By William Patalon III
Executive Editor
Money Morning/The Money Map Report

A hectic week on the economic calendar is highlighted by the initial look at second quarter gross domestic product (GDP). Remember, a recession is defined as two consecutive quarters of negative growth, so doomsayers have targeted this week’s release as confirmation of their pessimism.

Fortunately, the analyst consensus holds that the economy expanded at a faster pace than the 1% rate of the first quarter, putting us safely outside of recession territory. Investors get another view inside the struggling labor market where layoffs (mainly among financials) have resulted in overall job contractions for five consecutive months.

Economists hope for another positive showing for manufacturing from the ISM index, especially on the heels of last week’s strong durable goods data.  Finally, Exxon-Mobil Corp. (XOM) and Chevron Corp. (CVX) headline this week’s installments in the ongoing earnings season as investors get a reprieve from the weak financial releases and see just how much record oil and gas prices have padded the pocketbooks of those energy-sector executives [Click here for additional insight on Chevron, in Money Morning’s new “Buy, Sell or Hold” feature.]

Market Matters 

The Federal Communications Commission late Friday approved the $3.3 billion merger of Sirius Satellite Radio Inc. (SIRI) and XM Satellite Radio Holdings Inc. (XMSR), a move that means the still-nascent industry might actually be able to operate at a profit. [Please click here for a complete news story on this satellite radio merger posted elsewhere in this issue of Money Morning.]

With the immediate threat of a Freddie Mac (FRE)/Fannie Mae (FNM) failure looking less and less likely, investors were able to focus more on the heart of earnings season.  Thus far, the results have been mixed (or confusing) at best.  Of course, financials took top priority (again) as the nation’s largest bank by asset size, Bank of America Corp. (BAC), saw its profits decline by more than 40%, much to the delight – that’s right, delight – of investors who feared much worse.  Wachovia Corp. (WB) followed up with a trifecta of bad news:

• A greater than expected loss.
• A dividend cut.
• And some employee pink slips.

And yet, its stock price was up for the week as investors began to believe the worst of the news may be behind us (a feeling that will only last until the next bit of bad news hits).

Outside of the financial world, investors had plenty of reasons to grin. Heavy equipment-maker Caterpillar Inc. (CAT), oil giant ConocoPhillips (COP), communications staple AT&T Corp. (T) and the world’s biggest drugmaker Pfizer Inc. (PFE) each announced strong earnings.  Even Internet retailer Amazon.com Inc. (AMZN) shrugged off prospects for weak consumer activity and raised its year-end forecast.  Southwest Airlines Co. (LUV) accomplished what none of its competitors could do by reporting its 69th consecutive profitable quarter, thanks to some “ingenious” hedging moves.  On the downside, US Airways Group Inc. (LCC), UAL Corp. (UAUA), and JetBlue Airways Corp. (JBLU) suffered along with the rest of their winged brethren; Costco Wholesale Corp. (COST) showed that even discounters can struggle during dire times (apparently consumers can’t afford bulk purchases); and Ford Motor Co. (F) posted its worst quarter – ever. [Please click here for a “Buy, Sell or Hold” analysis of Ford shares elsewhere in today’s issue of Money Morning.]

United Parcel Service Inc. (UPS) had trouble dealing with the higher gasoline costs, while Texas Instruments Inc. (TXN) lowered its outlook for the year.  Some reports required a tad bit more analysis.  While Apple Inc. (AAPL) rejoiced over its “best June quarter for revenue and earnings” in its history, it disappointed investors with a weaker-than-expected end-of-year forecast.

Toymaker Hasbro Inc. (HAS) benefited from strong demand for “Iron Man” products, though management worried about the holidays as the company finds itself forced to pass along higher gas prices to consumers.  Merger talks resurfaced (another sign of business optimism) as drugmaker Roche Holding Ltd. (OTC ADR: RHHBY) will acquire the remaining shares in Genentech Inc. (DNA) it doesn’t already own.  Finally, Carl Icahn will have more say in the future of Yahoo! Inc. (YHOO) deals as he and his “cronies” will be given three seats on that “infamous” board. 

Consumers got an even greater reprieve from recent energy woes as oil prices continued their decline, and crude even dropped below $123 for the first time in several weeks.  Likewise, gas prices declined to just above $4 a gallon nationally (a drop of 10 cents per gallon) as the higher weekly inventory report revealed a continued slide in demand, and as service stations owners looked to regain those gas-guzzling customers.

While investors tried to make sense over the recent earnings reports, some took solace in the lower energy prices, and hope the “trend” continues as summer travel winds down and the holiday shopping season approaches. 

A surprisingly weak housing report put a damper on the newfound optimism from the oil decline and prompted some late-week selling that moved the Dow Jones Industrial Average Index into the red for the week.  Still, the general mood seems to be changing, as investors are more willing to dip their toes back into the equity pool – though let’s hope they do so without badly stubbing their toe in the process.
                       

Economically Speaking

     
With the dreaded “I” word – inflation — monopolizing much of the water cooler discussion these days (except here around Money Morning’s water coolers, where the “S” word – stagflation – is getting nearly equal time…) two million Americans were able to join in and explain why escalating costs are not necessarily a bad thing (at least, not for them).  The federal minimum wage rose from $5.85 to $6.55 an hour last week, on its way to $7.25 in 2009.  While higher oil-and-gas prices have been seen as the primary culprits for the recent pressures, expect some new wage inflation concerns to emerge as businesses look to pass along these higher costs to consumers. 

Housing reports highlighted the economic data of the week, and in general, “experts” agree that any rebound is still a long way from coming.  For starters, home prices fell in May by 4.8% from last year’s levels.  Existing home sales plunged by 2.6% in June, more than twice the estimate of most analysts, and more than 15% below the level of activity a year ago.

New home sales dropped by ONLY 0.6% in June, a better-than-expected showing that did little to reverse the concern of the prior (weaker) releases.  On the bright side (yes, there is always a silver lining), durable goods orders experienced its best showing since February, a strong sign that manufacturing is not suffering as badly as housing.

Likewise, a consumer sentiment index rose (ever so slightly) as Americans felt better about spending those refund checks that were part of that government economic stimulus package.  The U.S. Federal Reserve’s Beige Book showed that policymakers continued to grapple with how best to handle the dual crises (slow growth vs. inflation), though Fed Chairman Ben S. Bernanke seemed confident that the country could avoid the stagflation of the 70s.

For now, most economists expect the Fed to leave rates unchanged at the August 5 Federal Open Market Committee meeting.  After all, raising rates to combat inflation could prove harmful to the already weak economy; while cutting rates to stimulate growth could lead to further price pressures. 

Weekly Economic Calendar

News and Related Story Links:

Money Morning Stock Analysis Feature: Buy, Sell or Hold: Chevron Corp.

CNNMoney.com: Costco Says 4Q EPS To Be Well Below Consensus.

Reuters: FCC approves Sirius Satellite acquisition of XM.

Money Morning: Switzerland’s Roche Makes $43.7 Billion Offer for U.S. Biotech Pioneer Genentech

Money Morning: The Worst U.S. Housing Market in a Generation Could Mean $1 Trillion in Write-Downs

Money Morning: Government Data Stabilizes Stocks After Steep One-Day Sell-Off

I don’t know whether to be furious or relieved.

While at our Oxford Club Chapter Meeting in Colorado Springs last week, I happened to learn that Countrywide Financial Corp. (CFC) was planning to host several dozen mortgage company reps at the nearby Ritz-Carlton Bachelor Gulch ski area in Avon.

Unfortunately, public disclosure by The Wall Street Journal and other papers ruined their plans and the Calabasas, Calif.-based Countrywide cancelled at the last minute.

Countrywide claims to have cancelled all similar events, too, for the rest of the year "in light of recent events."

It’s for the best – believe me – for "swank" doesn’t begin to describe just how nice the Avon Ritz really is. For starters, weekday rooms there start at $750 a night.

As reported in the Rocky Mountain News, the multi-day soiree was set to start with cocktails and ski-fittings. Attendees were then to be feted at Spago on such delicacies as $105 a plate Kobe beef and $140 caviar, before enjoying a multi-day fiesta including hotel rooms, meals, skiing and gratuities – all of which was to be paid for by Countrywide and all of which is in line with annual industry "meetings" they’ve held since the 1990s.

Silly me … I thought the industry was in the dumper and that the company was struggling after taking $1.6 billon in losses during the second half of 2007.

Evidently things at Countrywide are a lot "richer" than most people think – and why shouldn’t they be?

If you recall, we suggested months ago that the real reason Bank of America Corp. (BAC) is buying Countrywide has nothing to do with the hundreds of millions of dollars worth of yearly loan-servicing revenue. Nor does it have anything to do with Countrywide’s dominant market share.

Instead, we posited that BofA was going to use Countrywide’s losses to offset its own taxable income.

Turns out we may have been "righter" than we care to admit.

Under the terms of the deal announced in January, Bank of America agreed to pay $4 billion in its own stock for Countrywide – slightly less than $8 a share. Proponents viewed the takeover bid as a much-needed rescue mission for Countrywide, which many believed to be out of cash at the time.

Just before the offer, Countrywide had seen its stock price plunge about 85% – a decline that steepened in the days immediately before Bank of America launched its bid.
Critics say the buyout offer was a bit on the rich side – especially after BofA Chief Executive Officer Kenneth D. Lewis had already injected about $2 billion into Countrywide to help prop it up last summer as the subprime mortgage crisis started to spiral out of control.

With mortgage defaults escalating, Countrywide was forced to boost its loan-loss provisions, leading to a loss of $1.2 billion in the 2007 third quarter and $422 million in the fourth quarter.
According to tax experts like Robert Willens, who was quoted in Fortune magazine at the time, the deal could be worth billions to BofA by the time all is said and done. In fact, in the first five years it owns Countrywide, BofA will be able to use a total of $1.35 billion of Countrywide’s losses to shelter its income. That works out, incidentally, to $270 million a year.
But here’s the kicker.

If Countrywide’s losses exceed $1.35 billion when the transaction ultimately closes [it's supposed to be finalized in the third quarter, as the two companies continue to work out the details], Bank of America could deduct the rest of the losses without limits beginning in year six.

What a country …run up billions of dollars in losses, hand your executives hundreds of millions in compensation, nearly wreck an entire industry single-handedly, spend millions on boondoggles…and qualify for an IRS sanctioned tax break at the same time!

Where do I sign up?

Wait…I already did. My wife and I got our mortgage through Countrywide. At least we haven’t been "countryfried" – yet.

Maybe that’s why shares of Countrywide rose a penny each after the ski trip was cancelled…to $6.96.

News and Related Story Links:

• CNNMoney.com:
  Countrywide Cancels Ski Trip Meeting.

• Money Morning News:
  Bank of America Will Buy Countrywide for $4 Billion in Stock.

• Money Morning News:
  Countrywide CEO Still Gloomy After $2 Billion Capital Infusion.

Employers added 166,000 employees in October, more than double analyst forecasts, the U.S. Labor Department reported Friday.

Most economists had only expected an increase of between 80,000 and 85,000 jobs. The report helped to ease concerns that the meltdown in mortgage markets and the heavy toll taken on homebuilding would spread to the broader labor market. It will also give the Federal Reserve a break from rate cuts in the face of growing inflationary pressures.

“The labor market continues to be inconsistent with fears of a recession,” said Dean Maki, chief U.S. economist at Barclays Capital and a former senior economist at the Fed, told Bloomberg News. “This report will increase the Fed’s conviction that it should keep rates unchanged in coming months.”

Service industries, which include banks, insurance companies, restaurants and retailers, experienced the largest workforce expansion. They added 190,000 workers in October, after taking on 127,000 new employees in September. Government payrolls grew by 36,000 during the month, after rising 23,000 in September.

Factory payrolls took the biggest hit, dropping 21,000 after decreasing by 17,000 in September.  The construction and lending sectors lost 5,000 jobs each, while finance, a sector that has been hit hard by the credit crisis, saw 2,000 payroll additions last month.  The unemployment rate held steady at 4.7%.

On Wednesday, the Commerce Department reported a surprising 3.9% GDP growth rate for the third quarter, outperforming analysts’ estimates by a large margin.  The employment report is further evidence that the U.S. economy is holding the line, despite the collapse of the housing market and credit crisis.

Every Silver Lining Has a Dark Cloud

While the report is overwhelmingly positive, some economists question the validity of the gains in the latest report, which will be subject to further revision.

“People got too excited about the job loss in August and they’re getting too excited about this gain,” John Silvia, chief economist at Wachovia, said in a recent CNNMoney report. 

It’s clear that Silvia and many other analysts expect much of this optimistic reading will soon be revised away, the same way that the 4,000 job loss originally reported in August has been revised twice, and is now regarded as a 93,000-job gain.

“It’s dealing with the month-to-month volatility in the sampling process,” Silvia said. “Clearly the 166,000 overstates growth. When the final numbers finally come in, it will probably be closer to the 80,000 gain everyone was expecting.”

Certain specificities within the report also came under scrutiny.

“The one warning sign in the report was a drop in trucking jobs,” said Joel Naroff, President and Chief Economist of Naroff Economics. “If we are not shipping goods across the country, there may be more weakness than meets the eye.”

Both Naroff and Silvia questioned the spike in public education hirings, which reportedly totaled 35,000.  The figure is likely the result of the Bureau of Labor Statistics catching up with seasonal gains from the start of the school year.

Regardless of certain inconsistencies the report still stands as a positive signal concerning recession and the U.S. economy. At least, that’s how the Fed will see it…

Fed Implications

The positive nature of the report suggests the economy, at the very least, isn’t falling apart. That means the Fed, which faced a backlash of criticism after slashing rates Wednesday, will be able to abstain from further rate cuts in the near future.

Fed policy makers cut the interest-rate target for loans between banks by a quarter percentage point to 4.5% on October 31.  This followed a half point rate cut at the end of September. 

The Federal Open Market Committee (FOMC) said in a statement that the cuts were meant to “help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets.”

However. many analysts second-guessed the decision, suggesting the move would have an adverse effect on the value of a dollar and, in conjunction with high oil prices, fuel inflation. 

Core prices, which exclude food and energy costs, rose at a rate of 1.8% in the third quarter, a 0.4% increase from the second quarter.  That may still be in the Fed’s comfort zone between 1% and 2%, but whether it will remain there remains to be seen.

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Merrill Lynch & Co. Inc. (MER) Chairman and CEO Stan O’Neal isn’t the only worker in the U.S. financial-services sector with a job-security issue. Indeed, once his ouster becomes official, O’Neal will become just one more of the 130,000 casualties that have already made 2007 the worst year ever for layoffs in the U.S. banking-and-brokerage marketplace.

According to outplacement firm Challenger, Gray, and Christmas, those 130,000 job cuts are nearly three times the 50,000 cuts reported for all of 2006, and has already smashed the all-time record of 116,000 layoffs set in 2001.

"It’s the worst year on record for job cuts in the financial services sector," John Pedderson, a Challenger, Gray, and Christmas spokesman told BusinessWeek.

According to Pedderson, about 80% of the job cuts were announced in the past two months, as finance firms suffered epic losses from subprime mortgage problems, a historic housing slump, and a debilitating credit crunch that turned into a global crisis this past summer.

In August, Accredited Home Lenders Holding announced it would cut 1,600 jobs.  That same month, Capital One Financial Corp. (COF) said it would close its Greenpoint mortgage unit, effectively dispatching 1,900 jobs. In September, Countrywide Financial Corp. (CFC) eliminated approximately 12,000 positions – more than 21% of its work force totals from the previous year. Also in September, IndyMac Bancorp (IMB) said it would terminate about 1,000 employees.

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Mortgage lenders have been the hardest hit in terms of job losses, but financiers, traders, and investment bankers have seen their share of layoffs as well. Morgan Stanley (MS) and the Bear Stearns Companies Inc. (BSC) are cutting 300 and 310 jobs, respectively. Credit Suisse Group (CS) is purging 170 positions, HSBC Holdings PLC (HBC) 750, and UBS AG (UBS) is eliminating 1,500 jobs.

Overall payroll growth has slowed sharply in the past year. Private payrolls were growing about 140,000 a month at the end of 2006, but that growth slowed to just 90,000 a month over the past three months. Economists expect only modest job growth in October, with a median forecast of 80,000 new non-farm payroll jobs for the U.S. economy, MarketWatch reported.

Economists have forecast modest job growth in October, and the unemployment rate is expected to remain at 4.7%. Monthly figures for initial jobless claims, the unemployment rate, and non-farm payroll additions are set for release later this week.

News and Related Story Links:

• Business Week:
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• Money Morning:
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• Money Morning:
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• Money Morning:
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