Google Google

Google is the rarest of companies. It is loved on Main Street. It is certainly loved on Wall Street. It went public after the NASDAQ tech bubble burst and has tripled since. It shares the unique branding ubiquity of its product, joining the hallowed ranks of Tabasco, Kleenex, I-Pod and others. Google is not only a product, but it is a verb as well—people no longer search or surf for what they want on the web—they simply “Google” it. What goes on behind closed doors in their HQ at Mountain View, CA; remains a hot topic of discussion. The company’s co-founders often grace the pages of magazines like TIME, GQ and People; often featured alongside America’s most eligible bachelors.

This begs the question (at least for me): What is Google?

If you “Google” Google, this is what comes up:

Google
Enables users to search the Web, Usenet, and images. Features include PageRank,
caching and translation of results, and an option to find similar pages.
www.google.com/ - 3k - Jul 25, 2005 - Cached - Similar pages


Hmmmmm. Sounds like a search engine to me. Search engines typically make money by selling advertising and services revolving around marketing (i.e. search keywords, rankings, etc.), no?

Do not get me wrong, the point of this entry is not to defame or critique Google. Google is a great company. Their growth is spectacular. Their cash flow is solid. To my knowledge, the company has done everything in accordance with the best interests of both their clients and investors, large and small alike. Management clearly has their finger on the pulse of technology—ostensibly they are the first company since the PC revolution to give Microsoft a run for its money.

I like Google. In fact, I like GOOG as a company a great deal—on every level. I do not own it, I would not buy it and I would not short it. I just like it. I respect it. In my opinion, it is one of those companies that will stand the test of time.

In a cutthroat market with few barriers to entry, they have gained (and maintained) their competitive advantage by executing the strategy they laid out before going public.

But here is what I do not like. I do not like the talking heads on TV and newsletter writers trying to justify Google’s price with obscure metrics, i.e. “Based on our projected enterprise value for 2012…” or “if GOOG earns $11 in 2008, then by our valuation model we can expect…”

Even worse are those who refuse to “pigeon hole” (sic) GOOG as a search engine:
“Google is a new media company…” or “Google is not your traditional search engine in the sense of…”

As Kerry Coughlin once told me, ‘it’s too bad stupidity isn’t painful.’ If it was, Google Analysts would all be in the Head Trauma Wing at Mount Sinai Hospital.

Just because Google offers a portfolio of products designed to compliment their business and provide a greater service along with the “traditional” search engine does not mean they are part of a “new” or “special” industry group, of which they are the only member.

AMR Corp., the parent company of American Airlines, offers mutual funds as one of its services—does that mean they are part of a “new breed” of airlines that cannot be valued with the rest of the sector?

General Motors owns GMAC, which provides financing to consumers for their vehicles, but also invests in Real Estate and even owns the magazine “Better Homes and Gardens”—should GM no longer be valued as an Automotives Manufacturer—should it be trading at the PE level of a Homebuilder or an Entertainment co. as a result?

Most large companies own or operate a business which may be slightly astray from their core competency. The purpose of this is to a) make money or b) supplement or compliment their current revenue/income and c) provide a greater service to their clientele. This is what the aim of good business is—to make money. If Google does not offer these other services, most likely people will leave their site to go to somewhere else, which puts Google at risk.

It is really that simple.


(This will be the final update until August 2nd)

ADDITIONAL DISCLOSURES: The information contained in this publication is based on sources considered to be reliable but is not represented to be complete and its accuracy is not guaranteed. The opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice. This publication does not constitute an offer to sell or a solicitation of an offer
to buy any securities. E1 Asset Management, Inc., and its officers, directors, and employees, and affiliates and members of their families may have positions in these securities and may, as principal or agent, buy and sell such securities before, after or concurrently with the publication.E1 Asset Management is a fully agency company and doesn’t seek any investment banking deals.

The War Being Lost

Most intelligence analysts, retired Generals and the Department of Defense believe we are winning the war on terror. By every measurable metric, substantial progress has been made since the restructuring of our national security in the days since 9-11. Many attempts at attacking us on our own soil have been prevented, key Al Qaeda leadership has been killed or captured (barring Bin Laden) and the terror infrastructure has been under assault in every capacity. This is where the old adage “the pen is mightier than the sword” really gains traction, as mainstream media coverage would have the average citizen believe that it is really our policies which don’t measure up. The West is losing the PR War.

Take last weeks joint press conference with Prime Ministers Blair and Howard, as a journalist attempted to make PM Blair admit responsibility for the two bombings which took place on UK soil.

Is the media insane?

What about Saturday’s bombing in Egypt that killed 88? What about the killing of the Egyptian Diplomat in Iraq? What about the kidnapping of the Algerian Diplomat in Iraq?

To my knowledge, Egypt and Algeria do not have any troops in Iraq or Afghanistan. They have, on the other hand, began shifting away from autocracy-style rule toward democracy, attempted to be stabilizing forces in the region and recognized the governments of Iraq and Afghanistan as legitimate.

What about all the reports regarding U.S. troops and the crimes they were accused of, but turns out were not true? Why has the media not fully fleshed out their own stories? What about a certain media organization urging journalists not to refer to them as “terrorists,” but “bombers” instead?

Why are the policies of our elected leadership under greater scrutiny than the tactics and atrocities of the fiends who commit them?

This morning, Al Qaeda is warning Rome—announcing that PM Berlusconi is essentially turning his country into a graveyard vis-à-vis his policy of committing troops to Iraq. Having seen the media’s coverage of the above incidents, this should come as no great surprise. Al Qaeda is using the democratic apparatus of a “free press” (something they vehemently oppose) in attempt to manipulate public opinion and ergo, public policy. They want us to make choices based upon the consequences they offer us.


9-11, East Timor, the Marine Barracks, the U.S.S. Cole, the Embassy Bombings, Iran hostage crisis (and others), all took place against coalition members before Iraq.

The Russian hostage crisis, the murder of the former Lebanese PM, the Egyptian Resort Blasts and the Bali Resort bombing all took place against countries with no military presence in Iraq. Russia even voted against the Iraq War in the U.N. Security Council.

The bottom line is that our system of government is under attack. Our freedom is under attack. Capitalism is under attack. Our lifestyles are under attack. We are under attack for who we are, not what we may or may not have done.

Back in Black

For the first time this year, the NASDAQ has managed to make it into positive territory. On December 31, 2004, the index closed at 2175, only to be slaughtered from the first trading day of 2005, falling almost 15% by the end of April. Since April 29 however, the tech laden composite has been nothing short of spectacular, rallying roughly 300 points despite record energy prices, rising rates and a host of terror fears.

So what gives?

As stated previously in this blog, bull markets climb a “wall of worry.” While earnings have been solid, economic data has been inconsistent, even despite the government’s best attempts to smooth readings to paint a more trend-oriented picture. Right around the time economists are comfortable stating that the economy is out of the woods is the time when investors should begin to redeem equity investments for cash. This is the essence of true contrarian investing—not to buy on a piece of really negative news/ sell on really positive news; rather investing based on a dramatic shift in sentiment.

At present, the bears are far from throwing in the towel. I hear reminders everyday on CNBC that the VIX is at very low levels and that this is a very reliable indicator etc….
One indicator alone does not make a top or a bottom. Most technicians look for overwhelming confirmation between price, pattern, volume, internals and indicators. Even fundamentals-oriented investors looking for bargains would be remiss to look at one metric for investment suitability.

Here are a few reasons why the market could continue to rally further:

1. No one knows seems to be aware of the market’s strong performance
2. Bullish Sentiment is surprisingly still contained. This is most likely the result of the news cycle mass media is comfortable shoving down our throats everyday—high oil prices, hurricanes possibly knocking over rigs in the gulf, the deficit, partisan politics in the beltway, Social Security being bankrupted, etc.
3. Unocal accepts Chevron’s bid. Short, sweet, easy resolution to a possible trigger point for a trade war with China over CNOOC.
4. Dollar rally. There are pros and cons to strong and weak dollar policies. In my humble opinion, a weakened currency is ideal to kick start an economy, while a stronger currency reflects a more mature economic environment where owning dollar-denominated assets is preferable. It may negatively affect U.S. based Multinationals, but the investment in the domestic economy as a whole typically overshadows that—so long as small business is responsible for the majority of GDP. Also, don’t forget that the U.S. is a consumer nation, something unlikely to change in our lifetimes.
5. Pro-Business policies. Despite all the shenanigans among lawmakers clamoring for the 2008 Presidential bid for their party, Washington (while tempted to stray on a few issues) has been abuzz with fiscal responsibility, free trade and tax cuts. This clearly shows that Wall Street was far more than an ATM for the current President and confirms the base is far larger than social conservatives.
6. The peace premium. It’s way gone. It is not necessarily a reason for the market to move higher, but as long as our enemies don’t wear uniforms and prefer attacking western soft targets, the market will always reflect a discount to true value which at times of heightened alert expands and afterward subsides.


But as always, only time will tell…

Encierro

It sure looks like the annual running of the bulls in Pamplona down the Avenida de Hemingway is taking place here on Wall Street a little later than usual this year. Sure YHOO, INTC and GM are all suffering today from acute earnings dysphoria—but this is the perfect cover story for two sectors which are out in front, The Transports and Biotechs.

After reporting a blow out quarter, AMGN is pacing the bios to new multi-year highs as it stands up over $9 to $80/share. The sector has been doing well, leading the NASDAQ’s recovery as renewed confidence continues to emerge with companies like DNA, GILD and CELG offering positive surprises to investors surrounding their pipelines and forward guidance.

ALEX, CNF and UPS are leading the Dow Jones Transportation Average to the highest level since oil hit $61/barrel. Positive earnings from AMR Corp, parent of American Airlines are also helping buyers overcome their recent fears of terrorism and place a bid under the whole sector.

More to come……

Ockham’s Razor, Overturning Kelo and More Greenspeak

Ockham’s Razor, also known as the Law of Parsimony, states that the simplest of several competing theories is most preferable, often taken to imply that entities should not be multiplied needlessly. The application of this principle to the present status of the global political economy yields a very interesting perspective on what led us here and more importantly, what can be expected in the future.

The Honorable John Roberts is the quintessential conservative jurist nominated last night to the highest bench in the country. He represents a consensus pick among the President’s conservative and corporate bases, yet poses a plethora of problems for democrats set to “go to war” over any of Bush’s selections (Senator Schumer of NY reportedly said this on a train en route to the capital).

President Bush covered all bases nominating John Roberts. Democrats and Republicans alike respect him as a tremendous and brilliant legal mind. He graduated Harvard and Harvard Law and has served on the Court of Appeals. He holds the distinction of arguing the most cases before the Supreme Court as a private citizen (39). As an advocate of the first Bush administration, he litigated against the decision in Roe v. Wade—which satisfies social conservatives, yet allows a dubious stance on the most polemic issue in judicial politics as Roberts was essentially acting as a mouthpiece for the President’s positions. He also will clearly please the business community (which has been devastated since the retirement of Justice O’Conner) as his views on jury awards and commerce parallels those of Wall Street.

In addition, Judge Roberts’ young age and lack of published opinions will clearly frustrate those looking to obfuscate his stance on hot-button issues, leading to a dearth of well-honed questions during the confirmation process. Knowing if successful, Roberts could serve the bench for 30 years plus will pressure democrats to flesh out his legal ideology; well aware his vote will be very crucial in the cases to be heard and could even lead to several re-hearings down the road.

Unless there are skeletons in his closet of a personal nature, i.e. Justice Clarence Thomas, look for Roberts to pass the confirmation process with a substantial majority.

For those unfamiliar with Kelo v. City of New London, it was a case recently heard by the court which found that government could repossess private property under the guise of eminent domain, when economic development was the central issue. Justice O’Connor wrote the dissent and presided over oral arguments in a close 5-4 vote which should clearly scare the hell out of anyone who owns their own home (or business).

While Roberts’ ascension to the high court will not affect the net balance of the jurists (ideologically), he will be seen as far less of a swing vote, often the way Justice O’Connor was perceived—consistently voting with Ginsburg and Breyer on social issues while favoring Thomas, Rehnquist and Scalia on states rights/commerce.

While one cannot expect Kelo to be reheard or overturned in their near future, adding a jurist to the bench who strictly interprets the meaning of the Constitution will narrow the scope of the application of eminent domain to property rights and individual liberties—paving the way for a clearer interpretation of the role of government in the lives of private citizens.

Lastly, this morning at 10am EST, Chairman Greenspan is set to make his final appearance before the House Financial Services Committee in Washington (formerly the Humphrey-Hawkins address). With the exception of Rep. Bernie Sanders (Socialist-VT), look for the same line of questioning (rates, economy, social security, housing market, etc.), the same confusing dead-panned answers and most likely glowing praise regarding his 3 decade span of shepherding the U.S. economy.

For all of the beating he has taken in the press, most notably during 2000-2002, Mr. Greenspan has done a tremendous job. He presided over the largest economic expansion in U.S. history, guided the economy through the dark days of 9-11 (and the recession that followed) and leaves behind a legacy of low unemployment, low inflation and record productivity. While one may take issue with his style as Chairman (often seen as the 2nd most powerful person in the world) and his peculiar choice of words at times (irrational exuberance, conundrum, etc.), his substance is beyond reproach and his policies will serve as a model for decades to come.

Bulls, Bears and Tiger

Last week was a solid week for the bulls as the S&P 500 registered 4 year highs and oil sank roughly 5%. The Dow and NASDAQ also closed in on key levels as the rally (that materialized from thin air) and has largely been bolstered from earnings momentum and strong economic data, continued to forecast moderate growth among weakening inflation pressures.

The bears, conversely, seemed to run for the hills as many of the stocks that had been firmly in their control seemed to wrestle free and break from months-long bases. Among the sectors making a move higher were technology, pharmaceuticals, basic materials and cyclical issues.

The most notable bear of all made his last appearance at the Old Course of St. Andrews amid a shower of cheers, tears and applause that would leave the most casual observer in awe of such a spectacle. Arguably the greatest golfer of all time, Jack Nicklaus, a.k.a. “The Golden Bear,” managed to birdie the final hole in what could only be described as a surreal Friday pairing with fellow competitor Tom Watson, and caddy/son Gary in tow. There was not a dry eye on the course as the earth shattering applause on his final approach even brought the always stoic Nicklaus back to a time and a place when “The Open” was literally his home away from home. He will surely be missed.

Just as Friday was the end of an era, Sunday was the extension of another. Tiger Woods managed to add a tenth major to his already lengthy resume of golf accolades. Despite many trials and tribulations in his personal and professional life, he seems to have gotten back to the fiery competitor that catapulted him to the top of the world rankings list since he cracked the ranks of the PGA.

If there is anyone who could break the impenetrable wall of records and accomplishments left behind by the Golden Bear (18 Majors and 100 Tournament Victories) it is Tiger. Sure Jack had inferior equipment (compared to today’s technology) and he also had to compete with the likes of Arnold Palmer, Tom Watson, Lee Trevino, Gary Player, Seve Ballesteros, Nick Faldo and others—but it is all relative. Today’s clubs and balls are available to all players (not just Tiger) and he has faced stiff competition among players, many of whom are just entering the twilight of their careers, such as Ernie Els, Phil Mickelson, Jim Furyk, David Toms and Vijay Singh. While it is clearly too early to tell, Tiger is the only golfer within an arms-length of Nicklaus and is sure to make it exciting along the way.



The Golden Bear on the Swilcan Bridge for the last time.




Picture Source:

ESPN courtesy of Getty Images
http://sports.espn.go.com/golf
(David Cannon/Pool/Getty Images)

The Omniscient Market

The market is never wrong. The market is all knowing. The market is dynamic. The market is also the most reliable indicator of future economic performance. It may act confusedly in any short time frame, but a study of longer term trends reveals the true brilliance of its predictive quality.

People however, when acting or reacting en masse, are usually always wrong.

Most of today’s WSJ/NBC opinion poll was to be expected, mainly the approval rating of the President continuing its recent slide; which can be chalked up to Iraq, Social Security, partisan bickering over judicial nominees and the recent CIA leak/Karl Rove investigation developments and the frustration over the daily turmoil in Iraq. What perplexed me was that the American public continues to feel that the economy is not on strong footing.

It’s a given that gas prices are high. It is also a given that the President does not receive much positive coverage from mainstream media. Take yesterday’s news on the budget deficit coming in far less than expected—a clear sign the Bush Tax Cut plan and the eponymous Laffer curve work—yet nowhere to be found in most conventional newspapers before page A17.

What is most astonishing is the blindness to the underlying strength of our economy despite these (non)events. Growth has been steady in the 3-4% range. Inflation remains low. Retail sales remain strong. Travel and domestic tourism are up. Unemployment is way down at 5%. On average, 181k new jobs are created monthly. The list goes on and on…

While surely this poll reflects negatively on the White House and GOP, it may be a huge boon for equity investors. We have been in a stealth bull market since April and although the first quarter was decidedly negative, the ‘04 lows have not come into play. While those ideologically conservative may have taken a hit in the polls, their wallets seem to be in fine shape.



Source:
www.wsj.com/JournalLinks







Do the American people choose to ignore their own financial situation or is the media is selling us the wrong news?

Anticipation

First, understand that the human factor surrounding current events, while tragic, is not being taken into consideration in this discussion.

What does a terror attack, $60 oil, two hurricanes, a possible trade war with China, political uncertainty and every housing market being called a “bubble” have in common?

None of the aforementioned could bring down the market.

While seemingly an aberration, this is typical of bull markets, often referred to as “climbing a wall of worry.” When fear dominates the headlines, rational people begin to seek out opportunities, while irrational people tend to withdraw funds and stash them beneath their mattresses. Surely the uncertainty found in the today’s global economic infrastructure qualifies as worrisome in the mind of even the most pessimistic observer. Such is the dubious nature of our markets.

This is why the most cyclical of stocks tend to top out with low PE’s (price-to-earnings ratio) and bottom with high PE’s. The stock market is a forward-pricing mechanism and a leading indicator; tending to trap those relying on past data and current events in their decision-making; and rewarding those possessing the uncanny ability to speculate accurately on the future.

Major buying opportunities tend to follow the darkest of days and the most catastrophic of events. Last weeks action in relation to the London terror attack is a clear example of said occasion. Take an intraday chart of any (or all) of the global equities/futures markets open during the calamity and the images are nearly identical. Pay close attention to the 5:45-7:15am time frame (U.S. Eastern Standard Time) and the churning action that accompanied it—that is an example of the retail investor panicking and selling his stock to the institutional investor.

So if markets tend to go up when things are at their worst, when should investors worry?

Obviously when things are at their best.

When things are at their worst, they can only get better; however, when at their best, they can only get worse.

Think internet stocks doubling everyday, the run-up in equities before the stock market crash of 1929 and even as recent as the market gapping up on the news of Saddam Hussein’s capture from the spider-hole. When growth is so high that the following years earnings will be hard-pressed to match or beat expectations, heed this warning. When news of the stock market’s returns makes the cover of non-business monthlies, heed the warning.

This is not to say that bad news should be bought and good news sold, the point is to be aware of extremes in sentiment; as people are the lifeblood of the markets.

The great English economist John Maynard Keynes opined that “successful investing is anticipating the anticipations of others.” It would behoove the retail investor to think long and hard about what that means.

CCI1 CCI2 charts





Is The Consumer Confidence Index ready to make new highs?

Big Pharma

It would not be surprising to many if “Big Pharma” went the way of the dinosaur. What started off as an industry with tremendous barriers to entry, occupied by a multitude of small companies led by the brightest minds in the medical fields, possessing core competencies in different drugs/treatments/diagnostics has evolved into several behemoths—offering huge portfolios of products, dwindling market share and staffed by executives spending more time on the witness stand than in the laboratory. Basically, the biotech sector is the pharmaceutical sector of yesteryear.

While “strategic acquisition” seemed to be the industry catch-phrase of the 1990’s (linking co’s like Glaxo-Wellcome and Smith Kline Beecham; Pfizer and Warner-Lambert Searle and others), a natural progression would be the decoupling of these deals, or basically the creation of spin-offs. It wouldn’t be surprising to see many of these “giants” sell their consumer products divisions (over-the-counter prods, aspirin, mouthwashes, soaps, vanity prods, etc.) in what appears like a bid to purge their balance sheets and get leaner, but in reality serving no other purpose than fueling the next round of M&A..

The mainstream media’s repetitive coverage of the industry yields a few clues:

1. The Canada Story. More and more people getting prescriptions filled online through Canadian doctors for a fraction of the cost in the U.S.
2. Lawsuits. Name one company not the subject of overzealous litigation.
3. Generic Competition. One of President Bush’s solutions to the health care coverage gap is to make proprietary drugs open to generic competition far sooner than present protection.


Universal pricing for drugs is a good starting point. For one, it would deflect much of the negative criticism emanating from Congress, lobbyists and think-tanks regarding the future of Medicaid/Medicare. It would also favor international opinion as discounts for humanitarian efforts (AIDS, Bird Flu, etc.) would have a far more equitable basis for comparison than simply picking the discount off the lowest cost distribution region.

A second natural progression would be a further consolidation of the industry, but in a different direction. As the protection periods for patents seem to expire earlier and earlier, it would behoove big pharma to begin wooing generic makers. This would at least cushion the decrease in sales volume/revenue per drug instead of the massive short-fall that occurs when it becomes open season on a drug/treatment/therapy. Take a look at a long-term chart of Schering-Plough next to a regulatory timeline of Claritin from approval to current over-the-counter status. Scary.

The third has already began to take shape and is yielding extremely favorable results thus far. This is the transformation from the “strategic acquisition” to the “strategic partnership.” Examine Eli Lilly, Roche and others who have began to make huge inroads into newer markets (mainly Cancer and Diabetes) through research and development partnering with smaller, more flexible biotechnology companies. In many of these relationships the Pharma is solely responsible for handling funding, the approval process, marketing and manufacturing, while the bio entity is responsible for discovering the drug.

Will the current pharmaceutical model be scrapped? Most likely. Operating under the average of 8 years and $800 million dollars for a new drug to reach the market, this is a huge capital cost and any cost-benefits analysis will show a lengthy negative run-rate, even in the case of many blockbusters! In order to boost the industry growth rate some significant changes will need to take place or they could find themselves taking a page from Philip Morris’ playbook, spending the rest of their existence fending off lawsuits and constantly trying to escape the strangle-hold of regulators.

The British Way of Life

Closing his statement on the terror attack yesterday afternoon, Prime Minister Tony Blair said “This is a very sad day for the British people, but we will hold true to the British way of life.” I am not British, nor is anyone at E1. But we, like many New Yorkers and Americans know what it is like to be attacked by a faceless coward. We also know enough about the British way of life to say comfortably that it began long before July 8, 2005.

If emulation is the highest form of flattery, then there is a reason why the Honorable Rudolph Giuliani, former mayor of New York, sought the wisdom of Prime Minister Winston Churchill during 9-11. There is a reason why the rebuilding effort in Lower Manhattan is often compared to London after the bombing that leveled it in WWII. There is a reason why President Bush keeps the bust of PM Winston Churchill behind his desk in the Oval office. There is a reason why President Reagan had a special bond with PM Thatcher that took them well beyond their time in office. There is a reason why Prime Minister Blair received a 10minute deafening ovation from Congress when he visited America in her darkest hour.

There is a reason why President Bush and Prime Minister Blair often stand shoulder to shoulder when addressing the world.

It is because “That which unites us is greater than that which divides us.”

Now is not the time for politics. Now is the time for solidarity, vigilance and resolve in the presence of this faceless coward.

We mourn your losses and offer our unwavering support.

UNIONJACK

E1 would like to extend our sincerest sympathies to all those affected by this Thursday's attacks in London.

We mourn your losses and pray for the health and well-being of your family, friends and colleagues in the face of this terrible tragedy.

China

What to do with our neighbors to the east? Certainly there is nothing resembling an easy answer in the search for policy initiatives and trade. Constructing a clear and coherent position on any one issue tends obfuscate the larger issues at work here, which will be outlined below in the case of CNOOQ’s proposed acquisition of Unocal.

The pro argument. The United States has long sought an established trading relationship with China, as documented by our sponsorship of Chinese membership in the World Trade Organization. The U.S. also accomplished a preliminary goal of promoting human rights in China by tying social reform to entry in the body.

Since the 1990’s the U.S. has also pursued free trade policies with many other countries through the use of alliances like NAFTA, CAFTA and others within the Americas. The labor markets of most of the countries (Canada being a noteworthy exception) have benefited by trading with the U.S. because of cheaper employment. In turn, our corporations have benefited in the form of cost-savings which are passed on to the American consumer and in the form of creating higher paying jobs in fields like research, development, marketing, sales, etc. This has also had the desired effect of raising the quality of life from the creation of jobs abroad, which in turn drives more capital into infrastructure, which has a positive reverberation and fuels further growth.

China is no different. The advantages expressed above will occur, except on a much greater scale because of the size of their population and the hyper-growth mode they have been in. The jobs that we will lose—would have been lost anyway! No amount of legislation or protective measures would keep them here! The U.S. has been trending towards a service-based economy since the 1980’s and the rapid globalization enveloping economies everywhere no longer recognizes brand name origin.

An example:

A Japanese branded car is manufactured in Ohio, using American labor, hot-rolled steel produced in Pennsylvania from iron ore imported from Australia, with pre-fabricated parts assembled in China, with tires from France who imported rubber from Malaysia and advertised/marketed using an English Multinational firm. Substitute any good for “car” and the same applies—this is how business is done in the 21^st century.

The con argument. Allowing a communist country to buy a U.S. company should be forbidden. Like it or not, the term “publicly traded” is a contradiction when applied to companies in China because they are all owned by the government. This is comparable to letting the Soviets acquire U.S. companies during the cold war, as China is the closest we have come to an equal since the establishment of the new world order.

They have not allowed their currency to float freely nor have they opened their doors to foreign investment, to levels prescribed by their WTO membership. This has given them an unfair advantage in labor markets and cost the U.S. billions in trade. Our manufacturing is incapable of competing, putting our national interests in jeopardy. China also does not respect intellectual property rights, as their country is a haven for pirating because of a dearth of commercial enforcement, not to mention the corporate espionage running rampant—keeping barriers to entry intact, keeping the competitive ability of American companies at another disadvantage. Free trade loses its meaning when only one side is free.

China’s entry into the U.S.’s energy market also poses a number of problems for National Security. Pentagon contingency planning has already begun to draft plans for a conflict with the mainland over Taiwan in the next decade. China also has another unfriendly habit of illegally attempting to buy (and steal) military and satellite technology from domestic defense contractors and even illegally contributing to U.S. elections using laundered money.

Having access to energy and mineral rights will be essential for any nation looking for a leadership role in the international community, and since the U.S. is viewed as the world’s policeman, it is imperative to fund and fuel the world’s protector. Giving China access to our reserves would pose a great risk to our right to defend ourselves and allow a potential enemy (as viewed by the Pentagon) to infringe upon our national security. Such strategic importance visibly lessens the chance of passage from our regulators.

The problems with both sides. China has the United States in between a rock and a hard place. They are a key player in talks with North Korea and have made good on promises to bring Kim Jong Il back to the bargaining table. Any chance of re-opening North Korea for inspection and providing much needed basic supplies to the population is up to Beijing.

Moreover, much of the success of our housing, banking, basic materials, chemicals, airline manufacturing and technology sectors (as well as others) is due to the Chinese. Most media outlets have kept a key part of the commonsensical argument out of the public’s eye and instead focused on the currency story, which again, is over-simplified in its coverage.

The currency peg at the current 8:1 ratio with the Yuan cannot just be changed with a swift decision on the part of Beijing, as there is far more at stake than just an arbitrary ratio that can be altered on a whim. This is the reason why Greenspan has stated on several occasions that the abandonment (of the peg) will do very little in reducing our trade deficit.

This interpretation is best summed up in the example of a U.S. based textile manufacturer utilizing Chinese labor:

When the goods are produced in China at pennies on the dollar there is a creation of wealth on the part of the Chinese company, which is indirectly owned by the Chinese government. The Chinese government then takes the proceeds of the labor and converts it into U.S. dollars and buys U.S. Treasury denominated debt. The result is two-fold (excluding the fact that the profits of using inexpensive labor increases the profitability of the U.S. Company). The first keeps the dollar strong and therefore desirable to attracting foreign investors and investment. The second, by purchasing Treasury bonds, it keeps interest rates low. As most are unaware, there is an inverse relationship between the face value and coupon of a bond, so when China purchases, the face increases, while the yield decreases.

The recent expansion of the U.S. economy (post-bubble) is largely the result of low interest rates. Low rates lead to lower mortgage payments, which has kept the housing market strong and as prices continue to appreciate, more equity is created. It has also kept bank lending rates low, which has lead to greater corporate spending, keeping the refurbishing and upgrade cycles intact. U.S. timber, steel, copper, cement and chemicals producers have experienced firmer pricing for their commodities from increased Chinese demand. All in all, low rates have put more cash in the hands of the consumer, even enough to overcome $60 oil and nearly $3 gas—something most European economies are having great difficulty overcoming.

Any disruption in this investment in our debt would send rates skyrocketing higher, leading to repercussions that would be catastrophic for the American economy and therefore the global economy.

This is perhaps the biggest conundrum of all and something that needs the greatest consideration of all in formulating any policy with our neighbors to the east.

The Week in Advance

With only 4 days in the U.S. work-week, it is shaping up to be one of the busiest of the year. Look for current events to keep the markets occupied until resolution on a few fronts looks more plausible. Some of the issues in the headlines:

1. Earnings. This Thursday unofficially begins the earnings season when Alcoa (AA) reports. Earnings for the S&P 500 are also expected to show a ~9% gain YOY compared to 21% this Q last year.
2. Oil. Do not look for oil to leave the headlines just yet. This could be one of the biggest weeks for energy traders as the data from the government suggests that the Strategic Petroleum Reserve (SPR) is less than 4 million barrels away from the 800 million barrel mark (meaning: full); which could put some short term relief within reach. Inventory numbers out Thursday morning as well.
3. Washington. After a short hiatus brought about by compromise on the “nuclear option” issue and a surprising ruling on “eminent domain,” the courts are about to retake center stage as the Senate readies itself for a battle on Supreme Court nominations. The retirement of Justice O’Conner is clearly a loss for business, who often ruled in favor of federal jurisdiction over settlements and limiting jury awards, but received much scorn from conservatives on social issues.
4. Europe. The G-8 summit kicks off at the world renowned Gleneagles in Scotland. Look for China policy and currency issues to guide talks while mass media continues to focus on Africa, debt relief and musicians/actors involved in LIVE 8. The possibility of a rejection of the Procter and Gamble/Gillette combination from Mario Monti’s successor will keep arbitrageurs busy this summer much in the way GE’s failed bid for Honeywell did.
5. M&A. Aside from the above, the deal-making deluge continues. Bank of America/MBNA, CNOOQ/Unocal, NYSE/AX and Mohawk/Unilin are just a few of examples of the marriages of behemoths.
6. Housing Market. MBA Refinancing Index this morning will only add fuel to the Bubble debate.
7. Interest Rates. Bank of England decides Interest Rate policy in the middle of the week. Analysts looking for unchanged as retail sales continue to struggle.





Weekly chart of S&P 500. Index finished the week relatively unchanged as it continues range-bound.