Archive for the 'China' Category



The Perfectly Written FOMC Statement For Stock Pickers

The concerns supporting a bear view on U.S. indices issues prior to yesterday’s FOMC press release were clear:

1)      “I’m negative on the market because the economy is not recovering.”

2)      “The Fed is killing us by keeping interest rates so low.  Savings accounts are a negative carry, hurting the household.”

3)      “The QE’s were a disaster and did nothing but we’ll take another serving.”

4)      “The banks can’t make money with a flat yield curve.”

5)      “Inflation is an issue.”

6)      “Europe and China will take us down.”

In my view, the FOMC press release was perfectly turned out for everyone except for those misguided souls staying too long at the bond party.  To paraphrase the statement:  the economy is recovering but we’re going to keep rates low until the end of 2014.  Instead of driving the markets lower, investors should do a hosanna, take a breath and start picking stocks – not any stocks, but those more dependent on the U.S. economy.   The rising tide lifting all stocks is ebbing making this a great environment for stock picking.

 

By not hinting at a QE3 while paying homage to an improving economy and labor market – I trust the Fed’s mark-to-market much more so than their forecasts –  a large part of the bear case for US equities was served a debilitating blow.  After a short period of adjustment the market will continue its assent.  Yes, markets do rise as the Fed tightens as long as monetary policy remains fairly accommodative.  But all is not lost as to the Fed and monetary policy.  As with a recovering addict in rehab who has been mainlining heroin courtesy of a benevolent pusher, the Fed will not force us to go cold turkey so I look for a modest bridge to higher rates upon the expiration of Operation Twist in June.

The focus of naysayers will now increase on the purported impact a slowing global economy may have upon the U.S.  and, ultimately, our equities.  What has resonated so loudly is silence on the fact that the U.S.  still has largest economy in the world and that while not entirely self-sustainable, we can drive decent growth given that our reliance on the EU and China as markets for our goods is small relative to our internal consumption.

Banks, already on the upswing from improving credit, upward trending existing home sales, and being the beneficiaries of distressed European banks’ need to sell non-distressed assets at distressed prices, will soon be able to make money on a steepening yield curve.  This environment should be panacea for U.S. banks providing they remain disciplined in feeding out their inventory of homes to an improving market.

Inflationary pressures caused by a weaker dollar will abate, not that the Fed ever saw them as anything more than transitory, pressuring gold but helping the consumer as will higher yielding bank accounts but pity the fool who doesn’t see major principal loss in much small moves in yield.

I continue to like the market primarily because I anticipate upside in this reporting season relative to expectations, laboring under the belief that businesses and individuals are stronger.  I like the USD long versus the Euro short.  I hate the Aussie dollar and added to my short; China is a drag on their export and minerals economy and they have extremely high rates that have to come down.  I am long domestically focused equities.  Technology continues to play an important part in my portfolio, the issue with SNDK specific to their business model (I bought today).  I am opportunistically shorting steel, copper and coal on a trading basis.

Go U-S-A.  U-S-A.  U-S-A.

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The market of the last two days reminds me of my grandfather, Phil.  He was a surly guy and had his voice been disassociated from his body, one would have envisioned a much more stout individual than he actually was. Gravity had taken its toll as he advanced into his 90’s, shrinking his frame to little more than five feet two on his tallest days.  The often inverse correlation of age to patience took its toll and his gruff and demanding personality continued to overshadow a diminutive frame, expanding to a size that would better fit someone sporting the physique of Ray Lewis or Vitali Klitcshko.  Phil was never indecisive in his demands but increasingly, he never wanted what he asked for.   The following true story provides an example and a parallel to today’s market.

“I’ll take the sirloin,” he grumbled.

“Of course, sir.  How would you like it prepared?”

“Medium” he groused in response.

The kitchen turned it out perfectly medium but his rote response, his knee jerk reaction, was to send it back.

“This is raw,” he said, misconstruing pink for red.  “It needs more fire.  I don’t want to see any pink.  I want it well-done,” he barked, clearly contradicting his original order although he didn’t see it that way.

The waiter did as he was told and again delivered the steak perfectly prepared to order; well-done, not charred.  My grandfather’s rebuke was even more harsh.

“This is burnt,” he said, chastising the defenseless waiter.

And so it went.  I left significant compensatory damages behind, padding my grandfather’s meager tips, hoping to assuage my embarrassment and to maintain my good standing with the service establishment in New York City.

The moral: .   While you can hardly compare ordering a steak to positioning a portfolio but if Phil had not pre-judged the result, determined to return the slab of meat even if it came out perfectly cooked, perhaps he would have been able to profit from a good result.

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News Flash: Europe is Slowing; News Flash: China is Slowing

March 22, 2012

News Flash: China is Slowing

News Flash: Europe is Slowing

News Flash: Goldilocks May Have Left the Building

“There is the school of thought, of which I am not a student, that believes we shouldn’t worry about China and Europe since U.S. GDP is not overly reliant upon either Europe, 2% of total U.S. GDP, or China, 0.6% of GDP, but given that our economic revival is not particularly robust, any potential hit to growth has to be regarded seriously.   And it is the strengthening domestic economy, abetted by perhaps misplaced optimism on the global economy that overshadows the current weakness abroad.”

Like most, I tend to operate from selective memory. Sometimes I have to venture far into the archives to find a pearl of wisdom, other times the proverbial ink has yet to dry. Fortunately, this occasion finds me in the latter camp leading to a trip back to March 6th.  I actually present this somewhat cheekily since the S&P has had a nice move since the date I wrote the above but completing the thought, I remained bullish equities within a much reduced net long position laboring under the belief the non-US swoon would not really hit our economy until year end.  That is still the case from an economic standpoint.  It shouldn’t be a surprise to anyone that the massive credit issues in Europe have caused a slowdown nor should anyone be surprised about China, where economic indicators have revealed a contracting economy for 4 months.  However, with the market being a discounting mechanism perhaps I was too optimistic.  I went on to say:

“To bottom line it, the market is in a consolidation phase and faces the likelihood of a minor correction near term while remaining highly dependent upon data in the U.S. and continued optimism about the European and Chinese economies.” 

This will update my outlook and clarify my views.  The market is in a consolidation phase with a slight bias to the downside in the very near term as we are in a good news vacuum pending earnings.  Optimism still reigns regarding China’s ability to manage their way out of their declining economic fortunes and the yields on sovereign debt in the countries that matter, while recently forfeiting some of their optimism, are still at much more reasonable levels.   THE KEY FACTOR GOING FORWARD WILL NOW BE EARNINGS SEASON which I suspect will acquit itself well in most areas of the economy except for certain sectors, such as coal and steel, where I have been very visibly short, and which have already updated their outlook.   (Every steel company, regardless of business model, has disappointed but has guided to a turn in fundamentals resulting in a nice move off the bottom.  I am still short.  And coal remains in a death spiral.)   This will provide support for the market at that juncture but for now, in a good news vacuum, the path of least resistance is slightly lower.

But the key to a further rise in equities is the direction of US govt bonds.  While flows continue into bond funds in a meaningful way and out of equities in a less meaningful manner, a situation that surprises me, I believe this will reverse. I am short through TBF and TBT because I believe most investors have come to expect unabated and unprecedented performance and don’t realize that a an 85 bps back-up in yield from 2.15% to 3% will result in approximately a 7% loss in capital, an untenable risk/reward when considering that any appreciation of Treasuries is in the best case, severely limited.   And as the EU sovereigns continue to hold these levels, funds will flow from bunds and bonds into their higher yielding debt.

Within the slowing of global growth view, I remain short the Euro and Aussie dollar, materials and transportation, CSX (dicey), and long technology, big US banks, and defensive value.  The market will continue to pause, but not collapse, into earnings season and unlike each of the other reporting periods since the bottom in March 2009, expectations are much lower setting up for decent equity performance for the next quarter unless sentiment regarding Europe and China fall off a cliff.  I realize this straddle risks my being likened to a sell-side strategist, a label more feared than “moderate Republican” but that’s how I see it.

 

Did You Hear the One About the Bull… China, Europe and Global Growth Stocks

There is an oft told, though not particularly amusing story about an old bull and his son who stood atop a hill glancing down at a herd of attractive heifers. Exercising his fatherly duties, the newly divorced elder bull cautioned the youngster about charging down the steep slope to, let’s politely say, curry favor with the cows that grazed below.

“Com’on, Dad. Let’s go get ’em.”

“Easy there, boy,” the father cautioned, “it’s not always good to move too far too fast. Just ask the hare that lives in that hole next door to the barn.”

“I guess you’re right,” the son responded. “Slow seems to win an awful lot.”

“Slow is not the same thing as deliberate. Deliberate is what I’m after.” “But what about the Roadrunner, Pops?” the young stud inquired, “That darn bird seems to win every time and he looks like he’s havin’ an awful lot of fun racing around.”

“You may have a point there, kid,” came the response as the father looked below, a smile forming on his lip, a twinkle brightening his dark brown eyes. “Let’s deliberately run down there and have a good old time. Don’t know what I was worried about.”

Setting aside his discipline and years of experience, the old bull was drawn in by visions of what could be if all went right. He galloped down the hill, pausing ever so briefly to enjoy himself along the way. But all good things eventually come to an end and often the easier it seems in the beginning morphs into greater difficulties at the end. Well, it didn’t end well that day for the elder bull who would eventually keel over, ending up as a set of loafers and matching billfold. In the interim, though, he sure had fun.

As with the bovines portrayed above, it’s been a quick and happy romp for the Wall Street bulls, of which I have been one. However, I have no intention of keeling over while hanging on for one more conquest. To some, the bull market is showing signs of tiring while to others, the indices will continue to move higher. Me – well, I have ratcheted down my exposure to a slight positive bias to the market – short global growth, long defensive. I am positioned this way because I see the cows at the bottom of the hill looking decidedly less attractive in the second half of the year when the slowdown in Europe and China become much more evident. That will be when the austerity measures come full measure and the realization hits that Germany alone can’t drive the EU economy but, rather, is itself dependent upon an increasingly inward looking and slowing China as well as its EU brethren who were the direct beneficiaries of Deutschland’s indirect largess via the troika. It is also when we will revisit Greece, if not sooner, and possibly Portugal. So without EU governments being able to stimulate their own economies through major public works projects; without their banks, despite the LTRO, having enough balance sheet to lend (or choosing instead to make easier money through the risk-less carry trade); without the ECB actually being able to print money; and with China’s property bubble gushing air instead of hissing, the headwinds will likely cause a downdraft in the averages.

China lowering their GDP target doesn’t bother me that much for a few reasons. First of all, it wasn’t a surprise – in fact, I mentioned it last week. No great vision on my part since it was the consensus estimate. Even more supportive of my fortune telling acumen, the government had leaked major portions of the statement. The bears fear not though for China has always outperformed their targets and is perhaps setting the bar low for the new comrades coming into office. And doesn’t it matter that 7.5% growth, which may in fact turn out to be 8% if history is a guide, will equate to just slightly less than the same amount of growth as in 2011 owing to a larger base from which to measure the change? (I actually find it somewhat amusing that much of what I read from the Street believes that China will continue to grow at 9-10% despite a clear trend lower.) But the action will turn inward as China grows the domestic economy through consumption rather than exports. This, to me, means less fueling of the global economy. And, of course, slower growth is, at the end of the day, slower growth. I am still not convinced China will have a soft landing – far from it. The property bubble is continuing to deflate and the central government still has little interest, it appears, in bailing out the Rolex wearing, Ferrari driving, developers. This has been made extremely clear in the beating back of measures enacted by local governments, including Wuhu and Shanghai, to foster a recovery in property prices through employing mechanisms such as relaxing credit or allowing the purchase of a second home. Not least of all, let’s not forget that some important economic indicators in China are showing contraction or multi-year weakness. There is the school of thought, of which I am not a student, that believes we shouldn’t worry about China and Europe since U.S. GDP is not overly reliant upon either Europe, 2% of total U.S. GDP, or China, 0.6% of GDP, but given that our economic revival is not particularly robust, any potential hit to growth has to be regarded seriously. And it is the strengthening domestic economy, abetted by perhaps misplaced optimism on the global economy that overshadows the current weakness abroad.

Not a lot has changed in my favorite longs and shorts with the exception of initiating a short position in U.S. bonds but I will leave that story for another note. I still prefer domestic focused companies that provide downside protection through yield or have branded franchises with a strong IP advantage or value proposition: VZ, QCOM, WLP, HK and CSC, a very interesting value name with a new CEO, low valuation and strong prospects for a turnaround. JPM is very attractive, as is WFC. They will pick up significant share from the moribund European banks, a taste of which was in WFC’s recent moves including announcing an expansion in Europe and buying BNP Paribas energy business. Strong foreign banks such as UBS will also benefit. This is an incredible opportunity for domestic banks to replace the earnings they lost from Dodd-Frank. Coal remains a core short, despite the decline in the price of the shares. Aside from WLT, which derives almost its entire earnings from met coal, virtually every other coal company generates 70-80% of revenues and earnings from steam coal. This is true of even two of the world’s largest met coal producers, ACI and BTU. Reportedly, ACI’s acquisition of Massey is not going well, an asset they clearly overpaid for, and Moody’s put them on negative watch. Additionally, as part of China’s 5 year plan, they intend to increase coal production by only 3.7%. This is despite the fact that reportedly, 40% of power generators in China that use coal lost money in 2010. Imbedded in the 4% inflation target in the 2012 plan are higher utility prices which is intended to provide relief while lowering usage. Domestically, the warm weather has resulted in stockpiles that utilities will take a long time to work off and the conversion to natural gas from coal at these plants is continuing, arguably picking up momentum. This is occasioned not just by price, but more so by environmental mandates. As to bituminous or met coal, my view on steel remains that as Europe falls into broad recession, China cools and construction continues to weaken, steel prices will continue to weaken. This will lead to more exports from Europe into the U.S. and, of course, China keeps adding to steel mill capacity. I am also short JCP, purely an issue of timing on the turnaround and what is already reflected in the stock price, and KSS. Both troll for customers in a very tough space. On the other side, I am long M.

To bottom line it, the market is in a consolidation phase and faces the likelihood of a minor correction near term while remaining highly dependent upon data in the U.S. and continued optimism about the European and Chinese economies. This Friday’s jobs number could untrack the indices either way but watch out for the second half when the can hits the wall.

Paris Hilton, Europe and China, Energy – Natural Gas: the new HK and CHK, AAPL

The ratings agencies continue to be as effective as Paris Hilton at a spelling bee as seen by Moody’s latest action of putting some banks under review.   The real troubled period for the U.S. banks has, for the most part passed, so near as I can tell the ratings agencies are pressing their shorts.  To paraphrase the anti-motto of the UFT: “Those that analyze, analyze and those that can’t, work for the ratings agencies.”  Throughout my career, I never recall anyone resigning from a fund or investment bank to go on to the greener passages of the ratings agencies.  “I’ve finally made it; my dreams have come true.  I’ve landed this incredible position at S&P.  Sure I will have to get a night job to make up for the lower pay and have to adjust to working in a cubicle the size of a bathroom stall – it’s not easy balancing my family pictures on a roll of toilet paper – but I have my nights free and significantly less pressure since there is no penalty for being late or wrong.”  As a comedian feels about a significantly overweight individual with a very bad toupee, we should all be indebted to the ratings agencies for providing us with such easy fodder.

 

China continues to be a primary concern for me. I noted yesterday the downside of China’s check in the mail commitment to assist in the European bailout as a sign that things are worse for China’s economy than the market has believed.  I postulated the Chinese are seeing more than passing weakness in their economy as a derivative of the weakness in Europe, their largest trading partner.  And today we see the rationale for China’s magnanimous and proactive statement of financial support.  Foreign investment in China is declining and is at the lowest level since 2009, the bottom of the last recession.  Earlier in the week, the city of Wuhu terminated their policy of providing subsidies to home buyers at the behest of the central government, signaling to me that they are more concerned with a property bubble and inflation than they are with a slowing economy, recognizing what Greenspan failed to see.  China bulls remain steadfast in their conviction of a soft landing, the strategy underlying this belief is that the communists will deploy their massive (but fading) foreign reserves in support of Ferrari driving real estate developers, overextended municipal governments (40% of revenues from property sales and subsequent deals to develop), shadow financiers and the occasional overextended homeowner.  Now add in profligate European sovereigns and we have the first “born again” communist country.  Somehow, I believe this will not be the case, given their very long term view; they will let these folks all suffer their sins to a large extent and not be as generous as a Greek politician who has had way too many shots of ouzo.

 

However, with Europe estimated to account for approximately 18% of their trade, look for  increasing comments professing support.  In fact, China may decide to tender for the EU rather than picking off their assets piecemeal.

 

Greece will ultimately default even though the troika may put them on an allowance rather than providing a lump sum.  The installment plan buys the troika more time to put together a plan to ring fence the other over extended sovereigns.   A Grecian default, not to be confused with allowing the gray to grow out from your scalp, would result in a knee jerk reaction lower in the markets and then a move higher as the credit markets realize that the EU is finally ready to enforce fiscal discipline.   This would actually cause a major rally in the Euro but for now I am staying short, having rebuilt the position over the last week on the belief that all the good news was out and as crowded as the short trade was, the long trade was now the more popular investment.

 

I’m still in the camp of consolidation with somewhat higher equity exposure in lower beta, value stocks and short positions in commodities such as coal, steel and copper.    Perhaps we get a reaction move lower but with the massive liquidity in global markets and more due on 2/29 from the new and kinder “ECB”, bonds are the riskier asset and stocks more attractive.

 

And  one more thing, Apple.  I get that the stock action has accounted for a large percentage of the underlying averages but two things: the story is far from over and the market can move independently from the shares of AAPL.

 

Natural gas.  Looks like the lows may have been put in.  At the end of the day, we’re capitalists and the energy industry in this country is still one of the best managed sectors we have.  While the glut is not over, and hopefully the government recognizes the wisdom of incenting greater usage of natural gas as a replacement for crude, the shut ins are encouraging.  Of course, while the warm weather has increased “inventory” levels of natural gas and coal, these will be depleted at some point and are arguably reflected in the price of the equities to a large extent.  We have two CEO’s in energy that actually do what they say they will do: Floyd Wilson and Aubrey McClendon.  Floyd has been a major creator of wealth as he built and sold, to the benefit of shareholders, 3 companies. He is now in the process of doing it again with Halcon Resources (HK, a ticker in the Hall of Fame for its association with Petrohawk, has had its jersey unretired).  He makes no bones about it: I will build it and exit.  The $550 million he brought to the party underscores his commitment.  As to CHK, admittedly the debt levels, not so onerous in a different environment, are squarely in Aubrey’s sights and he has surprised the Street yet again by targeting higher levels of asset sales and further pay down of debt.  Underlying this, and somewhat unnoticed, is the transformation of a company too dependent upon natural gas (they have also announced they will shut in some gas)  to one with a stronger focus on liquids.  This is what will also drive the new HK – a focus on liquids as opposed to Petrohawk’s dry gas model.  Top CEOs understand and respond to changing market dynamics.

 

Disclosure: I am long HK, CHK, EUO and short AAPL puts.

The Market: New Year’s Resolutions Are Made To Be Broken; More Positive On US Equities

The Market: New Year’s Resolutions Are Made To Be Broken

 

I sat back and marveled at the action in the global markets on Tuesday, wondering if these non-human entities had all of a sudden turned human making New Year’s resolutions to ignore underlying fundamentals and rally 2% a day. But guess what, markets don’t drunkenly warble Auld Lang Syne in symbolic banishment of times gone.  There is no Lord of the Calendar presiding over the indices, ripping the pages of 2011 from the binding, erasing the memory of an ailing global economy, resetting expectations to a level of attainability where economic indicators such as Eurozone PMI indicating a contracting economy are now a positive indicator.  In fact, the only symbolic symmetry I can find is in the economic hangover rattling the brains of money managers finance ministers and newly crowned technocrats the world over.

 

So as January rolls around we are still faced with the same positives and negatives, each release of data driving the markets, each tick of the currency market correlated to the price of commodities and equities.  But here’s THE but: I am more attracted to US equities than I was in 2011.  That is my resolution for the New Year BUT unlike those who resolve to lose significant weight in 2012, my complete transformation won’t happen in one day although it should endure past the next buffet – I mean, rally.

 

Yesterday’s Unicredit rights offering was not a positive sign for the markets.  The 27 investment banks underwriting the offering reportedly accounted for three-quarters of demand for the $9.8 billion offering, a high price to pay for a call option on future fees and one which toxifies (literary alert: new word) their balance sheets in the name of fees and, no doubt, in response to arm twisting by the ECB.  Shareholders were diluted to near zero and the deal was underwater from the first tick.   Can’t imagine there is much appetite for these types of deals going forward as it will swell “bad” assets at the banks involved, somewhat ironically I might add.

 

I still believe that we will see nationalization or partial nationalization of some banks.  The reason is simple: as with Unicredit, their problem loans and refinancing needs exceed their market caps.  Additionally, compliance with Basil standards has led to these banks pulling in credit lines, the most immediate response, which has stifled credit and slowed economic growth.  This, of course, is why the ECB has initiated their lending program.  I surmise that Draghi has had conversations with the banks taking advantage of this lending facility to participate in the new issue market.

 

Next week is critical as Italy and Spain come to market seeking capital from charitable buyers.  European debt is actually not a bad play if you can hold it longer term because it is extremely unlikely that either country will default.  However, I’m not playing and believe the price they have to pay to fund themselves will be extraordinarily high and for Italy this is only the beginning of their refunding.

 

All of this comes down to the fact that there is still no plan to “cure” the credit crisis in Europe, absent austerity measures that will likely not be enforced or enacted to the necessary magnitude and will only be effective in continuing to drive the EU economy into recession.  It is a lose-lose situation.  The loan facility has removed fears of a Lehman type moment but that is not nearly enough.  We still need to see the heavy artillery from the EU in the form of stimulus.  For example, Italy has had one of the slowest growing economies over the last 20 years of all OECD nations.  They can’t cut their way to growth.  I look at the banks continuing to park funds overnight with the ECB at record levels as insider trading: they know their market better than sell-side analysts or pundits and if they are willing to take such an imbalance in rates of return in exchange for the safety of the ECB, the problems are as bad as I imagine them to be.

 

But China will save us all!  No they won’t; they will look out for themselves and prey on the markets as they always have.  They see commodity prices declining so they will not enter the markets and be the support mechanism until they are down to their last copper penny.   China is on the bad end of two phenomenon:  its property bubble bursting and its primary end market’s  – the Eurozone – declining economy. Their trade surplus declined from $180 billion in 2010 to $160 billion 2011, numbers that any other nation would be happy with but not the Chinese.  This is positive for the US but may be a short lived victory as they dropped the value of the yuan this morning, a reversal of prior policy and a move that will undoubtedly flame already tense relations with the US.  This is a strong indication that the Chinese are very, and justifiably, concerned about their economy markedly slowing despite the recent PMI release.  This slowing will, of course, hit the global economy but especially Australia which is why I am short the Aussie dollar, albeit small for now.  Additionally, the property market in Australia is in horrendous shape and significantly hurting their banks and populous.  They have to lower rates, further pressuring the currency.

 

Now here is the good news as I see it and it resides squarely with the U.S. market and as a devout patriot, I couldn’t be happier.  The US treasury and stock markets are the global default markets of choice. Despite 2011 4Q negative pre-announcements hitting a high previously seen during two prior recessions in 2001 and 2008, the economic data is getting better.   Today’s jobless claims number continues to trend downward, which I believe is a function of a smaller sampling and companies having already cut through muscle so perhaps not an indication of a vastly improving employment picture but positive nonetheless.   Corporate earnings lag the improvement in the economy as companies ultimately respond by hiring more workers.  However, I do see earnings estimates continuing to decline, particularly multinationals from the combination of weaker export markets and a stronger USD.  Analysts are too optimistic in their S&P estimates for 2012.

 

So I remain relatively lightly position in equities, short the Euro against the dollar and short the AUD.  The U.S. equity markets will continue to react to the worsening situation in the EU and have a tough time rising near term.  However, asset allocation to equities, which I expected to see last year and perhaps we did to an extent, will ultimately drive equities higher so I don’t mind increasing my exposure opportunistically.

 

My preference is in defensive, domestically focused companies including healthcare, specifically managed care, nat gas, well-positioned retail, MLPs, utilities, US telecom and strong brands such as SBUX.  Some of my specific holdings are: CHK (CEO continues to pay down debt and restructure production toward liquids from nat gas as he said he would), WLP (inexpensive, buying back significant stock, defensive), NS (7.5% yld, insider buying), QCOM (market leader), GM (cheap but not in love with name), KO (yield, defensive but currency issues), EUO, short FXA.  Would not mind being short LNKD, GRPN, NFLX and ZNGA. This earnings season will be marked by currency adjustments and caution about Europe so I will mostly stay away from those companies playing in those areas.

 

Meanwhile, with some stability returning to the political scene in the US and Romney moving to the forefront, any sense of his emerging victorious in November will finally motivate US companies to spend the massive cash hoard on their balance sheet.  This is not an immediate event, however.

 

So there you have it. Nothing much has changed, the focus required to write 20”12” instead of 2011 really the only thing new.  I get the hang of that relatively quickly, usually after writing about 5 checks and filling out a few forms.  The markets however, have not changed their ways at all, renouncing their resolutions after a mere two days.

 

In sum, I am more positively disposed to the markets and have slightly increased exposure but want to get a better glimpse of the earnings season and the critical refunding periods for European debt before getting longer.

Europe: The Lehman Moment Is Fast Approaching

I was bearish before; I’m even more bearish now. European sovereigns are evidencing a lack of confidence in their own bailout plan and the Lehman moment is fast approaching.  Have to be crazy to have much, if any exposure, to this market.  We will hit new lows.  How’s that for dire?

Building the bailout fund is incredibly similar to building a book on an IPO or secondary, something I have done hundreds of times. I can tell a bad deal from a mile away. This deal is bad.  With a hot deal, everyone wants in regardless of their fundamental view.  Funds will even play in an “okay” deal if they are confident the syndicate bid will support the selling pressure.  Sometimes, a fund is even willing to take a small  hit in the interest in maintaining a good dialogue with the Lead Managers.  But no one willingly goes into any deal if they expect to lose substantial funds.  Insiders – in this case, the EU countries with the most to lose if the deal falls apart – often add to their holdings on the offering, justifying it as a capital infusion or a necessary sacrifice.  If the UK were convinced the current plan to stave off European default would solve the crisis and substantial principal wasn’t at risk, they would gladly contribute rather than being labeled the “bad guy” by sitting out the deal.   The UK, however, recognizes that this transaction will break syndicate bid before the shares are delivered and that they have to keep their powder dry for when contagion hits their shores in a much bigger way.  Once it becomes clear to a book running manager that the deal is being given the cold shoulder by the conventional buyer, they then approach others, such as sovereign wealth funds.  In this case, that would be China but they have said no as well.

Coming up 50 billion short on a 200 billion euro book is a huge miss.   Unlike a lot of IPO’s and secondaries, the EU bailout can’t be downsized to get it to the market in an effective manner.  And by the way, a lot of downsized deals often fail because the market regards them as troubled.

Ultimately, the markets shun the underwriters with poor performance by getting their borrows lined up even before pricing.  Given the track record of the EU and IMF, the UK and US have already decided the ESFS is a short.

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France, Italy – Slow and Angry; EU Ratification Will Fail; US Stocks.

First some good news, the ratings agencies have finally cast themselves as the most consistent market indicator with an inverse correlation of 1.00  as downgrade events are now reflected in market moves higher.   Enough said.

Monti has not been in office long enough to change a roll of toilet tissue yet already had to call for a confidence vote.  This does not bode well for the future.

My view has not changed.  Achieving ratification of the EU treaty will be akin to asking turkeys to vote for Thanksgiving.  And even if the 24 non-French, non-German, non-UK governments do approve this union with a gun to their heads, compliance with their provisions will be tough to come by.  Monti made that clear today in a veiled threat to the Germans

“To help European construction evolve in a way that unites, not divides, we cannot afford that the crisis in the euro zone brings us … the risk of conflicts between the virtuous North and an allegedly vicious South.”

In other words, “don’t even think about asking us to do anything that we don’t want to do such as collect taxes.  Culturally, we don’t do that kind of thing.”

We saw some minor protests in the Italian parliament regarding the austerity measures, with the largest Italian labor union protesting more loudly on the cobblestone streets.  Put into perspective, these protests are targeted at austerity measures being implemented by the Italian government.  Can you imagine the anger when the Germans try to pull in spending?  The Greeks rioted in the streets against fiscal prudence and cost G-Pap his job before the treaty was a twinkle in Merkozy’s eyes.  I’m going to wait until Solution #6 makes the rounds at the next summit.

But I finally understand the lack of speed which the French operate.  In fact, yesterday’s legal accomplishments, the conviction of Carlos the Jackal for blowing up part of Paris and the conviction of Jacques Chirac for raping Paris, only took 30 and 20 years, respectively.  Translated into sovereign debt issues, that should give French banks enough time for the terms of the CDS they wrote on sovereign debt to expire.  Brilliant strategy.

Germany has made it clear they won’t pay up, the US will not contribute to the IMF to bail out Europe and China will use their foreign reserves to buy Europe – not European debt – but rather Europe.  I have asked many what they see as the solution to this crisis and no one has come forward with a solution prior to Europe’s Lehman moment. That’s what it took in the US, and we only have a 2 party system.

French banks will be nationalized as will others throughout the EU.  But that is only part of the solution. Ultimately, the other twin, Mario Draghi, will have to print money and buy more bonds.  The decline in the Euro is far from over – this is only a momentary respite.

Of course, none of this bodes well for US equities.  While Europe represents only 15-20% of our end market, the contagion casts a much bigger shadow.  S&P estimates will have to come down as the dollar strengthens, resetting valuations.  Europe will cascade into recession and China’s economy will continue to contract, further hurting global growth and the US recovery which has been tracking nicely.

The E&C sector and commodities have to continue to weaken as global growth slows.  I like domestic stories that are not dependent on a burgeoning economy for earnings growth.  Managed care remains a favorite and these companies continue to raise their earnings outlook as MLR improves with fewer doctor and hospital visits. WLP at 8.3X EPS with a massive buyback (20% of shares on top of 5% retired earlier this year) still looks cheap.  If employment ever picks up, this will add to growth. Sequestration provides a better result for them than the elusive budget deal. Health care overall looks attractive. MDRX, a company that provides technology solutions to doctor practices and hospitals, supported by a $30 billion incentive boost from the government to put all patients on electronic records, is inexpensive and it is an attractive acquisition candidate for a company such as ORCL that is on record as saying it wants to increase its presence in this business.  I took a small position in CSC, a stock that has been justifiably destroyed, while I do more work on it.  Meantime I get a 3% yield which appears safe.   And of course, there is QCOM, unique in its fundamentals in the tech space.

RIMM – the only question on this company is which will last longer – my phone or the company. Right now its neck and neck.  I used to love my Blackberry but now the service and my 18 month old phone, perform as well as Michelle Bachman at a debate.

As to Bachman, she has to stop using Tammy Faye Baker’s make-up person to be taken as a “serious presidential candidate” (her words).


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