Is Google Recession Proof?

I've seen this question a couple of times in some other blogs. Here is what Yahoo said about the question of ad search revenues being resistant to any economic downturn.

Question

"What kind of impact in a hard recessionary environment do you think you could see in your display and search advertising, whether one would be more insulated than the other? Specifically in Search, to the extent that you were to see a major negative macroeconomic impact, do you think you would see that more in terms of advertiser demand or a change in user or searcher behavior?"

Answer

"We have, from time to time, seen pockets of weakness and certainly a couple of pockets in the fourth quarter as I outlined. We’ve also had areas of strength that have been offsetting."

"The challenge in answering your question is clearly the secular trends in online advertising have historically, and even today, very much been overwhelming the cyclical environment. It’s early to tell though if the weakness in the housing and financial and travel sectors -- a little bit in retail -- will start to affect the consumer more broadly and the advertiser more broadly and therefore searches in terms of what kind of commercial searches happen."

"I don’t think we have a crystal ball in that, but we are encouraged, actually, by how much offsetting strength we’ve seen in some of the other categories which has kept our overall marketing services growth rate in line in display and Search with what we saw earlier in the third quarter, or actually even a little bit better."

Transcript from Seeking Alpha

I Just Don't Get It

So here is what I don't get. The United States economy is slowing down, the extent of which is unknown, but certainly below its trend line growth of 3%. The consumer, which powered the economy, is stretched, suffering from the effects of the housing bust and high oil prices.

Oil, however, continues to strengthen in price, reaching $100 a barrel, based on continued strong demand from emerging economies, particularly China. Yet China is America's "factory floor" as one pundit put it. So how long will it take for the slowdown in spending to work its way through the supply chain. The conversation I suppose would go something like this:

Executive: Hey Li Shao...how are things?

Li Shao: Great...how is U.S doing?

Executive: Good. The reason I am calling is about the order we have pending with you guys.

Li Shao: Yes, we are working hard on it.

Executive: Well the thing is, we are going to have to cut it back by 50%.

Li Shao: What?

Executive: Well you know, the American consumer is stumbling a little with the housing crisis, high gas prices so we just wanted to be a little prudent about our inventory this year.

Li Shao: What? You can't do that.

Executive: Well actually we can. Why do you think we outsourced our manufacturing?

So here is the current consensus on Wall Street - the bull markets in emerging economies and therefore by extension commodities will continue despite the Housing debacle in the United States because these emerging economies have "decoupled" from the United States due in part to those emerging economies developing their own domestic consumption markets.

The rest of the world is no longer "dependent" on the U.S. economy. Not only will Commodities and emerging economies continue to boom, but all the domestic stocks that feed that boom will continue to grow. This would include the Energy Sector, most Basic Materials, Industrials and any other company that sells to export markets, dry bulk and other shippers that serve Asia, etc.

If this is true, then all power to them I say, but if it is not and the old saying "when the U.S catches cold, the rest of the world catches the flu" is still true then the short of a lifetime is developing here.

China exported $ 287 billion in goods to the U.S in 2006. This was 29% of its exports to the world, which totaled $969.1 billion. Although the conventional wisdom is that the slowdown in the US will not impact China because they have other markets now to sell to, this is not true. We are their largest customer. Also, if you look at the top export categories, they are the categories that are slowing down the most in the U.S:

Exports to U.S from China in 2006 (Billions)

Toys & games $20.9
Apparel $19.9
Furniture $19.4
Footwear & parts $13.9


Source

Oil finally cracked a little on Friday after the jobs report, but it would seem that there is a huge downside still to come on it and other commodities.

Toll Brothers Conference Call

A few excerpts from the Toll Brothers fourth quarter conference call held yesterday courtesy of Seeking Alpha

Interesting that he said that 1974 was a rougher downturn than the current one.

Comments on Current Conditions

"By many measures, fiscal 2007 was the most challenging of the 40 years that Toll Brothers has been in business. 1974 was perhaps rougher, but the difficult times only lasted one year."

"Since going public in 1986, we’ve just reported our first quarterly loss this fourth quarter after 85 consecutive profitable quarters. The loss was driven by $315 million of non-cash pretax inventory related impairments and related write-downs."

"The creation of projections is difficult at any time. In the current climate, it’s particularly difficult to provide guidance for fiscal 2008, given the numerous uncertainties related to items such as sales paces, sales prices, mortgage markets, cancellations, market direction, and the potential for and size of future impairments. As a result, we will not provide earning guidance at this time."

Random Thought of the Day - Nov 30, 2007

It doesn't matter what the Fed does to interest rates if lenders won't lend, so ride the rally up until the Fed cuts rates, and then get short. If you don't believe me then look at this study done by the Federal Reserve back in 2002.


Study

If it gets too dense then read the conclusion paragraph on Page 11 and 12

Thrift Capital Ratios

During the last significant recession in the early 1990's the thrift industry was ground zero for everything that was going wrong with the economy at the time, with hundreds of bank failures, etc. This time the problems seems to stem from the "smart money" bankers who have overextended themselves without regard to risk.

The Sept 2007 aggregate thrift financial report shows capital ratios actually getting stronger in September 2007, as measured on a year over year basis.



The full report is here.

Jackass of the Day - August 31, 2007

"The program could play a very important role in saving from foreclosure American homeowners who have been taken advantage of by unscrupulous subprime lenders and brokers,"

Senate Banking Committee Chairman Christopher Dodd, D-Conn

And how will you tell them apart? Can you distinguish between greed and stupidity?

Quote of the Day - August 31, 2007

"It's not the government's job to bail out speculators or those who made the decision to buy a home they knew they could never afford,"

-President George W. Bush.

A Storm Coming?

Here's what people should be thinking about - the New York Federal Reserve did a study in May 2002 called Credit Effects in the Monetary Mechanism. This study examined the effect of changing loan standards or as they put it "do bank lending standards "matter" for the economy—that is, do standards affect loan growth and, more broadly, GDP?....also explore whether credit standards are independent of the monetary policy process or, alternatively, a channel through which policy affects spending and the real economy." They used the Senior loan officer opinion survey for data in this study.

Fed Study

So what does all this mean? Two things - when banks have tougher lending standards does it effect the economy, and second, does it matter what the Fed does to help? The conclusion:

"First, changes in credit standards have a significant effect on both loans and GDP. Second, credit standards appear to be largely independent of the monetary policy process, showing little sensitivity to changes in the Federal Reserve's key policy instrument, the federal funds rate."

They get a little more specific here:

"An unanticipated 10 percent net tightening of standards in the augmented model causes output to fall 0.5 percent at its trough and loans to contract more than 2 percent."

A 10 percent net tightening is not a significant tightening. Using the 2001 recession as an example, net tightening in commercial real estate loans moved 41.2 percent, while net tightening in commercial and industrial loans moved 54.3 percent.

Here's a chart from the study showing the net moves over time.



So when Helicopter Ben says that there is no evidence that the recent credit market turmoil is affecting the economy, he's right because it has only been three weeks since it started. Let's hope the Fed keeps its eye on this measure.