Morgan Stanley Economy & Internet Trends

Here's an excellent presentation from Morgan Stanley on economy and internet trends. One of the key trends predicted here is on mobile internet. Iphone has dramatically revolutionized mobile internet. You can see the steep increase in mobile internet adoption, usage and bandwidth consumption since the launch of Iphone. Going forward mobile is going to drive internet penetration into developing countries and the day is not far when mobile internet usage will be higher than desktop/laptop users..

Morgan Stanley Economy Internet Trends

90% Tax on bonus: Are we being fair?

AIG bonuses has been the top issue in the news for more than a week now. Almost everyone including media, politicians, public are emotionally charged up. There is so much bad blood and negativity out there. Is all this hype & knee jerk reactions justified? I don't think so. We all seem to be carried away by this hype created/fueled by media & politicians and are failing to look at this in a bipartisan and level headed manner.

I agree that careless decisions by some of the senior banking executives led us to this current situation. In reality most of these execs who were responsible for this crisis have already left or have been forced to leave the financial institutions. They have made their money and have got away scot-free. The folks that are remaining are the folks that were working in profitable units of the banks(not involved with crisis), or those that have been hired/charged with fixing this crisis and getting things back in control, or relatively junior folks that merely followed orders. These are the folks that are working hard today to keep the system running, These are the folks that are trying their best to help us recover from this crisis. Is it fair on our part to penalize them?

One of the things that is happening today is generalization, rather than picking out and punishing the folks that caused this crisis, we seem to be indicting the complete banking community and focusing our ire & hatred on them. The politicians that are pushing for the 90% tax on bonuses today are the same folks that legalized & encouraged complex risky instruments like CDS etc in the name of liberalization. Don't they have an equal or higher responsibility for this bubble? Implementing the 90% taxation of bonuses for all bankers is a gross violation of individual rights(failing to pay for the work done/wrongly appropriating the money) and discrimination of banking community. This is no different than racial or ethnic discrimination, in this case discrimination is based on industry. This is also gross misuse of powers by the politicians. I can understand this happening in a Tanzania or North Korea but not in the US. The majority of folks impacted by this law are innocents. I'm surprised that there isn't any level headed person in our political system, that can rise above these silly politics and come up with a bi-partisan, honest and just solution.

Lastly, we seem to be looking at just one side of the coin. Here's a letter by an AIG executive to the CEO highlighting other side of the coin. I hope some of the media personalities and politicians that are fueling this hatred get to read this and realize their mistake.

Pls let me know your thoughts on this issue.

Photo Credits: fintag, hanneorla

Auto Meltdown - End of an era (Part III - Final Part)

In my earlier blogs in this series I had covered about the current state of auto industry and how the US auto industry got into this mess. In this post I be focusing on my thoughts around the future of the auto Industry.

Auto Industry is in a serious need for disruptive innovation. The internal combustion engine technology was invented in 1870's in Germany. It is the same technology that has been running our cars for well over 130+ yrs!! While there has been improvements, optimizations etc the base technology is still the same. Compare this with other fields - Energy/Power, Medicine, Telecom, IT, Aviation or any other field for that matter, we've had multiple disruptive innovations and technology has evolved leaps and bounds during the last century. Due to cheap availability of oil, the auto industry was complacent and failed to innovate. The auto industry in the current state is not sustainable. The technology running our autos need a complete refresh and be environment friendly for the industry to recover and maintain its growth. Since the beginning of this decade awareness of this issue has increased amongst auto companies. Huge amounts of money is being pumped into research in alternate technology cars. I expect this to spawn off a wave of disruptive innovations in the next 1-2 decades. We are currently at the beginning of this cycle.

Alternate energy/Clean tech cars are the buzz words these days. In terms of technology, Electric plug-ins leads the pack, Some of the other key alternate technologies that hold a lot of promise incude fuel cell, Solar etc. It will be few more years before these technologies mature. While all the auto majors(GM, Ford, Toyota, Honda etc) are researching in new technologies and are in various stages of development of alternate energy cars, there is a slew of VC funded startups that are working in parallel to come up with nextgen cars. Some of these start ups like Tesla, Aptera, Fisker etc are in advanced stages and plan to roll out their cars in the next 12-18 months. I expect some of these new startups to take off and go mainstream(if they dont get acquired!). This transition into alternate tech cars is going to shake up the industry in the next decade. Those players that are not in the forefront and capitalizing on this trend would get left behind and eventually perish. I also see the current gas-electric hybrid cars to be more of a stop gap till alternate energy cars mature . These will eventually get replaced. I expect this transition to clean tech to occur in the next couple of decades.

Next turning to key markets for car consumption US market is past its peak demand. As highlighted in my earlier post due to easy availability of credit & low fuel costs the demand had spiked during the last decade causing an auto bubble. The net new sales of 17-18M vehicles/yr is not sustainable. I see this number settling to between 12-15M vehicles/yr in the near to medium term(once we are out of this recession). US will be upstaged by China as the top car market in the world. Over the next decade I expect the car consumption in China, India and other developing countries to fuel the growth of car industry. This is the beginning of end of US domination of auto industry.

To sum up this series, we are currently in the midst of an unprecedented shake up in the auto industry. I expect this change to unravel over the next decade and will result in changing the complete landscape including technology, key players, key markets etc. It will be interesting to watch which players survive and which players will perish in this shake up. The time is here to clean up the auto industry and recreate it as a more sustainable and green industry!

Pls let me know your comments and thoughts on this series. Pls feel free to share your views on how you think the auto industry would evolve in the next 1-2 decades.

Photo credits: geeksg, cobra_x, Solaris_bot

Auto Meltdown - End of an era (Part II)

In my previous post I covered details on the current state of auto industry and the reasons that led us into this bubble. In this post I will be focusing specifically on US auto industry and how it got into the current mess.

The top 3 American auto companies(GM, Ford, Chrysler) are teetering on the brink and are currently going through the worst crisis of their lifetime. They have been piling up huge losses, losing market share to Japanese, Korean and German auto majors, their shares have been battered and are trading at 50-70yr lows and are almost on the verge of collapse due to a steep drop in sales. Feb '09 was the one of their worst months in several decades and most of them saw a big drop in demand - GM's YoY sales reduced by 53%, Ford reduced by 48% and Chrysler by 44%. For Q4 2008 GM alone lost around $30 billion and Ford lost around $5.9 billion. All the top 3 companies are running low on cash reserves, their corporate rating has suffered making it both expensive and tough to borrow in the market. They are currently looking to the US government to bail them out.

The decline of the big 3 companies started couple of decades back in the 80's when Japanese cars started making headway into US market. Here are my thoughts on some of the reasons that led them to the current state:

• Lower Product quality: Japanese cars are known for their quality and reliability. This was one of the key factors that helped them differentiate effectively against American cars and grab market share. The big 3 had ignored this for too long. By the time they started to improve their product quality, the flood gates had been breached and Japanese cars had established themselves in the US market. Though the gap has reduced over the last decade still Japanese cars are ahead of US manufactures in terms of quality and reliability.

• Lack of Innovation: The big 3 got too comfortable and were slow to innovate. Japanese cars had better technology & fuel efficiency than the equivalent American cars, which lagged Japanese cars in terms of technology by few yrs. Classic example is hybrid vehicles. Toyota had a head start on competition in hybrids. US car manufacturers are also lagging in their research for alternate technology cars. The internal combustion technology has been around for over 100+ yrs around and cars today are still based of the same technology that ran cars beginning of 20th century. Compare that with technology change in computer industry! The fact that oil is finite is well known. Car manufacturers are just waking up to the fact and developing alternate technologies.

• Slow to change to evolving market trends: American cars are traditionally known for their big, powerful and gas guzzling vehicles. Over the last few years due to steep increase in price of gasoline and increased awareness of environmental issues, consumers are starting to migrate to smaller more fuel efficient vehicles. American car manufacturers had failed to forecast this trend. They suffered heavily when oil prices shot up last summer due to their weak line up of small cars. In the small car market they are the underdogs today.
  

• Higher Cost of ownership: Though the purchase cost of American cars tend to be a little lower than equivalent Japanese cars their operational cost is higher due to lower fuel efficiency and lower reliability(especially as they age). The expected lifetime of American cars is also lower than Japanese cars. These factors together result in higher cost of ownership for American cars.
  

• Unsustainable Labor agreements: American car manufacturers had entered into unsustainable labor agreements with union back in the sixties when they were doing well and were flush with lot of cash. They are stuck with these contracts now and the cost of benefits/Pensions runs up to around 10% of car cost. This is unsustainable and is a big drag on American companies, forcing them to spend valuable cash into benefits than in R&D.

• Spread too thin and wasted money in acquisitions: Over the last couple of decades American companies spent lot of their cash on buying up multiple brands. They were looking at acquisitions as a key strategy of growth (inorganic growth). If you look at their portfolio there will be multiple cars from different brands in the same segment with little differentiation. Each of their brands were also fighting against each other and grabbing market share. A lot of these acquisitions were also overpriced and were not managed well. Classic example is Ford acquisition of Jaguar and Land Rover. Ford sold them last year after losing billions of $'s. In comparison, Toyota & Honda were very focused on organic growth and invested in their improving their products. They invested in improving the technology, quality and reliability of their products and used it to effectively differentiate and grab market share.

All the above factors had led to a gradual decline of American car companies over the last couple of decades. The last straw to break the camel's back was the sudden increase in oil price last summer and subsequent credit crisis/depression leading to a steep fall in demand. At this moment of crisis they are stuck with a line up of big, powerful vehicles that are not in demand anymore, precariously low cash reserves, excess capacity etc. Though their very existence is in question now, I think they will survive this crisis. However they are past their peak and I doubt if they can ever get back to the original market position.

Please let me know your thoughts on the above. If I've left out any more key factors feel free to add to the above.

In my final post of this series I will be covering my thoughts on the future of auto industry.

Photo credits : dsheubert

Auto Meltdown - End of an era (Part 1)

This is the first of a 3 part series on Auto Industry meltdown. As part of this post I will be covering the current state of auto industry and my reasoning on what led to this bubble.

Current State

February 2009 has been the worst month for US auto industry in decades. The overall auto industry demand has fallen to 4 decade lows of 9.1M vehicles in 2009. The top 3 US companies sees their demand halved from last year's base. GM was the worst with 53.1% decline, Ford 48% decline and Chrysler 44% decline. The Japanese car companies fared slightly better than US companies however still took a significant hit. Toyota saw 40% decline in sales, Honda saw 38% decline and Nissan 27% decline. There is a virtual blood shed happening in auto market both US and globally.

US has been the top auto market in the world for years peaking at 17M+ vehicle sales in 2007. China was a distant second coming in at around 7M+ vehicles in 2008. For the first time in history Chinese car sales exceeded US car sales in Jan 2009. Is this going to be trend in future?

Auto Bubble - How did this happen?

Over the last couple of decades US has been experiencing an 'Auto Bubble' similar to the housing bubble or the dot com bubble. The demand in US auto industry is unsustainable. Overall there are around 251M vehicles in US and 199M licensed drivers this translates to around 1.3 vehicles/driver. I think this would most likely be the peak vehicle ownership ratio. It will start going down from here and eventually settle down between 1-1.1 vehicles/individual. Here are some of the key factors that led to this bubble:

• Low interest rates and easy availability of credit in the last couple of decades fueled an increase in consumption(similar to housing) leading up to a bubble. It will be interesting to check out the foreclosure(or equivalent) rate for auto industry.
  

• Low cost of Fuel - Low gasoline cost in US meant low operating costs for owning a car. This spurred people to travel more and buy more cars and less fuel efficient vehicles. In fact the average miles/gallon in US is 17.1 which is very low by global standards. People really didn't mind this low fuel efficiency till recently due to low fuel cost in US(one of the lowest in western hemisphere).
  

• Reducing ownership cost -Technology improvements, innovation and automation has made cars more affordable and cheaper to operate at the same time offering more features and comforts. Opening up of US economy to Japanese and Korean cars also contributed to this trend.
  

• Increase in disposable income - Over a 30 yr window between mid 70s to mid 2000's the average car price of american cars increased by 15% in constant currency terms. The average per capita income increased by more than 270%.

All the above factors led to building up of a bubble over the last couple of decades leading to peaking of demand in 2007. When the economy took a turn for the worse last year due to credit crisis things really started falling apart and auto companies started taking big hits with a drastic reduction in demand culminating in halving of their sales this Feb.

Please let me know your thoughts on the above. If I've left out any more key factors feel free to add to the above.

In my next post I will be covering my analysis of how Detroit got into this mess

Planning to invest in Real Estate? Watch out the market hasn't bottomed out yet!

I came across this interesting graph on index of American home prices for the last 120 yrs that was originally produced by Professor Robert J Shiller and later updated by a reader and posted at www.ritholtz.com. Shiller had initially come up with this analysis as part of his book 'Irrational Exuberance'. The magnitude of the rise in housing values during this boom cycle was in excess of 100%, that too within a short span on 6-8yrs. In some of the hot markets like Florida, California, Nevada etc the price increase was much higher than the national average. No wonder the fall has been equally dramatic! Comparing this with the previous boom/bust cycles puts lot of things in context and brings out the magnitude of the bubble. As you can see from the chart, while the real estate prices has come down by a significant margin in the last couple of years, we are still at the mid-point and have a long way to go before the markets bottoms out.

Source: www.ritholtz.com

Note: The above chart is an adaptation of the classic Shiller housing price chart with updated data. The original graphic is via NY Times.

Here is another interesting graph from Reggie Middleton's boom bust blog. The below graph is an extrapolation of the Robert Shiller's analysis in comparison with interest rates, population growth, building costs etc and it highlights at what point the market is expected to bottom out. As you can see from the below graph, the interest rates and building costs came down during the 80's and 90's, setting the stage for this historic boom. Another interesting statistic to note is that, the last time the housing crash happened back around 1920 it took almost 25 yrs for the market to recover!

Source: www.boombustblog.com

One of the important parameters to consider for market recovery is the foreclosure rates. So far the housing bubble has led to foreclosure of around 2.3 million homes. In 2009, with all the economic issues and lay-off's that are happening, this trend is expected to accelerate further leading to foreclosure of around 2.4 million more homes. Looking at a longer term, around 8.1 million homeowners are expected to lose their homes by 2012. So we are in for a prolonged real estate downturn. If you are planning to invest on a home, wait and watch for another year or two before you take the plunge!

For those interested in reading more you could check out the below links:

United States Housing bubble
Causes of the United States Housing Bubble
No Ceiling yet on Home Losses: Report: Expect 8.1 Million Foreclosures by 2010

Credit Crisis demystified by Jonathan Jarvis

Here's an excellent educational video on the credit crisis by Jonathan Jarvis. The video explains how the whole mortgage & credit system works and what went wrong with the system leading us to the present crisis. This is a "must watch" video for folks who are closely following the credit/economic crisis and wondering how this all happened and why no one has caught this earlier.

I loved the way Jonathan has demystified this complex issue and presented it in such a simple and entertaining way. I've spent countless hours reading up numerous articles/blogs & discussing with my friends in financial world to understand the credit crisis, This is the best and simplest explanation I've seen till date. Hope you like it:-)

For those interested in reading more, here's an stirring article from Orin Woodward on why government shouldn't get involved in this credit crisis and use taxpayers money to bailout banks. He says that this is creative destruction and this would help us evolve much stronger from this crisis. While I do agree with Orrin's reasoning, Govt sitting back and letting things take its own course is definitely not an option given the current recessionary conditions & scale of this crisis. Some of the banks/bankers who were the prime reason for this crisis might stand to gain from this Govt intervention, that cannot be prevented and its part of the deal. The risk of Govt not intervening and letting the country/world go into prolonged depression is way too high. It is going to be more expensive to clean up later and people will have to go through more pains (similar to 1929 depression) before we get the system back on track.

2008 Economy & Stock Market Highlights

2008 will go down as a record year in the history. Most analysts and economists were predicting a slowdown in the economy and a soft landing earlier this year. However no one was even in the ballpark w.r.to the actual events. The complete world was taken by shock with the magnitude of the financial mess and global recession/slow down. There was unprecedented volatility in global stock markets, commodities like oil, Gold etc, Currencies, interest rates and a whole bunch of key economic fundamentals. This is expected to be the worst recession (some are even calling it depression) since the great depression in 1929. Almost all developed countries and key emerging/developing countries like China, Russia, Brazil, India etc are impacted in this global crisis.

Some of the key highlights/statistics from an economic perspective are listed below

ü All major stock markets down from their record highs in Oct 2007

o Dow is down almost 40-45% from its peak

o NASDAQ is down by around 45%

o S&P 500 is down by 40%

o BSE Sensex is down 55-60%

ü S&P 500 market has lost $6.17 trillion dollars in Market cap in the last year

ü S&P broad market index which has around 11,000 stocks in developed and emerging markets has lost around $17.7 trillion YTD

ü The entire Investment banks segment has been wiped out – Bear Sterns & Lehmann doesn’t exist anymore, Merrill Lynch has been acquired by BoA, Morgan Stanley and Goldman Sachs have converted into commercial banks

ü After Lehmann collapse the entire global credit market was frozen and there were massive money injections from multiple governments (US itself is investing over a trillion dollars this year to re-energize the market)

ü Several large & reputable US financial institutions have failed – Wachovia, Washington Mutual , Fannie Mae, Freddie Mac, AIG etc.

ü 25 US banks have failed so far this year and has been acquired by FDIC

ü US Federal Reserve interest rate is at a 50yr low of 0.25% with today’s cut

ü Oil started our 2008 at little under $100/barrel and reached a peak of $147/barrel in July and dropped to $40/barrel in Dec

ü In the last 15 months Gold which is typically the most stable asset went from <$700/ounce to a peak of $1020/ounce and is now back to $800/ounce

ü US Dollar has bucked a multi-year trend of weakening against global currencies and has appreciated against major global currencies by almost 15-20%

ü The US auto industry is in Doldrums and giants like GM, Ford and Chrysler are on the verge of going bankrupt

o GM’s stock is at a 80 yr low

ü US unemployment rate has gone up to 6.7% and number of unemployed people has increased by around 2.7 million during this year

ü All major global economies are either in recession or in the verge of getting into recession

o Ireland, New Zealand, France, UK, Germany, USA, Japan, Italy, Singapore, Spain to name a few

o China growth is expected to slow to 7.5 – 8 %. This is its lowest since 1990.

o India growth rate is expected to slow to 7.5% (from the 5yr average of close to 9%)

After reading the above the first question that comes to mind is have we seen the worst of this crisis?

I think we are in the middle of this crisis what we have seen so far is the first half of the crisis. There is more of financial crisis that is yet to come, Lay-offs are just starting out and has accelerated in the last 3 months and it will continue thru most part of 2009. There will be budget and spending cuts leading to reduction in customer spending and consequently impacting a wide range of industries etc. To cut to the chase the current scenario will continue thru the first half of 2009 and should start flattening out as we go thru the year. I expect the stock market to be volatile and fluctuate within a band during most of 2009 and start the climb up in 2010.

Is this shake out/recession good for us?

At the outset some of the news we hear and what we see in news would seem scary. However this is part of the economic cycle. The best part of open markets/economy is the self-correction. Companies start becoming inefficient and add lot of fluff over the years. These economic downturns are the times when some of the weak players are eliminated and strong players become more efficient and focused. While we go thru lot of pain in the near term it is good from a longer term perspective. Stock valuations, real estate valuations etc are very attractive now and while there is a little down side to it in the near term over the medium to long term they will start climbing up and this is a good time to start investing.

Stop worrying & start investing!!!

US Economic Outlook 2008 - 2011

Here's an interesting read on US economic outlook. This article talks about how some of the historic decisions made by Federal Reserve and US Govt are contributing to the currrent economic downturn. Though it paints a very grim picture of dollar being replaced as the world's reserve currency in the near future, I dont see it happening atleast for a few more decades till we get to a multi-polar world. US is still the only super power and has a good amount of leverage & influence on the world economy and countries. It will pull all levers at its disposal to prevent this from happening. US Economic Outlook 2008-11+ (Updated)

US Economic Outlook 2008-11+ (Updated 28 May 08); Discussion of Money, Federal Reserve, Dollar as World's Reserve Currency, Inflation, Deflation, Oil, OPEC, Debt, Saving Rate, Housing Bubble and Future Outlook for US Economy

An analysis of economic downturn by Sequoia Capital

I was browing the net and came across this presentation by Sequoia Capital about the economic downturn and what startups need to do to survive this downturn. Its a very insightful, creative & well structured deck.

Sequoia Capital on startups and the economic downturn

View SlideShare presentation or Upload your own. (tags: depression recession)

Sequoia Capital recently made a presentation to its portfolio companies about how to try to survive an economic downturn. Here's the presentation

SlideShare Link