The stock market has been racing ahead even as progress in the real economy has been much more muted.  The market, after all, runs on emotion in the short run and tends to look about six months ahead.  I’m as glad as anyone to see it go up but have the feeling that this is really just a rebalancing after having overshot to the downside.  In these financially perilous times it is prudent to rein in one’s “irrational exuberance”.

Meanwhile, back in the real economy, green shoots are heavily mixed with weeds. The consumer, who represents 70% of the U.S. economy, is broke.  Housing prices continue to decline, although at  a more gradual pace. People can no longer use their homes as ATM machines. Their 401Ks are down thirty to forty percent.  They have little or no savings and credit card limits are being cut.  At the same time, people are worried about their jobs.  The unemployment rate fell in July, dropping 0.1 percentage points to 9.4 percent. That still leaves us with U6 (a better picture of unemployment and underemployment) of 16.3 percent.  That means that one in nine Americans is unemployed, underemployed or for the time being has just given up looking for a job.  Another underpublicized number is that about a quarter of the improvement in job losses in July was due to government hiring.  In the private sector, companies are simply cutting heads more slowly.  Although the worst appears to be over that doesn’t mean that anything is getting better quickly.

With the consumer being so weak it should be no surprise that retail sales have continued to slide.  What about cash for clunkers you ask?  First of all, at best this is a one time boost.  It also represents a little sleight of hand for the government’s consumer spending numbers.  For example, I traded in a twenty year old Jeep that we only used off road and in the snow.  It could barely reach 50 mph and the floorboards were beginning to “Flintstone”.  I couldn’t have gotten a hundred dollars for that car.  I traded it in for a Subaru Outback.  Obama paid the $4,500 down payment and I got 0.0 percent financing over five years. Strangely the entire $24,000 cost of the car will be counted in the government’s August consumer spending numbers.  Wow.  I guess we should look for an artificial bump in consumer spending for August and September.

We should also consider a number of other problems which will loom large in the not too distant future.  One in eight U.S. households with mortgages is either in foreclosure or in arrears.  And there are even more mortgage resets coming in the next fifteen months than have happened to date.  Add to that mounting credit card losses and the coming commercial real estate debacle and it’s easy to see that we still have a long bumpy road ahead of us.

Despite all that, I am not a gloomster.  I would characterize myself as cautiously optimistic but a believer that things are going to take another year before they really get better.  Of course, I have no way of knowing that for sure.  Nobody does.  I can’t tell the future and neither can any of the talking heads you see on television.  What we do know is that someday somewhere in the future things will be better even if we don’t know when that will be.  What businesses and households can do is to look at the possible scenarios and budget in such a way that it is most likely that they will survive until better times are realized.

The different types of recovery that we are likely to see are: L, W, U or soup bowl, square root or V.  The L shaped scenario has only been seen once in U.S. history.  It is an extreme and if it happens again we won’t be worried about our budgets, we’ll be foraging for canned goods and bullets.  The government led by Ben “I’ll throw money from helicopters” Bernanke have promised to do everything in their power to avoid that grim future.  If it happens, there is little we can do about it outside of stockpiling krugerrands and Campbell’s soup.  So, let’s not even worry about that.

The W, U and square root models of recovery are the most likely scenarios while a V shaped one is unlikely for all of the reasons stated above.  Let’s start with the U shaped recovery (which I think is most likely, although that means very little).  In a U shaped recovery, after the roller coaster ride to the bottom that we saw in October 2008 and again in March of this year, there is a longer than usual period of no or slow growth before the economy begins to pick up again.  In this type of scenario businesses and households should budget very cautiously although not to the point of complete austerity.

With a W shaped recovery we would see a sharp upswing only to come crashing down again later before a real sustained recovery begins.  It’s important not to fall for a head fake like we could be currently seeing in the stock market but are yet to see in the actual economic data.  By budgeting for a U shaped recovery we are covering ourselves in case it really turns out to be a W and in fact can use the brief spike in the W to replenish cash reserves.

With a “square root” recovery, we again take that roller coaster ride to the bottom followed by more gradual growth rate.  Growth won’t be as rapid as a V shaped recovery but will begin far sooner than our U shaped model.  If we again budget for the U scenario, the downside is we maybe should have ramped up business investment a little sooner but on the upside we will have been sleeping at night.

What our back of the napkin game theory tells us is that although we really don’t know what the future looks like we can make intelligent budgeting choices which are likely to see us through until the economy improves.  Therefore, businesses, households and certainly Toyjobs should budget for a U shaped recovery and if things turn out to be better than that – great.

Whew.  Enough of that!  Obviously it’s been sitting and stewing in my head for quite a while and I feel much better now that it’s OUT!  Anecdotally, over just the last three or four weeks toy company hiring is beginning to get a little stronger.  The key words here are: “beginning” and “a little”.  Hiring is far from robust but it’s a lot better than the total job drought of the previous nine months.  As discussed above, businesses are “feeling” a little bit better about the future even if the actual economic numbers reveal only that things are no longer getting worse.  The seasonal nature of the toy industry impacts hiring as well.  Retailers confirm their orders later and later even as manufacturing and shipping cycles grow longer and longer.  More toy companies find that they don’t know how their year is going to turn out until July or August. That usually causes an increase in toy industry hiring from late August until the end of the year.  This time around, the usual August bump coincides with people generally feeling better about the economy at large so that this year I expect the usual trend to apply albeit on a more muted basis.  Unfortunately for job seekers in the toy industry, next year the usual seasonal hiring pattern will also apply.  I see toy industry hiring through the end of the year being better but not as strong as usual.

Toy companies will hit their reset button in January.  There will be continued uncertainty in the economy.  Retailers will continue to hold off on order confirmations until just after the last possible second.  My best guess is that we will see another year of weak (although not as bad as this year) toy industry hiring until we hit that early August time frame.  Then, as usual, it will improve.  How much will it improve?  It will depend on the real economy and real economy factors like:  unemployment, GDP growth, retail sales, etc.  I wish I could chart a clearer course but I’m smart enough to know that I’m not smart enough to tell the future.  That light at the end of the tunnel just might be an oncoming train.

Muddling thru,

Tom Keoughan

P.S.  Disney’s takeover of Marvel looks like a great strategic deal for Disney as it can drive Marvel’s product portfolio across all of its business platforms.  It will also have the opportunity to build Marvel’s myriad underdeveloped brands. Marvel’s shareholders make out well in receiving both cash and shares in a less volatile growth vehicle.  Although Disney paid full price (a 29% premium), in the longer term Disney shareholders should benefit by obtaining a strong strategic match that is large enough to move the earnings needle.  That said, there are some current licensing entanglements with rival studios that Disney may prefer not to have.  They will have to either wait them out or buy them out.  It appears that, aside from the usual backoffice consolidation, most Marvel employees will remain although that can always change over time.  Oh, in case you were worried about him, fear not, Ike Perlmutter makes out quite well as usual.  In addition to reaping a handy $600 million he will become Disney’s second largest shareholder, just behind the equally cuddly Steve Jobs.

P.P.S. (Driving the admins crazy!) Our final China Report Article – “The Yin and Yang of U.S. – China Relations” is pretty much a must read.

Have a great holiday weekend!!

Clichés spring like “green shoots” from the mouths of journalists, TV talking heads and mush mouthed politicos.  The media seems to have abandoned its age old “bad news sells” model with the sudden realization that too much bad news may put them out of business.  They have joined with beltway types to try to talk up consumer confidence in the hopes that a return to shopping will jump start the economy in a way that the current stimulus package will not until 2011.

In many ways it seems to be working.  The rate of new layoffs is slowing even though I would like to see a couple of more months of data before declaring it a trend.  The headline unemployment number is 9.4% and that is very scary but perhaps not as scary as it seems because it is a cumulative number which includes everyone who was laid off prior to the most recent month.  On the other hand, the official unemployment number is not what we should be looking at in the first place.

A broader statistic which gives us a much more realistic view of the unemployment picture is U6.  U6 includes people who have been looking for a job for so long that they have either given up in disgust or decided to just sit back and wait for things to get better before they even try.  They are not actively looking for a job but they would take one if it was offered to them.  The “regular vanilla” unemployment figure does not include these people.  U6 does.  It also includes people looking for full time jobs who have only been able to find part time jobs but really want full time jobs.  The “regular vanilla” unemployment figure does not include these people.  Huh.  U6 does.  U6 for May was 16.4%.  Whoa!  16.4% is a HUGE number!  More than one in six Americans is either unemployed or underemployed (do you want fries with that?).  It suddenly becomes very clear why the government talks about the “regular vanilla” unemployment figure and why you have never heard of U6.

So, things have indeed gotten very bad although for the time being they have ceased getting worse.  It has to be considered very good news that the global financial system is no longer teetering on the brink of total collapse.  That said, we still have a severe recession to work through.  To paraphrase Warren Buffett (I’d quote him but I can’t write that fast) “The financial climate is much improved from the October through March period which sets up the stage for the economy to grow stronger.  That hasn’t happened yet but we’ve reached the point where it can.”  Many are predicting a soupbowl shaped recovery.  The economy came down hard and will drag along the bottom for quite a while before it starts back up the other side.  That sounds just about right although I have no way of knowing.  In fact, I’m still a little leery of other shoes yet to drop (commercial real estate, credit card debt, and we still haven’t exactly gotten rid of all that toxic waste yet, have we?).  If I seem to be prevaricating and slowly feeling my way along like a blind man in the dark, well, I am.

This leads everybody from consumers to manufacturers to retailers to remain extremely cautious.  For their part, retailers are taking longer than ever to finalize orders.  Of course, they don’t see themselves as being late.  They just want to push as much risk as possible onto their vendors (ahem, “partners”).  With so many Chinese factories having closed, so many laid off Chinese workers, and the lengthened quality regimen, we are fast approaching the point when manufacturers will be physically unable to deliver goods by the time that retailers want them.  Later commitments don’t mix well with longer cycle times.  The prevailing retailer attitude seems to be “We don’t care – get it here or somebody else will fill our shelves.”  But who?  And with what?  Why, the big boys, of course.  Mattel, Hasbro and Lego (do we still consider Leapfrog a big boy?) can afford to tool up and manufacture earlier because they get to amortize costs over a gazillion units sold.  They also get earlier commitments from retail than the rest of the toy industry.  This means that the shelves will be filled with less variety this year.

Another onerous note is that Wal-Mart is reducing its toy space by more than half.  The toy department itself has never been all that profitable for Wal-Mart.  Instead it has been used as a loss leader to drive foot traffic during the last four months of the year.  Over the last five or six years, Wal-Mart has committed heavily to the grocery business.  Grocery is also a low margin business but one where Wal-Mart has an advantage because it is not unionized . . . . . yet.  The move into grocery has worked out brilliantly as a traffic builder.  The average Wal-Mart customer now visits their stores once a week rather than once a month.  The toy aisle is no longer needed to drive traffic.  Of course, they’ll keep their hand in and stock the obvious big company items backed by big advertising dollars but they’re not going to think too hard about the toy industry anymore – no more guessing on what will be a hot seller.  They’re just going to focus on moving merchandise – like big jars of pickles.  This will obviously benefit big toy companies who are able to make big TV advertising commitments.  Toys ‘R’ Us also stands to benefit – if they are able to execute.  It’s as if Wal-Mart is taking its foot off of TRU’s throat after nearly destroying them.  It’s certainly not an act of good will, it’s just that toys aren’t that important to Wal-Mart anymore.

As for toy company hiring, we are still going through a dark period where there have been many layoffs and very little hiring.  As I have said in this space before, most companies tell me that operationally they need people but their banks won’t let them hire anyone.  Most companies operate on lines of credit, letters of credit and bank loans.  This year many banks have said something on the order of “we’ll give you seventy percent of your usual line of credit but you’ve got to cut costs by twenty percent”.  Due to the seasonal nature of the toy business this has pushed many companies to the brink of solvency.  Many companies are meeting with their banks every two weeks to be told which bills they are allowed to pay.  It’s almost as if the banks think we don’t know who caused the financial crisis in the first place.  It would be nice to see them get their own houses in order before making judgments about others.

Toyjobs has noticed that the hiring climate has grown tricklingly better during May and early June.  I would anticipate that by the end of the second quarter retailers will have mostly finalized their orders and toy companies will be able to approach the banks with a better story to tell.  This leads me to believe that by late August/September toy industry hiring will have improved noticeably although it will still be a long way from good (it’s easy to improve noticeably from zero).   2010 should be better as we move along the gradually inclining slope of the soupbowl curve.  Unfortunately, retailers will continue to push off purchasing commitments as long as possible.  Toy companies won’t be able to breathe easier until July/August meaning that it likely won’t be until late August/September that there is a true resurgence in hiring.

Muddling thru,

Tom Keoughan

The Superior Court of New Jersey has awarded Toyjobs a default judgement against A-HA Toys.  The court is expected to rule on Toyjobs’ suit against A-HA president, Ivars Sondors, shortly.

Toyjobs’ president Tom Keoughan said “Whenever I hear about a company not paying its vendors, I become very reluctant to do business with that company.   I always wonder how companies that don’t pay their vendors will be able to deliver goods to their customers.