisis was over, it was an inadequate leavy in a flood of capital out of the equity markets and into more stable gold and treasury bonds.

And there’s reason to believe that the markets will keep falling in the great financial crisis of 2008. Some major macroeconomic indicators point to tough times in coming quarters.

Here’s a top 5:
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I know what you’re thinking - why invest in Apple when its stock price fell 18% today? But think literally about apples, which you’ll find in any outdoor fruit stand on the streets of New York. Today, our sadly ineffective government failed to pass its so-called “bailout” plan. The meaning is clear - our economy is going to get a whole lot worse before it gets better. People are going to be out of their jobs (some estimate as many as 6 million Americans will soon be unemployed) - so saddle up the push cart, hit the pavement, and get ready to earn a living one apple at a time.

What happened today was historic, and the market knew it. $1.2 trillion was erased from the market value of American stocks as frightened investors fled for the safety of gold and government Treasury bonds. The Dow Jones Industrial Average fell 777 points, the largest one day decline since the index was first published in 1896. The S&P 500 fell almost 9%, a drop not seen in two decades. Meanwhile, Wachovia Bank was bought by Citigroup for $1 a share, making it just the latest financial institution to surrender in a fear-driven downward spiral that has crushed venerable institutions like Lehman Brothers, Merrill Lynch, and Washington Mutual in recent weeks.

So where does it end? Our country’s economic leaders, Paulson, Bernanke, Dodd and Bush, were hoping that today would bring a tourniquet to stop the bleeding. Bush worked the phones on Monday morning, calling undecided Republican congressmen to plead his case. But it didn’t work - 133 House Republicans voted against the bill, compared to just 65 in favor. They were joined by 95 Democrats who were afraid to pass a bill sure to be met with anger among their constituents. In Congress, just as in the markets, fear was the main factor impeding progress. With elections coming up in 36 days, it seems many members of the House interpret “public service” as “Save myself, F**K the public good!”

September 29, 2008 Vote, U.S. House of Representatives

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On Tuesday, Deutsche Telekom AG unveiled the first smart phone that will use Google’s new Android operating system.  The device is called the G1, sold by Deutsche Telekom’s subsidiary T-Mobile, and it looks a lot like the iPhone and other competing smart phones (well, except for the Google logo on the back).  But its the software, not the hardware, that T-Mobile and Google hope will set this new product apart. It will need to be special to crack the dominance of RIMM’s Blackberry and Apple’s iPhone in the smart phone market.  Those two companies controlled a combined 65% of the market in 2008, ahead of a long list of competitors that also includes PALM, Motorola, LG, and Samsung.

Smart Phone Market Share as of May 2008

But smart phone users are savvy folks, and they’re looking for devices that will make life more efficient, and more enjoyable.  That’s where the cache of Google’s brand name comes in.  But will Android work as promised?  And, importantly, what effect will this new product have on the earnings (and stock prices) of Google, Deutsche Telekom, and the other companies involved in the cell phone industry?
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As the WSJ reported today, the collapse of Lehman Brothers and the sale of Merrill Lynch to Bank of America is just the latest chapter in a stunning redesign of the financial world.  Stand-alone investment banks are dying rapid deaths, with three down in 2008 already (who can forget the spectacular demise of Bear Stearns?).  In their place, a new king is rising - commercial banks.

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The government takeover of Fannie Mae and Freddie Mac will have far-reaching economic effects.  For example, hedge funds that bet against the two companies have already seen windfall profits as the stock prices of both companies plummeted over the weekend, while the financial institutions that invested in the nearly $5 trillion in mortgages and mortgage-backed securities that FNM and FRE guarantee can breathe a sigh of relief.  The government bailout should help avoid a global financial crisis - but it might not help all of the Real Estate Investment Trusts (REITs) that depend on loans from Fannie and Freddie to finance their growth.

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The problems plaguing the Big Three American auto makers in 2008 have been well-documented.  The push for flashy SUVs that guzzle gas but impress at the suburban strip mall caused Ford, GM, and Daimler to shift production towards these bigger cars, but these divisions have become huge drains on profits in recent quarters.  Consumers have responded to the explosion of oil and gas prices and stopped buying trucks and sport utility vehicles, looking instead toward more fuel-efficient and hybrid vehicles.

Europe drank the renewable energy Kool-Aid long before it reached America, and the big car companies have already focused their European and international production on smaller cars that consume less gasoline.  As the global economy sags, these economical cars have continued to sell, and results abroad have been the lone bright spot for Ford, GM, and lower-profile players in the auto manufacturing industry.
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The economic visions of the presidential candidates in 2008 are dramatically different, and the contrast is most striking when they discuss taxation. Barack Obama will steal from the pages of English folklore and take from the rich to give to the poor; well, actually, to the middle class, who will benefit from major tax cuts. John McCain sees things differently, and he will cut taxes across the board - most heavily in the highest income bracket, who will see more than $250,000 pumped back into their wallets.

Source:Tax Policy Center via CNNMoney.com

In the battle for supremacy in the aircraft business, there are only two real players - Boeing Company (NYSE:BA) and Airbus (EPA:EAD).  These two companies compete for market share in commercial and military planes, with demand far exceeding each company’s manufacturing ability, and both have a long order backlog.  Some of Boeing’s customers, for example, will wait as long as five years before the planes they ordered are delivered.  And while they fill these orders, both companies must keep innovating.  As oil prices continue to soar, and airline companies like Delta and American Airlines struggle with tight margins, planes that fly faster, fit more passengers, and consume less fuel are at a premium.

And so each company has designed its own new super-plane - for Airbus, the A380, and for Boeing the 787 Dreamliner.  The Airbus plane has already debuted (its first flight was in October 2007), while Boeing continues to get hit by production delays, and the Dreamliner is optimistically scheduled for release in third quarter 2009.

Boeing 787 Dreamliner vs. Airbus A380