Archive for the 'Stocks' 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: Loch Ness Monster Ensnared In SEC Sting on Quarter End Mark Ups

The simple and stark truth is that the phenomenon of a quarter end mark up in equities is a myth.

First the statistical evidence.  I reviewed the last eight quarter endings, taking note of the closing prices of the SPY’s  on the two days prior to month end, the preceding pattern and the first two days of the new quarter as well as the ensuing days of activity.  It would be reasonable to expect that the market would sell off on the first couple of trading days of the new quarter if it were being marked up at prior month end window dress a portfolio but that occurred in only 2 out of the last 8 quarters, one of those events being immaterial and the other a move from 113.15 to 109.93; this occurred in 3Q 2011.  The next trading, 10/4, saw almost a full recovery to month ending levels.  Furthermore, in 7 of the 8 periods, the uptrend of the first 2 trading days of the new quarter continued over the next week or so.

Now, the empirical evidence.   Long only funds generally run with low cash levels as mandated either by asset allocators or charter.  Hedge funds, that is the good funds, the professional funds, could care less about supposed month end markups, preferring to stay disciplined and loyal to their strategies.  After all, that is how they became successful.  In fact, I can’t say I know of any investors, big or small, that is willing to make an investment decision based upon what they believe a bunch of insignificant players may or may not do into month or quarter end.  That would essentially be ceding the management of their funds to those individuals and that is not about to happen.  Furthermore, transparency has increased dramatically with most funds.  I know how I would feel as an investor if the fund I was invested in told me they were 40% net long on the 25th of the month because of their assessment of the market and opportunities and then were all of a sudden 60% net long – or higher – as the month drew to a close when the investment case was unlikely to justify such an increase in exposure.   I don’t invest with managers who play those games because they are too hard to play.

Of course, there is the possibility that specific, illiquid issues could be manipulated higher into quarter end – I’m not naïve – but I do believe that this activity is insignificant and in a more highly regulated industry, where penalties have actually become very harsh for doing so and the reward paling in comparison to the risk, is much less common than it was years ago.  But we need not debate the quarter end mark up issue since the facts make a compelling case that it doesn’t happen.  Sure, conspiracy theories are fun to talk about and a convenient excuse as to why a fund manager is under invested but until they actually find the loch ness monster, I’m not a believer.  I’ll just chalk it up to people trying to sound smart.

Oh, and this is a helluva a mark up the last two days.  Nuff said.

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.

 

Greece, Diamond Foods, Euro, Santorum, Friess and Me

Another day and Diamond Foods (DMND) is still with us. I took my profits on the trade, selling the stock when it was up 7% on the day versus a decline of 1% for the broader market.  Will possibly return.

I have been advocating for months that Greece be pushed into default.  Perversely, this would be the best outcome for the markets and the Euro after the knee jerk reaction lower.  Greece, in fact, is less important to the European economy than AIG was to the global economy, than Lehman or Bear was to the US economy.  Germany’s interest is clear in keeping Greece and other profligate sovereigns in the Euro which is that it is the 50 pound weight at the other end of the barbell.  Were Germany to be the even more dominant in the Euro, their goods would be less attractive, harming their export economy.  This would be good for other exporters such as the US, although our goods are already cheap in relative currency terms.

I have a small short position remaining in the Euro.  I cut the core position and had stopped trading around it as it moved to breach the 130 level because the market had become incredibly conditioned to a negative outcome, perhaps proof no more evident than the current level of the Euro versus other currencies despite the headlines.  My short on the Euro was never based upon a break-up of the currency; it was based upon the view that there would be massive stimulus, including rate cuts, to support a weakening EU economy.  Essentially, they would have to inflate to forestall a deep recession.  This has been the policy outcome and I expect it to continue.  I would be more comfortable sizing up the Euro short if Greece stays in the currency than if they are unceremoniously shown the door since, admittedly, perversely, I see a Greek exit as a strengthening event as the world will realize that the EU is one “sovereign” that is willing to do what it takes to address its budget deficits although this would be more of an accidental outcome than deliberate, having everything to do with Greek  insouciance and an unhealthy dependence on ouzo than the execution of a strategic plan.  Keep in mind the folly of the lack of any real plan by the EU: the EFSF relies on contributions from countries including Greece, Italy, Spain and Ireland.  The far-reaching agreement on a more uniform budget reform process is also of negligible value since lack of adherence by the signatories will result in sanctions and fines.  Of course they will have to borrow money from the IMF and the EFSF to pay these fines but that is beside the point.

Let’s just get on with it. Let Greece default, put it behind us and move on to Portugal, a country that the Germans apparently feel more kindly toward.

Despite all this, and despite Santorum mucking up Romney’s path to the nomination, I am still positive on US equities although fully anticipating a consolidation. I am not one of those in the camp hoping for consolidation because it is healthy for the markets.  I’d rather see an unhealthy market go up every day although that is, of course, unrealistic.

When I was a salesperson at Salomon Brothers many years ago, I received a call from Friess Associates, an account I covered (the Brandywine Fund), inviting me to a cocktail reception at the home of Foster Friess.  I had never met Foster – he had already ceded active portfolio management to his staff – but had been in his office a few times. Lining Foster’s office wall were pictures of him with Presidents and other important people.  I asked why I was being so honored.  Well, came the response, Foster wants your support for Rick Santorum, a candidate he is endorsing.  You can send a check if you can’t attend.  This was a less than subtle way of asking me to contribute to Santorum’s campaign. I said I would look at Santorum’s platform  and get back to them. This was not a response they appreciated.  After looking into his background, I decided very quickly that I couldn’t support Santorum and declined, offering instead to make a contribution to any children’s charity of their choosing.  As with my initial response, this did not go over well.  And times haven’t changed –  I still can’t support Santorum and Friess still does; in fact, he is Santorum’s main backer.  There is a reason these two hang together and both are scary. http://www.reuters.com/article/2012/02/10/us-usa-campaign-friess-idUSTRE8190AK20120210.  And, by the way, I’m a Republican.

YHOO – Machiavellian or Failed Negotiation

YHOO – the hiring of the new CEO is either a brilliant negotiating ploy or the end of the auction process.  As to the former, first assume that the BOD and potential acquirers were far apart in price – perhaps $0.50 – 1.00/share which would equate to $600 mm to $1.2 billion.   At EBAY, Scott Thompson received $960,000 in cash compensation in 2010 with stock and option awards bringing his total compensation to $10,436,593, making him the 2nd highest compensated employee and providing a nice jump in comp from his average of $2.9 mm in 2008 and 2009.  Now, YHOO’s BOD sends a message to potential acquirers “your price is way too low, we’re moving ahead with the company as a standalone entity and have just hired a kick-ass CEO.”   Not many candidates in a strong current position would switch to a company in the midst of a potential takeover, abetted by an activist shareholder base.  But Thompson is 53 and assuming he receives a monster pay package with a boatload of options that vest upon a change of control or sale of substantial assets, he would be a great stalking horse for YHOO.  Whether they paid him $50 or 100mm, a substantial closing of the price gap in negotiations would still net YHOO shareholders a much better price  Thompson then does what every other former tech CEO does, becomes a VC investor.

I have no position in YHOO.

Draghi’s Diabolical Plan: The Carry Trade

Brilliant maneuver by Draghi – likely unbeknownst to him.

ECB lends money to the troubled banks at 1% who then go out and buy troubled debt, including new issue, at much higher coupon, taking in the difference as income.  These banks then use the bonds as collateral for the ECB loans.  Essentially, Draghi is doing indirectly what he can’t do directly:  buying sovereign debt new issue.  These bonds still find their way onto the ECB’s “balance sheet” and undoubtedly will not be marked to market should their prices collapse which of course would otherwise require more capital.

Problem is these carry trades never end well nor does the piling on of more debt solve a debt crisis.

The unintended consequences of an insufficient plan.

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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