Posts Tagged 'WLP'

China: Re-Entering The Atmosphere With A Hard Landing; Earnings Season And The Markets Disconnect; Energy; And Here We Go Again In Europe – But Wait! There Is Value

China is launching a major offensive for headlines with the EU.  Wen’s comments over the weekend were his strongest and most pointed yet as he warned of the possibility for “huge downward pressure” on the economy.  At the same time, inflation was reported at a very modest 2.2% leaving open the possibility of additional near term stimulus.  Additionally, Wen, in separate comments, remained resolute in keeping property prices under control.  As much credit as is inexplicably given to China by way too many strategists for ultimately being able to manage their downturn and draw a line in the sand at nothing less than 7.5 – 8% GDP growth, Wen does not seem as sanguine.  Whether China ultimately experiences a hard landing remains an unimportant conclusion at this point as that is the direction they are moving toward.  The bursting of their property bubble will be much more damaging to their economic future than was to the US when ours fizzled given that so many important Chinese cities have relied upon land sales and borrowing for their out-sized infrastructure spending.  It’s one thing for an individual to be upside down on their mortgage, but quite another for a large portion of a country to be in that position particularly when so much of the world’s economic growth has been dependent on China’s previous voracious appetite for commodities, machinery, etc.

But wait – there’s those trillions in reserves that China is going to shower on the economy much like an NFL defensive back at a “gentleman’s” lounge.  My view is that China, continuing to think long term, would rather see asset values to decline meaningfully so that they can swoop in and acquire them.  It’s not only asset prices that soften, but also political resistance in the targeted countries as the fate of elected leaders is tied to declining personal fortunes of their constituents.

Steel stock rally?  Done before it started.  Angang Steel said it will report a loss of 1.98 billion yuan for the first six months compared to a profit of 220 million yuan last year.  Angang is China’s largest HK traded producer of steel.  Despite this, China keeps adding to its steel capacity and keeps running its plants at capacity, more concerned with employment levels than price realization.  It’s expensive to shut down capacity in steel and it remains the industry with the highest costs of exit.  Sector will bounce around but direction is lower. Take a lesson from coal (PCX bankruptcy filing) and stay away.

And within the backdrop of all this, those optimistic about the market say all the bad news is fully discounted.  After all, once it’s in print, see yesterday’s WSJ’s article on the earnings season – it is immediately old news.  That’s an interesting thought considering that the S&P is up mid-single digits this year while expectations on global growth have been ratcheted much lower.  Seems like a disconnect to me.  I’m not looking for a major sell-off but a slow ebbing of the averages.

Meanwhile, back in Brussels, the framework announced out of the latest – that is the 19th, EU meeting to solve their financial crisis, has hit a predictable speed bump as Hollande offered that a more unified political and banking system will not happen as quickly as thought while Germany remains resolute in requiring government to be the ultimate guarantor for the debts of troubled banks.  Seems that the Europeans don’t yet realize that substance is actually longer lasting than headlines.  Not sure the markets realize this either.

So here we go again. Rather than focusing on current fundamentals, the markets pin their hopes on major fiscal policy moves by China,  the US and, of course, the EU – hoping coordinated easing becomes reality, stimulating spending, credit and investment. Could be but I still don’t see an immediate, significant QE3.  But there is good news: the EU has set the bar very low.

There is value to be found.  I still believe the Euro is overvalued relative to the USD; that higher yielding equities with good fundamentals will continue to offer a good total return (mortgage reits, telco); and certain areas of energy remain attractive longer term such as natural gas and special situations.  TOT has a monstrous yield and HK, a build it and sell it story run by someone who has built it and sold it multiple times before (Petrohawk being the latest), is in a great spot, being able to acquire assets cheaply with financing both available and inexpensive.  I mentioned on CNBC on Thursday that I was starting to rebuild a position in WLP.  This group is also inexpensive, but I would wait for a pullback after yesterday’s action.  Sentiment has been horrendous and MLR’s are likely going higher this quarter, but in an industry with changing fundamentals, the smart players find opportunity.

 

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.

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.

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).

The Icarus Market: High Fliers Beware

Daedalus would have made one helluva portfolio manager during these troubled times.

He was a man of moderation, caution and ingenuity.  It takes all three to succeed, or at least not lose, in this environment.  King Minos had imprisoned Daedalus and his son, Icarus, in the Labyrinth as retribution for a number of heroic acts.  With escape routes by land and sea impregnable, Daedalus used his ingenuity to fashion a set of wings for he and Icarus out of wax and feathers.  Before taking flight he cautioned his son to not fly too high lest the sun would melt the wax nor should he fly too low for the sea would dampen the feathers. Moderation, mid-level altitude, was the best course for escape and survival.

As the myth goes, Icarus had quickly mastered the use of his new wings.  He would soar and dive, soar and dive, each time extending the upper and lower levels of his flight path.  Alarmed, Daedalus repeated his warnings but the words were lost in the vacuum of the skies. Having in his mind successfully tested the boundaries of flight, Icarus decided that soaring into the skies was much more exhilarating than maintaining a steady path.  He flew higher and higher, unaware that the sun was beginning to take its toll.  The wax melted, the feathers floated down and Icarus crashed into the sea.  As he was drowning, he could be heard to say: “Damn, if I had only gotten out just before the top. Next time…”

This is an Icarus Market.  The rallies, the feelings of euphoria, suck people in and they ignore the risks, as their focus turns to the exhilaration of higher highs, a new trading range, much like Icarus extending upward his flight path.  They focus on the positives, not the negatives.  Like Daedalus, I am suggesting a moderate path, not net short and not all in long.  While I believe that the risk may be to the upside, there are too many unresolved, potentially devastating issues for me to throw caution to the wind.  My exposure remains light.  I like defensive stocks or stocks not dependent on the economy.  WLP (despite issues from the Super Committee), QCOM, value plays – my Ahmadinejad stocks as I like to call them because they are so hated (small positions in RIMM, HPQ which I shaved a bit and CSC), short EURO -long USD and of course, yield equities.  Coal continues to act like garbage and steel had no basis for rallying.

Near as we can tell Europe has not meaningfully progressed toward a workable solution to the crisis, announcing a less than suitable framework for resolution.  What was missing from the Merkozy plan was a ring-fence  for Spain and Italy, the two major trouble spots, and funding.  From the recent headlines, they are no further along to increasing the ESFS than they were then, with France still looking to the ECB in order to preserve their AAA rating, while Germany wants no part of bailing out the Icarus like French banks that assumed much too much risk. France’s AAA is gone – the S&P fat finger flub reminding me of newspapers that have already written the obituary of dying celebrities in advance of them taking their last breath.

And Europe’s recession will spill into the US, directly, and indirectly, through China.  US multinational earnings will of course be hit by recession in Europe so look for the S&P estimates to decline. China’s major end market will also suffer, continuing to pressure their exports.  And, while on China, is anyone still hanging onto the laughable hope that this bastion of self-interested opportunism is going to bail out the EU?  They won’t even do the easy stuff such as sanction Iran.  They have their own issues to contend with.

Before moving onto actual data, here’s where I am.  I fly to the underbelly of Daedalus.  As I weigh the pros and cons, I am encouraged by the US economy while expecting some moderation of corporate enthusiasm as seen in the recent reporting period.  I do not believe that we can use historical measures for determining that the market is compellingly cheap since we are in a low growth environment.  European troubles concern me the most and I would rather wait for a legitimate solution to be announced than get in front of it. Thus I don’t see significant downside to the market because each day the bar gets set lower and the bad becomes the not so bad.  If I had told you a year ago that Spanish and Italian bond yields would be just below and above 7%, respectively, you would have ventured a target on the S&P of 1000.  But the market has shown a tremendous capacity for resetting its threshold for bad news. So we will wallow in this extended trading range and likely not revisit the lows.  In fact, more money can actually flow into the US equity markets as it exits Europe but I fear that is a wish and not reality.  I would potentially turn more positive if I thought that more European Prime Ministers were poised to resign; each of the last two was worth a decent market rally.  There are 15 more PM’s in the Euro that are candidates with relative value S&P points of 5 to 15.  And even though there are no working monarchies, if say a King Juan Carlos abdicated, I would be willing to throw in a mid-afternoon rally for that – what the heck.

And the IMF will not be the answer even if they toss more chips into the pot.  I offer these charts from JP Morgan’s strategist, Michael Cembalest, showing that promises by the IMF have not yielded a great result in the past.

IMF

And while I’m in a plagiaristic mood, here is a chart from my friend David De Luca that I had sent out last week along with some commentary.  It shows the fear in equity markets. If you are one of those who believe the credit markets are leading indicators of the direction of equity markets then its time to head for the hills.  Within the past week almost $45 billion was taken out of the banking system and placed at the Fed, matching the move last seen in September 2008.  Surpassing the $108 billion peak post-Lehman, $125 billion is now being held at the Fed representing funds for loans that won’t be loaned anytime soon.  As the chart below indicates, this size withdrawal usually leads to a steep decline in the equity markets but that has not occurred yet as I do not believe today’s decline in the futures has anything to do with this. My point is that a whole lot of bad news is being obscured by other bad news or worse, bad news that is perceived as good news such as when a major corporation (read: country) loses its CEO (read: Prime Minister) without any replacement.

Repo

Am I Bearish – Part II: Very Much Not – For Now

As I detailed in my post from 10/21, the resolution to the European sovereign debt crisis has played out according to what I had anticipated.  Merkel had sufficiently lowered expectations to allow for a plan the market would embrace.  U.S. corporate earnings are benefiting from the same mechanism: beating lowered expectations.  With bearishness so high, as expressed in cash not just sentiment, the market was spring coiled for a pretty strong move higher.   I had raised the prospect of a knee jerk sell on the news, always need an “out,” but that was not my high probability case and I did say I would have added on that momentary decline.  I dont’ expect same reaction in US markets as we had in Europe.  Asia type pop is more likely today.

But that is just for today, we will go up by 10-15% from here.  How do I get to my upside: market basically flat on the year despite S&P earnings up approximately 15% this year and forecast up 13% next year.   So we’re behind by that 15%, at least.

So where are we now?  Europe is in a recession and it will deepen.   In order for the banks to get to 9% Tier 1 ratios, they will begin by pulling in credit lines, removing that portion of  their liabilities.   This will lead to a further stifling of credit. Austerity measures will further crimp spending.

But most importantly we face the overhang of the details.  But at this point there is no reason not to believe that the EU will work out sufficient details to support the plan.  Maybe Washington can take a lesson on getting a plan to the finish line from the 17 EU currency countries. Nonetheless the trend of the market is higher. I am still sticking with high quality defensive stocks for the most part: WLP, KO.   After today, junk will still be junk and quality, still quality.  NFLX still overvalued, RIMM, despite all its problems, still cheaper than NFLX.  At least they are making money during an all out assault on their business model.  Hold sold most of NIHD before release given high expectations and big run but will buy tight here, down 14%.

Am I Still Bearish? Sort of Not

I have had very light equity exposure for an extended period of time with periods of being net short to being fairly long. Fortunately, with the indices having been range bound, the opportunity cost has been insignificant. As I mentioned in a prior note being bearish is exhausting, lonely and counter to my natural optimism (although I do admit to always maintaining a healthy dose of cynicism). Imagine taking your child to see 101 Dalmatians and loudly rooting for Cruella deVille to come out on top. Your kid shrinks away to another seat on the other side of the theater while others shun you. That’s how bears are treated.

I continually second guess my investment thesis, trying to see what the other side sees. I weigh the inputs underlying my stance, marking them to market. I try to remove the bias of my position as I seek additional data that is either supportive or unsupportive of my position. And of course, there is always the fear of acting from emotion that prompts a change in thinking, a feeling that you weren’t invited to the party, of being left out. And most of all, there is that greatest fear of all, of having reversed course at absolutely the wrong time. And in full disclosure, I have not always made the turn in a very timely fashion. I did well in 2008 but hardly made any money in 2009. Although I was still ahead of the game, it still didn’t feel good missing out on a ripping bull market move.

So where am I now? I am warming up to the market. Why? Well, I have often said I have seen this movie before and it ended badly but maybe there will be a different ending to this installment because everyone else had also seen the prequel to the 2011 financial crisis. My ending has banks struggling to raise capital, some, like Dexia or perhaps Greece, going belly up, credit continuing to tighten, economies contracting – the culmination of all these fears and others I haven’t listed causing a massive wave of selling. But guess what? Merkel and Sarkozy and the more responsible members of the G-20 and EU were also around in 2008 and they have no interest in revisiting that scenario. Granted they have waited too long and the cost of delay has ratcheted up the price of a cure. Germany and France have the most to lose by not putting forth a viable solution. While expectations for a total and complete solution are still high, they have been ratcheted down enough to be attainable, or near attainable with the promise to be completely resolved in the next 3 to 6 months. Shock and awe is not in the cards and everyone knows it. But will they give us enough to put a floor under the market and cause under invested funds to chase performance? I think so.

Swimming upstream, against the tide of bullishness that is the unwavering stance by the vast majority of pundits and market participants is difficult enough but imagine the flood gates being opened and the water gushing at you as you flutter kick your portfolio like a foam kickboard. The world is awash in liquidity. It all comes down to not fighting the Fed. But the much maligned U.S. Fed has recruited a legion of Central Bankers to fight the battle: the EU, IMF and China. This is a massive liquidity push by every printing press on the planet. So for now, I am entering into surrender negotiations and further increasing my exposure further.

I am by no means becoming fully invested for I still have that evil twin whispering in my ear. The global economy is in terrible shape but what do I know that others don’t? I don’t have an edge on China – it’s a property bubble that has already begun to leak – but the Chief Communist (as opposed to Chief Economist) knows that. I think that will end ugly but they can throw enough money at it in the interim to allow the S&P to rise to 1250, a random number, while their market declines. Europe is in recession but that thinking is convention and is nothing that $1.3 trillion can’t cure.

The most alpha will likely be generated through commodities and materials – the most economically sensitive investments – but I can’t go all that way in. There is too much risk in case I am wrong. I do like the fertilizer companies for the long term and although recovering, they have been beaten worse than a Middle Eastern dictator. I still prefer the more boring fundamentally, bottoms up investments epitomized by MDRX, KO, QCOM, WLP, NIHD. My risk is in bottom fishing on HPQ and, dare I admit it, RIMM. I cut back my Euro short against the dollar but will rebuild that position again at some point.

How long the cure lasts is what keeps a lid on my exposure. At some point austerity leads to slower growth and U.S. economic policy is non-existent as Washington remains rudderless. Everyone believes China will bail out every local government, corporate and individual spectators but I don’t. After all, they are communists and not prone to providing handouts to failing billionaires or local governments who have repeatedly disobeyed central government directives. There will be some pain to teach them a lesson.

I won’t be discouraged if there is a sell on the news mentality once the EU deal is announced. And I am rooting for another delay in the announcement because that means they are still arguing – eh, negotiating. And I expect leaks from the negotiations to cause some volatility. We should continue to move higher, perhaps rally 20% before going lower, likely hitting prior lows.

Whoops, there I go again.

Have We Seen The Future: The European Solution/ China Slowing?

Being bearish is so exhausting.  I felt so lonely; every day reading analyst research reports increasing estimates, strategists targeting S&P 1300 – it was getting to me. And then the endless articles about the negative feedback loop, castigating those who dared voice a jaded view on the economy.  Much like those kindergarten girls who I coached in soccer many years ago, I thought every broad based comment was directed at me.  I needed a break.  I decided it wouldn’t be that difficult to change my outlook since I tend to be more optimistic than pessimistic. I find life much easier that way and with my golf game if I focused on the negative, if I only looked at the blemishes, I would be a really bad tennis player instead of a decent golfer (caution: literary license at work). I looked for an opening, a sign of what could go right.  Europe was the biggest near term issue and I decided to put myself in the Germans’ shoes. I took off my Tod’s, after all, they are a sign of profligate Italian spending, and figuratively put on a pair of Jackboots. I channeled Merkel and decided that the German motivation for holding the Euro together was stronger than the Greek’s desire to derail it.  After all, given that Germany is one of the strongest economies in the world with trade surpluses only recently surpassed by China, if they were to have their own currency it would decimate their export economy.  Germany needs weak partners in the Euro so that their machine tools and cars look cheap to the rest of the world. 

 

I took off all my short exposure, primarily index shorts, beginning of last week, which of course, took my long exposure higher. I added to this by increasing my holdings in some core holdings including KO, QCOM and WLP, and picked up a bargain in NIHD. I started to pare back exposure yesterday, first at a leisurely pace, only to see the news about the potential framework of the European bank recapitalization erase about a third of yesterday’s gains. The news wasn’t a surprise to me; I had written that I had expected bumps in the road to EU resolution from “leaks” and dissension to occur before we reached the moment of resolution. Slovakia didn’t scare me; their decision was an easy one – either return to using live cattle and goats as a currency or approve the ESFS.  For the Slovakian politicians, with 50% of their trade into the EU, it is only a question of how many new Mercedes and Volkswagens they could wring out of the Germans.  My reason for cutting back exposure was fairly simple which is that the market move higher was, in my view, entirely due to Sarkozy and Merkel guaranteeing a “deal” by November 3rd.  For bulls, the European debt crisis had been the governor on the market, holding it back from much higher levels, believing that corporate earnings remain robust and that China is not slowing.  But has the market been too generous in taking Merkozy at their word when they have arguably done little to earn it.  And, by the by, the EU isn’t only about France and Germany.   

 

So what is the market assuming?  My best guess is that equity investors assume a shock and awe plan which would entail:  massive liquidity injections into the economy whether in the form of a TARP like plan or some other mechanism: continued buying of sovereign bonds; capital injections into banks and backstopping future equity holders accompanied by massive dilution to existing shareholders; and either Greece defaults in a controlled manner, with a one time alimony payment, or a write-down of its debt to believable levels.  SIGN ME UP.  Actually I did sign up as I noted above.  Instead what we got yesterday was the hint that the banks may be given a period of time to raise their Tier 1 capital ratio to 9%.  They are a number of ways to do this: sell equity which they have said they don’t need thus limiting the appeal of doing so at 50% of book (I choose not to believe those numbers); convert debt to equity; or cut credit lines which, of course, has the impact of improving the balance sheet. If this were to be the plan, we saw the future yesterday in terms of US equity market reaction and today, in the sell-off of the European markets.  It wasn’t good.  But even assuming the markets go for this plan either because optimists win the day or because the market retreats thus lowering the hurdle rate what is acceptable, and the banks succeed in raising capital, there will be marked uncertainty during the period of capital raising and the eventual effect will be a slowing of growth as credit availability declines.  And this, of course, assumes that investors are as gullible in believing that Tier 1 capital is 9% as they were in believing the stress tests were accurate.  Bottom line, to quote that noted philosopher Michelle Bachmann “the devil is in the details.” 

 

The other issues of course are what a Greek default would do to the markets and the potential for a downgrade of French debt.  The best news for France is just like in WWII, they were on the sidelines while we fought the battle.  As the US came through virtually unscathed so will the French.  As to a Greek default, the result is more up in the air. Most equity investors I believe assume that any default would be accompanied by ring fencing the debt of Spain and Italy and this would be positive.  Who needs ouzo when we have grappa? Of course, any significant haircut only worsens the bank’s balance sheets but that is assumed to be taken into account as well. What about a big haircut: well, the banks responded to that potential today much like Hercules did when faced with the same scenario. 

 

But wait! Here comes Mario Draghi to the rescue.  That’s like putting Bernie Madoff in charge of compliance.  Draghi knows how to spend it so he knows austerity from the other side.  He will undoubtedly cut rates at either his first, or more likely, second meeting.  By that time, European numbers will show recession and commodities will have declined to a level low enough to provide cover for a 50 BP cut. 

 

Unless the Troika comes forth with a plan of shock and awe that removes all doubt about further contagion, I see the market fading.  Even if the shock and awe doesn’t dazzle, the surrounding issues are becoming too prevalent to ignore. In my view, as evidenced by the trade numbers form China, the European economies are slowing significantly.  US earnings season has a decidedly different tone out of the gate then those of the past 6 or so quarters. And Washington is still a mess. Actually the bright spot from Washington is that I expect a partial ray of sunshine as the Republicans and Democrats come to common ground on some mechanism to create jobs. I would expect infrastructure spending and military put to work in some fashion but keep in mind that there is a decent lag to the passing of the bill and the actual spend.  I also believe that if Romney is able to break to the front of the pack convincingly, it might actually help matters in D.C. and bring Obama more to the center while also giving business leaders hope if Romney can take a strong lead in the polls over Obama.  However, with no votes being cast in any primaries just yet, this is way too soon to call.

 Is China’s export economy slowing or are they trying to fend off a trade war and pressure to let their currency rise by showing such poor numbers?  Depends if you believe their numbers or not.  I do in this case but only because it supports my investment thesis on China slowing. I’ll take what they give me.  Jawboning down economic activity further pressures commodity prices allowing them to stockpile inventories. 

 JPM:  if JPM can’t put up decent numbers with the strength of their franchise, then what does that say about the rest of the financials?  The regional brokers are in for a world of hurt. JPM is picking up share in IB and still down 31%.

 Although I disagree with what appears to be the overriding premise of the OWS movement which is the distribution of earned wealth to those who haven’t earned it such as community organizers (sorry that slipped.  After all, community organizers are the farm team for the Presidency), I do admire their ability to mount a globally coordinated effort.  In fact, I would like to see them share their insights with the EU and Washington in terms of how to accomplish a purpose, any purpose at this point. 

 I think RIMM’s moment of silence for the passing of Steve Job’s lasted a bit too long.

The European Sucker Play; US Stock Bargains; Apple

The most important real near term news coming out of Europe will be the ECB rate decision tomorrow. Trichet is bidding adieu at the end of October and this is his last opportunity to reverse the prior rate hike. Does he head to Hotel du Cap admitting a mistake or stick to his guns and allow Mario Draghi to cut, although he has previously said it isn’t necessary. Perhaps the economic releases this morning may spur the correct decision, in conjunction with recent declines in commodity prices. Eurozone services PMI fell to 48.8 from 51.5 according to Markit survey, first month since August 2009 below 50. In other releases, Germany was sub 50 as well, France barely above 50, Italy and Spain continue below 50 at very low levels of 45 but they are already in recession. My guess is that France and Germany experience contractions in economic growth as well.

More importantly, does the troika come up with a major bail out prior to Trichet leaving and before Draghi takes over. Not sure how many EU members want an Italian telling them they have to pony up vast sums to save Italy. Fox guarding the chicken coop? Not quite but this will ratchet up the opposition or lengthen the time to cure if Trichet doesn’t act first.

The Financial Times had the story that wasn’t a story. The following 2 lines squeezed the shorts, lit a fire under those with light exposure and gave us all something to talk about.

“There is an increasingly shared view that we need a concerted, co-ordinated approach in Europe while many of the elements are done in the member states,” Olli Rehn, European commissioner for economic affairs, told the Financial Times. “There is a sense of urgency among ministers and we need to move on.”

“Capital positions of European banks must be reinforced to provide additional safety margins and thus reduce uncertainty,” Mr Rehn said. “This should be regarded as an integral part of the EU’s comprehensive strategy to restore confidence and overcome the crisis.…”

Rehn’s statement was nothing more than an attempt to put a temporary halt to the market crisis, an admirable goal, but hopefully there is ultimately more substance behind it. With the public division in the EU about solutions, I fear any resolution will be a long time in coming. Even the ESFS is flawed with Italy and Spain committing to guarantees of 79 billion Euros and 52 billion Euros, respectively. And, of course, Greece has agreed to be on the hook for 12 billion. I feel better now.

So the market basically did a hosanna that it has dawned on the EU finance ministers that they have developed a sense of urgency and will act together. Truth is we don’t know that they will act together but ultimately there has to be a plan. Unfortunately, from where I sit, the plan won’t be good for anyone, particularly the banks. We need a flush of the credit markets with tremendous pain being visited on the private sector because the political will for government to bail out all troubled banks and PIIGS does not exist. The result would be to wipe out the equity of a number of French banks as we are seeing with Dexia, which was originally bailed out in 2008 by France and Belgium. Now here they go again. Public shareholders have twice suffered significant losses. Dexia is also a good example of contagion as the municipalities in the US that do business with Dexia will likely see their borrowing costs increase as a result. And this is a minor case of contagion; it will get worse (Plus the 2008 similarities continue with good bank/bad bank solutions that don’t work.)

My bet is that Greece defaults in a “controlled” manner (not sure that exists) with limited alimony payments from the EU as a going away gift. At the same time, Italian and Spanish debt issues are ring fenced, the French banks recapitalized after taking significant write downs which almost wipes out equity holders with new shares or debt being backstopped by Germany and France as the main players. France loses their AAA, which is past its sell-by date anyway. We will also see massive liquidity injected into the European financial system causing a further decline in the Euro.

I’m waiting for this event to increase my exposure. With the slowing in China, Europe and the U.S., I’m highly confident that I can get a better entry point and keep more hair from falling out.

AAPL – still a cheap stock and the issues are well discounted in the stock price. I’m not going to beat up on Street research – well yes I am. The Street clearly has no idea what is going on with the company. If they can’t get major product launches correct, how are they doing the more difficult task of forecasting. It took me a few days to get a number I was looking for which is what percentage of ipads sold are wifi only. I’m going with the only answer that I got which is 65 – 70%. This is interesting because much was made of the fact that the new Amazon product is only wifi. Well, at a $300 difference for a product with a great brand name and very good functionality, if I didn’t own an ipad, I would seriously consider the Kindle Fire. I know that the ipad has 425,000 apps and the Fire doesn’t, but frankly, I ran out of patience after putting the first 150,000 apps on my screen. My issue with AAPL is margins. With strong competitors like Amazon and Google (android) at lower price points, is yesterday’s pricing of the iphone 4 and 4S a harbinger of lower margins and more competition? Apple has never been one to price to competitors’ levels but shouldn’t hat have to change? Tim Cook noted that 92% of the Fortune 500 are testing ipads. The opportunities in the enterprise space are interesting but keep in mind that most likely this is demand push by Apple, a common sales technique which I am glad to see them employ. I’m sure there is reverse inquiry as well. I would also guess that corporate procurement execs are more concerned with costs in a challenging economic environment and agnostic as to which quality brand they purchase. The dominant corporate usage is also likely wifi since it will be on premises as ipads are not a good substitute for laptops. Nonetheless this is a great revenue opportunity particularly if it scales into other Apple products.

Finally, on the US. We’re still without a plan and the economic numbers continue to look punk, today’s non-mfg ISM the latest example. Freight stocks are moving higher despite yesterday’s IATA airfreight numbers remaining below seasonal trends indicating a slow economy. Asia and the US showed particularly poor.

Even though the market is oversold and will have bear market rallies, I remain on the sidelines for the most part but do like a few stocks.

Wellpoint’s valuation seems compelling at less than 9X 2011 EPS. Company guidance is in a tight range either side of $7.00. They just added $5 billion to their buyback, an astonishing 21% of the company. Management said it will be completed over several years but they just bought back $1.5 billion since announcing a $1.6 billion program in February. That was about 5%. Plus I’m getting an okay yield of 1.6%.

I also like KO. Not huge growth but very dependable, the risk to earnings from currency being discounted by recent downgrades from the Street. At a 12 P/E and 3% yield it provides good, lower beta market exposure. If market explodes higher, neither WLP or KO will lead the pack but I will participate in the upside with limited downside.

QCOM remains a core holding. Tim Cook is an engineer and over saw procurement so he’s definitely on board with QCOM as the relationship, started in earnest this year, has taken root on his watch. They own CDMA and are embedded in android as well as ipad and iphone. QCOM ahs also been very friendly to shareholders, often returning capital.

HPQ is also inexpensive, even with a haircut (all the rage in financial circles these days) to earnings. My primary concern management, including the BOD. Still wish Meg didn’t speak about making the quarter. Would rather have had her reset bar lower.


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