Monday, December 8, 2008

McDonald's (MCD) Same Store Sales Continue to Be Solid

McDonald's (MCD) has been one of our 2 "Pooring of America" themes (the other rhymes with Ballmart) [Do the Bottom 80% of Americans Stand a Chance?] and November same store sales continued to impress both domestically and across the globe.

These results are a bit weaker than October however [Nov 10: McDonalds Strong, Circuit City Out] where global sales were up 8.2% and domestic 5.3%. Europe is also down from 9.8% last month to 7.8% same store sales this month. If one is a very dire bear you could theorize that as Americans (and Europeans?) become more cash poor they will simply opt for grocery and start eating at home more to save even more money. It will be interesting to watch the trend the next 3-5 months. It is too hard to extrapolate much from 1 data point but if next month we see further deterioration in same store sales it will be interesting. (and again, it is all relative as "weaker" same store sales at MCD are much better than anything in the industry) [Sept 19 2007 - Tough Times Ahead for Restaurants?]

I watch this company more for economic reasons than for company specific reasons. The stronger dollar has actually hurt them (which we warned would happen to all US multinationals this summer), but at some point (when risk is embraced again in capital market) I expect the dollar to begin its move down... in fact we are seeing some weakness today which is one of our tells for being "bullish" (since the dollar broke out upward, the US markets have basically imploded)

I continue to expect 2009 to be a good year for MCD as the economy worsens; however what will be interesting from a stock market perspective is will investors eventually abandon these two names as they "front run" an economic recovery (that will remain an elusive dream all year). Remember, reality means nothing - only thesis. Ironically a stronger US economy "thesis" could cause investors to abandon these stocks as they believe US consumers are ready to go back to their normal shopping habits. It will be an interesting tell in the year ahead simply in terms of perception - of course on our thesis for the economy, next year will be wonderful for cheap eats. I also believe the investment professionals of America understate the damage the real estate/stock market has done to personal balance sheets, and that there is no "going back" to 2005-2006 spending levels for a long time, even if the economy "recovers". But I'm in a tiny minority camp on that one.
  • Consumers hungry for cheap meals boosted worldwide sales at McDonald's Corp.'s established locations by 7.7 percent in November, more proof of how the fast-food leader is thriving in a downturn that has eaten into sales at its competitors. U.S. same-store sales -- or sales at locations open at least a year -- rose 4.5 percent, the company said Monday.
  • The Oak Brook, Ill.-based chain said the increase came from strong sales of breakfast items, chicken sandwiches and the chain's value menu options. It comes even as U.S. consumers increasingly opt for eating at home to conserve cash.
  • Morris noted that McDonald's positioned itself well even before the economy took a turn for the worse by adding healthier options to its menu and enhancing the quality of its food. Those changes have helped the chain expand its sales ahead of the rest of the industry for months. Those changes have helped make the chain more palatable to consumers looking for good food at lower prices.
  • Total sales worldwide for the month ending Nov. 30 rose 1.9 percent. The increase would have been higher but a stronger dollar ate into gains. McDonald's, like other U.S. companies that operate overseas, translates its revenue into dollars, so a stronger dollar in comparison to other currencies can hurt revenue. Excluding currency effects, worldwide sales climbed nearly 10 percent. "Foreign currency is starting to be a drag on the company and that could continue for the next few quarters," Owens said.
  • Same-store sales were also strong overseas, rising 7.8 percent in Europe and 13.2 percent in the Asia/Pacific, Middle East and Africa division. Overseas sales gains came from the chain's open early and close late -- if at all -- mantra and its breakfast menu.
[Nov 5: Keeping an Eye on....]
[Oct 10: What are Walmart and McDonalds's Telling Us?]

No position

Updated Battle Plan

Isn't it amusing how fast money flops from sector to sector? Friday it was all in housing; today it's all moved to infrastructure. All based on government announcements; which goes back to one of our 9 conditions for actual investing, rather than whatever this casino has become. Real fundamentals need to begin to matter more than government announcements. What is shocking to me about the infrastructure move is that it was a surprise to anyone - did we not know for weeks (months?) on end that Obama was pushing for stimulus through infrastructure? Now that he said it again this weekend, it now matters? Either the market is not paying attention to the news or we just need a thesis of the day to run up certain segments of the stock market. Anyhow, we are not participating in this run on infrastructure because names I was interested in Friday had settled right up against resistance (which they blew through today) and chasing something up 20% in a day or 40% in a week has proven to be a losing strategy for a long time. Aside from the engineering and contruction names we mention often a lot of material names are also flying on this news. There is such a huge irony because all the same names one could play a year ago based on China strength you can now buy again and just replace "China" with "Obama". Ah yes the "efficient markets". Here is another name which has been "Obama-ing" for 2 weeks; up just under 100% in 2 weeks because of "stimulus".

Now, I'm wondering with Obama's push for alternative energies why these stocks are not rushing upward or maybe oil in the $40s is more important than Obama. Or until Obama explicitly says in an interview "I love solar", then flashes a signature smile or a Palin wink - and then the solar stocks will run up 50% in 2 days or 100% in 4 days. It really has gotten that inane in Ceasers New York City.

As for the market, hey we were up 4% at 3 PM which means as we jump the shark for the 6th straight session (whatever direction we are at 3 PM we go another 2% by 4 PM) we should be up by 6% by 4 PM. (I'm being facetious - it's simply become ridiculous at this point) Again, this is becoming so obvious it's going to eventually snap off a lot of people's limbs when it stops working - one day we will be up by 3% at 3 PM and close down 1% and the jump the shark 3 PM trade will be done with. But apparently not yet.

My game plan is as follows - we went into this week with the lowest short exposure in months and I want to respect the power of Kool Aid. We are making our first real move over the 20 day moving average in 3 months (excluding 1 day in early November), and we now raise troops to attack the 50 day which is S&P 950 (roughly). As we get there I am going to mimic the bank trades I made earlier today - which is to lighten up exposure as we get to a key resistance area and then sit back and watch. In fact I've taken off more of the long financial and commercial real estate late this afternoon - the latter of which makes my skin crawl to be long (however, hard to argue with the P&L benefit). Either we fall back at resistance (S&P 950) and turn back down or we break through and party with Santa Obama. I don't know what we will do, nor do we need to guess. When we get there the price action will tell us - predictions are just for pundits. So we are going to lop off long exposure as we move upward and then be super high in cash awaiting the market to tell us where we go next. Being flexible, we will be more than willing to get the long exposure all back if we blast off past S&P 950.... but within the confines of a primary bear market sell first, and assess second. And more than willing to turn back to the dark side if we begin a breakdown (if hope fades)

If we break through 950 (bullish) we then have a very easy tell at S&P 1000 which were early November highs. That will be the next resistance and we'll do the exact same operations we do at 950 - cut back as we hit it, assess. Rinse, lather, repeat. A break above 1000 would be bullish again.... respecting the downside, I look at S&P 900 which we broke above for the first time in 3 weeks today to act as a support. And then we repeat all the levels we've talked about the past few weeks, S&P 870 and 840 etc etc. The importance is the behavior - will participants "buy on dips" this time - the dips which are sure to come relatively soon after this insistent of a move up? That will be key of a change to character.

Remember, this behavior is much more normal in bear markets then what we've been through the last 3 months - seeing absolutely no rallies is the abnormal act. Not the act of seeing multi week, in fact multi month rallies within the bear market - that's typical. This helps us work off some very oversold conditions. So this is about 2 weeks of rally... nothing special. Just volatile. You can see "reversion to mean" trades everywhere - all the worst hit stuff is now rallying the hardest - Prologis (a REIT) up 40%. Las Vegas Sands (LVS) reliant on US consumers spending again? Up nearly 20%. DryShips (DRYS) - global trade is back on as the global economy revives? Up 50%. MercadoLibre (MELI) - as China rebounds so will everything in South America? - up 36% Etc. Reversion to mean trades everywhere aka shorts run for cover. None of this is leadership or a new group(s) emerging as stock market leaders- that's what we really need.

Remember, this is all sort of a big hoax of a rally - it's all about sentiment and "looking through the darkness" and "knowing the worst is behind us" blah blah blah. We've had these rallies over and over in 2008 and I expect throughout 2009. This is the "2nd half 2009 recovery" rally combined with "government will save us" rally. Even if they are premature we still want to catch some of the upside and not get punished with our short exposure, so we can be cynics but we don't want to be poor cynics. Obama has high intellect and will energize the troops and people will be thankful there at least appears to be some grand plan, as opposed to the current administration which has been exposed as clueless in every facet over the past decade. So just from a "we might have a chance with these guys" sentiment stand point we should be more bullish from there. I still contend the Obama honeymoon will be over as reality settles in by late spring/summer - we should be facing 8%+ unemployment and Obama will say "I told you it will get worse before it gets better". But the market is not about reality - perception is reality. For now "we are saved". Let's position ourselves accordingly - enjoy the gains, while protecting a large part of our portfolio from a return of reality/downside risk. With these crazy ETFs, we can return with half our portfolio what used to take 80% exposure.

At some point here in the next weeks/months the galloping market will offer us some excellent profit opportunities on the short side... the higher the better (more profit when we falter) We can profit both down and up; the trick shall be timing the sentiment shifts. And as you can see everything I talk about is technical because fundamentals mean nothing and government interventions dominate every day. Hence the rules of the game change by the day, so we have nothing left but technical indicators - i.e. what is the herd doing? So we're sticking with that until the government stops dominating the discussion.

Tribune Files for Bankruptcy

Sam Zell is not having a good year. There was an excellent article on this summer in BusinessWeek on Zell's "Deal from Hell" in regards to his purchase of Tribune. [Jul 30 BusinessWeek: Sam Zell's Deal from Hell] (a great read if you want to learn about this sort of thing)

Well today, hell arrived and Tribune filed for Chapter 11.
  • Media conglomerate Tribune Co. has filed for bankrutpcy protection, pressured by high debts. Tribune, the privately held publisher of the Chicago Tribune and Los Angeles Times, in recent days hired Lazard Ltd. as its financial adviser and a legal counsel for a possible trip through bankruptcy court, the Wall Street Journal reported, citing people familiar with the matter.
  • The Wall Street Journal said Tribune has been on wobbly footing since last December, when real-estate mogul Sam Zell led a debt-backed deal to take the company private. It said that the company's cash flow may not be enough to cover nearly $1 billion in interest payments due this year, and Tribune owes a $512 million debt payment in June.
  • One of Tribune's most pressing concerns is that the company is likely to be in violation of debt terms that limit borrowings at the end of the year to nine times its adjusted profits, the paper said.
While this is a rich individual and you may or may not care about Tribune, this is a symptom of a disease I expect to hit the greater private equity world in 2009 and I believe its worth readers attention to understand the "system". If you are not familiar with this game - basically you buy cyclical companies with money from your investors, load them with debt, take a lot of fees for your "expertise" as a buyout maven, get rich and laugh to the bank. The problem is the whole "debt" part [Nov 3: New York Times - Debt Linked to Buyouts Tightens the Economic Vise] If the companies go bust based on your 'expertise' later down the road? No worries - you made your riches and your 'financial engineering' assures you are loaded to the gills no matter the eventual outcome of your target company. If I remember the Zell story from this summer correctly, he has it structured so his exposure is minimal even if the company goes up in flames. (Heads we win, tails we win - notice a pattern?)

If you are intellectually curious about this type of thing, I'd read the post from Nov 3rd, and then what opened my eyes to this game a few years ago, also in BusinessWeek [BusinessWeek - April 10 2006: Where's the Beef?] about how the game is played, in this regard specific to Burger King. That's one of my favorite stories period in terms of learning what exactly is going on out there in the highest reaches of the fiefdom. While the serfs... err sheep are oblivious to it all. It really is eye opening and shows you how the greater good (existing companies that were just fine until these "titans" came onboard) is sacrificed so a few can extract a ton of money out of these situations. This is part and parcel with our economic system - risk the many for the riches of the few. If the company goes bust, who cares - many of the peon class (workers) lose their job, but those who played the game win as they extracted their fees (management consulting fees and others) for doing the deal. If a lot of people lose their jobs and homes - that's ok - the big money made their scratch. Even Chapter 11 bankruptcy is not really losing anymore.

Anyhow, it really is amazing how the "titans" have gamed the system - heads we win, tails we win - not much different than the corporate executives compensation system. Cramerica - for the corporation, by the corporation. Just a sign of the times - as the tide rolls out, the dirty underwear is showing its skid marks all over America. Expect a lot of these in 2009. (no worries - the government will fix it)

Thesis vs Reality: More than Half of Homeowners with Modified Loans are Back in Trouble

This story is exactly why it's so tricky to be an investor. The great hope now is 4.5% mortgage rates for all [Dec 4: WSJ Treasury Considers Plan to Stem Home Price Decline], modifying loans for all [Dec 4: Here Comes the Foreclosure Cavalry], and we can get this American engine of (over) consumption back on its tracks. That's thesis. Reality is millions now live in underwater homes (they owe more than the value), many are losing jobs, many who have jobs are being cut back to part time, and the cost of life relentlessly moves upward as median wages stagnate (at best). Hence even after they are modified MANY will fall right back into the trap and we're just forestalling the inevitable for millions. Which is why this is going to cost us untold trillions and most of it will be wasted money. I expect a massive amount of new initiatives to help home owners in early 2009 that will make the market sing with happiness. Then we'll see in fall 2009 how ineffective much of it was... this is why I'm cynical about a lot of the "realities" that will come from current hopes; yet recognizing the market is all about perception. The perception is this will all work. Here is the reality. The truth is we are going to throw a lot of our grandchildren's money at a problem, trying to avert the free market from working. And most of it will fail.
  • More than half of all homeowners who had their loans modified to make the payments more affordable in the first half of the year are already in default again, banking regulators said Monday.
  • The new data raise questions about whether government money may be better spent on creating jobs, rather than averting foreclosures, said John Reich, director of the federal Office of Thrift Supervision office at a housing industry forum sponsored by his agency. "I do have concerns about allocating federal resources" Reich said.
  • Nearly 36% of borrowers were more than 30 days past due on the loan payment three months after their loan was modified and nearly 53% were more than 30 days late after six months, according to the OCC.
  • "The results, I confess, were somewhat surprising, and not in a good way," Comptroller of the Currency John C. Dugan said in a speech in Washington, D.C. on Monday. Mr. Dugan said it wasn't clear whether the low success rate reflected the fact that the modifications weren't reducing monthly loan payments enough to be truly affordable, whether the mortgages were so badly underwritten that they weren't affordable, even with lower payments, or if both factors were at work.
So there you have it: 1 in 3 people were 30 days past due WITHIN 90 days of their modification. 1 in 2 people were 30 days past due WITHIN 180 days. I cannot stress enough how backwards this recession is; usually housing falls during the recession - people lose jobs and then the housing market falters as response as people cannot make payments. This is the only time the housing market STARTED the recession. So we are now going to layer on the worst post war recession on top of a demoralized housing market. None of this is a surprise. We should (in a normal recession) just this past summer began to see the effects on the housing market. Instead, we've already had 2 years of the housing downturn (and the most vicious one since the 1930s), and just now the "normal" recession pattern is being birthed. But never fear - the government will fix it all. So says the stock market.

The next round of modifications will be Fannie/Freddie led and be far more draconian - if you owe $250K on your mortgage, put nothing down and the house is now worth $170K, are late on your payments... POOF! MAGIC! The government will say you own $150K. The government will take the loss but not call it a loss (remember it's an investment that we'll all make money in the long run) and say you will be forced to share the profit on when you sell the house as "things return to normal in a few years" (what a dream). So in return for government generosity you have to give up some of the huge winnings you will make when you sell the home. So when you can sell the house for $200K in 2012, the government gets half the $50K gain and so do you! We all WIN in socialism!

Then when the house falls to $140K in 2010 we'll all look around and say that was a waste of money. But it's time to do a new program to help the homeowner in 2010! This time it will work - we'll move principal down to $100K! So you took the mortgage down out at $250K and put nothing in the house but the government essentially just gave you $150K since they have now valued the mortgage at $100K. Beautiful. But that's ok - our government pockets are endless. The message this sends to people who are playing by the rules is pathetic. Unless these new intiatives coming from Obama's team are air tight it's going to lead to many people who had been paying their mortgage to default as well so they too can be part of the government largess. Which is the irony of it all. The sucker who has been paying their mortgages? Nothing for them in this Ponzi scheme.

This is why it will be difficult to short the market effectively until the Obama news flow fades and the honeymoon is over. The level of government interference coming in the housing market is the next few months should be awe inspiring - interest rate buydowns, principal reductions, outright purchases of mortgages - it's all going to be on the table. I still think there is an outside chance of outright purchases of homes (to reduce supply on market) via federal funding to states. And Wall Street will cheer and whoop every moment of it - the nanny state has come to clean their mess. This will be socialism of the highest order that causes some of our European friends to drop their jaws at the things we are going to do.

Bookkkeeping: Cutting some Bank Exposure

We have very excellent technical set ups in 2 of our 3 banking stocks - Regions Financial (RF) and BB&T (BBT). Both stocks had broken down when we had that bought of reality the past few months, and now have rallied back on the hope phase to come within spitting distance of some key resistance areas. I'm going to employ strategy I use in a normal market even though we live in abnormal times; that is cut these names sharply as they bounce from below key technical support, and then if the stock shows enough strength to burst through, we'll buy back our exposure at higher prices, but with more confidence the market believes in these names. For RF that is a close above $10.50 and BBT a close above $31 - these are actually some of my favorite sort of set ups.

BB&T was a 1.0% position and RF Financial was a 1.5% position, so we're cutting both back to 0.1% holding stakes. (we';re moving 2.4% of exposure from "financial" to cash) RF in $9.90s and BBT $29.50s. Again, if these move back above the key levels we mentioned above, we'll pile right back in and declare the "bottom in financials" as we bathe ourselves in Kool Aid and kiss posters of Obama.

We own 3 bank stocks and than the financial ultra long ETF - with this move our exposure remains in 2 of the 4 instruments. Despite all the hoopla about financials thus far these have been losing trades for us as we bought in late summer during the last round of Kool Aid. We did not go extra heavy into financials since we were cynical about the call for their (73th iteration) "bottom", but the drumbeat grows louder among the investment community that banks will be the cool kids on the block for 2009. Failing commercial loans, mortgages, credit cards as the economy worsens? No problem - the government will buy it all from the banks.

Long BB&T, Regions Financial in fund; no personal position

Obama Hearts Infrastructure

Thesis rules. Every infrastructure stock we outlined last week in [Dec 3: Back of Envelope Look At Infrastructure] is up 12-18% today.

Thesis is everything - with Obama spending like mad dry bulk shippers will once again be in need, coal production will ramp, steel will be in shortage, oil might make a race for $200 again... or so the stocks act like today.

Reality? None of the above, but this is not a market of reality. Perception is reality.

The government has saved us. Again.

While mocking it, we are willing participants in the Kool Aid. If the move lasts, all the lowest quality most beaten down stuff will make up the next leg of the rally - Obama solar stocks, small cap/mid cap Chinese stocks, and the "early cycle" plays of course (finance, housing, construction, retail) Nevermind the news, it will all be better in 4-6 months.

As I swig on Kool Aid an envision an America full of teeming shoppers emboldended by 4.5% mortgage rates for all, I am taking some of my Ultra Real Estate (URE) and Ultra Financial (UYG) off here as they are now both in the 6-6.5% range of the portfolio (12% total). While these 2 always seem to trade in concert I'm actually leaning more to the financial over real estate because the government won't be bailing out commercial real estate ... and it is a more direct victim of the flailing economy. So while I'm trading them in tandem only because the market is a monolith and we "student body" buy or sell everything, these two should separate at some point as the business bankrupcies reign down in first half 2009, while the United States of Banks meanwhile has the not so invisible hand permanently injected. It will be interesting to see when the fortunes of these 2 sectors separate.

China is no longer just poised for a breakout [China Just About Poised to Break Out] - it has. Pity the fool shorting China (source: Mr. T)

The seeds for the rally were there [Dec 3: Seeds for a Rally] and we laid out our near term upside targets [Nov 26: Let's Look at our Potential Upside] Party on.

Long Ultra Financial, Real Estate in fund and personal account

Wall Street Journal: Heebner the Contrarion

Speaking of "the playbook", this is appropriate. Ken Heebner is moving into the early cyclicals - we'll see if the timing is appropriate. As we saw a few weeks ago, Mr Heebner was going heavy into financials [Nov 14: Ken Heebner Moves into Financials Big Time] - that was a bit early as Citigroup almost disintegrated but when the government has your back no matter what, EVENTUALLY the trade will work. (although if your timing was off you suffered dearly) We bought a trio of banks this summer and thus far have been minting losses off them! Thankfully only a small part of the portfolio thus far. Heebner has had a lousy year, but everyone does every so often - still one of the best over the past decade. [May 28: Ken Heebner - America's Hottest Investor]

Remember to do this "early cycle" trade (of which financials are a big part) you have to cover your eyes from all current news, and "look through the valley to the other side" in a time when Americans act like... well Americans have the past 25 years. It doesn't have to be correct; you just need the horde to follow you in - as long as you all suspend disbelief together and all play by the same playbook - you can all win. As I wrote in my previous entry a lot of people tried to play this angle via huge gulping of Kool Aid (the government will save us, there is no recession, ok there is a recession but it's short and shallow, etc etc) throughout 2008. Eventually it will be "right".
  • After making a fortune betting against financial stocks until this summer, mutual-fund manager Ken Heebner is turning bullish on the sector. Mr. Heebner, who runs one of last year's best-performing mutual funds, is sure banks and insurers will recover next year, thanks to Treasury Department and Federal Reserve efforts to bolster lending. "A year from now, credit will be available because of the government's actions," said Mr. Heebner, who works at CGM Funds in Boston.
  • Only time will tell if he is right. Meanwhile, that switch has harmed his performance lately.
    His CGM Focus fund, which for years has posted a string of market-beating returns, this year is lagging behind the Standard & Poor's 500-stock index by 11 percentage points. For only the second time in his 11-year tenure, he is in the red, off 52%. But the money manager, who often goes against prevailing trends, contends his plan eventually will pay off.
  • CGM Focus is famous for betting big on a few economic themes. This risk-loving fund often is at the top of its "large blend" fund category -- which buys both quickly expanding growth stocks and cheap value stocks -- but sometimes near the bottom, such as now and, most recently, in 2004.
  • This fall, Mr. Heebner built a more than $1 billion combined position in Citigroup Inc. and Bank of America Corp. He has put $780 million in two Brazilian banks, Banco Bradesco SA and Banco Itau Holding Financiera SA, counting on U.S. actions to help lending abroad. CGM Focus's biggest holding through September was $552 million in Wells Fargo & Co. About 40% of his $4.3 billion CGM Focus was in financial stocks as of Sept. 30, according to its portfolio report.
  • In determining which ones to buy, Mr. Heebner is leery of certain traditional earnings multiples that don't always best gauge affordability. So for banks he uses two other measures, which suggest they are at historically cheap levels and, because he feels strong rebounds are assured, are ripe for plucking.
  • One such metric is "price-to-tangible book value." For 20 big lenders, including Citigroup, Bank of America and Wells Fargo, this runs about 1.1 times, compared with 2.7 on average since 1990, according to a Goldman Sachs report. Tangible book value is the net worth of a company after stripping out intangible assets such as goodwill and patents. A lower ratio suggests a bank's stock is undervalued but can also suggest assets are overstated.
  • His second measure is the "price-to-preprovision earnings" ratio. For these 20 banks, it is 5.4 times compared with 12.2 times on average. Preprovision earnings exclude provision expenses for loan losses and measure banks' earnings power. A relatively low ratio can mean the market is underestimating the value of a bank's potential for profits. But a low ratio also can be warranted if the market believes a company hasn't provisioned enough for such losses.
  • Financial stocks have been relatively cheap for some time, and many fund managers got into them early, and paid for it dearly. Managers such as Oakmark Funds' Bill Nygren still held Washington Mutual Inc. earlier this summer. Regulators seized the firm in September and sold its banking operations to J.P. Morgan Chase & Co. His nearly $2 billion Oakmark Select Fund is down 43% this year, following a 14% slide in 2007.
  • In September, when the government started taking steps to inject capital into banks and back troubled assets, he became convinced that confidence in credit markets would be restored and financial stocks would benefit.
  • Mr. Heebner knows his positions in financials could suffer more pain, as the recession brings more mortgage foreclosures and asset write-offs. He admits that the eruptions of bad news are sometimes disconcerting.
  • Citigroup's announcement last month that the government will absorb as much as $249 billion in potential losses on real-estate loans and securities held by the bank "came out of the blue" and "I was scratching my head," said Mr. Heebner. (I'm surprised by those comments considering we were on Citigroup death watch here)
  • He is offsetting those bets with defensive picks. That includes Wal-Mart Stores Inc. and McDonald's Corp., bargain-oriented retailers that would both benefit as consumers rein in spending. Gold stocks such as Goldcorp Inc. and Barrick Gold Corp. represent another haven. (agree with these as we mention often)
[Aug 18: 24/7 on Ken Heebner's 6/30 Holdings]

Sunday, December 7, 2008

Bookkeeping: Weekly Changes to Fund Positions Year 2, Week 18

Year 2, Week 18 Major Position Changes

Fund positions of 1.0% or greater can be found each week in the right margin of the blog, under the label cloud and recent comments areas; I highlight weekly the larger position changes.

Being a long only fund, via Marketocracy rules, the only hedges to the downside I have are cash or buying short ETFs. I cannot short individual equities.

To see historic weekly fund changes click here OR the label at the bottom of this entry entitled 'fund positions'.

Cash (2 positions [SHV/BIL] + cash): 45.6% (vs 38.0% last week)
32 long bias: 49.9% (vs 53.1% last week)
7 short bias: 4.5% (vs 8.9% last week)

40 positions (vs 41 last week)
Additions: N/A

Removals: Mastercard (MA)

Top 10 positions = 28.2% of fund (vs 31.6% last week)
30 of the 40 positions are at least 1% of the fund's overall holdings (65%)

Major changes and weekly thoughts
Please note on a technical note - the closing prices from Friday are not registering in and with the large moves in the last few hours there is a severe difference in some positions in terms of size and value versus what they should be. Since I have no other alternative I am using the position weightings as listed currently, although they are incorrect based on incorrect pricing of ETFs and equities. I am not sure what prices is using since it is not Thursday's close, apparently some moment in time Friday (which doesn't narrow it down much considering the huge intraday swing)

We'll begin this weekly summary with our list of conditions to change to "investors"
  1. reduction in volatility
  2. separation of "benign" sectors from "poor" sectors
  3. separation of "solid" companies from not so solid within a sector
  4. the end of "student body left" (sell everything!) and "student body right" (buy everything!) trading
  5. the ability to invest in 98% of stocks with more than a 2-48 hour time frame
  6. the emergence of any sort of sustained leadership
  7. stocks that go up on bad news (bad news priced in) .... or at least stocks that respond to good news!
  8. individual company metrics mean more than government announcements
  9. a 20 second comment on CNBC doesn't move the stock market 5%
Item 7 remains the primary change from the past few months; this past week not only did the market shake off bad news the vast majority of the time but a lot of individual companies that warned shook off the bad news and traded if not up, then at least sideways. One could make a case that condition 5 is improving but that's still up for debate. The monolithic trading (buy everything or sell everything) continues as does the rampant volatility. The last hour moves which seem to be an "Ultra" (long or short) of the rest of the day continues. Hope of government saving us all continues with even more announcements this week including plans to move the mortgage rate to 4.5%.

Our allocations are understated to the long side due to the previously stated malfunction in pricing in our tracking system at We are (for now) going with the flow and ignoring the bad news, although we believe it will last far longer than the "consensus". Even during a bear market rally we will still hold high cash and our bullishness will be expressed by a lower than average short exposure - until the market improves for a multi-month period we won't be drawing down the cash exposure by a huge amount. A real bull market will last years, not 3 months - so missing 5 weeks won't mean much in the really big picture. And within a bear, you can see the downside moves are hefty and quick - we don't want to be exposed so heavily to a market that can take away a month of gains in 2 days, even if we miss some upside during Kool Aid times. The technical picture will tell us when to get back to a real bullish posture and we are not even within a remote zip code of that address.

I believe much of the next 7-9 months will be a continuation of this pattern - the ping pong between "hope" and "reality". We will constantly "hope" that we should be buying today because "it can't get worse" and "the bottom is here within 4-6 months". And then reality will strike. On weeks hopes dominate we will trend up, on weeks reality strikes we will trend down. This will define the market for the better part of the next year. How do I know that? Because that's all we've been doing for over a year. Remember some of these? "Bernanke has cut the discount rate! The Federal Reserve is here to save us! Don't fight the Fed! The playbook says so!" "Abu Dhabi is putting $7.5 Billion into Citigroup! The smart money is in, buy financials! follow smart money! the bottom is in!" "Paulson is coming up with a Super SIV to save the banks and put all their bad assets into an off balance sheet entity! buy financials! the government is here! the bottom is in!" "HopeNOW is going to save the homeowner! We can stave off foreclosures and homes are the source of all our ills! the government will save us - the bottom is in!" Folks, that is all fall 2007 and early winter 2007 Kool Aid. I won't even bother to list the 2008 Kool Aid. Just know 90% of it revolves around the government saving us which is where we are again. I find it ironic that a populace that complains about how incompetent the government is, is more than willing to put faith that they are the ones to save us....

Since this ping pong between "hope/news events" and "reality" is nothing more than a sentiment change, it makes for tricky positioning because the change in sentiment is a lot different to measure than changes in business operations. Don't believe the hype about the market as a discount mechanism and that the "strength" is telling us the economy will be just fine in 4-6 months. Maybe 30 years ago - but not in this system where huge money can move markets like they can now. When a pundit tells you that, ask the pundit what exactly the market was discounting "4-6 months out" in October 2007 as it went to all time highs? Or what oil at $147 was telling us about demand 6 months out?

On an anecdotal note I was watching Fox Business "Happy Hour" and saw a segment where two professional money managers (NOT traders) but "investor"/"strategist" types were talking their books and the whole conversation centered about what double or triple ETF's they were playing that day. This really showcases to me, what I've been suspecting for a long while here - how everyone is turning into a daytrader and the lack of need of exposure to individual names since the ETF trading dominates. It really has simply turned into a casino when professional money managers leave you with lines like "I decided to go long triple long the market around 1 PM when the market went back to neutral after a lousy jobs report" and "how much lower can oil go? I went long double oil as we hit the low $40s" etc. What will be interesting to look back on in 2-4 years is if this is a complete character change of the market, or a symptom of a batty thinly traded market where individual company metrics have meant nothing for so long. But what used to be a very short term oriented market, has turned even more so by many degrees the past few months. We probably won't know if it's a character change until the next bull market arrives. I can only hope it once again has some semblance of reflection on underlying business prospects. To whit, may I quote from Barron's this weekend

Mike O'Rourke at the institutional broker BTIG: "These nearly 5% intraday moves are becoming ridiculous. The ridiculous aspect is that they occur in roughly half-hour time spans, and bids instantly disappear."

Watch the tape, and the dominant impression is of machines -- cybertrading funds using algorithms -- arguing among themselves.

That last one could be my favorite quote of the year.

Technically we actually have an almost identical set up to this point a week ago, in which the markets put on an impressive reversal, we were sitting above both our key support levels (S&P 840 and 870) and technical conditions would point to a continued move higher. We were then treated to a 9% loss on Monday, so it's hard to cling to any evidence as useful nowadays. One condition we've displayed is the inability to break over even the 20 day moving average on the S&P 500 in any material way for 3 months. Each time we tease it, the market gets our hopes us and then bludgeons the longs. The 20 day moving average should not be such a strong resistance level, but the fact it has been has shown the inherent weakness in the market. Frankly, for all the "ignoring of bad news" we've been doing, all it's gotten us thus far is back to the 20 day moving average. As we mention often, if the market breaks over its 20 day moving average the next level is the 50 day moving average - which is just about S&P 950 and falling fast. We haven't been meaningfully over this level since early June. (half a year) - that is 8.5% higher which in this day and age is one good afternoon in Ceasers New York City. To show how far we've fallen the 200 day moving average is up near S&P 1200... that's 37% higher from here and would still have us in a primary bear market until we break back above.

So is there upside? Certainly. Downside? Certainly. You'll hear excuses and explanations each day (down days = hedge fund selling, tax loss selling blah blah; up days = Obama effect, front running the January small cap effect, seasonally strong part of year, blah blah) It's all nonsense to fill up a lot of hours for financial media. This "efficient market" has turned into a random action machine and we'll go where we'll go; finding explanations just comforts us as to believe there is some rhyme to it. Market participants are confused and have been using the wrong playbook all year - continuously believing first no recession and then the corporate led recessions of early 90s and early 00s. We've said all along this will be the first consumer led recession since the early 80s. That has proven to be true. Now those people who live off the "playbook" will buy "early cycle recovery" names because that's all these guys know - the playbook. They did this 3-4x already this year, woefully early. And will keep doing the "playbook" each time we rally over the next 8-9 months because that's all they know - buy the financials, homebuilders, appliance makers, retail, et al. Why? Because I need to be in front of all the other guys buying the same names ahead of the recovery coming in "4-6 months". They did this last winter, they did this last spring, they did this last summer (they did not do it this fall because no one was buying anything) and they'll keep doing it. So each time these rally and you are told by pundits "it must mean something! It must mean recovery!" once more ask what it meant last winter, last spring, and last summer. Here is what it meant - small concentrations of big money can move subsectors in big ways and when they choose to play a thesis, stocks run. And it means nothing. It will be the wrong turn, over and over and over - until one day it is actually correct. But it doesn't need to be "right" - it just needs to be gamed. And that's your stock market of the new century. So for now we'll stay exposed to the "hope sectors" and hey we might even dive back into an infrastructure stock because the Obama thesis means every infrastructure stock is now blessed as well. Thesis is everything; perception is reality.

60 Minutes: Saudi Arabia Bullish on Oil

Interesting pieces on oil via Saudia Arabia; some amazing technology behind the scenes.

Two 12 minute segments

The good news is that the price of oil is falling - a lot; it's also the bad news if you're determined that the U.S. should kick its addiction to foreign oil. President-elect Barack Obama says now is the time to do that, even with the economy in recession.

But Saudi Arabia, the world's largest oil supplier - with the U.S. as its number one customer - is pulling all the levers and spending billions to keep the oil age going.

China is Just About Poised to Break Out

Notwithstanding my previous two posts, keep in mind thesis versus reality is all that matters in the stock market. Perception is reality. And the price action in Chinese stocks the past few weeks is encouraging... iShares Xinhua China 25 (FXI) needs to clear $28 and one can build a case for a technical breakout.

In theory this fits with our thesis of "the world shall lead the U.S." but for now all world markets just seem to be correlated - it's all one big monolith.

I'm not yet long this instrument but we've held it's inverse as a hedge fund a long time and we've cut back a lot of late as it's been quite week (signaling potential strength in what is it is betting against - effectively US listed Chinese large caps)

New York Times: China's Economy, in Need of Jump Start, Waits for Citizens to Loosen Fists

Now overlay the last story with this one, and then compare the attitudes of citizens towards savings here (or in Japan) versus the conspicuous consumption culture we celebrate. It is one stark difference - people who act like this in America are viewed as "strange" or "out of the ordinary". And why at the individual level (not for all, but for many) and national level, we rely on the generosity of others to be our creditors. Once more, one of the more interesting "fallouts" over the next 5-10 years will be to see the cultural and attitude changes that potentially (or not) happen after this "lesson". We'll see how soon we forget.
  • He does not know it yet, but Dang Fu has been tapped to save the Chinese economy. A ruddy-faced millet farmer from northeast China, Mr. Dang, 56, has managed to save two-thirds of his family’s $2,200 annual income in recent years. He grows much of his own food, wears a winter coat until it is ready for the rag heap and buys niceties only when his wife’s nagging becomes intolerable.
  • Last year’s indulgence, a new 25-inch television, still makes him wince. “It was painful to spend so much money,” he said, strolling through the aisles of a supermarket last week with his prodigal sister-in-law (she saves just half of her salary).
  • But such tenacious thrift, once an admirable quality here, has become a liability as the nation’s export-driven economy slows, a prospect that has stoked the government’s fear of unemployment and social instability, and that could threaten the Communist Party’s hold on power.
  • Government analysts are looking to consumers, especially the country’s hundreds of millions of high-saving peasants, to pick up much of the slack. “If we can boost people’s confidence and they spend more money, it will not only be beneficial to China but it will help stabilize the world’s economy,” Zhu Guangyao, the assistant finance minister, said last week. (I encourage a citizen exchange with Americans - you know a 1 for 1 trade for 6 months - plunk those peasants into a lifestyle of malls, celebrity culture, and "acquiring more toys than the Joneses", and send the Americans to be pig farmers or bean growers - that'll teach those Chinese folk how to spend like a true patriot! Or simply get your President to tell the citizens that the terrorists have won if we don't shop - it worked wonders here)
  • But getting people to spend more, especially in the face of an economic slowdown, may be a tall order. Consumer spending makes up 35 percent of China’s G.D.P., and that number has been dropping since the 1980s, when it stood at 50 percent; consumer activity in the United States, by contrast, is responsible for more than two-thirds of the economy.
  • As part of subsidy programs... the measures include subsidized housing to persuade homebuyers to fill their new dwellings with furniture, and rural electrification projects that will give farmers access to affordable power. On Monday, the government introduced a subsidy in 14 provinces that would make it cheaper for people to buy cellphones, washing machines and flat-screen televisions. (sounds good, we'll do the same thing here, but we don't mess with small stuff like that - we do it for homes - Americans need no major incentive to buy those small gadgets you speak of - all it takes is a Best Buy flier and a post Thanksgiving morning and they herd like cattle outside stores at 3 AM - again, about that citizen exchange program... a lot can be learned)
  • Mr. Dang and his wife, Zhang Fengxia, 52, are the apotheosis of Chinese thrift. They do not use banks — “better to keep money at home,” Ms. Zhang said — and the couple’s biggest expenditure was a used tractor they bought for $1,200 a few years ago. Everything else is set aside for their retirement and for potential medical costs.
  • Although high savings rates can be found across Asia, the Chinese propensity to save is rooted in deep-seated memories of scarcity and a tattered social safety net that forces people to save up for education, retirement and medical costs. The government has introduced a subsidized health care system in the countryside but most Chinese, rural and urban, live in fear of medical emergencies. (well some things are the same in both our cultures)
  • In addition to health care reforms and reliable social security benefits for retirees, Ms. Wang and other analysts say the floodgates of personal consumption may have to await a marked rise in wages. “That is something that will take years, not months,” Ms. Wang said. (hmm, more similarities)
  • For the moment, it is people like Li Xiuqing who hold the greatest promise for China’s emerging consumer economy. A secretary in a Beijing accounting firm, Ms. Li, 28, makes less than $600 a month but she spends almost every yuan on stylish clothing, restaurant meals and prepaid minutes for her fuchsia-and-gold Nokia cellphone. (ah the great hope! The youth of the world - bathing in American consumption habits - thank god for the internet where people can learn our habits from 8,000 miles away) Raised on a hog farm in Hunan Province, she laughs off the penurious ways of her parents and grandparents. “The most expensive thing my father ever bought was a wristwatch,” she said as she picked up a $100 pair of stilettos at one of the capital’s ubiquitous malls. “China’s days of starvation are over.”

Wall Street Journal: China Fears Restive Migrants as Jobs Disappear in Cities

As we've been saying for over a year, there is great "incentive" for China's government to figure out a way to keep all these newly urbanized people employed one way or the other. If they are to succeed, we won't know until after the fact but the pressure seems to be growing. The numbers are indeed staggering - 130 Million migrant workers is nearly half the entire US population. So I ask you, Americans, - please visit your local malls and "shop til you drop" even if you don't have the money (that's what patriots do!) - and in turn we can keep Chinese migrant workers working... as thanks the Chinese government will continue to buy the U.S. debt obligations to infinity and we can continue this charade for a few more years. I mean, it's been working like a charm so far!

From the Wall Street Journal

  • Fan Junchao has spent most of the past five years living hundreds of miles from his small family farm here. Encouraged by the local government, he leased out his meager plot and worked on construction crews in big cities, making several times what he could have earned on crops. Now his construction project has been halted, and Mr. Fan has returned home. "Right now, I don't have a plan," he says. "I'm just taking it one step at a time." (with a plan like that - Hank Paulson has a job for you in Treasury) Mr. Fan is among hundreds of thousands of China's 130 million migrant workers -- known as the "floating population" -- being cast out of urban jobs in factories and at construction sites. Migrant workers -- estimated to make up a tenth of the country's population -- have powered China's economic success in the three decades since free-market reforms began.
  • China's roaring industrial economy has been abruptly quieted by the effects of the global financial crisis. Rural provinces that supplied much of China's factory manpower are watching the beginnings of a wave of reverse migration that has the potential to shake the stability of the world's most populous nation.
  • Fast-rising unemployment has led to an unusual series of strikes and protests. Normally cautious government officials have offered quick concessions and talk openly of their worries about social unrest. Laid-off factory workers in Dongguan overturned patrol cars and clashed with police last Tuesday, and hundreds of taxis parked in front of a government office in nearby Chaozhou over the weekend, one of a series of driver protests.
  • At a train station 30 miles from Mr. Fan's village, officials are keeping 24-hour tabs on arrivals to monitor how many of the surrounding area's two million migrants will return from industrial centers. Around 60,000 have already done so, they say -- and many more are expected, despite Beijing's efforts to persuade workers to stay in cities and train for potential new jobs.
  • Many of the returning workers, like Mr. Fan, have too little income from the land to support their families. Beijing has been encouraging many to lease out their farms to more profitable cooperatives -- which don't share their increased earnings from the crops with the landholders -- at the same time it encouraged their moves into the cities, by loosening rules for doing both in the past few years.
  • Others have no farms to come back to, having seen their land gobbled up by decades of previous Chinese urbanization drives, in which unscrupulous developers and corrupt officials often illegally seized peasants' land.
  • Officials in the central province of Hubei estimate that they've also had 300,000 laid off workers come home just in the past two months. In Hubei's capital, Wuhan, officials estimate that the number will eventually total 600,000 in their city alone.
  • In Fuyang, the city nearest to Shuangfu, officials tracking returnees note that it's not easy for industrial workers to return to country life or work. "These aren't the same peasants like the peasants of yesterday," says an official from the city's Human Resource and Labor Bureau, "They don't raise crops, they have skills."
  • China has roughly the same amount of farmable land as the U.S., where only 2% of workers are employed in agriculture. But China has some 730 million rural residents -- more than twice the entire American population. Between 80 million and 100 million rural residents are either completely landless or don't have access to enough land for subsistence, estimates Joshua Muldavin, professor of geography and Asian studies at Sarah Lawrence College. "The increases right now with the large-scale return of peasants could add tens of millions to that,"

Saturday, December 6, 2008

Star Tribune: How Bad is Minnesota's Budget Deficit? Mega-Bad

Thanks to a reader for sending this - I did not even have Minnesota as one of my 15 or so states which will need a federal bailout. [November 2008 Thoughts/Roadmap] I am sure many of you will read similar things about your own states in the months ahead - if you see something similar to this please forward it to me via email; I'd like to know what states our tax dollars are going to bail out before hand. Remember states budgets go from Jul 1 to Jun 30th so the real panic has yet to begin. Early summer is going to be a doozy of financial crisis headlines.

Now, based on Obama's glad handling with governor's a few days ago, the state budget emergency might not be solved via "bailout" as I originally anticipated - instead they might get the money via the $500B to $700B New Deal 2.0 that will be rolled out in early 2009. So the problem will be "solved!" that way. But that's just nomenclature. It's a bailout that might be reclassified as a stimulus. And then we'll be in the same boat in the following budget year (summer 2010 - summer 2011) So another bailout... err stimulus package... will be brewed by then.
  • Minnesota is headed toward a historic budget deficit that could rock state government -- and the people who depend on it -- down to its core. State budget officials will release a two-year economic projection today that is expected to show Minnesota facing a deficit of anywhere from $4.5 billion to as much as $6 billion. At the upper end, the red ink would equal nearly 17 percent of the state's total budget.
  • "This is without question going to be the worst deficit in modern history," said Senate Finance Committee Chairman Dick Cohen, DFL-St. Paul. "We're heading into a terrible storm, and we have nothing left to face it with."
  • The state's budget reserve stands at a wafer-thin $153 million -- about one-tenth of the minimum recommended amount -- and that is about to disappear as the state attempts to head off its most immediate crisis: a short-term deficit for the remainder of the current budget period, which ends on June 30.
  • "We can't tax our way out of this problem," said Senate Taxes Chairman Tom Bakk, DFL-Cook. "You cannot raise taxes by that much. You can't cut the state budget by that much, either. (no, what you do is ask for a federal bailout) I would argue that everything -- every spending program, every tax -- has to be on the table. This will require a major reprioritization of programs."
  • ...spending already authorized is expected to grow by 6.1 percent.
  • Health care, schools, prisons, road projects, local government aid, all could come under the budget knife in the coming months. "This isn't one of those things where you can tinker around the edges," Bakk said
  • Stinson stressed that the forecast was not a worst-case projection. "Things could be worse, they could be noticeably worse between now and the end of the biennium," he said.

We're Down 33% in 1 Month on "Our" Investment

Talk about adding insult to injury - not only are our real investments being obliterated but even our tax dollars are being obliterated - "we're" down 33% in 1 month. But don't you worry, from government's mouth to God's ears, these are long term investments that will make us scads of money - just you wait. Unlike everyone else, the US Government is not a daytrader.

Foreign readers, I am sorry to inform you, you are not eligible for this once in a lifetime investing opportunity. Only those on American soil are so lucky to have this chance... please do not email me with your envious thought. I suggest immigration to take part in such bountiful excesses.
  • Stock intended to eventually earn taxpayers a profit as part of the Bush administration's massive bank bailout has lost a third of its value — about $9 billion — in barely one month, according to an Associated Press analysis. Shares in virtually every bank that received federal money have remained below the prices the government negotiated.
  • Shares in virtually every bank that received federal money have remained below the prices the government negotiated.
  • "We're not day traders, and we're not looking for a return tomorrow" said Neel Kashkari, the director of Treasury's Office of Financial Stability, which oversees the $700 billion financial rescue fund. "Over time, we believe the taxpayers will be protected and have a return on their investment." (I believe Yahoo should be worth $150 - if only the market respect my beliefs)
  • Most of the Treasury Department's investments since late October have been in preferred bank stocks, more than $180 billion worth, with investments in giants like Citigroup and JPMorgan Chase, and many small community banks.
  • But the government also negotiated options to buy up to 1.2 billion shares of common bank stock that was valued at $27 billion. Now, however, the value of that common stock is worth less than $18 billion. If the government exercised all its warrants to purchase the stock today, it would lose money on 51 of its 53 agreements. Taxpayers would be out $9.3 billion.
  • "The markets are saying this plan isn't going to work for the banks," said Ross Levine, Tisch professor of economics at Brown University. "They're asking where this plan is going."
  • Treasury Secretary Henry M. Paulson Jr. describes the cash infusion as "an investment, not an expenditure." So far, however, only two of the 53 banks can be considered a good investment. The AP's analysis found that only HF Financial Corp. of Sioux Falls, S.D., and First Niagara Financial Group of Lockport, N.Y., would make money for taxpayers if the common stock options were exercised today.
The irony of all this is, this is really a heck of a scheme - the government can continue to funnel money into the banks via TARP and other Federal Reserve moves, which HAS to at some point push the stock prices up at which point they can point to themselves as excellent investors. When you control the money flow, the stock market should be quite the easy place to play. Just not so far.

The other Paulson by the way (the hedge fund manager who is dominating this market) [Nov 18: Paulson Buying Mortgage Backed Securities] , said the government was far too generous in it's handouts... err bailouts... err investments.
  • Hedge fund managers, who rank among some of the world's shrewdest dealmakers, told Congress the U.S. government's bank capital injection program did not have enough strings attached. "The current terms are overly generous to recipients," said John Paulson, president of hedge fund Paulson & Co.
  • John Paulson -- whose attack on the plan was dubbed "Paulson versus Paulson" by the lawmakers -- said any bank receiving federal funds should halt cash dividends on common stock and restrict cash compensation to executives. He also said the government should demand a higher dividend payment from participating banks, possibly around 10 percent instead of the 5 percent rate now in place.
Don't worry John, we'll make money in the end; we're not daytraders.

With tricks like this it's no wonder
  • More companies would be in the black, but the government used a 20-day stock price average to set the warrant price, meaning it willingly negotiated to pay roughly 25 percent more than the stock was worth on the day it signed the deals on behalf of taxpayers.
Excellent move!
  • "It's a complete mistake to think this is a good investment for us," said Paola Sapienza, a finance associate professor at Northwestern University's Kellogg School of Management, who spearheaded a September protest of the bailout by more than 200 of the nation's leading economists. "It's a gamble. It's like going to Las Vegas."

Friday, December 5, 2008

Bookkeeping: Closing Mastercard (MA)

I am going to close Mastercard (MA) because it, at this moment, essentially goes against just about all my thesis for the next 8-12 months. I still like the name long term as the world turns from cash to plastic. But less people with jobs equal less spending via cards in the US and Europe. We restarted this Oct 10th in the $152s, so we're exiting the last 0.2% with a loss right near $140. We took most of this position off at $146s so no major skin off the nose.

Here is the irony right now - the rally is being led by retailers, financials, and homebuilders; the power of thesis tops the power of reality. Remember, the current thesis is 4.5% mortgage rates will allow everything to return back to America circa 2006. [The 'Consumer is Back' Trade is... Back] Nevermind the lack of jobs - low gas prices and home flipping will bring back the era of excess - even for the jobless. I'm not going to argue with it because the hedge funds have done this thesis at least 4x in the past 12 months, and each time was worth some huge moves. When they leave, these trades collapse. But it can work for a few days to a few weeks each time, and that's what the trade has been the past 3 days. (the irony is Mastercard should benefit from that thesis as well) About 4-5 months before the economy bottoms, this actually will be the right trade... but for now it's the trade for the "2nd half 2009 recovery" crowd. Which appears to be almost everyone (except me) ;)

I'm playing the thesis with egregious exposure (4.5-5.25% each) of Ultra Financial (UYG) and Ultra Real Estate (URE) - party like its 2005. So that's about 10% pure Kool Aid exposure for us. Again, the stock market is not the economy and technicians will be slobbering over each other watching 4 days of bad news pretty much ignored aside for that last hour or two of selloff yesterday. Hence the ball is in the bulls court. Not only has S&P 840 been regained but S&P currently sits over the other resistance that we keep pointing to -> 870. (still have 15 minutes so we'll see if that one holds) So we go with the flow and drink Kool Aid. But we'll use the ETFs rather than some of these individual stocks - if we can get another week of financial rally I'll probably exit some of these bank stocks and just use the financial ETF since everything trades in 1 monolith.

I don't want to sound like a party pooper but these last hour moves are now becoming so obvious it is getting long in the tooth - very rarely does anything so explicit last long on Wall Street and one of these times by buying the last hour direction and riding it for 59 minutes and 30 seconds it is going to blow up a lot of people in a large way. It hasn't yet but it is setting up this way soon. And I say that as the host of the casino.... we've truly jumped the shark on this one. But for now, all is well - malls teaming, homes flying off shelves and banks lending. Good times. Or so the stocks in these sectors imply will be coming "in 6 months". See you back at Ceasers New York 3 PM Monday.

Long Ultra Financial and Real Estate in fund and personal account

Bookkkeeping: Booking Profit on our Genoptix (GXDX) Trade

Unfortunately, we are all daytraders now or at best 24-48 hour swing traders. When profit is offered we have to take it. We rebuilt our Genoptix (GXDX) position hoping a double bottom had been formed Wednesday [Starting to Rebuild Genoptix] - the timing was excellent and we just about caught the exact bottom just over $26.00. The stock was back up to $29s yesterday and sits there today despite today's selloff.... we have a 12% gain in 48 hours so I'm going to book it Dan-O. As I wrote Wed:

Looking at a long term chart the stock bottomed in early July around $25, so I am hoping this creates a "double bottom" situation again. A close below $25 would be bearish as this condition would be broken so we'd sell assuming there is more downside from there. But for now, we'll increase exposure from 0.2% of fund to 1.4%, with purchases just over $26.00. Unfortunately, support turns into resistance so until proven otherwise the upside will be limited to the 200 day moving average which it just broke through not long ago (just under $31)

So we'll get out here in the $29.30s although I could still see another dollar of upside to mid $30s. I won't be greedy. A move north of this $31-$32 congestion in which a whole bunch of longer term moving averages collide would have us back to the name for a different reason (buying on strength) as opposed to why we just bought (buying on weakness and a long term double bottom) We are exiting our 1.6% position and taking it down to a 0.1% stake. It's nice to see a few trades actually work in this environment although it's like fending for table scraps in a back alley in 1934 America.

As for the market, we are still getting the "all the bad news is priced in" action - as I wrote yesterday

Everyone knows tomorrow will be a disaster on the employment report - after the initial knee jerk reaction we want to see what the market does around noon to 1 PM. That should be telling - but there has been a lot of shrugging off of bad news most of this week. Bulls will cling to that and if it continues one has to respect it. The faith in government to "save us all" which was so prevalent in latter 2007 and parts of 1st half of 2008 (in retrospect it was very misplaced) seems to have re-emerged with the Obama honeymoon factor. That is all based on sentiment which is impossible to game - you just have to watch the stock price action and if the equity market "believes" we go up. (even if the debt markets disagree).

So far so good - it's played out exactly as we imagined. Knee jerk reaction, bulls fighting back saying "all the bad news is priced in" - S&P 840 remains a pivotal point which is the area we are retracing to over and over... but nothing matters until 3 PM. The casino opens and each and every day this week the indexes have moved 2.5% in that hour. Bulls need to regain S&P 840 on the close; it remains all about sentiment and government actions since the news shall be horrid for a long time to come. Your hostess will be coming around to serve drinks in 90 minutes. Common sense would dicate a late day selloff as longs do not want to carry positions into the weekend but the market has very little to do with common sense.

Long Genoptix in fund; no personal position

An Outperformer in Defense: Axsys Technologies (AXYS)

A reader emailed me about a name on one of my long lost watch lists, that frankly I lost track of over time - Axsys Technologies (AXYS). Despite my doom and gloom on the economy the world is not ending; it will just be different. And the stock market is not the economy for long stretches of time (note all time high in stock market October 2007) One of the two areas I still think outperform are companies who have the unending pockets of the US government as their main customer - we have two names of this sort - Emergent BioSolutions (EBS) [all entries on this name here] and AeroVironment (AVAV) [all entries on this name here]. In fact I just bought some of the former on it's pullback to the 20 day moving average (under $21) this morning - a stellar chart. Axsys is a defense "oriented" type of company and not all defense companies are doing great or have solid charts but this name seems to be in quite a sweet spot as the 2 year chart demonstrates.

Even in this horrid market, it's held its ground the past 6 months - flattish

From a technical perspective is has pulled back nicely today and yesterday afternoon from $72s to $62s (50 day moving average) so it's tempting to get involved today. I'd like to see what casino hour (3 PM) brings to the market first, and a purchase near the 200 day moving average would be even more appealing ($56s). But as we view the next 18 months or so we need to focus on businesses that are sheltered... that doesn't mean they will provide the most return - trust me at some point these commodity stocks will put on 80% moves in 2 weeks (but from what depressed level?) and housing stocks can double in a week in this environment on "hope". But those are trades at this point. We're looking under every last rock for a few things we can actually invest in (and trade around a core position) and hold without fear for more than 48 hours. This is the type of name we'd put into that category.

Axsys deals in 2 main product lines - imaging (70% of sales YTD) and surveillance (30% of sales YTD) - both produce lines growing in the 40% year over year range. Website here. Product overview here. Customer list here: Army, Navy, Air Force, Coast Guard, Border Patrol, Homeland Security (never a cutback in these areas) - along with many private defense oriented companies.

For over 40 years, Axsys has been designing and delivering accurate and reliable optical and motion control solutions to the US government and to high performance commercial markets. Axsys engineers are applying this experience to create increasingly sophisticated, vertically integrated systems that combine optics and motion. These systems are enabling a growing range of demanding optical applications such as thermal weapons systems, nighttime surveillance cameras, and highly precise medical imagers.

They actually play on the same "pilotless drone" theme as AVAV for part of their business. Here is some data from their latest earnings report in late October (what recession? We have the US government's unending pockets as our friend) Sales up 43%, gross margin improved from 32.4% to 34.9%, operating margin up from 13.5% to 18.2%, net income up 118%; earnings up 107%; new record backlog. What is "great" about the U.S. government is it seems to be such a nice customer - almost every company I look at that has the US government as its main customer is expanding margins very nicely - it appears price is "little object" when the US government is the customer. Shocking...
  • During the third quarter of 2008, Axsys generated sales of $64.8 million, compared to $45.2 million in the third quarter of 2007. Net income was $8.0 million or $0.69 per diluted share, up from $4.1 million or $0.37 per diluted share in the third quarter of 2007. Our results for the third quarter of 2008 were favorably impacted by a below average tax rate of 31.6%.
  • Sales growth in the third quarter of 2008 was mainly driven by continued strong demand for infrared cameras and lenses.
  • Our Nashua facility also made a concentrated effort to increase shipments during the third quarter in order to mitigate the anticipated disruption associated with the Surveillance Systems Group's move to a second Nashua facility in the fourth quarter. The growth in sales resulted in improved leverage in both business segments.
  • The Imaging Systems Group's margins were also positively impacted by a favorable product mix during the quarter. Backlog growth was mainly attributable to strong demand for thermal camera systems.
  • Compared to the same period in the prior year, the Surveillance Systems Group increased sales by 39%. This segment's growth was due to continued strong demand for a variety of camera systems, particularly for use in land-based perimeter security and border protection applications.
  • The Imaging Systems Group's sales grew 45% year over year. Increased throughput in our motion control and infrared lens businesses drove the growth in this segment.
  • Backlog increased to $184.5M
Increase in Guidance for 2008
  • Sales $242-$244M, up from $237-$241M
  • EPS $2.28-$2.30, up from $2.09 to $2.15
2009 Guidance
  • Sales $278-$282M
  • EPS $2.66-$2.72
And this statement summarizes exactly why this is the right company in this environment

``In these uncertain economic times, we are fortunate that our products are largely sold into markets that are not directly affected by the general economy,'' continued Mr. Bershad.

Investor's Business Daily, as they always do, wrote an easy to understand summary of the company in early October
  • The military knows that what it can't see can hurt it. Axsys Technologies (NasdaqGS:AXYS - News) makes lenses and systems that help it see incoming missiles through dark, cloudy skies, or peer down on troops in distant battlefields.
  • With still-hot wars ongoing in Afghanistan and Iraq, and civilian border-security issues heating up at home, Axsys is selling its systems faster than it can make them.
  • The Rocky Hill, Conn.-based company's sales were $60.3 million in the second quarter, which ended in June. That was up 40% from a year ago. Its backlog of orders grew to a record $174.1 million. The 54 cents earnings per share was also up 54% from a year ago.
  • "The company appears well positioned for long-term success in light of its exposure to the fast-growing infrared market," wrote Stephens Inc. analyst Tim Quillin in a client note. Stephens estimates that infrared imaging is a $5 billion-a-year market globally. About 80% of that is military spending.
  • At the same time, the Pentagon is increasingly fond of pilotless drones, which can safely and stealthily prowl over battlefields and insurgent bases. It more than doubled use of such drones in 2007, logging more than 500,000 hours in Iraq and Afghanistan. Flight hours could crack a million this year. The small, remote-controlled planes need infrared cameras and lenses to see things the human eye cannot. And to deliver a usable image, they need advanced gimbals and stabilizers -- another Axsys specialty.
  • Today, Axsys is split into two divisions. The Imaging Systems Group makes optical and motion-control components that are sold to other contractors and incorporated into larger systems. Sales there made up 65% of total revenue in the last quarter. Infrared lenses were a high-margin, fast-growing product in that group.
  • The Surveillance Systems Group division designs and makes stabilized and non-stabilized camera systems for air, sea and land mounts. These are the pole-mounted cameras that watch the borders, or the eyes aboard Predator drones and television news helicopters.
  • Direct government sales accounted for only 3.6% of revenue in 2007. But 66.4% of the year's revenue came from subcontractors that incorporated Axsys' parts into larger systems and weapons platforms.
  • Axsys still has value to private-sector firms. Hollywood filmmakers and television broadcasters turn to its stabilizers for cameras mounted under helicopters, for instance. Even those civilian systems use sophisticated military-grade parts. The components are so sensitive, in fact, that the Bush administration had to grant a temporary waiver for a British company to bring Axsys' camera stabilizers into China for helicopter broadcasts of the Beijing Olympics.
  • The company says its ramping up engineering to develop new products and improve existing ones. For instance, the company is working on smaller gimbals for unmanned vehicles. It's developing laser range finders and new radar sensors, Bershad told analysts after the last quarter.
  • "So there's still, I think, a lot of opportunity out there, not the least of which is penetrating the existing markets we're competing in," Bershad said in a conference call with analysts. "You know we have a significant competitor out there who we'd really welcome the opportunity to take more share from." That significant competitor -- Flir Systems (NasdaqGS:FLIR - News) -- also relies heavily on military contracts for its thermal imaging and infrared vision systems.
  • All are subject to the same lumpiness inherent in weapons systems contracts. And all face the same uncertainty around future military spending in the next presidential administration. But most military budget analysts think that whoever wins, spending on sensors and vision technologies will continue.
I don't think Obama will cut back defense spending because he doesn't want to be set up as "weak" in the 2012 election. In fact, a war is what got us out of the last Depression so I guess it's too bad Bush is leaving; a 3rd war might be just the stimulus?? (sarcasm folks)

No position but strongly considering

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