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Tony Sagami

Tony Sagami

Harvest Advisors

Tony Sagami is the owner and founder of Harvest Advisors, an investment research and money management company. Sagami has been managing money for more than…

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Connecting the Dots

Cisco offers disappointing look forward
World's largest steelmaker warns of slowdown
Small business feels the pain at the pump
Fannie Mae misses deadline, faces NYSE delisting

After rubbing the sleep from their eyes and realized that Asia sharply rallied last night -- 197 points for the Nikkei and almost 300 points for the Hang Seng index -- the bulls were ready to rock this morning.

At one point in the morning, the Dow Jones was up by more than 100 points to 10,719. Those bullish dreams, however, ran into a brick wall called $64 oil.

The catalyst for the surge in oil prices was a bigger-than-expected spike in oil imports and bigger-than-expected drop in gasoline inventory. As a result, the price of oil jumped by $1.83 to $64.90.

That jump makes T. Boone Pickens, who was on CNBC, look pretty darn smart for confidently predicting that oil would hit $70 within a year.

Within a year? How about within a week?

The bulls have to be pretty disappointed that their 104-point rally evaporated into thin air and turned into a 21-point loss by the time the market closed.

I pay very close attention to these failing rallies because they frequently mark and important inflection points. It is a little early to declare the start of a bear market...but I am on my own personal high alert.

Cisco offers disappointing look forward. Cisco hits its Q2 number square on the head. But everything else looking forward didn't sound so good.

Sales slowdown #1: Q2 sales only showed an 11% year-over-year gain from 2004 -- not very impressive. The real bomb was the news that Cisco only expects Q3 sales to increase by only 10% over 2004.

Sales slowdown #2: Cisco expects sales in the next 12 months to grow by 10% to 12%. Since Wall Street was anticipating 12% sales growth for the year, this 10% to 12% forecast is admission that Cisco expects business to get even worse.

Buyback hanky panky: The Wall Street crowd thinks stock buybacks are universally good news. Wrong! Cisco uses an aggressive stock repurchase program to mask dilution from overly-generous stock options and to goose earnings. Cisco spent $2.5 billion in Q2 to buy back stock - more than its total free cash flow.

Bad timing: Cisco paid an average of $19.14 for those 130 million shares it bought back last quarter. With Cisco trading in the mid-$18 range now, Cisco lost a cool $60 to $70 million on buying back its overpriced shares.

Stock options cost shareholders: Cisco was one of the most vocal opponents of expensing stock options. Tough -- new accounting laws require all companies to account for the cost of stock options and Cisco confessed last night that expensing stock options will reduce its profits by 3 to 4 cents a share each and every quarter.

The world just isn't stampeding to buy Cisco high-priced routers and switches like they used to.

Nobody should pay 17 times earnings for a company that is only growing by low double-digits.

Nobody should pay 5.2 times sales for a company that uses fancy accounting tricks and stock buybacks to goose its EPS numbers.

Even the attention-deficit-disorder crowd on Wall Street is starting to get the picture. Standard & Poor's downgraded Cisco and warned that it didn't see any "material catalysts on the horizon."

I couldn't agree more. Cisco is a dog and well on its way to seeing its stock price fall drop into single-digits in the not-too-distant future.

World's largest steelmaker warns of slowdown. The global economy is built on several critical building blocks: oil, copper, aluminum, and steel.

Warning: Mittal Steel, the world's biggest steelmaker, warned that demand is falling, creating a global oversupply, and pushing steel prices downward by 33% this year.

Mittal reported a 18% drop in its Q2 profits and warned that Q3 profits would be below expectations. CEO Lakshmi Mittal was blunt:

"Looking ahead to the third quarter, we are expecting conditions to remain difficult."

I'd listen to Mr. Mittal. According to Forbes Magazine, Mittal is the third-richest man in the world only behind Bill Gates and Warren Buffet.

And I'd run far, far away from other steel producers, such as Nucor, U.S. Steel, Allegheny Technologies, and Commercial Metals.

Small business feels the pain at the pump. You commonly hear that small businesses are the backbone of the American economy. If that is true, America may have cracked its back.

A Wells Fargo/Gallup survey of small businesses showed a sharp drop in confidence of small business owners.

The index of small business owner confidence dropped from 110 in March to 99 in June. That is the lowest reading since December of 2003.

The reason for the caution is simple: sky-high gas prices. Dennis Jacob, the chief economist at Gallup said:

"Small-business owners are closer than a lot of Wall Street to the average consumer. When they see what higher pump prices are doing to consumers ability to buy, I'm not surprised their future expectations have declined."

Higher gas prices are making business owners cautious:

==> The percentage of business owners that had a positive outlook for 2006 dropped from 82% to 78%.

==> The present-situation component fell to 41 from 45, and the future-expectations component fell to 58 from 65.

==> The percentage of owners that said their cash flow was "good" or "somewhat good" dropped to 58%, the lowest number since the survey began in August of 2003

==> 17% of owners expected to cut capital spending in the next year, the highest number since March of 2004.

Confidence surveys are NOT the most reliable indicators in the world. They are, however, extremely useful in the context of other economic and corporate reports. What this survey does for me is confirm the growing pile of okay-but-far-from-great reports that keep rolling in.

As a side note, the one portion of the survey that caught my personal attention (because it hit too close to home) was the answers to the work schedule questions. The survey found that 57% of business owners work at six days a week, more than 20% of them work seven days a week, and 14% take zero vacation days a year. If you're a business owner, you know exactly what they are talking about.

Fannie Mae misses deadline, faces NYSE delisting. Fannie Mae is doing a great job of proving the accuracy of my corporate America cockroach theory: the first corporate cockroach is never the only one.

Fannie Mae doesn't have a monopoly on dirty executive, but it definitely has more than its fair share of them. The newest bombs to be dropped by Fannie Mae are:

==> Fannie Mae will not file the mandatory Q2 earnings report with the SEC. Wall Street is surprised, but I sure don't know why -- Fannie Mae hasn't filed a quarterly earnings report with the SEC in a year.

==> Fannie Mae will not be able to file a re-stated 2004 annual report until "second half of 2006." That's a major, major problem because the NYSE has the authority to delist Fannie Mae if it doesn't file that 2004 annual report by December 16.

None of this is new news to readers of this column because we've regularly warned you about the accounting tricks because played at Fannie Mae.

What is new are some details of Fannie Mae's mega-sized derivative portfolios. CEO Daniel Mudd said:

"We estimate we will need to record over one million lines of journal entries, determine hundreds of thousands of commitment prices and securities values, and verify some 20,000 derivative prices."

20,000 derivative prices? 20,000!!!

Fannie Mae is sitting on over $1 trillion of derivatives.

$1 trillion!

There is no way that anybody on Wall Street can evaluate or quantify the risk, leverage, volatility, or explosiveness of that portfolio. Therefore, it is impossible to accurately analyze any financial companies with huge derivative portfolios. That is true of Citigroup, J.P. Morgan Chase, Aon, as well as Fannie Mae.

Warren Buffet said it best when he described derivatives as "financial weapons of mass destruction."

Fannie Mae is sitting on a derivative portfolio big enough not to just put itself out of business, but big enough to take the entire real estate market with it.

I say that because Fannie Mae finances one of every five home loans in the United States. If Fannie Mae blows up, the real-estate-never-goes-down crowd is in for a very rude surprise.

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