Chicago, IL – November 18, 2009 – Zacks.com 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: PNC Financial Services (PNC), Bank of America (BAC), Bank of New York Mellon Corp (BK), MasterCard (MA) and JPMorgan Chase (JPM).

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Here are highlights from Tuesday’s Analyst Blog:

BofA Continues CEO Hunt

Recently, William Demchak of the PNC Financial Services (PNC) was offered the position of the next CEO of the Bank of America (BAC). However, the offer was turned down by Demchak.

We suspect Demchak declined the offer as the pay package is likely to be among the least competitive in the industry, especially since the Obama administration's pay czar took the axe to seven institutions' pay plans, chopping the average high-end salary by 50%. Moreover, the bank is also operating under a memorandum of understanding with regulators, who are scrutinizing the top gun's every decision.

The present CEO of the Bank of America, Mr. Ken Lewis, is set to leave the position, stepping down at the end of the year. It may be noted that he succumbed to the pressure to resign after his company’s Merrill Lynch acquisition.

Earlier this month, Robert Kelly of the Bank of New York Mellon Corp (BK) was offered the role of CEO by the bank. Former Bear Stearns CEO Alan Schwartz is among those reportedly approached who turned down the CEO job offer, as did MasterCard (MA) President Ajay Banga. Others may include Moffett and Charlie Scharf, who runs JPMorgan Chase’s (JPM) retail operations, among others.

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Continuous coverage is provided for a universe of 1,150 publicly traded stocks. Our analysts are organized by industry which gives them keen insights to developments that affect company profits and stock performance. Recommendations and target prices are six-month time horizons.

Zacks "Profit from the Pros" e-mail newsletter provides highlights of the latest analysis from Zacks Equity Research. Subscribe to this free newsletter today: http://at.zacks.com/?id=5517

About Zacks

Zacks.com is a property of Zacks Investment Research, Inc., which was formed in 1978 by Leonard Zacks. As a PhD in mathematics Len knew he could find patterns in stock market data that would lead to superior investment results. Amongst his many accomplishments was the formation of his proprietary stock picking system; the Zacks Rank, which continues to outperform the market by nearly a 3 to 1 margin. The best way to unlock the profitable stock recommendations and market insights of Zacks Investment Research is through our free daily email newsletter; Profit from the Pros. In short, it's your steady flow of Profitable ideas GUARANTEED to be worth your time! Register for your free subscription to Profit from the Pros at http://at.zacks.com/?id=5518.

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Sterling's paper is in part a response to earlier analyses by John Taylor (2008, 2009) and John Cochrane and Luigi Zingales who noted that the spread between the LIBOR interest rate (London Interbank Offered Rate) and the OIS (Overnight Index Swap) rose only gradually following the Lehman bankruptcy, leading these scholars to see Lehman as just one of many relevant developments at the time. But Sterling questions the meaningfulness of the LIBOR or OIS indicators during these weeks given that markets seized up and little trading activity was occurring in these instruments. Sterling instead proposes to take a look at Bloomberg Financial Conditions Index, which Bloomberg launched in August 2008. The index is based in part on the observations by Rick Mishkin on some of the regularities observed in earlier historical financial crises. The components of the Bloomberg index are as follows:

Source: Sterling (2009)

Here's Sterling's graph of the behavior of the Bloomberg index, in which the remarkable character of events following September 12 is pretty striking.

Source: Sterling (2009)

Even if the Lehman failure is agreed to as a definitive event, it is not clear to me that this establishes that all would have been fine if the Fed had only bailed out Lehman as they had Bear Stearns and AIG before. That question is inherently and unavoidably counterfactual. We can't know-- and decision-makers at the time couldn't know-- which domino might have been next to fall had this one been propped up.

But I think it is fair to conclude that the middle of September of 2008 marked a clear turning point in the unfortunate sequence of events through which we have recently come.

The chart below shows the Counterparty Risk Index (CRI) history since the beginning of 2008. The index is an unweighted average of the credit default swap spreads of 14 major financial institutions. The left-hand scale gives the cost (in basis points) of insuring against default for a five-year term.

The three big spikes on the chart mark the near-failure of Bear Stearns (in March 2008), the Lehman default (September 2008) and renewed concerns over bank safety at the market’s nadir in March 2009.

If crises appeared at six-monthly intervals since last spring, this time we appear to have broken out of the cycle.

What about the individual banks that make up the index? Here is a chart, courtesy of CMA Datavision, of the CDS spreads of the U.S. bank members of the index, plus Barclays and Deutsche Bank, the leading players in the U.S. exchange-traded note market.

Citigroup now ranks as the riskiest U.S. bank, and JP Morgan as the least risky, though it’s fair to say that the CDS spreads have converged significantly and there is far less difference between individual names than there was a year ago.

For the record, here are the levels from earlier today, ranked from least to most expensive to insure against default: JP Morgan (72bp), Barclays (76bp), Deutsche Bank (82bp), Goldman Sachs (107bp), Bank of America (120bp), Merrill Lynch (137bp), Morgan Stanley (140bp) and Citigroup (200bp).

(The fact that the Merrill Lynch CDS trades at a slight premium to that of Bank of America, its owner, is interesting.  This reflects speculation that the broker may yet be spun off from the parent bank, in which case the CDS would follow the reference entity, Dave Klein of Credit Derivatives Research told me.)

The levels should matter to exchange-traded product investors: All of these banks except Citigroup underwrite exchange-traded notes.

Is the worst now over? As Gillian Tett noted in a column in last week’s Financial Times, the concentration of overall (gross) risk in the credit derivatives market amongst the leading banks has actually risen since the AIG bailout of last September, and regulators are still finding it difficult to assess whether banks are handling their net risk exposures sensibly.

And, in what sounds like the ultimate reinsurance spiral, banks have become net sellers of protection on sovereign debt; hardly reassuring if one remembers that the banks are themselves propped up by the governments concerned. Lloyd’s, anyone?

So, while the reduction in overall default risk so far this year will come as a reassurance to investors, these are charts that are worth keeping an eye on.

Bear Stearns was one of the only prime brokers that had offered custody benefits to clients since 1997. The prime brokerage flourished after it was acquired by JPMorgan. Its Treasury & Securities Services division now manages $13.7 trillion in assets under custody and is the industry leader in prime brokerage and custody businesses.

The new development will further expand its product offering and deliver additional benefits to clients in a more efficient manner. As a result, it will be able to capture extended market share during the ongoing market challenges which have underscored the importance of partnering with a prime brokerage that can safeguard assets in a separate depository.

We think this is the right time to launch the Prime-Custody Solutions Group while the hedge funds are launching long-only funds and seeking structures that allow them to house certain assets with custodians.

Investors voted JPMorgan to receive 75 “Best in Class" awards and nine “Top Ratings" in Global Custodian’s 2009 Prime Brokerage Survey. During the second quarter, the company also repaid the full $25 billion in preferred capital received as part of the Troubled Asset Relief Program (TARP).

JPMorgan reported disappointing second-quarter results, with a 47.2% year-over-year drop in earnings per share. Although results benefited from a record performance by the investment bank and solid performances in other segments, Consumer Lending and Card Services deteriorated due to continued high levels of credit costs.

We expect continued synergies from the company’s diversification and strong capital position, but increasing provisions and worsening credit quality will be a drag on upcoming results.

Today, we're fortunate to have Simon van Norden, Professor of Finance at HEC Montréal (École des Hautes Études Commerciales), as a guest blogger.

"Once you've seen one financial market crisis...you've seen one financial market crisis."

-- Attributed to Federal Reserve Board Governor Kevin Warsh by former US Treasury Assistant Secretary for Economic Policy Phillip Swagel in The Financial Crisis: an Inside View, March 2009, p. 4.

The financial crisis has set a lot of records so far; it's certainly the worst US banking crisis of my lifetime. Some, as suggested by the above quote, see such crises as unique events; each one is singular and there's not much to be learned about how to handle one from looking at past crises. For example, there's no precedent that I know of for a banking crisis involves the failure of the biggest counterparties for credit default swaps.

I think a much smaller number of people see the crisis differently; they think of it as another potato, a big one. No two potatoes are exactly alike in size and shape, but they all taste pretty much the same and you can use the same recipe for most of them. For that reason, it's interesting to see to what extent the current crisis behaves like other crises, even if it has some unique features.

I think there's some interesting parallels between the current crisis, the Savings and Loan (S&L) crisis of the 80s and 90s, and the Long-Term Capital Management (LTCM) Crisis of 1998. But before I talk about that, let me talk about what a "typical" banking crisis looks like.

The Basel View of "Typical" Banking Crises

If we set the way-back machine to 2004, a time long before terms like ARM, CDS, and AIG entered common conversation, we can see what people thought a typical bank crisis looked like. That's the year the guys in Basel who worry about such things published "Bank Failures in Mature Economies." They looked at the main banking crises in developed countries from 1980 to 2000 and asked themselves what they saw. To be sure, they saw some differences, but they also saw some patterns. Here's part of their main conclusions (note that "credit risk" is Banker for "bad loans").

Most of the widespread [banking] failures required some amount of public support, sometimes in very large amounts. All of the episodes that involved large amounts of public support were caused by credit risk problems. ...The widespread banking crises that involved credit risk were remarkably similar. A period of financial deregulation resulted in rapid growth in lending, particularly in real estate related lending. Rapidly rising real estate prices encouraged more lending, abetted by lax regulatory systems in many cases. When economic recessions occurred, inflated real estate prices collapsed, leading directly to the failures. (BIS, 2004, p.66)

That sounds a lot like what the US (and some other countries) experienced immediately afterwards. There had been some financial deregulation, which was followed by a period of very rapid growth in real-estate-related lending. Rapidly rising real estate values encouraged more lending. The biggest difference seems to be the last point; the recession did not cause real estate prices to collapse; they had peaked by 2006 and fell before the recession started. We could probably also argue about whether it was financial deregulation or "financial innovation that avoided regulations" that helped fuel the increase in real-estate lending. However, in this view the boom and bust cycle in real estate, the subsequent fallout for the banking sector, and the need for a major publicly-funded bailout is not remarkable; we've seen this kind of story before. In fact, Reinhart and Rogoff have gone so far as to tabulate what happens to government debt in the aftermath of a banking crisis. They find that real government debt increases by an average of 86% in the three years after the start of a crisis. So regardless of how you feel about the US government's spending during the crisis, it seems less remarkable when compared to what typically happens in a banking crisis.

Three American Financial Market Crises

More support for the view that banking crises follow similar patterns can be found by comparing the last three US banking crises; the S&L crisis of the late 80s and early 90s, the collapse of LTCM and the most recent crisis. The S&L crisis closely followed the pattern described by the BIS report quoted above; financial deregulation, followed by a rapid growth in real estate lending, creation of local speculative bubbles in real estate prices, and the failure of institutions as bubbles burst (For descriptions of the S&L crisis, see BIS (2004) or the GAO 1996 report). The General Accounting Office put the cost of the S&L bailout to US taxpayers at $132.1 billion, or a bit under 2% of GDP (United States General Accounting Office (1996) "Financial Audit: Resolution Trust Corporation's 1994 and 1995 Financial Statements," Table 3 and author's calculations). That may seem small compared to the size of TARP or this year's projected federal deficit, but it was shocking at the time.

At first glance, the LTCM crisis appears quite different; no bank failed (LTCM was a hedge fund), its failure was unrelated to real estate investment or credit risk, and the crisis was resolved at no cost to the taxpayer. However, the LTCM crisis showed that, as a result of deregulation, a systemic crisis could start outside the regulated banking system. Another GAO study noted:

The LTCM case illustrated that market discipline can break down and showed that potential systemic risk can be posed not only by a cascade of major firm failures, but also by leveraged trading positions. LTCM was able to establish leveraged trading positions of a size that posed potential systemic risk primarily because the banks and securities and futures firms that were its creditors and counterparties failed to enforce their own risk management standards. (US GAO (1999) p. 29)

The same report noted:

• Gaps in [US Government agencies'] regulatory authority limits their ability to identify and mitigate systemic risk (US GAO (1999) p. 24)
• Regulators did not identify weaknesses in firms' risk management practices until after the crisis (US GAO (1999) p. 16)
• Monitoring did not reveal the potential systemic threat posed by LTCM (US GAO (1999) p. 17)

and provided a variety of proposals (some of which are mentioned below) to reform the financial system by reducing systemic risks.

The success of those reforms can be judged by role of similar factors in the most recent US banking crisis. An important factor in the latter has been the role of trading in derivative securities, primarily mortgage-based securities and credit default swaps (CDS). Again, government oversight of this market was limited due to faith in the market's ability to manage its exposure to risk, and was further weakened by divided responsibilities between multiple agencies. Regulators and private lenders alike were again unaware of major firms' exposure to losses on derivative securities; this time even the heads of major financial institutions were not aware of the extent of their own exposures. Again, this was in part due to the lack of transparency, lack of clearing and high leverage afforded by trade in Over-the-Counter (OTC) derivatives (particularly those traded at Bear Stearns.) Again, weaknesses in firms' risk management practices became apparent only in hindsight. Again, major financial firms that were not regulated as traditional deposit-taking banks took on highly-leveraged positions and posed major systemic threats to the banking system. These included several investment banks (such as Bear Stearns, Goldman Sachs, Lehman Brothers, and CitiGroup) and the insurance company AIG.

Conclusion

Looking at recent events from this perspective, I still see the size of the losses as breathtaking, but the causes and dynamics seem much more familiar. What bothers me is that some of the suggested solutions sound pretty familiar too; make derivative trading more transparent, improve coordination among the regulators, give regulators more power to control systemic risk in new places, and so on. Despite that, not only was there another crisis, but it was much larger than the two previous crises combined.

This post written by Simon van Norden.

Now, I wish that I could present PDFs of both reports here (i.e. the VP and Iberian Equity report), but I can't due to the fact that such reports are usually behind the firewall. However, this first note by FT's Alphaville on the VP report and the second note, just published, on the challenge by Iberian Equities are enough to get a sense of the argument.

I have seen VP's rebuttal and I still square with their side of the fence. Especially, Iberia Equities make the following point in their report;

"Variant claims Spanish banks are not marking their loan books to market. Non-performing loans in Spain (4.6% of the system’s loans by the end of Jun’09) are marked-down according to different provisioning calendars set by the Central Bank. For non-mortgage loans, NPLs are provisioned at the end of year 2. The majority of mortgage loans (40% of loans or two thirds of mortgage loans) have been – until the BoS made changed the interpretation of the rule - also 100% provisioned by year 2. Only a small fraction of
low –risk mortgages (20% of loans) are provisioned according to a long calendar (100% provision by year 6). By international standards, Spain’s provisioning calendars are quite strict especially considering >60% of loans have a mortgage collateral".

To which VP replies;

"Non-performing loans are being passed off as current, vacuumed up and rolled ito cedulas to deposit at the ECB's repo window.  (Incidentally, that is the only way many Spanish banks are finding any semblance of liquidity right now.  Without the ECB, some Spanish banks would have the same liquidity problems that subprime mortgage originators had.  The ECB is a mega warehouse, effectively, for the Spanish banking system.  This is intimately tied in to the question of funding excess consumption in Spain, which we discussed.)"

In my opinion and apart from the glaring neglect, in the Iberian Equity report, on the macroeconomics of the situation this is the most important omission. This is to say, that had it not been possible (which it still is) for Spanish banks to park many of their assets at the ECB as collateral for funding, they would have effectively needed to mark to a non-existing market (i.e. write off the whole thing in one swoop in which case it would have been bye bye Sandy). I mean, this was what happended with Bear Stearns and Lehmann and then only afterwards did the Fed (and the "appointed" buyers) wade in to scoop up these assets which are now sitting and waiting for better times (presumably, I mean, I don't know how quick they are ground down to reflect market fundamentals).

So, as you can see, I am still with VP here but not everyone may agree in which case it is naturally something which should be debated with facts and reason.

Chicago, IL – July 21, 2009 – Zacks.com 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: Goldman Sachs (GS), JP Morgan (JPM), AIG (AIG), Bank of America (BAC) and Citigroup (C).

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Here are highlights from Monday’s Analyst Blog:

Do We Cheer Banks’ Earnings?

It appears that the divide in the banking landscape between the “haves" and “have-nots" is increasing. Even among the big banks, there is now a clear two-tier system.

On one hand, we have Goldman Sachs (GS) and JP Morgan (JPM), which delivered record profits from their trading and investment banking revenues. There is no doubt that these two managed their affairs well, have increased their market share after the collapse of Lehman and Bear Stearns and also have benefitted tremendously from the various programs by the Treasury and the regulators. And, we should not forget the generous AIG (AIG) payout to Goldman.

On the other hand, the second-quarter profits of Bank of America (BAC) and Citigroup (C) were reliant on several one-time gains, resulting from asset sales etc, while weaknesses in some businesses and continued credit deterioration showed that there is more pain to come.

Bank of America’s credit-card unit lost $1.6 billion amid rising delinquencies, compared with a year-ago profit of $582 million. Its home-loan and insurance unit lost $725 million. The bank reported $8.7 billion in credit losses, up from $3.6 billion in the year-ago quarter. Its nonperforming loans jumped to 3.3%, up from 1.1% a year ago.

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Continuous coverage is provided for a universe of 1,150 publicly traded stocks. Our analysts are organized by industry which gives them keen insights to developments that affect company profits and stock performance. Recommendations and target prices are six-month time horizons.

Zacks "Profit from the Pros" e-mail newsletter provides highlights of the latest analysis from Zacks Equity Research. Subscribe to this free newsletter today: http://at.zacks.com/?id=5517

About Zacks

Zacks.com is a property of Zacks Investment Research, Inc., which was formed in 1978 by Leonard Zacks. As a PhD in mathematics Len knew he could find patterns in stock market data that would lead to superior investment results. Amongst his many accomplishments was the formation of his proprietary stock picking system; the Zacks Rank, which continues to outperform the market by nearly a 3 to 1 margin. The best way to unlock the profitable stock recommendations and market insights of Zacks Investment Research is through our free daily email newsletter; Profit from the Pros. In short, it's your steady flow of Profitable ideas GUARANTEED to be worth your time! Register for your free subscription to Profit from the Pros at http://at.zacks.com/?id=5518.

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Contact:
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Visit: www.zacks.com

The total-market Russell 3000 Index has seen some sizable changes in its sector weightings, although the top 10 remain very much the same. Figure 1 shows the new 2009 sector weightings according to the Russell sector classification system. Not surprisingly, financial services is no longer the largest sector: It now takes second place to technology, which is weighted at 16.19% versus financials at 15.27%. In 2008, those sectors were reversed, with financials at 17.24% and tech at 14.19%.

Health Care saw its weighting increase to 13.41% from 11.52%, popping it up to the third position from No. 5. It displaced energy, which fell from the third slot to the fourth, declining to 11.97% from 13.42%; presumably, declining oil prices had something to do with that. Consumer discretionary also fell: It was the fourth-largest sector after the 2008 rebalance, at 12.94%, but is now the fifth-largest, with a weighting of 11.86%. Producer durables, consumer staples, utilities and materials & processing maintained their same positions (six through 10, respectively).

The top 10 stocks in the Russell 3000 are by and large the same, except for one: ConocoPhillips was displaced by JPMorgan Chase & Co.—a financial company, of all things. Of course, JP Morgan did acquire two former giants in the field of finance last year: Bear Stearns and Washington Mutual. And it has been one of the least-scathed of the financial services companies.

While the other members of the top 10 remained largely the same, some of their positions did not. ExxonMobil is still at the top of the heap, like it was last year, but General Electric fell from the second-largest weighting in the Russell 3000 to the tenth-largest, with a weighting of 1.27%. Microsoft moved up from the third slot to the second, with a weighting of 1.87%. And Johnson & Johnson jumped to No. 3, befitting its strong performance.

Russell 2000

In the Russell 2000, financial services is still the top sector, increasing its weight to 21.10%. A surprising result, perhaps, but the sector was boosted by having hard-hit banks move out of the Russell 1000 and into the smaller index. Technology claims the second-largest slot, with a 16.75% weighting, displacing consumer discretionary, which falls to the No. 3 position, with a 14.68% weighting. That’s down from 17.65% in 2008. Energy only fell one spot, to No. 9, and saw its weighting nearly halved, falling from 8.60% to 4.52%, further emphasizing the differences between the large- and small-cap worlds.

Shares of nearly all of the companies in the group got a boost immediately following the election results in India on May 17th. Shares of Patni Computers (PTI) have appreciated the most, nearly 77% YTD (as of June 2nd), compared to the heavy-hitters in the industry: Infosys (INFY) up 43.6% YTD, Wipro Inc. (WIT) up 50.1% YTD, Cognizant Tech (CTSH) up 43.6% YTD and Tata Consultancy (TSC.NS) up 46.5% YTD.

However, it should also be kept in mind that most of the companies in the IT Services sector had also seen similar price declines on a relative peak-to-trough move in the 2008-2009 time period; PTIÕs price, for example, had fallen 73.9% from its relative high of $16.56 in January 2, 2008 to its recent low of $4.31 in March 3, 2009. On the basis of similar peak-to-trough price move, WIT had declined 64.6%, INFY 57.2%, CTSH 60.1% and TCS.NS 57.7%.

Generally speaking, the view of most investors toward the India-based IT services providers firms have been sounding incrementally positive of late. Infosys and Cognizant have signaled that the worst may have passed and that 2009 IT budgets have now largely been finalized, indicating better visibility by major clients into their IT spending plans.

These statements appear to have the effect of improved perception among investors for a recovery and may have contributed to the rally in the group recently. However, we think that the fundamentals continue to be challenged and are not likely to pick up pace at a rate that many investors are hoping for. New bookings remain light and pricing pressure continues to roll through the contract backlog.

The Impact of a Weak Financial Services Sector

Among the major players in the IT Services sector, the percentage of total revenues derived from the financial services vertical is split between Cognizant and Genpact (G) at roughly 45%, 43% for Tata Consultancy Services, 35% for Infosys and approx. 25% for Wipro. Given that a major portion of this exposure (more for the application outsourcing firms and less for the BPO firms) can potentially come from discretionary software development and other projects, the concerns raised about the negative impact of further tightening of bank IT budgets in 2009 is justifiable.

The attempts by the Indian IT outsourcers to mitigate these concerns by disclosing the revenue mix from the investment banking sector compared to the more secure insurance or commercial banking sectors have been met with tepid response so far. The differentiation has not gained much ground as the contagion seems to have spread to every corner of the financial services vertical.

While Infosys, Cognizant, TCS, Wipro and most other Indian vendors have alluded to the negative impact of a weak financial services sector, most of these companies after having posted somewhat strong sequential growth rates in their financial services verticals in Q2/Q3:FY2008, have began to falter. The current growth rate expectations have come down considerably since late-2008. It is, however, in line with expectation as a large portion of growth recorded in H2:2008 comes from the ramp of deals signed in 2007/2008.

Needless to say, most investors are now looking beyond H1:2009 and are weighing how the calamity in the financial services vertical will affect overall 2009 results. Investors are well aware that the March 2008 shock from the collapse of Bear Stearns caused several pending Indian application and business process outsourcing deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have had the same effect.

WEAKNESSES

The current feedback from the Indian outsourcing companies are still somewhat tempered. There are indications that Q2:FY2009 have fared better sequentially, but datapoints also indicate that enterprise IT spending is still depressed and new offshore IT bookings remain muted with a persistent 15%-25% pricing pressure. While existing projects are not necessarily being canceled, new deal activity has slowed dramatically.

Infosys indicated recently that many clients are still pushing the company to reduce its delivery costs so as to lower clients total offshore IT spend. The fact that most Indian vendors have very large (30%-50%) exposure to the financial services sector doesn't help and some vendors have high exposure to clients that are reducing headcount materially.

Many of the outsourcing advisory firms (which advise large enterprises on their deals with the offshore and domestic outsourcing vendors) are also reducing headcount and looking for strategic combinations. Add to this the negativity associated with the current anti-outsourcing sentiments and the fallout from the Satyam (SAY) debacle, and the picture is not so bright going forward.

OPPORTUNITIES

There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.

The consensus view is that the current slowdown will last at least a few more quarters and that Q3/Q4:FY2009 will be the recovery quarter with the industry in full gear in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions. The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009. The CEO of TCS indicated recently that a Q3:2009 recovery is more likely.

Also, the management of Infosys indicated that this year it is looking for growth for the IT industry at somewhere in the region of 15 percent, compared to 30% last year. Zacks Investment Research

Shares of nearly all of the companies in the group got a boost immediately following the election results in India on May 17th. Shares of Patni Computers (PTI) have appreciated the most, nearly 77% YTD (as of June 2nd), compared to the heavy-hitters in the industry: Infosys (INFY) up 43.6% YTD, Wipro Inc. (WIT) up 50.1% YTD, Cognizant Tech (CTSH) up 43.6% YTD and Tata Consultancy (TSC.NS) up 46.5% YTD.

However, it should also be kept in mind that most of the companies in the IT Services sector had also seen similar price declines on a relative peak-to-trough move in the 2008-2009 time period; PTIÕs price, for example, had fallen 73.9% from its relative high of $16.56 in January 2, 2008 to its recent low of $4.31 in March 3, 2009. On the basis of similar peak-to-trough price move, WIT had declined 64.6%, INFY 57.2%, CTSH 60.1% and TCS.NS 57.7%.

Generally speaking, the view of most investors toward the India-based IT services providers firms have been sounding incrementally positive of late. Infosys and Cognizant have signaled that the worst may have passed and that 2009 IT budgets have now largely been finalized, indicating better visibility by major clients into their IT spending plans.

These statements appear to have the effect of improved perception among investors for a recovery and may have contributed to the rally in the group recently. However, we think that the fundamentals continue to be challenged and are not likely to pick up pace at a rate that many investors are hoping for. New bookings remain light and pricing pressure continues to roll through the contract backlog.

The Impact of a Weak Financial Services Sector

Among the major players in the IT Services sector, the percentage of total revenues derived from the financial services vertical is split between Cognizant and Genpact (G) at roughly 45%, 43% for Tata Consultancy Services, 35% for Infosys and approx. 25% for Wipro. Given that a major portion of this exposure (more for the application outsourcing firms and less for the BPO firms) can potentially come from discretionary software development and other projects, the concerns raised about the negative impact of further tightening of bank IT budgets in 2009 is justifiable.

The attempts by the Indian IT outsourcers to mitigate these concerns by disclosing the revenue mix from the investment banking sector compared to the more secure insurance or commercial banking sectors have been met with tepid response so far. The differentiation has not gained much ground as the contagion seems to have spread to every corner of the financial services vertical.

While Infosys, Cognizant, TCS, Wipro and most other Indian vendors have alluded to the negative impact of a weak financial services sector, most of these companies after having posted somewhat strong sequential growth rates in their financial services verticals in Q2/Q3:FY2008, have began to falter. The current growth rate expectations have come down considerably since late-2008. It is, however, in line with expectation as a large portion of growth recorded in H2:2008 comes from the ramp of deals signed in 2007/2008.

Needless to say, most investors are now looking beyond H1:2009 and are weighing how the calamity in the financial services vertical will affect overall 2009 results. Investors are well aware that the March 2008 shock from the collapse of Bear Stearns caused several pending Indian application and business process outsourcing deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have had the same effect.

WEAKNESSES

The current feedback from the Indian outsourcing companies are still somewhat tempered. There are indications that Q2:FY2009 have fared better sequentially, but datapoints also indicate that enterprise IT spending is still depressed and new offshore IT bookings remain muted with a persistent 15%-25% pricing pressure. While existing projects are not necessarily being canceled, new deal activity has slowed dramatically.

Infosys indicated recently that many clients are still pushing the company to reduce its delivery costs so as to lower clients total offshore IT spend. The fact that most Indian vendors have very large (30%-50%) exposure to the financial services sector doesn't help and some vendors have high exposure to clients that are reducing headcount materially.

Many of the outsourcing advisory firms (which advise large enterprises on their deals with the offshore and domestic outsourcing vendors) are also reducing headcount and looking for strategic combinations. Add to this the negativity associated with the current anti-outsourcing sentiments and the fallout from the Satyam (SAY) debacle, and the picture is not so bright going forward.

OPPORTUNITIES

There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.

The consensus view is that the current slowdown will last at least a few more quarters and that Q3/Q4:FY2009 will be the recovery quarter with the industry in full gear in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions. The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009. The CEO of TCS indicated recently that a Q3:2009 recovery is more likely.

Also, the management of Infosys indicated that this year it is looking for growth for the IT industry at somewhere in the region of 15 percent, compared to 30% last year. Zacks Investment Research

"Looking forward, I believe a more macroprudential approach to supervision--one that supplements the supervision of individual institutions to address risks to the financial system as a whole--could help to enhance overall financial stability. Our regulatory system must include the capacity to monitor, assess, and, if necessary, address potential systemic risks within the financial system. Elements of a macroprudential agenda include:   

• "monitoring large or rapidly increasing exposures--such as to subprime mortgages--across firms and markets, rather than only at the level of individual firms or sectors;"

• "assessing the potential systemic risks implied by evolving risk-management practices, broad-based increases in financial leverage, or changes in financial markets or products;"

• "assessing the potential systemic risks implied by evolving risk-management practices, broad-based increases in financial leverage, or changes in financial markets or products;"

• "ensuring that each systemically important firm receives oversight commensurate with the risks that its failure would pose to the financial system;"

The solution to that is to make sure that no bank gets big enough to pose such a risk. It is time to break them up, both by function (i.e. reimpose a modern equivalent of Glass-Steagall) and perhaps by region. Ten mini Citigroups (C) would each would not pose an overall risk to the system if one of them were to fail.

Of course you would want to keep an eye on them, just as the military keeps an eye on its 1,000 lb conventional bombs. However, the consequences of one of those going missing is much less profound than a missing nuke warhead.

Unfortunately, in the largely ad-hoc response to the crisis, we have been moving in exactly the wrong direction. JP Morgan (JPM) swallows up Bear Stearns and Washington Mutual, Wells Fargo (WFC) takes over Wachovia, and Bank of America (BAC) now owns Countrywide and Merrill Lynch. All of them were too big to fail before this started, and now they are way too big to fail. Either we regulate them extremely closely -- to the point where they will be complaining that every credit card being issued has to be first cleared with the Federal Reserve Board of N.Y. (OK, I'm exaggerating for effect here) -- or we break them up.   

• "providing a resolution mechanism to safely wind down failing, systemically important institutions;"

Without being in bankruptcy, we had to honor the CDS contracts at 100 cents on the dollar. The result was a huge backdoor handout to the banks (a much bigger scandal than the bonuses, IMHO). This would have provided an intermediate step where the new 80% owners of AIG (aka the taxpayers) could have just returned the premiums on the CDS's and rewritten the bonus contracts when we came in.

We can do this with smaller banks, but not with big bank holding companies or huge non-bank financial firms. We need this, and we need it right away.   

• "ensuring that the critical financial infrastructure, including the institutions that support trading, payments, clearing, and settlement, is robust;"

• "working to mitigate procyclical features of capital regulation and other rules and standards;"

However, somehow I suspect that as soon as good times come back, the banks will flex all their political influence (they have a lot, as Sen. Durbin (D-Il) said of the bankers and the Senate, "they own this place") so the cushion is never built up in the good times. After all requiring more equity will result in a lower ROE, and that might result in bonuses that are only in the seven figures rather than in the eight figures. The horror, the horror!   

• "and identifying possible regulatory gaps, including gaps in the protection of consumers and investors, that pose risks for the system as a whole."

The OTS actively went looking for more institutions to fall under its supervision, and its key marketing policy was that it would be the most toothless and ineffective of regulators. It was the most gung-ho on deregulation, and many of the biggest failures were firms that it was the primary regulator for, including Washington Mutual, Indymac and of course AIG.

We have to find ways to stop shopping around for your regulator and regulatory capture. The Fed would be a very good place to start. It is not comforting that the head of the New York Fed comes from Goldman, and still holds over ten figures worth of Goldman stock when he is now the primary regulator of the firm. That is more than just an appearance of a conflict of interest.

The board of directors of each of the regional Federal Reserve Banks are all made up of bankers. That is because the Federal Reserve is not owned by the government, rather it is owned (literally, not just figuratively) by the banks. Perhaps it is time we reconsider that arrangement. 

The speech is a good start, but it does not go far enough. We need to return to the principals that were behind the financial regulatory reforms of the 1930's. The three-legged stool of good solid accurate information, including of potential conflicts of interest (the SEC), making it safe to keep your money in the bank (the FDIC) and making sure the bank does not take your money and use it to play the tables in Vegas (Glass-Steagall). The precise form will be different than the old regulations, but the new order should embody the same spirit.

The current financial market fallout adds further uncertainty to their growth picture, with roughly 50% of market cap already shaved off for the BPO companies since the fallout -- relative to its 52-week high, Cognizant Tech (CTSH) is down approx. 38%, Infosys (INFY) down 41.1% and Wipro (WIT) is down 38.8%.

There's no mistaking that the global financial crisis has found its way to India's shores at a time when the country is in no shape to weather it. With banks in the USA and Europe struggling to survive, outsourcing is less likely to be a dominant theme going forward. It is expected that the BPOs may cut their dollar revenue forecasts due to a downturn in the U.S. market, which contributes nearly half their revenue. These companies have already said that customers were delaying decisions on new projects in the tough global environment.

The Impact of a Weak Financial Services Sector

Among the major players in the IT Services sector, the percentage of total revenues derived from the financial services vertical is split between Cognizant and Genpact (G) at roughly 45%, 43% for Tata Consultancy Services (TCS), 35% for Infosys and approx. 25% for Wipro.

Given that a major portion of this exposure (more for the application outsourcing firms and less for the BPO firms) can potentially come from discretionary software development and other projects, the concerns raised about the negative impact of further tightening of bank IT budgets in 2009 is justifiable. The attempts by the Indian IT outsourcers to mitigate these concerns by disclosing the revenue mix from the investment banking sector compared to the more secure insurance or commercial banking sectors have been met with tepid responses so far. The differentiation has not gained much ground as the contagion seems to have spread to every corner of the financial services vertical.

While Infosys, Cognizant, TCS, Wipro and most other Indian vendors have alluded to the negative impact of a weak financial services sector, most of these companies after having posted somewhat strong sequential growth rates in their financial services verticals in Q2/Q3:FY2008, have began to falter. The current growth rate expectations have come down considerably since late-2008.

It is, however, in line with expectations as a large portion of growth recorded in H2:2008 comes from the ramp of deals signed in 2007/2008. Needless to say, most investors are now looking beyond H1:2009 and are weighing how the calamity in the financial services vertical will affect overall 2009 results. Investors are well aware that the March 2008 shock from the collapse of Bear Stearns caused several pending Indian application and business process outsourcing deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have had the same effect.

WEAKNESSES

The current feedback from the Indian outsourcing companies are still somewhat tempered. There are indications that Q1:FY2009 have fared better sequentially, but data points also indicate that enterprise IT spending is still depressed, and new offshore IT bookings remain muted with a persistent 15%-25% pricing pressure. While existing projects are not necessarily being canceled, new deal activity has slowed dramatically.

Infosys indicated recently that many clients are still pushing the company to reduce its delivery costs so as to lower clients total offshore IT spend. The fact that most Indian vendors have very large (30%-50%) exposure to the financial services sector doesn't help and some vendors have high exposure to clients that are reducing headcount materially.

Many of the outsourcing advisory firms (which advise large enterprises on their deals with the offshore and domestic outsourcing vendors) are also reducing headcount and looking for strategic combinations. Add to this the negativity associated with the current anti-outsourcing sentiments and the fallout from the Satyam (SAY) debacle, and the picture is not so bright going forward.

OPPORTUNITIES

There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.

The consensus view is that the current slowdown will last at least a few more quarters and that Q3/Q4:FY2009 will be the recovery quarter with the industry in full gear in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions.

The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009. The CEO of TCS indicated recently that a Q3:2009 recovery is more likely. Also, the management of Infosys indicated that this year it is looking for growth for the IT industry at somewhere in the region of 15 percent, compared to 30% last year. However, Infosys also reiterated that it would hire the 25,000 people it has targeted for this year and that there are no plans to cut headcount.Zacks Investment Research

The current financial market fallout adds further uncertainty to their growth picture, with roughly 50% of market cap already shaved off for the BPO companies since the fallout -- relative to its 52-week high, Cognizant Tech (CTSH) is down approx. 38%, Infosys (INFY) down 41.1% and Wipro (WIT) is down 38.8%.

There's no mistaking that the global financial crisis has found its way to India's shores at a time when the country is in no shape to weather it. With banks in the USA and Europe struggling to survive, outsourcing is less likely to be a dominant theme going forward. It is expected that the BPOs may cut their dollar revenue forecasts due to a downturn in the U.S. market, which contributes nearly half their revenue. These companies have already said that customers were delaying decisions on new projects in the tough global environment.

The Impact of a Weak Financial Services Sector

Among the major players in the IT Services sector, the percentage of total revenues derived from the financial services vertical is split between Cognizant and Genpact (G) at roughly 45%, 43% for Tata Consultancy Services (TCS), 35% for Infosys and approx. 25% for Wipro.

Given that a major portion of this exposure (more for the application outsourcing firms and less for the BPO firms) can potentially come from discretionary software development and other projects, the concerns raised about the negative impact of further tightening of bank IT budgets in 2009 is justifiable. The attempts by the Indian IT outsourcers to mitigate these concerns by disclosing the revenue mix from the investment banking sector compared to the more secure insurance or commercial banking sectors have been met with tepid responses so far. The differentiation has not gained much ground as the contagion seems to have spread to every corner of the financial services vertical.

While Infosys, Cognizant, TCS, Wipro and most other Indian vendors have alluded to the negative impact of a weak financial services sector, most of these companies after having posted somewhat strong sequential growth rates in their financial services verticals in Q2/Q3:FY2008, have began to falter. The current growth rate expectations have come down considerably since late-2008.

It is, however, in line with expectations as a large portion of growth recorded in H2:2008 comes from the ramp of deals signed in 2007/2008. Needless to say, most investors are now looking beyond H1:2009 and are weighing how the calamity in the financial services vertical will affect overall 2009 results. Investors are well aware that the March 2008 shock from the collapse of Bear Stearns caused several pending Indian application and business process outsourcing deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have had the same effect.

WEAKNESSES

The current feedback from the Indian outsourcing companies are still somewhat tempered. There are indications that Q1:FY2009 have fared better sequentially, but data points also indicate that enterprise IT spending is still depressed, and new offshore IT bookings remain muted with a persistent 15%-25% pricing pressure. While existing projects are not necessarily being canceled, new deal activity has slowed dramatically.

Infosys indicated recently that many clients are still pushing the company to reduce its delivery costs so as to lower clients total offshore IT spend. The fact that most Indian vendors have very large (30%-50%) exposure to the financial services sector doesn't help and some vendors have high exposure to clients that are reducing headcount materially.

Many of the outsourcing advisory firms (which advise large enterprises on their deals with the offshore and domestic outsourcing vendors) are also reducing headcount and looking for strategic combinations. Add to this the negativity associated with the current anti-outsourcing sentiments and the fallout from the Satyam (SAY) debacle, and the picture is not so bright going forward.

OPPORTUNITIES

There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.

The consensus view is that the current slowdown will last at least a few more quarters and that Q3/Q4:FY2009 will be the recovery quarter with the industry in full gear in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions.

The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009. The CEO of TCS indicated recently that a Q3:2009 recovery is more likely. Also, the management of Infosys indicated that this year it is looking for growth for the IT industry at somewhere in the region of 15 percent, compared to 30% last year. However, Infosys also reiterated that it would hire the 25,000 people it has targeted for this year and that there are no plans to cut headcount.Zacks Investment Research

For Immediate Release

Chicago, IL - March 27, 2009 - Zacks Equity Research picks Johnson & Johnson (JNJ) as Bull of the Day and Cadence Design Systems (CDNS) as Bear of the Day. In addition, the analysts at Zacks Equity Research discuss the latest on J.P. Morgan (JPM), Bank of America (BAC) and Wells Fargo (WFC).

Full analysis of all these stocks is available at: http://at.zacks.com/?id=2678

Bull of the Day

Johnson & Johnson (JNJ) has an enormously diverse revenue stream consisting of market leading products in all three of its business segments. However, due to a number of products expected to experience declining sales, revenue will likely fall in 2009.

We expect EPS to remain flat from 2008, benefiting form improving margins and share buybacks. Then again, J&J s consistency, product diversity, financial stability and long-term growth potential make it a very attractive holding in this turbulent market.

We rate the stock a Buy based on the stock's attractive valuation and strong company fundamentals. Our price target is $70.

Bear of the Day

We expect that a turnaround is going to take time for Cadence Design Systems (CDNS) due to mounting financial problems leading to lackluster growth. The company reported weak 2008 results and provided guidance for a poor 2009.

We have lost confidence in the company's ability to survive in the market and show healthy fundamentals. Cadence has been losing share to Synopsys and is struggling through a downturn in the semiconductor cycle. Cadence also withdrew its bid for Mentor Graphics in 2008, further dimming its growth prospects.

Cadence recently came out with enhanced version of its products, but it will take time for these to generate additional revenue. We maintain a Sell rating on the shares and maintain our six-month price target of $2.50.

Recent Analysis from the Analyst Blog

On Addressing Risk Prevention

When Bear Stearns was failing, the only safe port in the storm was J.P. Morgan (JPM) and when Merrill Lynch was about to go under, it was Bank of America (BAC) that stepped up to the plate to keep it alive. Both of these actions were actively encouraged and subsidized by the regulators. It would seem a bit two-faced to turn around and make them unwind the transactions so quickly.

We have, in a larger sense, also been going the wrong way on the whole issue of "too big to fail" for much the same reason. Not only did J.P. Morgan take over Bear Stearns, but it also took over Washington Mutual, the largest thrift in the country, when it failed. Wells Fargo (WFC) took over Wachovia, but not before a bit of a battle with Citigroup over it (talk about some potentially very ugly kids from that marriage!).

The problem of "too big to fail" has so far been addressed by making these institutions even bigger. But hey -- it was a crisis, and there were not a lot of other routes to go down, particularly if one wanted to avoid outright nationalization of institutions.

If we can't break up these financial institutions, the least we can do it to try to effectively regulate them. This is where the call for a systemic risk regulator would come in. Most likely it will be the Fed, but conceivably the job could be done by either the Treasury or the FDIC.

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PowerShares says it has filed to launch a pair of new actively managed exchange-traded funds focusing on non-agency residential mortgage-backed securities.

The two proposed funds are the Prime Non-Agency RMBS Opportunity Fund and the Alt-A Non-Agency RMBS Opportunity Fund.

The types of fixed-income both funds will hold come from non-subprime areas of the RMBS market. Credit requirements for prime loans are the most difficult to qualify for and Alt-A somewhat less.  

“We are hopeful that these ETFs will provide access and transparency into these markets along with some of the much needed additional liquidity originally intended by the TARP,” added Bond.  

Money managers have shown a lot of interest in buying investments they believe can take advantage of TARP and other government rescue programs. In fact, earlier this month an index came out of TARP companies directly involved in government bailouts. (See story here.)

The funds' holdings will be updated daily and run by parent Invesco's institutional money managers, according to PowerShares. No word yet on how much PowerShares will charge for the new bond funds. Its first actively managed bond ETF, the Active Low Duration Fund (NYSE: PLK) charges an expense ratio of 0.29%.  

But PLK has only attracted some $3.8 milllion in assets since launching in April 2008. It was actually the second active bone ETF on the market. Since the fall of Bear Stearns and its active bond fund, PLK has been the only player in that category of the active ETF market. (See related story here.)

But it's a short-duration fund and there are lots of currency ETFs out now, some of which are run through active managers. Since the proposed PowerShares RMBS funds will hold longer-termed issues, these will represent a broadening along yield curves in actively managed bond ETFs available to investors. 

It might be worth noting that markets have been warming to mortgage-backed securities as a whole for awhile now.

As related by Dow Jones Newswires' Ian Salisbury, who broke the story in the Wall Street Journal, several of the most popular mutual fund managers have already boosted their more diversified portfolios significantly in the RMBS market. (See third item in "Best ETF Stores In The National Media" here.)

And many broad index-based bond ETFs have already done much the same, following an ongoing and evolving market trend. 

As debated on these pages and others many times in the past, if nothing else the entry of two more actively managed bond ETFs from PowerShares raises a primary question investors must answer: Will active managers find more luck beating passively run portfolios in the ETF marketplace? (See related Journal of Indexes story, "Will Actively Managed Bonds Work?" here.)

There's no mistaking that the global financial crisis has found its way to India's shores at a time when the country is in no shape to weather it. Add to this the Satyam Computers (SAY) debacle and the recovery picture becomes all the more obscure.

Also, with banks in the USA and Europe struggling to survive, outsourcing is less likely to be a dominant theme going forward. It is expected that the BPOs may cut their dollar revenue forecasts due to a downturn in the U.S. market, which contributes more than half their revenue. These companies have already said that customers were delaying decisions on new projects in the tough global environment.

Additionally, German software maker SAP (SAP) warned that its sales had dropped and has toned down its guidance going forward as companies curtailed business software spending. This is expected to negatively affect the Indian BPOs with increasing revenue dependence in Europe.

The Impact of a Weakening Financial Services Sector

Among the major players in the IT Services sector, the percentage of total revenues derived from the financial services vertical amounts to approx. 46% for Cognizant (CTSH, Hold), 45% for Genpact (G), 43% for Tata Consultancy Services (or TCS), 35% for Infosys (INFY, Hold) and 25% for Wipro (WIT, Hold). Given that well over half of this exposure (more for the application outsourcing firms and less for the BPO firms) can come from "discretionary" software development and other projects, the Street has been justifiably concerned about the impact of even tighter bank IT budgets in 2009.

The Indian vendors themselves have attempted to soften these Street concerns by disclosing the portion of this revenue mix derived from the more volatile investment banking sector compared to the more secure insurance or commercial banking sectors, or (as in the case of Cognizant) indicating that its largest bank clients continue to spend while its smaller clients may be more vulnerable. This sub-sector distinction, while useful, has lost some value of late as the contagion seems to have spread to every corner of the financial services vertical.

While Infosys, Cognizant, TCS, Wipro and most other Indian vendors have been quite candid about the impact of the weakening financial services sector (citing lengthening sales cycles, delays in project ramps, consolidation of vendors and/or the loss of pricing power), most Indian firms had actually posted relatively strong sequential growth rates in their financial services verticals up until the last quarter in CY2008. However, the tone has since markedly changed from "stable" to "challenging."

Infosys recently reported fiscal Q3:FY09 results slightly below the low-end of its guidance and approximately in line with buy-side expectations. Infosys posted a sequential revenue decline of 4% to $1.17 billion, with constant currency sequential growth of 1% offset by a 5% currency hit. According to Infosys, the environment remains challenging and visibility into fiscal 2010 (ended March 2010) will be limited until its clients confirm their 2009 IT budgets, which Infosys is expecting in mid-February. The midpoint of the new March quarter revenue guidance implies another sequential revenue decline of 2%.

Similarly, TCS reported a sequential revenue decline of 6% in its December quarter and sequential constant currency growth of 1%, similar to Infosys. Overall, the TCS results suggest that volumes may have stabilized somewhat, but the company did not imply that growth would accelerate anytime soon. Keep in mind the major impact of the weak new bookings and delayed project ramps experienced in 2008 won't show up until Q1 or Q2:2009.

Needless to say, most investors are now are weighing how the calamity in the financial services vertical will affect 2009 results. Investors are well aware that the March 2008 shock from the collapse of Bear Stearns caused several pending Indian application and business process outsourcing deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have the same effect.

OPPORTUNITIES

There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.

It is also rumored that government-owned insurer AIG (AIG) has issued a RFP ["request for proposal"] for a multi-billion dollar IT and back-office outsourcing deal in an effort to cut costs. It is estimated that new deal awards in the month of October were $15 billion, exceeding the level of new contract awards for the entire September quarter. Note, however, that this total is down 12% from October 2007, and a full $2.5 billion of it stems from the TCS-Citigroup (C) deal and many of the deal awards were for network and IT infrastructure outsourcing that the Indian vendors often don't compete on.

The consensus view is that the current sluggishness will last at least a few more quarters, and that Q2:2009 or Q3:2009 will be the recovery quarter with the industry fully back on track in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions. The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009. The CEO of TCS indicated recently that a Q3:2009 recovery is more likely.

Also, the management of Infosys indicated recently that this year it is looking for growth for the IT industry at somewhere in the region of 15%, compared to 30% last year. However, Infosys also reiterated that it would hire the 25,000 people it has targeted for this year and that there are no plans to cut headcount. Although the company has seen delays in orders, there has been no change in its third quarter guidance so far.

WEAKNESSES

Companies in the IT Services sector, particularly the India-based ones, are still reeling from the aftershocks of one of he biggest financial scandals perpetrated by Satyam Computer (SAY, Sell). While much has been written (and even more verbalized) of the longer-term impact this may have on the industry as a whole, it appears that the companies in the sector have withstood the initial impact of the scandal.

The longer-term outcome, however, is not so clear. The Satyam stigma is clearly impacting other leading companies in the sector, mostly by default, and questions are already arising whether India may continue to be the favored destination for IT outsourcing. China, with less than 10% share of global IT spending and clearly lagging India in IT services outsourcing, is rearing its head to capitalize from the Satyam fallout, and large multinationals -- soured by the Satyam mess -- may start looking at non-India based outsourcers to fill its needs. Although it is too early to speculate, the developing trend does not bode well for Indian outsourcers.

The current feedback from Indian and U.S.-based outsourcing companies are somewhat tempered, with most sources saying that things are still getting worse. Many existing clients of these IT Services firms are still reducing their headcount and looking to cut back on their offshore IT spending. New deals and clients are extremely tough to come by given the economic uncertainty.

While existing projects are still not being canceled, new deal activity has slowed dramatically. Infosys indicated recently that many clients are still pushing the company to reduce its delivery costs so as to lower clients' total offshore IT spend. The fact that most Indian vendors have very large (30%-50%) exposure to the financial services sector doesn't help, and some vendors have high exposure to clients that are reducing headcount materially. Many of the outsourcing advisory firms (which advise large enterprises on their deals with the offshore and domestic outsourcing vendors) are also reducing headcount and looking for strategic combinations. All of these do not point to a bullish scenario.

CONCLUSION

We are supportive of a long-term bull case on Infosys (INFY), Cognizant (CTSH) and the shares of the other Indian outsourcing vendors. However, the prevailing argument leans towards a dismal scenario for a few more quarters, with a counter-cyclical recovery in offshore IT spending by late-2009 and return to 20%-30% growth rates by 2010. Assuming they can hold margins relatively constant, investors today appear to have the opportunity to acquire 20%-30% earnings growth for a below-market P/E multiple of 10x.

There are a few counter-points to this argument: (a) given that the core Indian software services companies are at a mature stage, the prospects of a recovery to 20%-30% growth is questionable. Client penetration rates for these companies are already high in the mature industries such as banking, insurance and telecommunications and core offshore ADM services have become increasingly commoditized. (b) Industry pricing pressure and a flat or appreciating rupee could act as a counter to the stable margin assumption. (c) From an investment timing perspective, we see no rush to rating upgrades when the stocks of Infosys and its Indian peers are trading at (not below) the same P/E multiples of many other high quality technology companies.

Clearly, a trough is not yet in sight and companies are more likely to lower their guidance. Also, sell-side estimates are still too high, in our opinion, and may be curtailed as we move forward.

The Indian outsourcing stocks have firmed up on the belief that volumes and overall constant currency growth have at least stabilized at around zero. Although that may seem optimistic, we are somewhat less confident looking forward and remain worried that industry pricing pressure is accelerating and that new bookings will remain soft for at least several more quarters, leading to further sequential revenue declines.
"CTSH" Free Stock Analysis: Buy? Sell? Hold?
"INFY" Free Stock Analysis: Buy? Sell? Hold?
"WIT" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

Here are some numbers for the compensation received in 2006 by some of the folks who helped get us into our current mess:

• Bear Stearns: $34 million for CEO James Cayne. The acknowledged direct cost to the taxpayers from Bear's demise so far is $2.7 billion; ten times that number may be a more reasonable assessment of the actual cost.
• Lehman Brothers: $27 million for CEO Richard Fuld. The financial freeze that followed the collapse of Lehman is seen by many as the key event that turned the recession of 2007-08 into the frightening freefall currently under way.
• Citigroup: $25 million for CEO Charles Prince. Citi's stock price has since fallen from $50 a share to $3.50.
• Countrywide Financial: $43 million for CEO Angelo Mozilo. According to Ashcraft and Schuermann, Countrywide was at that time the nation's leading issuer of subprime mortgage-backed securities and the third biggest originator of subprime mortgages.

That these individuals should have profited so richly from running their companies into the ground, and bringing the rest of us down with them, offends anyone's sense of justice. But it also raises a profoundly important question from the perspective of economic efficiency, in that the above numbers constitute a prima facie case that there were powerful economic incentives for these individuals to make decisions that were in fact not in their companies' or society's best interest.

That the incentives for CEOs need not necessarily coincide with those of the shareholders is a well understood phenomenon that is a special case of what economists call the principal-agent problem. This arises in situations when an agent (in this case, the CEO) has better information about what is going on than the principals (in this case, the shareholders) who rely on the agent to perform a certain task. One way to try to cope with these problems of asymmetric information is to tie the agent's compensation directly to performance.

What caused that principle to go so badly awry in the present instance? I believe there was an unfortunate interaction between financial innovations and lack of regulatory oversight, which allowed the construction of new financial instruments with essentially any risk-reward profile desired and the ability to leverage one's way into an arbitrarily large position in such an instrument. The underlying instrument of choice was a security with a high probability of doing slightly better than the market and a small probability of a big loss. For example, a subprime loan extended in 2005 would earn the lender a higher yield in the event that house prices continued to rise, but perform quite badly when the housing market turned down. By taking a leveraged position in such assets, the slightly higher yield became an enormously higher yield, and while the game was on, the short-term performance looked wonderful. If the agent is compensated on the basis of current performance alone, and the principal lacks good information on the exact nature of the risks, the result is a tragically toxic incentive structure.

I therefore read with interest the following story in last week's Wall Street Journal:

As annual-meeting season approaches, investors are focusing squarely on executive compensation.

Frustrated with managers who walked away from the financial crisis with tens of millions of dollars despite big shareholder losses, some investors want to limit pay and overhaul compensation practices. They say some practices encouraged executives to take big short-term risks, with little downside when the bets went bust.

Some shareholder activists view the financial meltdown and recession as a "once-in-a-generation" opportunity for change, says Patrick McGurn, special counsel at proxy advisers RiskMetrics Group Inc....

The American Federation of State, County and Municipal Employees has submitted 36 proposals, 32 of which address pay practices. AFSCME wants 10 companies to require executives to hold a majority of their stock and stock options until two years after retirement or termination. The union is also asking three firms to adopt "bonus banking," in which a portion of executives' annual bonuses would be withheld for three years, then recalculated based on updated corporate results.

My interest in this issue is not so much to exact revenge on those who created our current problems, but instead to ask, how can we change the incentives so that this kind of problem is not repeated again? And that in turn leads me to wonder, why limit the proposals above only to a handful of companies?

Technorati Tags: macroeconomics, economics, executive compensation, Richard Fuld

Even though some banks have been beaten down by the credit crisis, one can still turn to industry stalwarts that should be strong enough to stand on their own during turbulent times and possibly lead the industry to a recovery from current bargain levels. Two bank giants in particular are weathering the credit crisis storm relatively well and have a layer of reinforcement around them in the form of the government's Troubled Asset Relief Program, or TARP. These are JP Morgan Chase & Co. (JPM) and Wells Fargo & Company (WFC).

JP Morgan Chase & Co. (JPM) is an industry leader in terms of market capital with about $97 billion under its belt. In addition to fending off some of the effects of the credit crunch, JPM was healthy enough to acquire a couple of the victims. The company bought Wall Street's storied Bear Stearns at a deep discount. Subsequently, JPM acquired mortgage giant Washington Mutual, which was also a bargain and a boost to JPM's total U.S. deposits.

While analyst estimates have declined as is the case for virtually all banks, earnings forecasts for JPM have seen narrower reductions than most others. For the 2009 year, analysts are expecting year-over-year earnings growth of 71%. The company delivered earnings per share that topped consensus estimates 4 times out of the past 5 consecutive quarters. JPM's most recent surprise on estimates stands at an impressive 200%.

Earnings per share are expected to grow by 8% over the next 3 – 5 years, which is slightly higher than the industry average of 7%. JPM's net profit margin of 12% is in line with the industry average.

The company is scheduled to report results for the fourth quarter on January 21.

Wells Fargo & Company (WFC) is another giant in the in the industry with a market capital of approximately 81 billion. The company was able to get it hands on the majority of Wachovia's assets, which also toppled under the weight of the credit crisis. This move will give WFC the most bank branches in U.S.

WFC has also seen earnings estimate revisions that dipped lower by narrower margins than what has been seen by most of the industry. The company's earnings per share came in ahead of analyst expectations over the past 3 straight quarters. The average upside surprise during that time frame was 10%.

WFC earnings per share are projected to grow by 9% over the next 3 – 5 years, versus the industry average of 7%. The bank's net profit margin of 13% is a bit higher than the industry average of 12%. WFC's return on equity (ROE) of 14% tops the industry average of 10%.

The company is scheduled to release its fourth-quarter report on January 28.

Testing the waters with the aforementioned banks is a good way to start exposing one's portfolios to a corner of the market that is poised for a robust recovery upswing. As economic conditions improve and the TARP program further stabilizes the banking industry, additional domestic banks will become more and more attractive.

Having stated that, I do want to stress that this approach is certainly not without risk and not for all investors, especially those who are managing a portfolio with a short-term time horizon.

Those who are ready and willing to venture into banks at discounted share prices can further diversify exposure to banks by adding a solid international pick to the duo discussed above. In the age of struggling banks, Mitsubishi UFJ Financial Group, Inc. (MTU) offers outstanding fundamentals.

For the fiscal year ending March 2009, analysts hiked earnings estimates by an astonishing 126% during the past month. For the following fiscal year, earnings forecasts increased by 51% over the past 30 days. Analysts are looking for year-over-year earnings growth of 92% for the year ending March 2010.

The Zacks #1 Rank (“strong buy”) name is set to report next on February 5.

Again, it is important to remember that the 3 banks are not necessarily “get rich quick” plays and should be considered a risky component of one's overall asset allocation strategy. However, investors who take advantage of today's bargain share prices stand to be handsomely rewarded over the long-term.

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"WFC" Free Stock Analysis: Buy? Sell? Hold?
"MTU" Free Stock Analysis: Buy? Sell? Hold?
"JPM" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

However, this thesis is now undergoing some re-evaluation, given that overall recovery prospects are being pushed towards the latter half of 2009. The current financial market fallout adds further uncertainty to their growth picture, with roughly 50% of market cap already shaved off for the BPO companies since the fallout.

There's no mistaking that the global financial crisis has found its way to India's shores at a time when the country is in no shape to weather it. With banks in USA and Europe struggling to survive, outsourcing is less likely to be a dominant theme going forward. It is expected that the BPOs may cut their dollar revenue forecasts due to a downturn in the U.S. market, which contributes more than half their revenue.

These companies have already said that customers were delaying decisions on new projects in the tough global environment. Additionally, German software maker SAP AG (SAP) warned that its sales had dropped, and has toned down its guidance going forward as companies curtailed business software spending. This is expected to negatively affect the Indian BPOs with increasing revenue dependence in Europe.

Impact of a Weakening Sector

Among the major players in the IT Services sector, the percentage of total revenues derived from the financial services vertical amounts to 46% for Cognizant (CTSH - Hold), 45% for Genpact (G), 43% for Tata Consultancy Services (or TCS), 35% for Infosys (INFY - Hold) and 25% for Wipro (WIT - Hold). Given that well over half of this exposure (more for the application outsourcing firms and less for the BPO firms) can come from "discretionary" software development and other projects, the Street has been justifiably concerned about the impact of even tighter bank IT budgets in Q4:2008 and in 2009.

The Indian vendors themselves have attempted to soften these Street concerns by disclosing the portion of this revenue mix derived from the more volatile investment banking sector compared to the more secure insurance or commercial banking sectors, or -- as in the case of Cognizant -- indicating that its largest bank clients continue to spend while its smaller clients may be more vulnerable. This sub-sector distinction, while useful, has lost some value of late as the contagion seems to have spread to every corner of the financial services vertical.

While Infosys, Cognizant, TCS, Wipro and most other Indian vendors have been quite candid about the impact of the weakening financial services sector (citing lengthening sales cycles, delays in project ramps, consolidation of vendors and/or the loss of pricing power), most Indian firms have actually posted relatively strong sequential growth rates in their financial services verticals. In Q2:2008, Infosys recorded a sequential growth rate of 3% in its financial services industry, while Cognizant reported a strong 7% sequential growth rate.

In early September, both Infosys and Cognizant sounded reasonably bullish about their respective financial services verticals and in meeting their overall 2H:2008 revenue guidance. This, however, did not do much for the stocks of these companies, since a large portion of growth recorded in 2H:2008 comes from the ramp of existing deals signed in 2007 and in early 2008. Additionally, the major impact of the weak new bookings and delayed project ramps experienced so far in 2008 won't show up until 2009.

Needless to say, most investors are now looking beyond 2008 and are weighing how the calamity in the financial services vertical will affect 2009 results. Investors are well aware that the March 2008 shock from the collapse of Bear Stearns caused several pending Indian BPO deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have the same effect.

OPPORTUNITIES

There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.

It is also rumored that government-owned insurer AIG (AIG) has issued a RFP for a multi-billion dollar IT and back-office outsourcing deal in an effort to cut costs. It is estimated that new deal awards in the month of October were $15 billion, exceeding the level of new contract awards for the entire September quarter. Note, however, that this total is down 12% from October 2007, and a full $2.5 billion of it stems from the TCS-Citi deal and many of the deal awards were for network and IT infrastructure outsourcing that the Indian vendors often don't compete on.

The consensus view is that the current sluggishness will last at least a few more quarters and that Q2:2009 or Q3:2009 will be the recovery quarter, with the industry fully back on track in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions. The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009.

The CEO of TCS indicated last week that a Q3:2009 recovery is more likely. Also, the management of Infosys indicated recently that this year it is looking for growth for the IT industry at somewhere in the region of 15 percent, compared to 30% last year. However, Infosys also reiterated that it would hire the 25,000 people it has targeted for this year and that there are no plans to cut headcount. Although the company has seen delays in orders, there has been no change in its third quarter guidance so far.

WEAKNESSES

The current feedback from Indian and U.S.-based outsourcing companies are somewhat tempered, with most sources saying that things are still getting worse. Many existing clients of these IT Services firms are still reducing their headcount and looking to cut back on their offshore IT spending.

New deals and clients are extremely tough to come by given the economic uncertainty. While existing projects are still not being canceled, new deal activity has slowed dramatically. Infosys indicated recently that many clients are still pushing the company to reduce its delivery costs so as to lower clients total offshore IT spend. The fact that most Indian vendors have very large (30%-50%) exposure to the financial services sector doesn't help and some vendors have high exposure to clients that are reducing headcount materially. BT Group PLC (BT), which recently announced a 10,000-person lay-off, is the largest single client of Infosys.

Similarly, Credit Suisse (CS), with a major lay-off in sight recently, is a client of Wipro, Cognizant, Patni (PTI) - Hold) and Satyam (SAY - Hold). Many of the outsourcing advisory firms (which advise large enterprises on their deals with the offshore and domestic outsourcing vendors) are also reducing headcount and looking for strategic combinations. All of these do not point to a bullish scenario.

Based on the recent relationship between currency shifts and the adjustments to the company's revenue guidance, it is expected that the currency shifts since mid-October are likely to reduce the dollar-denominated reported revenue growth rate for INFY in the coming quarters by a further 3%. This currency shift alone would therefore reduce the midpoint of the company's growth guidance to 7.5% for the December 2008 quarter and to 1.8% for the March 2009 quarter.

CONCLUSION

We are supportive of a long-term bull case on Infosys, Cognizant and the shares of the other Indian outsourcing vendors. However, the prevailing argument leans towards a dismal scenario for a few more quarters, with a counter-cyclical recovery in offshore IT spending by late-2009 and return to 20%-30% growth rates by 2010.

Assuming they can hold margins relatively constant, investors today appear to have the opportunity to acquire 20%-30% earnings growth for a below-market P/E multiple of 10x.

There are a few counter-points to this argument: (a) given that the core Indian software services companies are at a mature stage, the prospects of a recovery to 20%-30% growth is questionable. Client penetration rates for these companies are already high in the mature industries such as banking, insurance and telecommunications and core offshore ADM services have become increasingly commoditized. (b) Industry pricing pressure and a flat or appreciating rupee could act as a counter to the stable margin assumption. (c) From an investment timing perspective, we see no rush to rating upgrades when the stocks of Infosys and its Indian peers are trading at (not below) the same P/E multiples of many other high quality technology companies.

Clearly, a trough is not yet in sight and companies are more likely to lower their guidance. Also, sell-side estimates are still too high, in our opinion, and may be curtailed as we move forward.

Abdul Saleh is a senior analyst covering the business process outsourcing (BPO) market for Zacks Equity Research.
"INFY" Free Stock Analysis: Buy? Sell? Hold?
"CTSH" Free Stock Analysis: Buy? Sell? Hold?
"G" Free Stock Analysis: Buy? Sell? Hold?
"WIT" Free Stock Analysis: Buy? Sell? Hold?
"PTI" Free Stock Analysis: Buy? Sell? Hold?
"SAY" Free Stock Analysis: Buy? Sell? Hold?
Zacks Investment Research

The current global economic and market downturn has taken its toll on the IT Services group as a whole. The Business Process Outsourcing (BPO) companies were all under significant pressure even before the current economic malaise, with a slowdown in its growth trajectory for 2008, and the Street had already discounted the 2008 slowdown relative to 2007. In other words, the BPO companies were all trading with an early-2009 growth/recovery story in mind.

However, this thesis is now undergoing some re-evaluation, given that overall recovery prospects are being pushed towards the latter half of 2009. The current financial market fallout adds further uncertainty to their growth picture, with roughly 50% of market cap already shaved off for the BPO companies since the fallout.

There's no mistaking that the global financial crisis has found its way to India's shores at a time when the country is in no shape to weather it. With banks in USA and Europe struggling to survive, outsourcing is less likely to be a dominant theme going forward. It is expected that the BPOs may cut their dollar revenue forecasts due to a downturn in the U.S. market, which contributes more than half their revenue.

These companies have already said that customers were delaying decisions on new projects in the tough global environment. Additionally, German software maker SAP AG (SAP) warned that its sales had dropped, and has toned down its guidance going forward as companies curtailed business software spending. This is expected to negatively affect the Indian BPOs with increasing revenue dependence in Europe.

Impact of a Weakening Sector

Among the major players in the IT Services sector, the percentage of total revenues derived from the financial services vertical amounts to 46% for Cognizant (CTSH - Hold), 45% for Genpact (G), 43% for Tata Consultancy Services (or TCS), 35% for Infosys (INFY - Hold) and 25% for Wipro (WIT - Hold). Given that well over half of this exposure (more for the application outsourcing firms and less for the BPO firms) can come from "discretionary" software development and other projects, the Street has been justifiably concerned about the impact of even tighter bank IT budgets in Q4:2008 and in 2009.

The Indian vendors themselves have attempted to soften these Street concerns by disclosing the portion of this revenue mix derived from the more volatile investment banking sector compared to the more secure insurance or commercial banking sectors, or -- as in the case of Cognizant -- indicating that its largest bank clients continue to spend while its smaller clients may be more vulnerable. This sub-sector distinction, while useful, has lost some value of late as the contagion seems to have spread to every corner of the financial services vertical.

While Infosys, Cognizant, TCS, Wipro and most other Indian vendors have been quite candid about the impact of the weakening financial services sector (citing lengthening sales cycles, delays in project ramps, consolidation of vendors and/or the loss of pricing power), most Indian firms have actually posted relatively strong sequential growth rates in their financial services verticals. In Q2:2008, Infosys recorded a sequential growth rate of 3% in its financial services industry, while Cognizant reported a strong 7% sequential growth rate.

In early September, both Infosys and Cognizant sounded reasonably bullish about their respective financial services verticals and in meeting their overall 2H:2008 revenue guidance. This, however, did not do much for the stocks of these companies, since a large portion of growth recorded in 2H:2008 comes from the ramp of existing deals signed in 2007 and in early 2008. Additionally, the major impact of the weak new bookings and delayed project ramps experienced so far in 2008 won't show up until 2009.

Needless to say, most investors are now looking beyond 2008 and are weighing how the calamity in the financial services vertical will affect 2009 results. Investors are well aware that the March 2008 shock from the collapse of Bear Stearns caused several pending Indian BPO deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have the same effect.

OPPORTUNITIES

There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.

It is also rumored that government-owned insurer AIG (AIG) has issued a RFP for a multi-billion dollar IT and back-office outsourcing deal in an effort to cut costs. It is estimated that new deal awards in the month of October were $15 billion, exceeding the level of new contract awards for the entire September quarter. Note, however, that this total is down 12% from October 2007, and a full $2.5 billion of it stems from the TCS-Citi deal and many of the deal awards were for network and IT infrastructure outsourcing that the Indian vendors often don't compete on.

The consensus view is that the current sluggishness will last at least a few more quarters and that Q2:2009 or Q3:2009 will be the recovery quarter, with the industry fully back on track in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions. The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009.

The CEO of TCS indicated last week that a Q3:2009 recovery is more likely. Also, the management of Infosys indicated recently that this year it is looking for growth for the IT industry at somewhere in the region of 15 percent, compared to 30% last year. However, Infosys also reiterated that it would hire the 25,000 people it has targeted for this year and that there are no plans to cut headcount. Although the company has seen delays in orders, there has been no change in its third quarter guidance so far.

WEAKNESSES

The current feedback from Indian and U.S.-based outsourcing companies are somewhat tempered, with most sources saying that things are still getting worse. Many existing clients of these IT Services firms are still reducing their headco the March 2008 shock from the collapse of Bear Stearns caused several pending Indian BPO deal awards to get delayed, and there is no reason to believe that the September 2008 shock won't have the same effect.

OPPORTUNITIES

There is, however, a silver lining in the dark clouds. Some of the companies have indicated that the level of client discussions is still healthy, even though these discussions are converting to signed deals at a much slower clip. It also appears that deal activity in continental Europe and in the local Indian market is healthy, although neither region represents a material portion of the revenue mix for most of the Indian outsourcers.

It is also rumored that government-owned insurer AIG (AIG) has issued a RFP for a multi-billion dollar IT and back-office outsourcing deal in an effort to cut costs. It is estimated that new deal awards in the month of October were $15 billion, exceeding the level of new contract awards for the entire September quarter. Note, however, that this total is down 12% from October 2007, and a full $2.5 billion of it stems from the TCS-Citi deal and many of the deal awards were for network and IT infrastructure outsourcing that the Indian vendors often don't compete on.

The consensus view is that the current sluggishness will last at least a few more quarters and that Q2:2009 or Q3:2009 will be the recovery quarter, with the industry fully back on track in 2010. The fact remains that visibility is so low that no one really knows when companies will feel comfortable enough to move forward with strategic offshore outsourcing decisions. The new bookings recovery was initially pegged by the Indian vendors for Q4:2008 and then it was pushed to Q2:2009.

The CEO of TCS indicated last week that a Q3:2009 recovery is more likely. Also, the management of Infosys indicated recently that this year it is looking for growth for the IT industry at somewhere in the region of 15 percent, compared to 30% last year. However, Infosys also reiterated that it would hire the 25,000 people it has targeted for this year and that there are no plans to cut headcount. Although the company has seen delays in orders, there has been no change in its third quarter guidance so far.

WEAKNESSES

The current feedback from Indian and U.S.-based outsourcing companies are somewhat tempered, with most sources saying that things are still getting worse. Many existing clients of these IT Services firms are still reducing their headcount and looking to cut back on their offshore IT spending.

New deals and clients are extremely tough to come by given the economic uncertainty. While existing projects are still not being canceled, new deal activity has slowed dramatically. Infosys indicated recently that many clients are still pushing the company to reduce its delivery costs so as to lower clients total offshore IT spend. The fact that most Indian vendors have very large (30%-50%) exposure to the financial services sector doesn't help and some vendors have high exposure to clients that are reducing headcount materially. BT Group PLC (BT), which recently announced a 10,000-person lay-off, is the largest single client of Infosys.

Similarly, Credit Suisse (CS), with a major lay-off in sight recently, is a client of Wipro, Cognizant, Patni (PTI - Hold) and Satyam (SAY - Hold). Many of the outsourcing advisory firms (which advise large enterprises on their deals with the offshore and domestic outsourcing vendors) are also reducing headcount and looking for strategic combinations. All of these do not point to a bullish scenario.

Based on the recent relationship between currency shifts and the adjustments to the company's revenue guidance, it is expected that the currency shifts since mid-October are likely to reduce the dollar-denominated reported revenue growth rate for INFY in the coming quarters by a further 3%. This currency shift alone would therefore reduce the midpoint of the company's growth guidance to 7.5% for the December 2008 quarter and to 1.8% for the March 2009 quarter.

CONCLUSION

We are supportive of a long-term bull case on Infosys, Cognizant and the shares of the other Indian outsourcing vendors. However, the prevailing argument leans towards a dismal scenario for a few more quarters, with a counter-cyclical recovery in offshore IT spending by late-2009 and return to 20%-30% growth rates by 2010.

Assuming they can hold margins relatively constant, investors today appear to have the opportunity to acquire 20%-30% earnings growth for a below-market P/E multiple of 10x.

There are a few counter-points to this argument: (a) given that the core Indian software services companies are at a mature stage, the prospects of a recovery to 20%-30% growth is questionable. Client penetration rates for these companies are already high in the mature industries such as banking, insurance and telecommunications and core offshore ADM services have become increasingly commoditized. (b) Industry pricing pressure and a flat or appreciating rupee could act as a counter to the stable margin assumption. (c) From an investment timing perspective, we see no rush to rating upgrades when the stocks of Infosys and its Indian peers are trading at (not below) the same P/E multiples of many other high quality technology companies.

Clearly, a trough is not yet in sight and companies are more likely to lower their guidance. Also, sell-side estimates are still too high, in our opinion, and may be curtailed as we move forward.

At least, over the long term.

Let's start with John Bogle. (Doesn't it always start with John Bogle?)

Judging by the series of interviews he's been giving lately, Bogle is very worried about the U.S. economy. As he said in an interview with Forbes today (highlighted by Murray Coleman in our invaluable new daily news roundup), "it will be a year-and-a-half to two years before [the U.S. economy] turns upward."

That doesn't mean investors should be sitting on the sidelines. Far from it. Bogle says the market may be undervalued by about $7.5 trillion right now, and thinks that the market has likely over-discounted the impending recession.

Bogle's not alone. In the forthcoming January/February issue of the Journal of Indexes, Rick Ferri (a great financial advisor) calls this "the greatest opportunity in our lifetime" for young and middle-age Americans to "set [them]selves up for retirement." Buy now, he says, and in 10 years you will be very happy.

David Kotok of Cumberland Advisors is even more bullish, saying markets could "gap" higher in 2009, and warning that investors who aren't in now will find themselves chasing a market that may have already moved much higher.

The list goes on: Wharton professor and WisdomTree advisor Jeremy Siegel thinks stocks are "dead cheap"; Larry Swedroe thinks stocks will recover; even PIMCO's Bill Gross is turning positive.

What separates all these analysts from the parade of negative voices filling CNBC, TheStreet.com and similar properties is that they are focused on the long haul. And from that perspective, understanding the market is easy.

I have no idea where the market will be three or six months from now. But 10 years from now, do you really think the Dow will be trading at 8,000? I sure don't.

Here's a thought: About a year ago, when the Dow was trading at 12,500, I bet our executive vice president Don Friedman $100 that the Dow would fall below 10,000 before it hit 15,000; in other words, that it would fall 2,500 points before it rose 2,500. I was worried by the failure of Bear Stearns and what it meant for the economy.

Right now, I'd make a similar bet, but on the upside. I'd bet $100 that the Dow will hit 10,000 before it hits 6,000; in other words, that it will rise 2,000 points before it falls 2,000.

How many people would take the opposite side of that bet?

• World stock markets tumbled Thursday, with benchmarks in Tokyo and Seoul losing almost 7 percent each. (AP)
• Five years after Federal Reserve Chairman Ben S. Bernanke helped stamp out the risk of deflation, the threat is returning as the financial crisis and a worsening economic slump pull inflation lower. (Bloomberg)
• The RBA said in a monthly bulletin today that it bought A$3.15 billion ($2 billion) of its own currency last month, the biggest net purchase on record, as the local dollar posted a record monthly decline.

• U.S. options trading slowed this month from a record pace after hedge funds collapsed and the biggest market swings since 1929 made equity derivatives too expensive to be used as insurance against stock losses. (Bloomberg)
Key Reports (WSJ):
8:30a.m. Initial Jobless Claims For Nov 18 Week: Expected: -11K. Previous: +32K.
10:00a.m. Oct Conference Board Leading Indicators: Expected: -0.6%. Previous: -0.3%
10:00a.m. Nov Philadelphia Fed Business Index: Expected: -38. Previous: -37.5.
10:00a.m. DJ-BTMU Business Barometer For Nov 8: Previous: -0.7%.

Quotable
“Early in life I had noticed that no event is ever correctly reported in a newspaper.”

  George Orwell

Best of CC: Below is a reprint of our 9 July 2008 Currency Currents where we examined the break down in the correlation between oil and the dollar—it was telling us something as we suspected.  It’s another example of why we pay close attention to intermarket correlations; it can be a very powerful tool for currency traders. 

FX Trading – $ vs. Crude…Hmmm! (9 July 2008 Issue)
Can we continue to hang our hat on the view that much of the bad news is already in the price of the dollar?  Well, based on the dismal views about the US economy, which we don’t dispute, which we seem to find everywhere we look, the short answer is yes.  But it’s not just that belief.  Something seems to have changed—though even this is a thin reed of reasoning we grant you.

Back in mid-April the US dollar index made its closing low (and its all-time low in mid-March, the day the Fed saved Bear Stearns).  At the time, crude oil was trading at $116 per barrel (heck, downright cheap in retrospect…LOL).  By now of course, everyone had caught on to the crude-$ connection that says the dollar goes lower when oil goes higher.  But, the problem with this new theory is that crude oil has rallied about $29 since mid-April, or a cool 25%!  However, the US $ index has rallied too—up 2%! 

Based on the crude-$ connection, that wasn’t supposed to happen. 

Chronology of key players’ recent trips to the Middle East (read Saudi Arabia):

• Vice President Dick Cheney – Mid-March
• President George Bush – Mid-May
• Treasury Secretary Hank Paulson – Late-May and Early-June

And on June 1, 2008 this from Reuters:

ABU DHABI (Reuters) - Treasury Secretary Henry Paulson said on Sunday leaders of Gulf oil producing states had told him that abandoning their currency pegs to the dollar will not solve their inflation problems.
Paulson, two-thirds of the way through a four-day trip to Saudi Arabia, Qatar and the United Arab Emirates, said leaders in the region have "quite an awareness that the peg does not influence inflation to a significant degree.
"They recognize that inflation is the overriding issue ... Ending the peg is not the solution to the inflation problem."

Hmmm…

Is it possible the Gulf States were treated to a litany of promises that the dollar was nearing a bottom and now is not the time to abandon said dollar pegs?  Again, we have no clue. But, it would be a nice fit with the ongoing lack of correlation between all-time highs in crude and the $ index cautiously trending higher.

Stranger things have happened.  Stay tuned. 

Regards,
Jack&JR

“We shouldn’t worry about the deficit next year or even the year after,” the U.S. president-elect Barack Obama said on 60 Minutes over the weekend.

We were afraid that Barack’s message of “change you can believe in” was going to make it harder to take issue with politics as usual in Washington. But now we see he already drank the Kool-Aid and we…

- Here’s the breakdown, from CreditSights, a research firm in New York and London, as reported in Forbes magazine.

The Fed

• $1 trillion in overnight or short-term loans since March to primary dealers through its emergency discount window*
• $1.8 trillion in loans to primary dealers through the Fed’s term auction facility since in January*
• $29 billion in Bear Stearns debt
• $60 billion of credit available to American International Group
• $22.5 billion to set up…

HA! Had you there for a minute! The dollar rallied once again, when the deep, dark, dangerous clouds returned, and the risk takers…

The Select Sector SPDR - Financials (NYSEArca: XLF) closed today at $13.80/share, just 62 cents above its all-time low of $13.18/share, set on October 27. It's now down 16% in the past four trading sessions, and is trading right about where it stood on October 7, when the U.S. House refused to pass the initial bailout package and many Americans (including me) thought another Great Depression was on its way.

Meanwhile, the news from the sector is unremittingly bleak.  The Feds have had to nearly double the size of the AIG bailout, from $84 billion to $153 billion. If you're doing the math, that is $500 for every man, woman and child in the U.S. I say we just give them $1 trillion and be done with it.

Of course, it's not just AIG. Fannie Mae reported a loss this week of $13/share for the third quarter, which is quite impressive when you consider the stock only trades for $0.72/share. Fannie says it might have to tap into the Fed's $100 billion "lifeline."

Even Goldman Sachs and Citigroup, two relatively strong companies, are at trading at multi-year lows. Citigroup's shares now down 80% over the past year and trading well below the levels they were at during the worst of the credit crisis; some people think it's on the ropes.

All that has me nervous. The credit crisis seems to have hit us in waves.  The Bear Stearns blow-up in March was the first big wave, followed by a mini-panic in July, and then capped off by the debacle of September and October. Now, things feel calm again, but the persistent and rapid decline in XLF is worrisome.

Or perhaps, it's an opportunity. Throughout the crisis, I've been monitoring the TED Spread as the key "tell" on the level of concern among bankers. The TED Spread measures the willingness of banks to lend money to one another. It shot up in September and October from approximately 1% to 4.65%, an all-time high, as the credit markets froze up. To give you a feeling for how absurd 4.65% is, the TED Spread's previous peak was just 3%, set on Black Monday in 1987.

But once the bailouts were in place, the TED Spread started to fall ... tentatively at first, and then quickly.  Throughout October, it continued down, down, down. Today, I believe, was the 22^nd consecutive day that the TED spread has shrunk. It now stands at just 1.81%. That is still extremely elevated on a historical basis---the long-term average is something like 0.30%---but it's back in the range we lived with for most of 2007 and 2008, and well off its panic high

As long as that TED spread keeps quieting down, it tells you that the institutional money is getting more comfortable, and that suggests things will turn out OK.

Then again, wasn't it that institutional money that got us into this mess in the first place?  Maybe it is time to panic again...

Well… We might as well get right into this… I’m sure you heard that the Jobs Jamboree was awful on Friday. UGH! Jobs are dropping like the temperatures outside, and there doesn’t seem to be anything to stop them from dropping either! For the record… October’s jobs losses were worse than expected (-200K) and came in at -240K… OUCH! But the real kicker, something the mass media might not have covered, was found in the September revision… Recall that September’s Jobs data showed a negative -159K… Well, that number was revised to -284K! Double OUCH!

I would…