Marcial: IBM, a Solid Play In Troubled Times

While the stock market may have taken some comfort in the passage by the U.S. House of Representatives of the government's financial rescue plan on Oct. 3, investors remain nervous. They have been looking to recalibrate their portfolios with higher-quality investments as markets continue to be besieged not only by concerns about the spiraling financial crisis but by a looming global recession as well. In the search for solid stocks, stalwarts like IBM (IBM) stand out in troubled times.

IBM itself got pummeled in recent days, in part because of concern the crisis might hurt sales and earnings. IBM tumbled on Oct. 2 to 104 a share from 110 the previous day. On Oct. 3 the stock rebounded early in the day but closed at 103.44. Any negative consequences from events won't be immediate, although some analysts argue that the consolidation in the financial services industry may even benefit Big Blue.

Merger activity has certainly been heated, amid deals like Bank of America's (BAC) rushed acquisition of Merrill Lynch (MER) and the Citigroup (C)-Wells Fargo (WFC) contest for Wachovia (WB). "Even though many of the mergers may be shotgun marriages, these would still require integration of systems," says Amitabh Goel, tech analyst at investment firm First Global Markets. That would bring in more business for IBM. "We are closely monitoring the impact of the financial turmoil on IBM's business," says Goel, and the firm maintains a "moderate outperform" rating on IBM, he says. Some 30% of IBM's revenues comes from the financial services industry. "A major portion of this revenue is recurring in nature," notes Goel.

"defensive characteristics"

Some IBM bulls argue that any drop in the stock's price makes it an even more attractive buy. And analysts continue to favor it. As of Oct. 2, 16 of the 24 analysts who follow IBM still rate it as a buy and just one recommends selling, according to data from Bloomberg. Six rate it a hold.

A.M. Sacchonaghi Jr., technology analyst at investment firm Sanford C. Bernstein (it has done banking for IBM), is bullish on IBM partly because of its high level of recurring revenues and profitability, broad geographic dispersion, and below-market valuation. He rates the stock overweight, with a price target of 134 a share. "Our preference for stocks with more defensive characteristics is supported by the observation that IBM has historically outperformed both the tech universe (by an average of 30%) and the broader market (by 5%)," he says. The stock has outperformed the S&P 500 index year-to-date, but it continues to trade below the market's price-earnings multiple, notes the analyst, "thus mitigating the risk" of a reduction in IBM's p-e multiple.

Chevrolet Pins Europe Hopes on Cruze

Chevrolets are rarely seen on the streets of Paris. But General Motors (GM) has chosen the Paris Motor Show, which opens to the public on Oct. 4, to launch one of the most important new Chevy models in years.

The Cruze, a compact sedan set to go on sale in Europe next March and in the U.S. in 2010, will be Chevrolet's first global small car. With its sleek, arched roofline and high-tech interior, "it's one of the global Chevrolet products that are the future of where this brand is going to be," says Wayne Brannon, Chevy's European chief.

GM has been trying for several years to establish Chevrolet as its main global brand. Unlike rivals Toyota (TM) and Honda (HMC), GM has a balkanized brand portfolio—with Chevy dominant in the U.S., Opel in Europe, and Buick in China. After taking over South Korea's Daewoo in 2002, GM rebranded some of its models and now sells them under the Chevrolet name in Asia and Europe.

A Crucial Moment

But the Cruze is a brand-new design—and it comes at a critical time. GM needs foreign growth to offset a deep U.S. auto sales slump (BusinessWeek.com, 10/1/08). At the same time, Chevy is counting on the Cruze to fight its way back into the compact car market in the U.S. (BusinessWeek.com, 9/15/08), which has now become vitally important as customers flee gas-guzzling SUVs and trucks. Though the company hasn't yet disclosed fuel-efficiency figures for the Cruze, it has promised they'll be "north of 40 mpg." (BusinessWeek.com, 9/15/08).

European motorists will be a tough audience for the Cruze. Fuel economy of 40-plus miles per gallon (under 5.9 liters/100 km) may impress Americans, but it's ho-hum to Europeans who drive Volkswagen (VOWG.DE), Ford (F), and even Mercedes (DAI) models getting 50 to 60 mpg. Fuel efficiency is crucial in the Old World, with gas costing $8 a gallon and up in most countries.

And while the Cruze's design is a big leap forward from Chevy's existing Cobalt compact, it won't stand out in the crowded field of stylish European models. Another problem: Most Western Europeans prefer hatchbacks, while the Cruze is a 4-door sedan.

"It will do moderately well, but it's unlikely to change Chevrolet's fortunes," says Paul Newton, an auto analyst for consultancy Global Insight in London. He predicts only 12,000 Cruzes will be sold in Western Europe in 2009 and 30,000 in 2010—barely a drop in the region's 14.2 million total annual auto sales.

Eastern Strategy

For now, Chevy is pinning its hopes for the Cruze mainly on the Continent's eastern rim, in countries such as Russia, Poland, Hungary, Romania, and Turkey. Brannon says the Cruze will be positioned as a "good value for money" vehicle, with marketing emphasis on the brand's "iconic" American roots. Chevrolet hasn't announced pricing for the Cruze, though it has said the U.S. version will cost more than the Cobalt, which sells for $15,000 to $17,000.

Chevy has reasons for optimism in Eastern Europe. Its Polish-made Aveo, a Daewoo-developed subcompact, is selling well in the region, and Eastern European drivers are more partial to four-door sedans than their counterparts in the West.

Already, strong sales in Russia and Ukraine helped Chevy rack up an impressive 23% sales growth Europewide during the first half of this year, after a 26% rise in 2007. Still, Chevy's market share in Europe as a whole is barely above 2%. Global Insight reckons Cruze sales in Eastern Europe will be no more than 50,000 in 2010. Western European automakers, including VW with its Skoda brand, already have built strong customer bases in the region, Newton says.

The European version of the Cruze will have a 1.6-liter or 1.8-liter gasoline engine, or a 2-liter diesel engine. It will be manufactured initially in South Korea, although GM plans to open an assembly line in St. Petersburg, Russia. The U.S. version will be built in Lordstown, Ohio.

Will the Cruze be a game-changer? Perhaps not in Europe. But if it can post respectable sales in this fiercely competitive market, it could give a big boost to Chevy's global brand aspirations.

With David Welch in Detroit

The Bailout: What Does Paulson Do Now?

With the House of Representatives' Oct. 3 passage of the Treasury's $700 billion plan to stabilize the financial markets by buying up troubled mortgage-related assets, you could almost hear the sigh of relief spreading throughout Washington and Wall Street. After two weeks of nearly nonstop negotiations in which the bill repeatedly appeared to flounder, it was quickly passed on to President George W. Bush, who signed it into law within hours.

Now comes the hard part: getting the Mother of All Buyout Funds up and running.

Treasury officials have made clear they want to do that as soon as possible, and have told congressional leaders and Wall Street executives that they will conduct the first auction to buy assets within four weeks. The work needed to accomplish that is well under way, by a team of Treasury officials led by Ed Forst, a Goldman Sachs (GS) alumnus who left the firm this summer to become a senior administrator at Harvard University. In late September, Paulson asked him to come to Treasury to work on the bailout program. Forst, who is on a temporary contract, began to outline the plans for implementation even as Congress wrangled over the details. With the deal now done, Treasury hopes to hire five to 10 asset managers to oversee the purchases, each of whom will manage up to $50 billion in assets. It also hopes to hire another couple of dozen bankers, lawyers, and accountants needed to run the program, with much of the hiring expected within the month.

"Treasury is acutely aware that it must build an early record of success in order to maintain market and political confidence," says Howard Glaser, a high-ranking housing official in the Clinton Administration and former chief lobbyist for the Mortgage Bankers Association who now runs the Glaser Group consulting firm. "Paulson did not want to lose precious days waiting for Congress to pass the final bill before putting together the implementation plan."

Purchasing Discretion

Already, Paulson's priorities are becoming clear. It will have to decide which assets to go after first, and who to buy them from. Congress has given Treasury wide discretion to decide what assets to target. Although most of the funding is likely to go toward buying up mortgage-backed securities and whole home loans still held on the books of the lenders who originated them, Treasury can also buy up construction loans, home equity loans, or even credit-card debt or car loans if it decides that is necessary.

Treasury also has plenty of room to determine which types of institutions to buy from. Though banks, investment banks, and insurers are high on the list, the purchases could also be extended to hedge funds and others if need be.

Sources closely following the plans say that Paulson is intently focused on making sure Treasury gets the biggest bang for its billions. "It can't do anything too exotic right off the bat," says Tom Gallagher, the head of Washington policy research for institutional broker ISI Group. "It needs to have a quick impact."

So the first order of business will be ensuring that the initial auctions it holds to buy up assets are a big success—indeed, some say Treasury wants to see that they are oversubscribed. Those will be "reverse" auctions, in which sellers compete by submitting prices they would be willing to accept, generally allowing the buyer to select the lowest. So rather than Treasury bidding a certain amount to buy up a bundle of mortgage-backed securities, for example, the agency would tell financial institutions that it wanted to buy up a particular type of mortgage-related debt. Then it would buy those securities from whichever seller offered them for the lowest price.

The Bailout: Public Anger, Private Talks

The Bailout: House Jitters?

On Thursday night, Oct. 2, all eyes were on the Vice-Presidential debate. Friday, however, they will turn again to the House of Representatives, as it holds a do-over of its dramatic Monday vote. Will the House this time deliver the financial-system bailout that the Administration and business groups are demanding, and which the Senate passed Wednesday night?

The odds seem good. But that's a far cry from the near-certainty that preceded the Senate vote. And after Monday's sudden about-face, it hardly inspires confidence.

To be sure, new poll figures suggest public opposition to the financial rescue bill (BusinessWeek.com, 10/2/08) isn't as strong as it seemed Monday. Several dissenting lawmakers have publicly said they'll vote "yes."

Buffett on the Horn

Lobbyists are pulling out all the stops (BusinessWeek.com, 10/2/08). And word is that House leaders won't bring the bill to a vote at all unless they are sure—really, absolutely sure—that it will pass. Democrats were set to caucus at 6:30 p.m. ET Thursday. Meantime, rumors raced that the Oracle of Omaha, Warren Buffett himself, had been calling lawmakers to urge passage. His $5 billion investment in Goldman Sachs (GS) and $3 billion investment in General Electic (GE) could run into big trouble if the package does not go forward. (Buffett's office declined to comment.)

So maybe everyone's just being careful to avoid falling flat on their faces again. And yet, there are a few troubling signs. "I don't think they have the votes yet," Dan Clifton, a Washington analyst for Strategas Research Partners, said Thursday afternoon.

A good part of the uncertainty lies in the very changes that the Senate made to win over the Republicans who balked on Monday. The bill, which started life as a three-page proposal from Treasury Secretary Henry Paulson, has swollen to more than 400 pages (BusinessWeek.com, 10/1/08), fattened up most recently with tax breaks and an increase in federal bank-deposit insurance limits, as well as the mental-health parity bill that is being used as the procedural vehicle to carry the whole shebang from Senate to House.

Fostering Green Energy

A slew of tax breaks added in the Senate—many of them extensions of existing business breaks or intended to foster green-energy initiatives—have boosted support from nonfinancial companies, who now have an incentive to lobby for the bill.

The tax package included many popular provisions aiding not only businesses but upper-income households—it would continue a fix to prevent millions of taxpayers from being subject to the dreaded Alternative Minimum Tax, for example. Yet not all of those provisions are paid for by spending cuts or new revenue—something detested by fiscal conservatives, whose ranks include many Republicans as well as the so-called Blue Dog Democrats.

At the same time, the various concessions to business and the right has many on the left, including unions and consumer groups, hopping mad. "They've Christmas-treed this up for business," one lobbyist said before the Senate vote. Left-leaning groups have been pushing for the House to add various measures to aid families, homeowners, and municipalities in return, such as extending unemployment benefits, reviving a previously discarded provision to allow judges to modify mortgages in bankruptcy, or offering assistance to state and local governments. They hinted that more Democrats might bolt if these measures aren't taken.

Fears of Bogging the Bill Down

House leaders have been scrambling to head off problems—and resisting calls to add anything more to the bill for fear of bogging it down. A senior Democratic staffer says the Blue Dog Democrats are expected to support the measure on the grounds that their fiscal principles favor aiding the broader economy. And he says House leaders are likely to offer an extension of unemployment insurance with a separate bill. That avoids another vote in the Senate to approve any changes to the financial-crisis measure; there's been no deal with Republicans to pass an unemployment measure, the staffer adds.

A handful of public vote-switchers suggests the House leadership was having some success. Representatives Ileana Ros-Lehtinen (R-Fla.), Zach Wamp (R-Tenn.), and Emanuel Cleaver (D-Mo.) are among those reported by the Associated Press to be for the bill after previously being against it. They cited the tax-break additions and changes in public sentiment for their changes of heart.

"I hate to say it, but the Dow being down 300 points (BusinessWeek.com, 10/2/08) helps the vote count," says one well-connected Republican lobbyist from the manufacturing sector.

The Bailout: Public Anger, Private Talks

Why You Shouldn't Bail on Stocks Now

To many panicky investors, it feels like financial Armageddon. But decades worth of investing precedent suggest otherwise. And investors who bail on stocks now might come to regret it.

Make no mistake: The freeze in the credit markets is frightening. "People don't have any experience with this kind of thing happening," says Martin Barnes, managing editor of Bank Credit Analyst. "People can't look back at previous episodes and take comfort and say, 'I've been here before.'" And so, almost by default, we are given to extreme bearishness—invoking the Great Depression and Japan's lost decade is all the rage. "Sure, these things are possible," says Barnes. "But not likely."

Sept. 29's 778-point drop on the Dow doesn't even rank among the top 10 in percentage terms—it was 7%, compared with 22.6% in 1987. Yet the very system that rewarded risk taking for years is now holed up in the closet under a security blanket. Hedge fund traders, banks, individual investors, small businesses—you name it—have been piling into ultrasafe short-term Treasuries, which now yield close to 0%.

We've felt the sky was falling before. Recall that one-day panic on Oct. 19, 1987, or the savings and loan crisis of the early 1990s, or the Asian meltdown in 1997, when Koreans lined up on the streets of Seoul to donate jewelry to shore up their currency. The markets took big hits in all of those cases, but ultimately bounced back. By the beginning of 1989, for example, the Dow had returned to its pre-crash levels.

The smart money knows that banking crises are par for the course. According to the International Monetary Fund, the past quarter century has seen at least 124 banking crises around the world. "It is important to recognize that this isn't the first time the U.S. financial system has experienced—and survived—a financial crisis," says Eric Bjorgen of Minneapolis-based Leuthold Group, an investment research firm.

BARGAIN INTERNATIONAL STOCKS

The time to panic, if there ever was one, was a year ago, when stocks were hitting their highs—not now, when they are hitting their lows. Today's extreme bunker mentality has the stock market looking cheaper relative to Treasury bonds than it has since 1978.

That's precisely the environment in which savvy, patient investors make their fortunes. Case in point: legendary cheapskate Marty Whitman of Third Avenue Funds, an octogenarian who lives for volatile times like these. "Right now is a time when deep value investors excel," he says. "People like myself got rich in '74 and '87, unlike those who tried to pick bottoms." The common stocks of companies that need access to capital markets are "toast," he says. "The common stocks of companies that can finance themselves have never been more attractive."

Whitman says that many international shares in particular have never looked so cheap: "There are unbelievable bargains. It's terrific for us." Stocks he thinks are especially cheap include Hong Kong-based real estate investment holding companies, including Cheung Kong Holdings, Hang Lung Group, Henderson Land Development, and Wharf Holdings.

Even Rob Arnott, chairman of investment advisory firm Research Affiliates and a bear long before it became fashionable, says the current panic "is creating some really spectacular opportunities for those who are nimble and weren't overly aggressive." The reaction in financial-services stocks is overdone, he says. "We have an anti-bubble—when a sector of the market falls to levels that no plausible scenario would justify." Arnott also sees "great bargains" in convertible bonds and says the debt of "many emerging markets is more creditworthy than U.S. Treasuries". The broad U.S. stock market, however, has a chance of falling further as consumers begin tightening purse strings, he says. Arnott thinks investors should lower their long-term expectations of stock returns to about 6%.

Of course, bargain-hunting always sounds great in theory. But people have shown time and again a predilection to sell low—just as they tend to buy high. Princeton economics professor Burton Malkiel, author of the best-seller A Random Walk Down Wall Street, notes how much hot money piled into equity funds in early 2000, just as the market was about to peak. Then, as stocks were nearing the bottom in the third quarter of 2002, that money fled in droves. The timing couldn't have been worse. "One of the things we know about individual decisions in markets is that people generally do the wrong thing," he says. "I know money is coming out now. I don't know whether this is the bottom. But taking money out now, when things look horrible, is almost always the wrong thing to do."

Business Exchange: Read, save, and add content on BW's new Web 2.0 topic networkResearch from Ibbotson Associates shows that returns from both growth investing and the Standard & Poor's 500-stock index are trumped by long-term gains from value investing, especially in recessions, according to a Sept. 30 article on the Motley Fool Web site. In the seven periods of recession since 1970, value stocks returned an average of 3.1%, vs. a loss of 0.8% for growth stocks. To read the Motley Fool story go to http://bx.businessweek.com/value-investing

Marcial: Regional Banks’ Road to Recovery

Nokia Aims to Be No. 1 on the Mobile Web

ESPOO, FINLAND If being first mover meant anything, Anssi Vanjoki and his colleagues at Nokia (NOK) would already rule the mobile Web. Way back in 1996, the Finnish company launched a prototype phone with a "dangerometer," which used software and satellite technology to match your location to an online database of crime statistics. If you strayed into a dodgy neighborhood, the meter would turn from green to red, and an icon popped up inviting you to buy life insurance online.

Vanjoki, a Nokia executive vice-president, chuckles as he recalls the farfetched idea. Yet he and his team at Nokia headquarters, on a quiet cove outside Helsinki, are convinced the day they've long hoped for has finally arrived. After a decade of false starts and half-kept promises, the Net is breaking free of its desktop chains and going mobile. "The next generation of the Web is going to be all about the small multimedia computer and not the PC," says Vanjoki.

There's increasing evidence that he's right. The number of people who use their phones to cruise the Web is surging worldwide, with the figure in the U.S. rising 36% over the past year, to 40 million, according to researcher Nielsen. Phones are getting better at handling data, their Web-surfing software is easier to use, and rates for mobile surfing are plummeting. In addition, wireless operators have loosened their grip on what customers can do with mobile phones, making it easier for people to install their own software and buy services from third parties. "The mobile Web is set to take off because the barriers are coming down," says Tim Berners-Lee, inventor of the Web and director of the standards-setting World Wide Web Consortium.

TAILORED FOR EVERY MARKET

Vanjoki may have had an early vision of this emerging future, but lately Apple (AAPL) has led the way in realizing it. The company's iPhone, with its iconic touchscreen design and near-magical software, has turned millions of U.S. users on to the mobile Net. Just a year after debuting its first phone, Apple has snatched the spotlight from Nokia and rivals like Research In Motion (RIM).

Now, Nokia is striking back. The company is launching its first mass-market touchscreen phone this month. The 5800 will have a shape and screen similar to the iPhone, but its price will be about a third less than the Apple device. In addition, the Nokia phone will come with a year-long music service subscription that will let customers download and keep all the music they want from the four major record labels. Nokia plans a steady stream of touchscreen phones in the coming months, an effort aimed at overwhelming Apple and others with devices for different customer segments and price ranges in local markets around the world. "We're able to do this faster than anyone else," says Vanjoki. "We have a localizing machine that spans all countries."

That's easy to forget with all the euphoria surrounding the iPhone. Nokia is still far and away the biggest and most influential player in this industry. The iPhone may win the hearts and fill the pockets of jet-setters and gadget hounds, but they're a relatively small group. Nokia will sell nearly half a billion handsets this year—50 times the number of iPhones Apple hopes to sell. The Finnish company already is well entrenched in the chaotic streets of Lagos, the rice paddies along the Ganges, and in factories and schools from So Paulo to Shanghai. Its phones are ubiquitous in areas where people have never heard of Apple.

So for much of humanity, it will be Nokia, far more than its American rivals, that will define the mobile Net. "We touch so many consumers," says Vanjoki. "They expect Nokia to offer them new things."

Nokia’s Touch Screen 5800 Nods to iPhone

The iPhone Kill-Switch Kerfuffle

Stocks: Still Too Expensive?

Falling stocks have one upside for investors: The further stock prices plunge—and U.S. stock indexes are down more than 10% in the past month"the more bargains there are for long-term investors.

That's the theory anyway, but it's being tested by a highly unstable environment.

To spot cheap gems, value investors try to focus on fundamental measures, such as earnings. Thus, the famous price-to-earnings ratio, or p-e, is a common, and simple, measure of how cheap or expensive a stock is.

If earnings hold steady, falling prices should make stocks more attractive to long-term investors. But that's not necessarily true if earnings fall as fast, or faster, than prices do. Many investors worry that such is the case right now, as the financial crisis and recession worries intensify.

Record Profits Next Year?

According to Standard & Poor's, which compiles analysts' earnings estimates, analysts expect earnings for the large-cap benchmark S&P 500 index to be flat in the third quarter but rise quickly in the fourth quarter and keep rising into next year. Analysts are even predicting earnings will hit an all-time high in the second quarter of 2009.

"Earnings expectations are still too high," says Michael Yoshikami, president and chief investment strategist at YCMNET Advisors. Analysts seem too optimistic about the U.S. economy, he says.

Another problem for value-seeking investors is that data on p-e ratios can be subjective and contradictory—and seem even more so than usual in the past year. Do you focus on earnings of the past year, which have been disappointing (and thus make stocks look more expensive)? Or, looking ahead, do you focus on the better earnings expected to come down the pike?

Historically Alluring

For the S&P 500, the current p-e for the last four quarters is about 16.7, S&P says. But based on analysts' hopes for the next four quarters, the forward p-e is a much more attractive 11.2.

By historic standards, both numbers are fairly attractive p-e ratios. The average trailing p-e ratio in the past 10 years is 21.2, and the average for the past 20 years is 19.3.

But those numbers rely on operating earnings, which excludes unusual items that can hurt corporate bottom lines. Estimates of operating earnings often exclude such major charges as layoffs and investment losses of the sort that have pummeled the financial sector in the past year.

Looking at total earnings instead, the p-e for the past year is now 22.5, while, based on S&P's total earnings estimate for next year, the forward p-e is 19.81. Using this same measure, the historical average p-e for the past 10 years is 25.98 and for the past 20 years is 22.63.

September Quarter Holds a Clue

Brian Gendreau, strategist at ING Investment Management (ING), says there is a strong argument that, after recent declines, stock valuations are at attractive levels. "But that looks attractive only if earnings don't fall out of bed," he says.

The third-quarter earnings season could be a key test. Alcoa (AA), traditionally the first major stock to release its quarterly numbers, is expected to announce results Oct. 7. If earnings for the September quarter hold up well, that could lift the stock market, Gendreau says.

But in response to the market frenzy of the past month, many analysts and investors have become increasingly pessimistic. Bruce Bittles, chief investment strategist at R.W. Baird, believes the earnings season will prompt analysts to start lowering profit expectations. "Expectations have got to come down," he says.

But the Credit Crunch...

Standard & Poor's index analyst Howard Silverblatt agrees, noting that fears of a full-blown recession have returned to Wall Street in recent weeks. The cost of layoffs, as well as rising commodity costs, will likely hurt corporate earnings.

Analysts are already expecting the financial crisis to do plenty of damage. According to S&P, third-quarter earnings for the S&P 500 financial sector are expected to decline 52.4% from a year ago. That's bad, but much better than the huge losses of the previous three quarters, when declines exceeded 100%. In the fourth quarter, analysts are expecting financial earnings to rebound 200% from the huge losses of late 2007.

The rocky condition of the credit markets in the past few weeks, however, raises worries that these estimates are far too optimistic.

...Could Hammer Profits

Credit market troubles may have a broad impact on earnings, warns Brian Reynolds, chief market strategist at WJB Capital Group . The crisis boosts companies' costs of raising capital, which in turn hurts profits. And, Reynolds says, those same troubles also hurt customers, causing sales to fall.

The media firestorm around the economy could also further undermine consumer confidence. "Retailers were already bracing for a difficult holiday," Yoshikami says.

In an environment as unstable and unpredictable as this one, analysts say, p-e ratios and other fundamental measures are only so helpful. Judging whether stocks are cheap or expensive is very much a subjective undertaking, determined mostly by whether you think things are about to get better or get even worse.

S&P, like BusinessWeek, is a unit of the McGraw-Hill Companies.

Is Wal-Mart Stock Peaking?