The report states that semiconductor consumption in the Chinese market, driven by growth in electronics manufacturing, continues to outrun the rest of the world. Since the industry put a bottom from the last semiconductor business cycle in 2001, China’s semiconductor consumption market has grown at a 31.5% compounded annual growth rate [CAGR] compared to a worldwide market CAGR of only 10.6%.

In fiscal 2007 China’s semiconductor consumption grew by 23% to reach $88 billion, representing 34.4% of the worldwide semiconductor market. In contrast, the worldwide market grew by only 9% in fiscal 2006 and 3% in fiscal ‘07. China consumed for the first time last year more than a third of the chips produced globally.

“Semiconductor consumption in the Chinese market is growing at a faster pace than what the industry anticipated,” said in a statement Mr. Raman Chitkara, global semiconductor leader at PricewaterhouseCoopers.

China’s consumption of semiconductors now exceeds the markets in Japan, North America, Europe and the rest of the world for the third consecutive year. However, the Chinese semiconductor industry, notes the report - remains widely scattered with no dominant players. This will most likely change within the next five years, as the Chinese semiconductor industry further matures and creates the right conditions for the emergence of a dominant player in the market.

The largest suppliers to the Chinese market continue to be the multinational semiconductor companies. Still, 32 of the top 70 suppliers to the worldwide semiconductor market in 2007, remain below average in terms of market penetration in China, the fastest growing semiconductor market in the world.

“Over the near term, established multinational semiconductor companies may find an unparalleled market opportunity in China, but over the long term the widening gap between consumption and production of semiconductors represents a domestic industry void that will inevitably be filled,” Chitkara said.

A recent analysis by the China Semiconductor Industry Association pointed out that China’s semiconductor industry grew only 1.1% in the third quarter of 2008, the slowest rate on record. While further slowing is expected, forecasts for China’s growth rate still exceed the worldwide rate by at least 50% for the remainder of this decade.

What happened to all the money? About a third has gone into dividends the banks are paying their shareholders. Some of the rest into executive salaries and bonuses. Another portion toward acquisitions designed to raise share values. Another chunk for bailing out giant insurer, AIG.

That’s not what taxpayers bargained for. Paulson originally told Congress he’d use the money to buy mortgage-backed securities that were clogging the financial system. He’d create a market for them by holding a kind of reverse auction, buying them from the banks at the lowest prices they’d be willing to sell them for.

But Paulson has abandoned that strategy and is now just handing the money directly to the big banks, and AIG — all of which are using the money for their own purposes. It’s the worst type of trickle-down economics. Taxpayers are sending the money upward, and almost none of it is trickling back down.

The lame-duck Congress should amend the so-called Troubled Asset Relief Program to prohibit banks that are receiving the money from paying dividends, executive bonuses or deferred compensation, or doing acquisitions.

And Congress should save the rest of the $700 billion program for a new administration that will put it to better uses. For example, as FDIC Chair Sheila Bair has suggested, use the money to guarantee payment of mortgages whose terms are eased by lenders. Use it also to restructure automobile companies whose creditors, executives, shareholders, and workers agree to put up money as well. Use it to guarantee loans made to credit-worthy small businesses, college students, car buyers, and others who at this moment cannot get credit — and who therefore cannot keep this economy moving forward.

In other words, use it for a bottom-up bailout, rather than trickle down.

Transitive has a diverse range of computing platforms, from desktop systems and high-performance workstations, to enterprise servers and a variety of OEM equipment. The co.’s OEM customers have included Apple (AAPL), IBM and Silicon Graphics. Transitive’s technology is currently included as part of the IBM PowerVMTM software which is designed for customers to consolidate their x86 Linux workloads onto IBM Systems.

This acquisition is part of IBM’s strategy to help clients optimize the efficiency and productivity of their computing infrastructure and improve the utilization of the servers that run them.

With this translation technology, along with existing migration capabilities, IBM systems give businesses a faster, easier path for server consolidation to reduce operational expenses, floorspace and energy costs.

Transitive’s breakthrough technology has earned the company more than 70 worldwide patents and numerous industry awards and accolades.

Transitive Corporation has a research and development team in Manchester, UK. The company was founded in 2000 as the vehicle to develop the QuickTransit technology for the commercial market. It receives funding from Pond Venture Partners Ltd., Manchester Technology Fund, Crescendo Ventures, Accel Partners and Meritech Capital Partners.

Financial terms of the acquisition were not disclosed.

Fixed income arbitrage is, at its core, fairly simple. Start with a bond that yields x% (over and above some hedge in some cases), assume one can borrow y% of the par amount at a cost of z%. If the math of all that works out to a reasonable IRR on the residual, the arbitrage works.

These arbitrage accounts were the marginal buyers in the fixed income markets. As long as the arbitrage remained attractive, yields (or yield spreads) would remain within a narrow band. When an investor wanted to sell a bond, even if there was no long-term buyer at the ready, arbitragers would step in and provide liquidity. In this way, leveraged buyers were ensuring that the market remained efficient. Spreads would only meaningfully widen when credit risk increased.

We know it went too far. CDO^2 and SIVs were the most obscene examples. But even reasonable arbitrage strategies, like TOBs and CLOs became too large as a group. They stopped just being the marginal buyer and became the whole market.

That marginal buyer is gone, and isn’t likely to come back any time in the foreseeable future. Admittedly, it isn’t as though leverage is being pushed to zero in the fixed income markets, but haircuts (i.e., the amount of margin that must be posted) are now such that levered buyers cannot force efficiency. Take something simple like Fannie Mae 5-year bullet bonds. Should have a very small spread versus Treasuries given the government backing of the GSEs, but instead the spread is currently around 1.45%. It seems like an arbitrage.

But in order for an actual arbitrager to realize a decent IRR on the trade, it probably needs to be leveraged 20x or so. Now maybe one can actually get that amount of leverage versus Agency collateral, but what happens if the trade initially goes against you? The potential margin calls would kill you. Its a difficult arbitrage to actually realize.

The consequences for investors are far reaching. First, bonds will be permanently less liquid. Dealers will be going away from making money via bond arbitrage and go back to making money on transaction flow. In order for that to be viable, the bid/ask spread is going to have to stay much wider than in 2006. Odds are good that trading volumes will also remain much lower than was the case in 2006.

Second, yield spreads will probably remain more volatile than in years past. This is because real money buyers, like mutual funds and banks, will become the marginal buyer of bonds. The technicals of real money demand will suddenly become much more important in determining short-term spread movements.

Third, new debt issues will need to have a greater concession to secondary trading in order to get sold. Take a look at Thursday’s 30-year Treasury auction to see what I mean. Primary dealers aren’t able to keep Treasury auctions orderly in a world where Treasuries in general are in hot demand. The result? The 30-year Treasury priced about 2.5% lower in price than where it was trading the previous day. By Friday morning, it had regained all that it had lost. The same thing will happen to new issue corporate, municipal, and even agency bonds of large size.

In the short term, what should investors consider in bonds? If banks, mutual funds, and other long-term investors are going to be the new marginal buyers, buy what they are going to want. That is high quality, high yielding bonds. This means longer-term or bonds with option risk, such as callable agencies, municipals, and agency mortgage-backed securities.

Finally, if liquidity is going to remain challenging, buy bonds you are comfortable owning for the long-term. If you do buy a corporate bond, assume that it will cost you 3-5% of the bond’s value to sell at short notice.

This leads to some meaty theoretical stuff and I certainly don’t have all the answers. By now you should have figured out whether you think 40-50% down will be about it or more like 80% is it (just picking two extremes you can think of it however you want).

I said weeks ago that if you really thought this was the great depression coming at us again you should sell. That probably still stands up now. If you do not think down 80% is in the cards then selling now would simply be selling low, very low.

Anyone reading this site for a while knows I do not think this will be a depression, I think the bottom is about in in terms of price but that we will have several more months of running up and down in roughly the same range we have been in recently.

If that pans out as I think then it will be a long time before we start to feel good about stocks. Individual issues could continue to get pasted even if the market doesn’t do anything very different for a while.

That brings up a useful distinction; “what should investors be doing now?” Any buying someone might be inclined to do now can try to do one of two things (talking about long term investors not traders) either buy stocks that you think will work now or buy stocks that you think reposition for whenever the turn up finally occurs.

Buying the stocks that should work now is likely not the way to go because really what is working now (this gets at the heart of top down)? Pretty much nothing is working now. Buying something now as a place to hide out is the wrong strategy. When the market turns just about everything still standing will work as was the case in 2003. In that light it makes more sense to point any buying you are inclined to do toward the recovery even if that is a couple of years from now.

This is not a call to buy them with both hands, I am not doing that. I disclosed having done a little buying and having plenty of cash still. The names I’ve bought are places I expect to lead a recovery or otherwise snap back quickly.

This idea concedes that a recovery could still be a long way off but going overweight health, telecom and staples now seems late in the game. I’ve been overweight those areas for a while and generally it has been right, relatively, but now that we are down 45% from the peak I’d say it’s too late to overweight those areas.

At this point, however, Macro Man is refraining from embracing the downdraft with both arms. There have been too many intraday reversals to make him comfortable; while that may be a precondition for the next leg lower, the burden of proof is on the index to close lower. Sometimes looking at a simple line chart can provide insight; as the graph below demonstrates, the SPX has yet to close meaningfully below 850 despite plenty of intraday action below that level. A close anywhere near current futures prices (834) would therefore be significant.

There is a similar pattern in currencies, where EUR/USD, for example, has been confined between 1.25 and 1.30 on a New York closing basis, despite plenty of price action on either side of that range. For choice, Macro Man favours a break lower, as his sense is that there remain plenty of embedded overweight, offside euro positions out there.

Perhaps we might need to see vol sellers come out of the woodwork before a break can happen, however. While currencies have been tracing out (admittedly broad) ranges for pretty much all of November, a broad measure of implied currency vol remains near its highs. Markets being markets, this might nEed to come lower before realized volatility can increase again.

Elsewhere, Macro Man had to laugh at a Bloomberg story about one of the Fed’s alphabet soup programs, the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. Incredibly, this program seems to go by the shorthand acronym ABCPMMMFLF, which appears to be less a government liquidity program than the product of wiping spilled coffee off a keyboard.

Clearly, there is a gap in the market for snappily-named government programs. Image, as Andre Agassi used to say in the early 90’s, is everything- and what sort of image does a program called the ABCPMMMFLF convey? “We don’t know what we’re doing“.

What the situation requires is a public-spirited advertising agency to rebrand the dizzying array of government rescue packages in a way that will capture the public’s imagination and boost confidence in the economy and financial markets.

In the absence of such an agency, Macro Man is happy to step into the breach. He has cobbled together a series of programs that should do a much better job of conveying their purpose to the public, and thus restore confidence in policymakers.

The first port of call is to revamp the liquidity and asset support programs. In the Macro Man Program (MMP), there will be two primary facilities:

* The Commercial paper Recovery Assistance Program (CRAP), and
* The Treasury Unsaleable asset Recovery Directive (TURD).

The MMP also provides for two programs that are designed to help banks shore up their financial standing:

* As previewed in this space last month, the Special Capital Raising/Extended Writedown Undertaking (SCREWU) will enable financial institutions to increase their capital base while reducing holdings of dodgy assets.

* Meanwhile, a special accounting framework for structured credit will be instituted until market conditions normalize: the Special CDO Accounting Mechanism (SCAM).

What to do with the GSEs? “Conservatorship” is an ugly word that is difficult to understand. Much better for the government to manage them under the auspices of the:

* Federal Residential Agency Unwinding Directive (FRAUD).

Meanwhile, we should probably assume that Ms. Pelosi’s desire to divert some government funds to the automotive sector will be successful. This will be accomplished via a:

* Automakers’ Recovery and Stability Enhancement (ARSE) program.

Let’s not forget the international efforts at crisis resolution, either.

* The primary outcome of the weekend G20 meeting will be a new Liquidity Enhancement and Modality Origination Network (LEMON). As an aside, Macro Man has thought about it for another 24 hours….and he still doesn’t know what a “modality” is.

* In Europe, where banks are behind the curve in owning up to losses, policymakers are rushing to create a Harmonized European Accounting Directive for Implementing New Standards for Assets and Nonstandard Derivatives (HEADINSAND).

Finally, it is worth observing that amongst the plethora of government programs produced over the last few months, very little has been done to address the original source of the crisis: US homeowners.

In conjunction with consumer advocacy groups, Macro Man has designed a program that seeks to aid troubled homeowners. Congress can expect to see lobbyists agitating for its passage in the new year:

* A Single Home Owners With Mortgages Extended Treasury Home Equity loan Modification with Offsetting New, Equilibrium Yields program. A bit of a mouthful, to be sure, but its acronym is sure to resonate with an irate electorate: SHOWMETHEMONEY.

HP should be very proud of its continued success in a brutal economy, but the company did not stop there. HP offered upbeat guidance for the year ahead, continuing to project per share earnings of $3.88-$4.03 versus First Call’s estimate of $3.85 for the upcoming fiscal year ending October 2009. It is certainly refreshing to see a tech company both having success in the current environment and remaining confident of its future earnings prospects. Most other tech companies are being defensive and just trying to maintain sales and earnings; HP is not satisfied with stasis and believes that it has the ability to outperform its peers in a rough climate. Thus far in Tuesday’s trading its bullishness is contagious and HPQ is trading nearly 11% higher than yesterday’s close.

Time will tell if HP is out over its skies, but for right now it is breath of fresh air for a company to be realistically optimistic. The technology sector has been particularly affected by the market drop, especially in October. Year to date, the S&P 500’s technology component is down close to 50% and Bloomberg’s IT tracking index has fallen to below 12 times earnings, the lowest level since Bloomberg began tracking the sector more than 13 years ago. We at Ockham Research upgraded HPQ following the massive losses in October because the stock was still fundamentally strong but those fundamentals are supporting a much reduced price (down 37% since the start of October). The stock is also cheap compared to what the market has traditionally been willing to pay for given levels of sales and cash flow. For example, HPQ over the last 10 years has sold for .72x to 1.23x revenue per share, but the current price-to-sales is well below that normal range at .65x. Price-to-cash flow is an even wider difference, as the historically normal range is 10.05x to 18.37x but it’s currently only 5.65x.

HP has shown strength while its competitors are flailing. Sales continue to grow and the acquisition of EDS has started to boost its bottom line. Management continues to cut costs, especially in workforce redundancies from the EDS purchase. What’s more, the company is cash rich, which is a highly sought after attribute right now. We are maintaining our Greatly Undervalued rating for HPQ as it is the class of the technology sector. HP’s Chairman and CEO Mark Hurd said it this way:

“Our ability to execute in a challenging marketplace differentiates HP, enabling it to increase share, expand earnings and emerge from the current economic environment as a stronger force.”

• UBS reins in compensation for top executives reports Reuters
• The Charlotte Observer cites Goldman in recognizing pressure is growing for all bank executives to give up their bonuses
• Andrew Cuomo thinks execs at Citigroup should follow Goldman’s lead – New York Post
• How to Sharpen Banks’ Corporate Governance – The Financial Times
• The WSJ discusses United Shareholders of America over the weekend

As for assessing the here and now, it’s clear that the deflationary winds are blowing. Producer prices posted a jaw-dropping 2.8% tumble last month, the Labor Department reports. That’s the deepest monthly decline for this series since the Great Depression, although that’s just an educated guess since the Labor Department’s PPI archive on its web site only has numbers going back to 1947. Since then, last month’s drop is by far the biggest.

Monthly declines in the PPI series are hardly unprecedented, even if the magnitude of last month’s drop is in a class of its own. But that’s not the issue; rather, the economic context of the moment, coupled with a massive price decline in wholesale prices, suggests that an extended bout of deflation may be at hand. Tomorrow brings the October update for consumer prices, and the news is expected to be better, i.e., prices are expected to rise. We’ll see.

Why all the anxiety about the potential onset of deflation? To be blunt, avoiding the Big D is always a priority for policymakers. Typically, the inflationary bias does the heavy lifting on that front, leaving governments to worry about other things. But sometimes the pricing landscape turns upside down. Is such a moment at hand? As always, the future’s unclear, but it may be time to err on the side of caution about deflation’s threat.

Although the prospect of falling prices has obvious appeal for consumers, economically speaking it’s a virus that, if allowed to fester, creates any number of problems. The reason is that if deflation takes root, the normal incentive to buy and borrow takes a holiday, which elevates the odds for economic contraction. The fact that the U.S. is already in recession only makes the additional threat of deflation all the more troubling.
If prices are falling and everyone expects more of the same, the temptation increases for delaying purchases to cash in on future discounts. But the sentiment motivates more of the deflationary momentum, which inspires more deferred consumption. At some point, the trend turns into a deflationary spiral that feeds on itself, and at that point there’s not much anyone can do to pull the economy out of a dire tailspin.

Borrowing and lending in a deflationary environment also suffer since debt servicing becomes increasingly burdensome. The normal inflationary scenario is borrowing in today’s dollars and repaying tomorrow in less-valuable dollars. Under those conditions, there’s a natural appeal for assuming loans. The opposite is true with deflation: the expectation of repayment with dearer dollars creates a disincentive for assuming debt. All the more so since purchases implies buying assets that are likely to decline in value, which is no one’s idea of a savvy business plan. For obvious reasons, this scenario is a disaster for stimulating economic growth.

History is quite clear on those rare occasions when deflation strikes. The two great 20th century examples of deflationary environments—the Great Depression in the 1930s and Japan’s experience for much of the past 18 years—need no explanation for why price declines of any duration must be avoided.

The good news for the moment is that there’s still hope. In today’s news on producer prices, the primary source of the price decline in October came from collapsing commodities, energy in particular. Core PPI, which strips out food and energy, actually rose last month by a rather robust 0.4%, matching September’s gain. Deflation, in other words, hasn’t affected all prices. Therein lies the basis for hope that deflation generally can still be avoided.

Nonetheless, today’s PPI report sends a strong signal that the risk of deflation has jumped substantially. It’s not yet fate, but it could be if policymakers don’t act forcefully and in a timely manner. The risk is real, in contrast to the Fed’s ill-advised deflation fears in 2001-2003. This time it’s the real thing, and the clock may be ticking. Indeed, the recession has only just begun, and so it’s not yet clear how deep and enduring demand destruction overall will be.

Tomorrow’s consumer price update will offer further guidance on the state of the pricing environment. But given the general economic backdrop of fading demand, which feeds deflation’s fires, today’s wholesale price report must be taken a warning sign that the D threat is a real and present danger. If and when deflation has the economy by the throat, the virus becomes far more difficult, if not impossible to contain.

Indeed, the usual monetary levers no longer work in deflation because interest rates can’t be negative even though prices can be. And so the limit imposed by what’s known as the zero bound in monetary policy may be near. The Fed funds rate is already at 1%, meaning that the opportunities for lowering interest rates are constrained. To be sure, the Fed has alternative means of stimulating demand, although it’s unclear how effective such efforts will be, in part because they’re so infrequently used. Deflation, in short, is the exception and so there are few real world examples of fighting the beast.

Once again, let’s remind that it’s not yet clear that deflation is destiny for the U.S. economy, even if the risk has jumped sharply. Much depends on how fiscal and monetary policies unfold in the coming weeks and months. Ditto for the economy. It’s possible that the deflationary risk will pass of its own accord, but for the moment that’s a risk the country can’t afford to take. Better to err on the side of too much stimulus rather than too little.

Yes, there’s a risk that the excess stimulus won’t be pulled back in once the deflation danger has passed. That too is a potential problem that can’t be dismissed. But that’s a battle for another day. Now is the time to prepare for an all-out war on preventing deflation.

TIC Report Explains Dollar Rally

Demand was particularly strong for US Treasuries and equities but foreigners dumped corporate bonds on the fear of default risk. As a testament to China’s rising economic power, they have now surpassed Japan as the largest holder of US debt. In September, increased repatriation led to a net sale of US securities by the Japanese while China accumulated a growing amount of US securities for the third consecutive month. The increase in foreign holdings of US debt helps to explains the dollar’s recent rally because despite higher issuance, demand for US Treasuries remains voracious.

Top 5 Owners of US Treasury Securities

Watch out for Paulson and Bernanke

The strong TIC report and the positive news from the tech sector is helping to fuel a recovery in Dow futures, which is driving the US dollar and Japanese Yen lower. We could see a recovery in carry trades today as long as Bernanke and Paulson don’t rain on the party when they testify on the government’s implementation of the $700B bailout plan before the House Financial Services Committee. This is a big risk since Paulson indicated yesterday that he will be leaving the clean up job for the new Administration. He does not plan on requesting the second half of the $700B bailout plan to leave firepower for Obama’s team. If Paulson continues to wash his hands of this mess, the market may begin to sell off once again, driving carry trades lower on the fear that nothing new will be implemented until Obama takes office. With 8 weeks to go before Bush leaves office, the current Administration is more focused on wrapping things up than starting new initiatives.

Higher Core Prices Will Not Stop the Fed From Easing Rates in December

Headline producer prices saw the largest drop on record, but core prices edged higher. The big drop was hardly a surprise because import prices, a leading indicator for producer prices fell as well. Although the jump in core prices is a bit surprising, lower headline prices should eventually filter into core prices while slowing global demand could naturally drive down prices. Inflation is not a problem and will not stop the Federal Reserve from easing interests again in December.