Spinoffs, Merger Mania, and a GDP Warning Shot

Let's consider the GDP numbers for the 4th quarter of 2005:

• Today the BEA published the GDP "advance release" .
• Next month we will see the "preliminary figures".
• After that we will see the "revised preliminary figures".
• The "final numbers" will be published when no one is looking.
• The "revised final numbers" will come out when someone wants to backdate the start of the upcoming recession.

Following is a synopsis of the "Advanced Release":

Growth in the U.S. economy slowed dramatically to a 1.1% annual rate in the fourth quarter, the weakest growth in three years, the Commerce Department estimated Friday. The slowdown in real gross domestic product from 4.1% in the third quarter to 1.1% in the fourth was largely due to weak auto sales, slower business investment, a rise in imports and a large drop in federal spending. Inventory building was the main engine of growth in the quarter. Final sales fell 0.3%, the first decline since 2001. The core personal consumption expenditure price index rose at a 2.2% annual rate in the quarter. For all of 2005, the economy grew 3.5%, down from 4.2% in 2004. The personal savings rate was negative for the first year since 1933.

CNN Money notes GDP posts smallest gain in 3 years.

The nation's economy grew at its slowest pace in three years in the fourth quarter, according to the government's gross domestic product report Friday, which came in far weaker than economists' forecasts.

The broad measure of the nation's economic activity showed an annual growth rate of 1.1 percent in the fourth quarter, down from the 4.1 percent growth rate in the final reading of third-quarter growth. Economists surveyed by Briefing.com had forecast a 2.8 percent growth rate in the fourth quarter.

Treasury Secretary John Snow tried to downplay the disappointing report on the nation's economic strength.

"The preliminary estimate of fourth quarter 2005 GDP is inconsistent with the underlying strength of the U.S. economy," he said in a statement. "I would not read too much into today's numbers. They are somewhat anomalous, reflecting some special factors. They are not consistent with other data on the U.S. economy which paint a picture of good growth."

[Mish Question: Exactly what data are you looking at Mr. Snow? Don’t you think it’s high time you toss that “paint by numbers” picture are you working on and look at the real world? That’s the problem with these “paint by numbers” kits. There never seems to be a storm cloud on the horizon.]

"The sharp pullback in economic growth during the final three months of 2005 shows the law of gravity has not been repealed," said Bernard Baumohl, executive director of the Economic Outlook Group. "When consumers are burdened with heavy debt loads, rising interest rates, higher energy costs, no personal savings and household income growth that falls below inflation, something had to give. This retrenchment in spending was generally foreseen, though economists weren't sure on the timing and magnitude."

Anthony Chan, chief economist for JPMorgan Private Client Services, said that any concern among investors about slower growth was more than balanced by their glee that the report could stop the Federal Reserve from raising interest rates after its Jan. 31 meeting, at which another quarter-percentage point hike is widely expected.

"The collapse of growth will serve as an incentive to stop the Fed from overshooting (on rate hikes)," said Chan.

[Mish Note: I guess we will see. We will explore this idea in just a bit]

David Wyss, chief economist for Standard & Poor's, said the GDP report changed his mind about what the Fed would do on rates.

"At this point I think the Fed pauses after the next rate hike," he said. "I had been looking for one more hike, although I had thought the chances were just a little better than 50-50. Now I think it's a little less than 50-50. Of course we'll get a lot more numbers before that Fed meeting (March 28)."

A big part of the slowdown was a 17 percent drop in spending on durable goods in the quarter, particular on cars and aircraft, as well as an unexpected 13 percent drop in government spending on national defense.

A nearly month-long strike at Boeing in September affected aircraft deliveries in the third quarter. And auto purchases, which saw sales record in the summer due to "employee pricing" offers from the Big Three automakers, fell 8 percent compared to a year earlier and 18 percent compared to the third quarter of 2005 due to the lack of remaining 2005 models that normally would have been purchased in the fall.

The drop in spending on motor vehicles was responsible for a 2.06 percentage point drop in the GDP by itself. The drop in military spending accounted for another 0.66 percentage point decline in the fourth quarter GDP, after adding 0.46 percentage point to the third quarter GDP growth.

"We knew the car sector was weak. Almost the entire surprise was the drop in government defense spending," said Wyss, commenting on the surprise. "Maybe the war is over but more likely you often get these oddities at the beginning of the fiscal year (that starts Oct. 1) because Department of Defense plays cash management games."

"I am confident the Pentagon will be spending more money at some time in 2006," Wyss said. "

[Mish note: I am confident of that as well. $300 billion wasted in Iraq is not enough to satisfy this administration.]

Part of the problem, a lot of the quarterly data has been distorted by (Hurricane) Katrina. We need another quarter to figure out what's going on. I think it's clear things are slowing down, the question is how much they're slowing down."

[Mish note: Katrina was indeed a distortion. All the "broken window theory" proponents are now seeing the payback. Any strength shown on account of hurricane cleanup was a mirage. Think back. How many times did the press talk about all the jobs it would create to rebuild New Orleans. It's sad economics, and obviously wrong, when CNBC cheerleaders proclaim disaster are good for the economy, yet they do it every time. I heard some say that it would be good for homebuilders.]

The most immediate impact could be making it more difficult for President Bush's speech writers to point to the strength of the economy in his State of the Union address Tuesday night. The president said Thursday that economic strength would be one of the subjects he will raise when campaigning for Republicans in this year's Congressional elections.

"They don't have a lot of tail wind with this number," [Chan] said.

[Mish note: Not only is there not a tail wind, that is a full force gale blowing in this economy's face. I believe the GDP actually went negative in the 4th quarter. For a better understanding why please read Grossly Distorted Procedures. If you are not aware of the lies and silliness behind the GDP numbers, that article might prove to be a real eye opener.]

Well, the bad news buyers were out in force again today on the mistaken notion that lower interest rates will save this economy. I have news for them: It won't. Furthermore, the more merger mania, buybacks, leveraged buyouts, and other nonsense like yesterday's Chipotle IPO Fiesta just might keep the FED hiking far longer than they might otherwise be inclined to do. Let's take a look at the latest fiesta:

Investors piled into the initial public offering of Chipotle Mexican Grill Thursday. But as the stock gets a chance to simmer in the market, investors could find that their optimism about the burrito chain is based on a hill of beans. After the 7.9-million-share offering priced at $22 a share, Chipotle shares doubled to close at $44 Thursday, after reaching as high as $48.28. Chipotle sold 6.1 million shares in the deal, raising about $134 million, while its parent, McDonald's sold 1.8 million shares. Morgan Stanley and S.G. Cowen led the underwriters. The casual dining chain's dizzying debut marked the biggest opening-day gain for a U.S. IPO since late 2000, according to Thomson Financial. At $44, shares of Chipotle are trading at roughly 80 times earnings. Meanwhile, Applebee's and Ruby Tuesday are trading closer to 20 times earnings, making Chipotle's valuation look laced with some irrational exuberance, even when its growth prospects are accounted for.

After the offering, McDonald's will have an 88% voting interest in Chipotle and a 69% economic interest. The fast food giant's decision to sell part of Chipotle in the public market was announced last fall, amid shareholder pressure to take action to boost its stock price.

The article claims that McDonalds is acting on "shareholder pressure" to boost the stock price. McDonalds is going the spinoff route to "unleash shareholder value". Other companies are doing the reverse. For them it is "merger mania" in an attempt to boost stock prices. One such deal resulted in a huge bidding war between Proctor & Gamble and Boston Scientific over Guidant. I note today that regulatory action could kill Guidant deal.

Does any of this remind anyone of March 2000? Here we are with housing obviously peaked, a FED merrily hiking away with 14 consecutive hikes, a GDP bordering on recession, a yield curve that is inverted, yet there is a stock market buy the dip mentality feeding frenzy unlike any we have seen since 2000. Speculation is rampant. Companies are going to the junk bond market to raise funds just to buyback shares. They all seem to want to burn up whatever cash hoard they have now.

Roll the dice baby. Is Chipotle worth 80 times earnings? Of course not. Who cares, anyway? All that matters is that it is going up. By the way, does anyone remember the flame out with Krispy Kreme Dougnnuts (KKD)? Pull up a chart and take a look.

In Has the FED already overshot? I made the case that the FED has indeed already overshot. I am sticking to my guns here. The FED has already overshot. I think the turndown in housing and GDP proves it.

Furthermore, unless the FED is stupid they know it. The problem is they created not only a housing bubble but they are also to blame for the repeat of the spinoff, merger mania, and leveraged buyout madness of 2000. If the FED can not rein in this madness not only will it be dealing with the housing bubble it created, but it will also have to deal with companies wrecking their balance sheets a second time.

Welcome to the FED Ben Bernanke. I am sure the upcoming recession welcomes you as well. It seems to me you are damned if you do and damned if you don't. So which is it?

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/