Here is a comparison that illustrates the value of Cisco’s business: Apple (AAPL) – which arguably makes better personal computing products (Mac/iPad vs. PC), better smart phones (iPhone vs. other smart phones), and better music products (iPod/iTunes vs. conventional MP3s) than its competitors – may have what large groups of people want.  But Cisco has what large groups of people need.  If all of Apple’s products disappeared spontaneously from the face of the Earth tomorrow, there would be a lot of disgruntled people lining up to buy competing products to make do.  If Cisco’s products spontaneously evaporated, cities, countries, and companies all over the world would suddenly slip into IT darkness.

Still, Cisco’s stock has not been a star since the tech bubble burst in 2000-2001.  In the low $20’s ($22.05 at market close on August 17), Cisco is basically priced in the middle of its trading range for the last nine years even though its 2009 earnings per share (EPS) for the year of the financial crisis were 4.2 times its 2002 EPS.

Given the above, the investment case for Cisco is in my view intertwined with four particular reasons for downward pressure on the stock.  These are:

1)    No M&A premium. Lots of stocks benefit from an ongoing sugar high of takeover rumors that keep the price up.  Cisco isn’t one of them.  Given the dominant position and ultra large cap value of the company, including almost $40 billion in liquid reserves,² it’s hard to imagine a scenario where anyone could buy Cisco out.

2)    No dividends. Cisco is the only Dow component that does not pay dividends. ³ Consequently, many portfolios will not hold Cisco no matter how good the investment thesis, reducing demand for the stock.  This is especially true at a time of post-financial crisis uncertainty, when investors are biased towards the perceived security of holdings that pay cash dividends in real time, and also make up for lost interest income due to near-zero interest rates.

3)    Residual fear over tech bubble losses. On March 27, 2000, Cisco’s stock hit an all time high of $82 a share, and the firm was billed as climbing to a $1 trillion market capitalization. ⁴ By October 8, 2002, after losing a substantial portion of its customer base when the dot-com bubble burst, it fell as low as $8.12.⁵  This history provides a psychological barrier to big jumps in the stock price.

4)    General post-financial crisis fears about the economy and markets.

The first point is not likely to change anytime soon, though it’s a good point for understanding why Cisco stock may not make big moves when others do.  The second, third and fourth, however, may change over the next few years.

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1. Cisco’s fiscal year ends on July 31, while Juniper’s ends on Dec. 31, though the comparison roughly holds for previous years.
2. See Cisco’s form 8-K filed August 11, 2010, available at http://investor.cisco.com/sec.cfm?NavSection=SEC.
3. See Wall Street Journal Data Center at http://online.wsj.com/mdc/public/page/2_3024-dowyield.html.
4. “Firm’s market cap climbing to $1 trillion,” March 17, 2000, San Jose Business Journal, available at http://sanjose.bizjournals.com/sanjose/stories/2000/03/20/story2.html.
5. See Financial Accounting Case Study: Cisco Systems, Universitat Pompeu Fabra (UPF) MBA program, December 11, 2003, available at http://www.econ.upf.edu/docs/case_studies/42.pdf, for a good summary and discussion of Cisco’s history through the tech bubble.

The news has initially sent shock waves about the stock with the price falling to close at $41.85 on August 6 when Hurd’s resignation was announced, losing 9.7% of its value from the previous day’s close at $46.35.¹  But there are reasons why this drop may be an overreaction:

• Hurd has a history of creating a foundation for value that outlasts his presence.  NCR (NCR) continued to flourish after he departed as CEO, with its stock price rising from $18.27 on March 28, 2005, the day before the announcement that he was moving to HP, to the mid-$50 in 2007 prior to spinning off Teredata, Corp. (TDC).  While NCR’s shares have recently languished, Teredata’s stock hit an all time high this summer.
• The fact that Hurd and the HP board quickly resolved the situation prior to rumors eroding internal morale and the company’s reputation is a big step towards maintaining internal and external confidence, and minimizing damage.
• HP’s stock was already beaten up, down from a high of $54.75 on April 16 earlier this year.

Hurd’s tenure as HP CEO was, other than the allegations that precipitated his departure, a major success.  But his departure—while a setback—does not pose the same degree of risk for the company and investors as the departure of a CEO whose personality is ingrained in the company, as I and others have argued is the case with Steve Jobs of Apple (AAPL).

Hewlett-Packard’s situation will become clearer as the direction of the search for a new CEO takes shape and CFO Cathie Lesjak takes the reigns as acting CEO in the interim.  But while the post-Hurd aftermath keeps the price down, there’s a good rational to support the risk of buying into HP.

Disclosure: The author is long on Hewlett-Packard (HPQ) as of the original publication date of this post.  The author does not hold a securities position in NCR (NCR), Teredata (TDC), or Apple (AAPL).  The information provided in this post does not constitute professional investment advice, and should only be used in consonance with all available information, including the opinion of a professional adviser, to make an investment decision.

1. There is some confusion over HP’s August 6 closing price, and it seems that the $41.85 indicated by major services as the market close reflects after hours trading following the announcement on Hurd’s resignation after 4 pm.  See “HP Stock Price on Electronic Exchange Direct Edge Lowered Closing Quote,” Nick Baker & Nina Mehta, Bloomberg, August 8, 2010, at http://www.bloomberg.com/news/2010-08-09/hp-s-stock-price-on-electronic-exchange-direct-edge-lowered-closing-quote.html.

I’m sure that the crews working to fix the current power outage in the Washington area that has cut off electricity for hundreds of thousands of people – mostly in Montgomery County, Maryland – are working tirelessly, and making progress.  But what’s absolutely clear is that Pepco’s public communications effort has been terrible.

Twenty-five hours into the crisis, Pepco only published a news release outlining its progress or explaining the recovery process in any degree of detail in the last few hours. ¹  The last release was posted last night. ²  Pepco essentially went most of the business day immediately after the crisis without posting anything outlining what happened.  And its web site even went down this morning. ³

Obviously, the priority is for the Washington area to get back up safely.  But as the questions mount on the adequacy of its communications during the crisis,⁴, it’s important that Pepco not forget and make good use of the lessons learned.

1. http://www.pepco.com/welcome/news/releases/archives/2010/article.aspx?cid=1478.
2. http://www.pepco.com/welcome/news/releases/archives/2010/article.aspx?cid=1476.
3. http://voices.washingtonpost.com/local-breaking-news/dc/pepco-problems-force-website-d.html.
4. see http://www.washingtonexaminer.com/breaking/fenty-frustrated-with-pepco-storm-response-99260414.html.

An oft-heard criticism of government administration in the U.S. is that too many people stay in government jobs for too long, causing workers to become stale and lose perspective, and impeding advancement for top performers trying to work their way up the ranks.  Large pensions may be one of the roots of the cause.  Workers who long ago gave up hope for further advancement or lost job satisfaction associated with serving the community stay in jobs despite dissatisfaction just to wait for their pension rights to vest.

Moreover, indirect effects of public sector pensions may also impede some brave enough to forgo prospective retirement benefits by leaving government service in mid-career.  Because the economic incentive is to stay, those who wish to venture out may find a dearth of former public employees in parts of the private sector they want to transition to because nobody else has tried to leave, making it hard to network to start a new private sector career.

This is not to say that government retirement benefits should be axed.  Secure retirements are often one of the benefits used to attract quality workers to government jobs when political constraints make it hard to offer salaries competitive with private sector peers.  Moreover, for some public functions where the physical demands of the job protect public safety—like law enforcement and firefighters—it makes sense to allow some kind of early retirement so those who do not enter the management ranks or acclimate to other desk functions can start second careers.

Pensions can and should be part of the compensation offered to address these policies.  But programs that create too much of an incentive to keep workers with the government through retirement age should be scrutinized.  Hybrid retirement programs that include a portable retirement savings account that employees can take with them when they choose to leave public service are a step in the right direction.

1. “States Shift to Hybrid Pensions, Wall Street Journal, July 10-11, 2010, B1 & B4.

The immediate cause of the delay in passage is that Democrats are concentrated on getting landmark financial reform legislation passed, a task complicated by the death of Sen. Robert Byrd.  Democrats still control both houses of Congress and with two huge policy initiatives behind them – health care and financial reform – it’s fair to think that they can somehow nail down the unemployment insurance extension.

But the political winds are likely to shift in November.  The party in power usually loses congressional seats in a mid-term election, and with the recession continuing through the first half of this presidential term, Republicans are well positioned to pick up seats. ²  However, given the difficulty Democrats are having in passing the extension of unemployment benefits with a majority of over 58% in both houses, it’s hard to imagine further extensions passing in their current form after the elections even if Democrats maintain a slimmer majority in both houses.

What this means for investors is another source of turbulence.  It’s not clear whether curtailing benefits will ultimately hurt or help the big picture.  Curtailing benefits would remove needed cash from the economy and cause many individuals and families to slip deeper into distress, some into welfare programs.  It’s also possible that it could prompt some results that eventually contribute to stability, pushing: 1) laid off workers who have been holding out for a job like their last to return to work for a lower-tier position; 2) households where both spouses worked but one was laid off to permanently adjust to a single income lifestyle; and 3) unemployed workers with the resources to retire to leave the workforce.  But any process where positive results like these come to fruition would likely be protracted.

So expect the coming months to include a political process sorting out the future of unemployment benefits, and an economic process where the real-life consequences play out.  In short, a lot of unknowns.

1. House passes unemployment benefits extension, CNNMoney.com, July 1, 2010, http://money.cnn.com/2010/07/01/news/economy/unemployment_benefits_extension/index.htm?hpt=T2.
2. See Generic Congressional Ballot, Rasmussen Reports, June 28, 2010, http://www.rasmussenreports.com/public_content/politics/mood_of_america/generic_congressional_ballot.

It’s true that the potential for deflation probably was underestimated in some quarters.  Conventional wisdom said that mortgage rates would rise earlier this year after the Federal Reserve ended its mortgage‑bond purchase program.  Instead they have fallen to an all-time low, reflecting a decrease in the cost of borrowing on top of the collapse of home prices.  Weak energy and commodity prices have also caught some financial superstars, like energy trader Andrew Hall, off guard. ¹

But over the long term, strong forces can be expected to counter deflation in the United States.  Though I continue to believe that hyperinflation is not a likely outcome in the U.S. for the foreseeable future, the sheer size of the U.S. budget deficit provides a check to deflation through the regular inflationary pressure of printing money.  Unlike the deflation of the Great Depression-where demand cratered worldwide-emerging economies in Asia will support the price levels of globally traded goods.  Even if this has been slow to restart in some ways, today’s lower prices may just allow emerging nations to develop infrastructure and expectations of the good life faster, increasing their demand up the line.

Japanese-style deflation is also not likely to translate to the U.S.  Japan borrows over 90% of its debt from domestic investors willing to accept low interest payments. ²  Since 2009, the U.S. has borrowed more from abroad than home, exposing the U.S. to the prospect of foreign investors eventually demanding higher interest rates. ³  In turn, the Federal Reserve would likely charge U.S. banks more to borrow, which banks would pass on to businesses and consumers by raising their interest rates, ultimately raising prices.

That’s not to say that all is well, but just that the dysfunction that could impede a robust recovery is not macroeconomic.  In other words, right now inflationary or deflationary pressures are more of a symptom than a cause of the real challenges, and the Federal Reserve’s current monetary policy is apparently not doing anything to aggravate either one of them.  Arguably, the real long-term question for the U.S. economy is the aggregate of many smaller microeconomic questions:  Are American businesses making products that can beat out foreign competition both domestically and abroad, generating profits that create U.S. jobs.  When the financial crisis broke, the strongest U.S. sector relative to foreign competitors was investment banking-now three of the five big independent players in that sandbox are gone, with Goldman Sachs (GS) and Morgan Stanley (GS) the lone survivors.

This means that investors who dump their assets into long-term low interest rate Treasuries to guard against deflation risk being disappointed.  But the shocks that the equity markets have absorbed since 2008 also mean that positive sentiment is less likely to spill over to the share prices of “weak sisters,” companies in sectors with strong demand that are doing well because of a windfall rather than good management.  If this holds true, the broader markets may find it harder to sustain the rapid upswings of the pre-2008 era, but long-term investors who are able to pick well-run companies before their demand upswing can do well.

Disclosure: The author does not hold a securities position in Goldman Sachs (GS), Moody’s (MCO), or Morgan Stanley (MS).

1. “Commodities Star Absorbs Loss,” Gregory Zuckerman, Wall Street Journal, June 25, 2010, http://online.wsj.com/article/SB10001424052748704227304575327252693597316.html.
2. “Japan’s Deficit May Spark Next Sovereign Debt Crisis, Kusano Global Says,” Yasuhiko Seki & Yumi Ikeda, Bloomberg.com, June 3, 2010, http://www.bloomberg.com/news/2010-06-04/new-leader-must-address-deficit-to-avert-debt-crisis-kusano-global-says.html; “How Far Can Aaa Governments Stretch Their Balance Sheets?,” Moody’s (MCO), February 2009, p. 12, http://www.docstoc.com/docs/4808646/Moodys-How-Far-Can-Aaa-Governments-Stretch-Their-Balance-Sheets-February-2009.
3. See “Foreign Ownership of U.S. Debt Continues to Grow,” Veronique de Rugy, Mercatus Center, George Washington University, April 5, 2010, http://mercatus.org/publication/foreign-ownership-us-debt-continues-grow.

It’s an age old question:  Do government payouts to help those in a fix give the helping hand that helps people stand on their own two feet, or provide an incentive not to help one’s self?  Obviously every individual situation is different, and no doubt many who receive unemployment compensation work hard to land a new job, and the benefits help meet critical family needs in the interim.  But it can also be argued that for some, benefits will be a crutch that saturates motivation to pound the pavement.

The program that Congress did not extend provided up to 99 weeks of benefits—almost two years—and its expiry may end benefits to 1.3 million Americans. ¹   The wisdom of letting this happen can be reasonably disputed.  Some will argue that ending benefits risks upsetting the delicate recovery process, others will say that this is the push needed to get people back to work.

The fact that the Obama administration was not able to push this through Congress when both the House and Senate are controlled by Democrats may reflect that even those in more liberal quarters are becoming exhausted with the expansion of government benefits and deficit growth.  However, failure to pass the legislation may also be due to the fact that the administration has used so much of its political capital to win passage of the health care legislation (now the Patient Protection and Affordable Care Act (PPACA)) and advance the financial reform bill that it simply lacked the pull to extend the unemployment benefits.

Regardless of the why the bill died, expect economists and other market commentators to increasingly focus on the question of how the ending this program will affect the employment numbers as new jobs reports come in.

1. “Jobless Bill Dies Amid Deficit Fears,” Gregg Hitt & Sara Murray, Wall Street Journal, p. A1, A2, June 25, 2010.

• Now is generally a good time for U.S. investors and others with portfolios heavy on U.S. equities to consider diversifying by adding holdings in European shares while the Euro is still near multi-year lows, though this should be done carefully to avoid companies heavily impacted if there is a protracted European recession.
• The bulk of what ING needs to do to make amends for the state aid received from the Dutch government during the peak of the financial crisis has likely already been revealed, including splitting its banking and insurance business and selling the ING Direct U.S. operation.¹
• It’s fair to expect that the European Commission will be reasonably flexible in dealing with ING going forward because the current European debt crisis is largely a struggle for the wealthier Northern European nations to save more debt-laden Southern members, making the players reluctant to overly burden the economies of Northern states like the Netherlands.
• When divestments and special items are subtracted, ING made € 0.27 per share in the first quarter of 2010,², which using an exchange rate of 1.24 (approximately the rate at this writing) rounds to $ 0.33 per share.  Just sustaining those earnings over a year would produce a P/E ratio of 6.32 at current share levels, supporting a higher share price even if the Euro stays in the same place against the dollar.
• Intangibles also weigh in ING’s favor.  The company has been very successful in marketing its highly regarded ING Direct savings account,³ and even if it the company does eventually sell ING Direct by 2013 as currently expected to meet the Commission’s requirements,⁴ it should command a good price.

Finding exactly the optimal time to buy is always a challenge—there may still be dips below $8 given the volatility of the current European situation but waiting for a perfect situation for too long may result in a good one being be missed.  I also think that those who can hold out for the long haul with ING will do best, as many of the key events that will add value, like reviving dividends and selling ING Direct, may not happen for a few years.

Disclosure: The author is long on ING ADR’s (ING) and ING 6.2 % preferred perpetual securities (ISP).

1. See “ING to separate banking and insurance operations,” October 26, 2009, at http://www.ing.com/group/showdoc.jsp?docid=417610_EN&menopt=prm|pre|apr|010.
2. See ING Group Quarterly Report, published May 12, 2010, available at http://www.ing.com/group/showdoc.jsp?htmlid=419558_EN&menopt=ivr|qtr|qtr.
3. For an assessment of ING Direct, see “ING Direct Review,” Bargaineering.com, at http://www.bargaineering.com/articles/ing-direct-review.html.
4. “EU Forces ING To Sell Off ING Direct US By 2013,” October 27, 2009, at http://www.mybanktracker.com/bank-news/2009/10/27/eu-forces-ing-to-sell-off-ing-direct-us-by-2013/.

The White House has said that President Obama wants the financial reform legislation passed by the July 4 weekend.  The Democrats need to step up the pressure on the bill, so whether or not it’s eventually passed on that timetable expect that markets will be shaken at times over the next couple of weeks as different stories on the legislation break.

1. http://www.cnbc.com/id/37646351.

New earned income in the pockets of nearly half a million people is still good news, and dollars spent by government workers are just as green as private sector employees.  So a big question for the week is whether economic data will show that demand from the hiring is stimulating private sector job growth.

A theme that may take on greater relevance as the job recovery takes shape is the question of who is getting hired.  The United States needs to add 100,000 to 125,000 jobs each month just to keep the unemployment rate from rising due to people who join the workforce, such as recent graduates and immigrants.¹  If most newly hired workers are heads of household with a mortgage, the job recovery may be further along than it seems.  But if recent grads are getting the jobs while family breadwinners are still pounding the pavement, the situation may be more stagnant than hoped.

The point here:  The negative sentiment created by the May jobs numbers could still be overcome by economic data or opinion indicating a real rise in demand and reduction of non-performing mortgages, which could jumpstart private sector job growth.  We’ll see.

1. See, e.g., Justin LaHart, “Jobless rate Rises to 8.9% But Pace of Losses Eases,” Wall Street Journal Online, May 29, 2009, http://online.wsj.com/article/SB124178530342200595.html.