China shrinkage

China shrinkage... Distressed mining behemoths... Credit-card defaults rise... Negative T-bill yields... Campbell Soup vs. the Treasury... Hair of a big damn dog...

CEMEX, the Monterrey, Mexico-based cement maker, tried to swap $418 million of short-term commercial paper for longer-term bonds and managed to exchange only $71 million worth. The iceberg under this tip is $6.5 billion of debt due by the end of 2009. Emerging-market companies need to roll over $300 billion in debt next year.

Economists estimate China's economy is growing around 8%, but those numbers might be overstated. Chinese exports dipped 2.2% in November, marking the first fall in seven years. Imports dropped 17.9%. The exports number was expected – as world demand falls, China's exports will fall. But such a huge drop in imports is jarring. It shows China's domestic demand is also shrinking. It might be time to side with Jim Chanos and start shorting mining and infrastructure stocks.

Mining companies, whose shares skyrocketed over the past few years on booming Chinese demand, have gotten smashed by the recession. BHP Billiton, the world's largest miner, has dropped 56% this year. Rio Tinto, the world's third-largest miner (and former takeover target of BHP) plunged 84%. Yesterday, Rio Tinto announced it will cut 14,000 jobs, reduce capital spending by more than half, and sell "significant assets" as demand for metal shrinks. If these companies can't make a profit selling their metals, it makes more sense to slow production and close mines.

Matt Badiali commented on similar actions from the world's largest publicly traded copper company last week.

Procter & Gamble, the world's largest consumer-products company, said sales in the current quarter will fall short of the 4%-6% growth it previously predicted. I'd expect with the world coming to an end, P&G would do worse than merely not growing as fast.

In the November issue of Extreme Value, I wrote about the coming tsunami of charged-off credit-card debts and named a likely beneficiary. Today, the Wall Street Journal says 20% of delinquent card balances are being charged off, about one-third more than last year.

The December issue of Extreme Value (due out tomorrow) features a company born in the depths of the 1970s Great Inflation that has logged positive sales growth in every one of the last four recession years. The company has earned $6.5 billion since 1997... and paid shareholders $6.4 billion. Click here to get access to tomorrow's report.

Signs of a bottom... Investors are so skittish they actually paid the government for the privilege of owning U.S. Treasury bills. The yield on three-month Treasuries briefly traded at negative 0.01% on Tuesday – the first time that has happened since 1940. The huge demand helped the government auction $30 billion worth of short-term securities yielding zero percent. It could have sold four times as much. And this comes on the back of an auction on Monday for $27 billion of three-month Treasuries yielding 0.005%. The silver lining to all of this... This free money means we may see 4.5% mortgage rates.

Of course, as the government continues issuing more and more debt, the odds of a default grow (theoretically speaking). Traders have pushed up the cost to hedge against losses on Treasuries, which recently surpassed the cost of default protection on bonds from Campbell Soup and Baxter International. With some economists predicting the government will spend $4 trillion on this bailout, thereby debasing the currency and causing rampant inflation, this fact isn't that surprising.

As Scott MacDonald, head of research at Aladdin Capital Management points out, "It's a certain absurdity, but it's also a question of supply and demand. We have another massive stimulus package coming. Does Campbell's Soup have a stimulus package coming? No." That Campbell Soup doesn't need a bailout seems to have gone entirely unnoticed. Campbell's has lost some market share the past few years, and still dominates the industry it created, controlling 69% of the soup market.

But if the government does default on its debt, don't worry. It looks like the Federal Reserve will be issuing its own debt soon. The Fed already has the power to print as much money as it wants, but it cannot yet issue its own debt. The Fed has already approached Congress with the idea.

Again and again, we see the problem offered as the solution. Government-sponsored entities (GSEs) – in other words, Freddie and Fannie – took on too much debt... so the Fed wants to become a new GSE, issuing still more debt. If this is supposed to be a hair of the dog that bit us, it's one big damn dog.

Mohamed El-Erian, co-CEO of bond manager PIMCO, yesterday said the U.S. economy "unambiguously" faces the chance of zero growth in 2009, even if interest rates continue falling. "It puzzles me that people feel confident to declare the bottom," he said. "What we're looking at is a very bumpy journey that will continue well into 2009. We're looking at multiple bottoms."

El-Erian said PIMCO is buying high-quality debt, like "triple-A" bonds issued by banks and backed by the Federal Deposit Insurance Corp. (FDIC), and mortgage and agency securities. He believes it's too early to buy U.S. equities or high-yield debt. He also said Treasury inflation-protected securities, or TIPS, look attractive.

New highs: none.

Are you buying stocks hand over fist? Or are you too terrified? Or perhaps pursuing some other strategy? Let us know: feedback@stansberryresearch.com.

"Regarding: 'loans modified to make payments more affordable in the first half of the year are already in default again.' For subscribers who are fiscally responsible and got a fixed rate loan because they could do basic math, are still employed, and haven't fallen behind in their mortgages, is there anyway to get a sip from this gravy boat of mortgage restructuring? Could you tell us what kind of restructuring is happening, so that we could know whether to sit tight and be happy with our 5.75% fixed mortgage or default in hopes of cutting a better deal (putting the payments into some of your newsletters excellent recommendations)? I, of course, propose the later facetiously, but seriously would like to get a peek under the kimono of restructuring." – Paid-up subscriber John Ware

Ferris comment: I don't know. I saw the general comments about modified loans defaulting and noted Sheila Bair's lame response. The ultimate modification awaiting many loans is the writedown to zero.

"Well, I decided I was happy with 122% profit so I bought back my SLW calls! Thanks!" Paid-up subscriber Sharen Kirkham

Ferris comment: 122% is great... especially in one week. Hopefully you made the Goldcorp trade, too. Readers who sold puts on Goldcorp in October made at least 71%. Following Jeff's Short Report trades is one of the best ways to make quick gains in these difficult times. If you'd like more information on the service, click here...

"I was so saddened by the news that [Steve Sjuggerud's] had died from his bicycle accident. I enjoyed reading your interesting tribute to your father and his background. I grew up in Appleton WI and we summered in Menominee at a cottage that my parents rented every summer. Everyone always looked forward to our summer 2 week vacation there. Lot's of fond memories. I will be sending a check for your Memorial Fund. Hoping you and your family have a Merry Christmas, although it certainly will not be the same without your Dad there, and a Joyous New Year." – Paid-up subscriber Sharon Clapham

Regards,

Dan Ferris

Medford, Oregon

December 11, 2008

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