The Zacks Analyst Blog Highlights: DuPont, Union Pacific Railroad, Ford, General Motors and Exxon

Sep 26, 2011, 09:30 ET from Zacks Investment Research, Inc.

CHICAGO, Sept. 26, 2011 /PRNewswire/ -- announces the list of stocks featured in the Analyst Blog. Every day the Zacks Equity Research analysts discuss the latest news and events impacting stocks and the financial markets. Stocks recently featured in the blog include: DuPont (NYSE: DD), Union Pacific Railroad (NYSE: UNP), Ford (NYSE: F), General Motors (NYSE: GM) and Exxon (NYSE: XOM).


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Here are highlights from Friday's Analyst Blog:

Which Deficit Caused the PIIGS Problem?

I have long maintained that the trade deficit is a more serious economic problem than the budget deficit, particularly in the short-to-intermediate term. It is the trade deficit (or to be more precise, the current account deficit, which is technically slightly different, but I will use the terms interchangeably here) that is directly responsible for America being in hock to the rest of the world.

The trade deficit directly lowers GDP. It is right there in the GDP equation as (eXports - iMports). Thus if the trade deficit increases, then GDP growth slows. Even if it just continues to run in the red to the tune of $45 to $50 billion per month, it means we are going into debt with the rest of the world by that amount. That's more than losing a DuPont (NYSE: DD) or a Union Pacific Railroad (NYSE: UNP) per month.

Curing the trade deficit, or at least making substantial progress on it, would work wonders on bringing down the unemployment rate. With more people working, and thus having an income (that would be taxed) and also not having to rely on the social safety net (very much fraying), the budget deficit would come way down.

Did Trade Lead to PIIGS Problems?

There is also good evidence from abroad that the current problems in Europe from the PIIGS came from trade problems, not from their government being irresponsible on the fiscal side. The two are not mutually exclusive, of course, governments can be irresponsible fiscally both in a trade surplus, and a trade deficit position.

The PIIGS acronym stands for Portugal, Ireland, Italy, Greece and Spain. Of the five, the two that appear to currently be in the worst shape are Greece and Portugal, but all five have given the world financial markets bouts of indigestion of late. Those two were clearly "double offenders" -- running awful trade deficits of 9.4% of GDP in the case of Portugal, and 8.4% of GDP in the case of Greece in the run up to the financial crisis.

Note, however, that France and even Germany and the Netherlands were running substantial budget deficits in the run-up to the crisis, and they are now seen as the strong core of Europe. Conversely, Spain and Ireland averaged budget surpluses in the run-up to the crisis. That is hardly a sign that the governments were being excessively profligate before the excrement hit the rotary wind-creating appliance.

All five were running chronic trade deficits. The current strong core were all running very large trade surpluses.

Was it a case where there was a big change of direction in their the fiscal or the trade balance before and after the adoption of the Euro? In some cases, but generally it was not that these countries were paragons of virtue on the fiscal side before the Euro was adopted, and they then became a bunch of spendthrifts.

The Street Light post also includes graphs for all of these countries, but Italy tracked the path of both fiscal and trade deficits/surpluses both before and after the adoption of the Euro. I have put them in the order of the most troubled to least troubled currently.

Greece was running a trade deficit back when it was on the Drachma, and there was some deterioration leading up to the adoption of the Euro, but the deterioration really picked up steam after adoption, especially after 2004. There was also a fairly steady deterioration in the budget deficit in Greece.

As I said, the two problems are not mutually exclusive. If it were only Greece that was the problem, it would be hard to say which deficit was at the core of the issue.

Portugal did not have a big problem with its trade deficit up until just before the adoption of the Euro. It was, however, having very real budget deficit problems. Those, however, generally got much better in the post-Euro period than they were in pre-Euro period.

Trade deficits of over 10% of GDP are huge. Budget deficits of 2 to 3% of GDP are generally sustainable provided that the economy is growing at least that fast. In other words, the ratio of government debt (accumulated deficits) is not rising.

However, this means that you will not have the flexibility to run budget deficits when you need to -- when the economy turns south. While not a paragon of fiscal virtue either before or after the adoption of the Euro, Portugal was not particularly "naughty" in the post-Euro adoption period.

Prior to the advent of the Euro, Ireland was moderately "naughty" on the budget deficit side, but was running very significant trade surpluses. That changed in the immediate lead-up to Euro adoption and it was an absolute paragon of fiscal virtue, running budget surpluses (thus paying down its previously accumulated debt) in the post-Euro period. On the other hand, the trade surplus evaporated and became progressively more problematic after the adoption of the Euro.

Ireland's big mistake came during the crisis, when it decided (the first country to do so) that bank bondholders would be fully protected from the consequences of their investment stupidity. That, in turn, forced the U.K. to do much the same -- and after the U.K. did so, the rest of the world was more or less forced to follow.

The big trade deficit, however, clearly played a major supporting role. The large budget surpluses it was running in the run up to the crisis more or less disproves the idea that the current problems facing the PIIGS are just a case of the "chickens coming home to roost" after the now-troubled countries were acting fiscally irresponsible before the crisis hit.

Spain is probably an even clearer case than Ireland. Certainly a good argument could be made that the Spanish were irresponsible on the fiscal front before the adoption of the Euro, but they were getting their act together in the lead up to it. They continued to become more and more responsible during the post-Euro adoption/pre-crisis period.

The same is decidedly not true on the trade deficit side. It went from a position of near trade balance prior to dropping the Peseta and using the same currency as the rest of Europe, to a deep and very troubling trade deficit.

In some ways, though, Spain was sort of the Florida of Europe. It has a sunny climate, and lots of people from Northern Europe and the U.K. were building second or retirement homes there in the pre-crisis period. In many respects, relative to its GDP, Spain's housing bubble was even bigger than that of the U.S. (at least if you take the U.S. as a whole, but not as bad as the U.S. poster-child states of the housing bubble like Florida and Arizona), but there were very similar dynamics at work).

Using the St. Louis Fed's FRED database, I tried to produce a similar graph for Italy, only unfortunately the Italian budget deficit was not among the data series available. As a very rough proxy, I included the Italian government's final consumption expenditure as a share of GDP. That is spending excluding transfer payments. It shows a slight increase in the government share of spending, and that its tax collections did not increase commensurately would indicate a slight upward trend in its budget deficit.

Meanwhile, the large trade surpluses it was running prior to the adoption of the Euro evaporated. Given that the data source is not the same and the budget deficit proxy is an extremely rough one, I don't think the Italian graph lends a lot of evidence either way, but I wanted to put something in for the sake of completeness.

What's Clear About the Crisis

I think the evidence though is pretty clear that the current crisis in Europe is due to the inherent flaw of forming a currency union in the absence of a fiscal union. After all, the countries had the same currency, and money poured into the PIIGS from the core of Europe (Germany, France, the Netherlands, etc). That is the flip side of a trade deficit.

In many cases, that capital helped fuel a housing bubble, which collapsed in much the same way that the U.S. housing bubble collapsed. That flood of capital also resulted in higher inflation in the PIIGS, and they gradually became less and less competitive. If they were still on the Peseta and the Drachma, those currencies would have fallen relative to the Mark and the Guilder, thus blunting the size of the trade deficits.

With the devaluation option off the table, they now have to undergo a "domestic devaluation." In other words, inducing deflation in their domestic economy's harsh enough to bring down their costs to make them competitive with the core countries. That means very sharp recessions in those countries. Deep austerity on the fiscal side is one of the tools that causes that to happen.

There are major questions as to if the Euro will be able to survive even for a few more years. That is not something that is going to make the Euro a strong currency.

While given its international reserve currency status, the U.S. can withstand chronic trade deficits better than most other countries can, there is a limit to that. Even though the Dollar is a freely floating currency, the reserve status prevents it from falling enough to eliminate our trade deficit. That is a persistent drag on our economy and leads to higher levels of unemployment than if we were not running a trade deficit.

We need to see a much weaker Dollar as part of a two part effort to bring down the trade deficit. That will help on about half of the problem. Unfortunately, the Euro is sort of the "anti-dollar." Taken together, the Euro-zone is an even bigger economy, and has more people in it than the U.S. It is the only other possible contender for the role of international reserve currency.

Foreign exchange is always a relative game. If the Euro is going to be weak, it is going to be almost impossible for the Dollar to be weak at the same time. Curing our trade deficit means that some other country much run a smaller trade surplus, or a larger trade deficit. World-wide, the trade deficits of all countries have to sum to zero  Alleviating the pain here will mean imposing pain elsewhere in the world.

The Other Half of the Problem

The other half of the problem though is our addiction to imported oil. When the Dollar falls, the price of oil tends to rise, which negates the dollar drop effect. We need to shift to using more domestic sources of supply and to using the oil we do import more cautiously. That means major efforts to increase energy efficiency.

A crash program to shift towards the use of domestic natural gas, of which we have very abundant and growing supplies, is one of the most promising ways to bring down the oil side of the trade deficit. I was disappointed that President Obama's "America Jobs Act" did next to nothing in this regard (OK, there was some money in there for energy conservation work, but it was not the main thrust of the proposal).

That, however, does not make that much of a difference, since it is clear that regardless of what Obama proposed to jump-start the economy, it would not make its way through the current Congress. Moving towards using Natural Gas as a transportation fuel (and thus replacing imported oil) faces a huge "chicken and egg" problem.

Ford (NYSE: F) and General Motors (NYSE: GM) are not going to pour a lot of resources into developing Natural Gas powered cars because there is nowhere for people to refuel them. Exxon (NYSE: XOM) is not going to spend a lot of money creating outfitting their Gas stations to become Natural Gas stations if there are not a lot of cars that will buy that Natural Gas. 

The government could help solve this problem. I don't know exactly what it would cost to install the equipment to rapidly refuel cars with natural gas. However, if we assume that it costs $500,000 per station, then for each $1 billion spent, 2000 stations could be equipped. If the government paid half, and the gas station owner/big oil companies paid the other half, then this could be stretched to 4000 stations. On a nationwide basis that would not be enough, but 40,000 gas stations probably would be.

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