Tuesday, February 17, 2009

David Stern - NBA Bracing for Salary Cap to Go Down for First Time Ever

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We've been waiting a long time for the shoes to begin falling in the sports world; the only place living in more of an ivory tower than Hollywood and Wall Street. They're falling one by one... as predicted

[May 14, 2008: Whole Foods Market CEO at a Loss of Why Sales are Slowing]

I've written as well, I believe discretionary entertainment will also take a hit (ex video games) - RVs, boats, even sporting events ALTHOUGH most sporting events are now populated by the upper 10% whom this slowdown will hit last, and corporations. But I just cannot imagine the average football game where parking is $30, concessions are $50 for a family of 4, and tickets are $150-$200 being at top of mind for the bottom 80% in this country. Things like NASCAR which caters more to middle America will take a hit.


[Jun 24, 2008: IBD - Heating, Electricity Rates Rising]

Without wages rising much, the pie of spending must draw down from one place (sporting events, camping trips, entertainment, non essential travel, Vegas, boating, eating out at restaurants, buying that extra pair of shoes) and go into essentials. This is pooring of America 101, and why sentiment gauges continue to fall to ungodly rates


[Oct 14, 2008: WSJ - As Economy Weakens, Sports Feels a Chill]

I've been watching intently for the first signs in the sporting world since this is (a) one of the last things Americans want to give up and (b) ticket prices have gotten to a point where many families of the lower 2/3rds to 1/2 in America were frozen out a long time ago - hence the slowdown means the upper 1/3rd (and corporations) are finally getting hit. Here we go. I do believe this will lead to the first deflation in ticket prices and concessions in many many years. What would be really shocking would be seeing athletes median salaries go DOWN year over year - when is the last time that ever happened? Never, in my memory. I think it's a distinct possibility if things drag out as long as I believe they will.


[Nov 14, 2008: November 2008 Thoughts/Roadmap]

#2 Sports - I predicted last year that sports will take their first hit in America - we discussed this in May , June, and October. By that I mean spending at stadiums, merchandise, and the like. I said it would start at the NASCAR crowd and move it's way up to other sports - remember much of middle class America has been priced out of many sporting events; it's now corporate driven. Based on the corporate retrenchment combined with economic stress moving up the food chain from poor to working poor to middle class to upper middle class to lower upper class... I see sports taking a real hit in 2009 and 2010. It would be a major outlier to call for salaries to ever take a hit but I will be interested to see if we ever reach a point like that (but not until 2010)


Here we go... the NBA's Commissioner David Stern warns of the first fall in salary cap (ever) in the league
  • As commissioner David Stern warned at All-Star Weekend, the NBA is bracing to have the salary cap (and luxury-tax threshold) go down this summer for the first time ever. The picture might be even gloomier in 2010.
  • With season-ticket renewals expected to plunge because of the weakness of the economy, some league executives expect the cap to fall significantly, which could have serious ramifications for a number of teams.
  • .... one NBA executive told ESPN.com. "It's really ugly. Owners are scared to death right now."
Also...
  • Finally, let me share a juicy tip from a league source on the state of the salary cap. Basically, the situation will be worse than many people expect, and the luxury-tax level next season will be set even lower than what several teams are currently planning for. The implications will be huge as we head into next season.
  • Here's the more interesting part of what I was told: Next season's luxury tax might just be the tip of the iceberg. The salary cap (and thus the tax level) could drop massively in 2010; my source used the term "bloodbath."
  • All this would be a prelude to the labor negotiations for a new collective bargaining agreement in 2011. If money gets as tight as some project, things could get ugly.
Also...
  • Teams are already panicking about being over the luxury tax during this "bloodbath" season (in terms of the owners' extra-NBA holdings). If the luxury tax line shrinks substantially, everyone is going to be worried, and teams will be fighting with each other to lose contracts to below-cap teams.

Finally...
  • We're waiting for New Orleans to break up a team that came a game away from winning the No. 1 seed in the West last season because of the 2009-10 luxury tax, and that's incredibly sad. Multiple that by 10, and that's what we could very well get over the next season.
  • Phoenix is trying desperately to exile a 26-year-old all-NBA first-teamer to get under the line. Think about that. This isn't solely a product of Robert Sarver's fidgety ways, or some sort of bad juju in the Valley of the Sun. Multiple teams might be doing this by next February. San Antonio cannot pay the tax -- let alone a few million in tax. Could Tony Parker or an expiring Manu Ginobili hit the fire sale trade market?
As I write this, I still remember famed pundit/economist Brian Wesbury saying on CNBC in 2007 (I paraphrase) "housing is only 4.5% of GDP, what's the big fuss?" Or Sir Hank Paulson (in "he" we trust) saying "subprime is contained" in 2007.

Not so much fellas - even a lowly blogger could see this coming.

Bookkeeping: Closing Last of American Science & Engineering (ASEI) Hedge

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The force is strong with this one... I have a sizeable (3%) long position in American Science & Engineering (ASEI) [been adding drips and drabs on this sell off the past few sessions] but when it broke the 50 day moving average on a Motley Fool "hey I found 1 line item to wring my hands about" article I decided to hedge the position with short exposure as insurance.

I think there is a lot of fuss over nothing in American Science & Engineering (ASEI) but let's protect ourselves a bit. The 50 day moving average is $75. After yesterday's hammering the stock bounces right back to that level; I had a limit buy to short placed at $73.50 for a 1.9% stake (so I'm quickly underwater but I'm good with that) My long position is about 2.2% so this is almost fully hedged 1:1.

Strategy here is if ASEI regains the 50 day moving average to get rid of the short and yesterday's Motley Fool flap was nothing but a short term blip. If ASEI continues downward my short exposure will offset just about all of my long exposure and I'll cover as we fall.


The stock has been an ox in today's tape and after a morning sell off has been trending up all day, and is one of the few green stocks in my entire watch list. So while it stinks for one of your shorts not to work on a -4% day, I am ok with it since the long exposure was higher than the short. I'm dutifully impressed and wish to find something else to use as a hedge... I am closing out the remaining 0.7% short position with a 5% loss and we're only "long" at this point. The only day it closed below the 50 day was the Motley Fool article day and since then it has bounced nicely.

Now, if I had the perfect pairs trade I would of married a long in ASEI with a short in competitor Flir Systems (FLIR)! Aye carumba!


EDIT 4:10 PM - I just checked through my watch lists and only 12 stocks (of 500) that are not gold/silver related were in the green. That's amazing - two were based on earnings and two were stocks obliterated last week (LPHI, GERN). Talk about bad breadth; that's horrific.

Long American Science & Engineering in fund; no personal position

Yahoo Tech Ticker - Howard Davidowitz: "Worst is Yet to Come" "Americans' Standard of Living Permanently Changed"

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Back when I started the blog, I coined a phrase "The Pooring of America" - this was a theme based on a confluence of events, some of which we brought upon ourselves, some global changes. We don't spend a lot of time talking about the "long long" term because in the stock market "long term" is now next week. But if you are newer to the blog you probably want to read a piece I penned in late 2007 [Dec 8, 2007: Do the Bottom 80% of Americans Stand a Chance?] Aside from self made events we brought upon ourselves (and continue to do so), I believe the globe is heading to a more equivalent wage among workers in various countries (you have seen this is in flattening wages the past decade). The "shopping culture" we've transformed into, while dispensing with productive industries - is also a whole 'nother animal. Awful leadership full of cronyism and lobbyist domination is yet another. I could go on and on...

Aaron Task over at Yahoo's Tech Ticker has had some great guests on of late - one of my favorite's is retail analyst Howard Davidowitz. He appears to me, to be one of the few who 'see the light' - or at least my light. He is Anti Kool Aid [Aug 14, 2008: Howard Davidowitz - the Only Realistic Retail Analyst in America?] [Mar 30, 2008: Howard Davidowitz on US Consumer] I do believe the average American, in narcissistic form, is in denial as is our leadership. I was saying the same "alarmist" type of things about the economy in 2007 - and was proven correct. This "Pooring of America" mantra will take much longer to play out so I cannot be proven wrong or right as quickly as came to be with the economy. But we'll check back in 2019 on this thesis of mine ;) One can agree or disagree with this view today - but I'd ask people to consider viewpoints that differ from theirs. We have a too many people who act like ostriches with head in the sand; until you recognize a problem you cannot begin to address it.

Some other related posts
  1. [Dec 29: What Happens if America Returns to a Historical Savings Rate?]
  2. [Sep 20: US News & World Report - The End of the Shopaholic Nation?]
  3. [Nov 23: David Walker in Fortune Magazine]
  4. [Mar 26: Annual Spring Entitlement Warning Falls on Deaf Ears]
  5. [Feb 4: Clusterstock: Americans Lost $10.2 Trillion in 2008]

Here are 2 videos put up today with Aaron and Howard - both 5 minutes in duration.



There's no question the American consumer is hurting in the face of a burst housing bubble, financial market meltdown and rising unemployment.

But "the worst is yet to come," according to Howard Davidowitz, chairman of Davidowitz & Associates, who believes American's standard of living is undergoing a "permanent change" - and not for the better as a result of:

  • An $8 trillion negative wealth effect from declining home values.
  • A $10 trillion negative wealth effect from weakened capital markets.
  • A $14 trillion consumer debt load amid "exploding unemployment", leading to "exploding bankruptcies."

"The average American used to be able to borrow to buy a home, send their kids to a good school [and] buy a car," Davidowitz says. "A lot of that is gone."

Going forward, the veteran retail industry consultant foresees higher savings rate and people trading down in both the goods and services they buy - as well as their aspirations.

The end of rampant consumerism is ultimately a good thing, he says, but the unraveling of an economy built on debt-fueled spending will be painful for years to come.



Everywhere you look, retailers are slashing prices. Such markdowns reflect a fundamental shift toward lower prices, says our guest, retail consultant Howard Davidowitz, chairman of Davidowitz and Associates:

  • "70% off is the new 50% off," he says.
  • Expect apparel prices to drop 30% -40% from a year ago.
  • Consumers should actively bargain for lower prices for big-ticket items, especially furniture, jewelry, appliances and electronics.

Luxury retail may never be the same. The Wall Street Journal traced the beginning of the end for exorbitant prices to the fateful decision by Saks Fifth Avenue to slash prices by 70% on designer goods before Christmas:

"Saks's deep, mid-November markdowns were the first tug on a thread that's now unraveling long-established rules of the luxury-goods industry. The changes are bankrupting some firms, toppling longstanding agreements on pricing and distribution, and destroying the very air of exclusivity that designers are trying to sell."


Kansas Joins California in Budget Woes

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Readers if you have any interesting budget shortfall stories in your local state please email me... I can't catch them all.

********************

Can you imagine the state of our country at this moment if the federal government could not print or borrow money? Many of our states act as subprime borrowers - spend, spend, spend as if there is no rainy day coming in the future. I wish there was some instrument to short individual states budgets because we would of been rich since we've been on this story since 2007. Now it is bearing fruit, if you will, across the nation. Back "then" (see posts below) we were still in denial or ignorance on Wall Street.

[Dec 16, 2007: California in a State of Fiscal Emergency - Coming to a Theater Near You]

One point I forgot to mention in the 2008 1st half predictions piece is the role of ever decreasing housing values on state (and city) revenue. A large part of revenue inflows is based on an asset (real estate) that is decreasing throughout the country. Budgets (and benefits) are set to recent 'good times'. Like most enterprises very few government institutions will save for coming rainy day times - they just assume the good times will continue to roll. But when they don't, they are in trouble. Especially if a very large revenue source starts to shrink (property taxes). And this should be happening over the next few years throughout the country.

What's the solution? Print more money. Wait. You can only do that at the federal government level. So I guess the solution is.... well, I don't know what the solution is.

Again, keep in mind how critical California is - its GDP if it stood as a stand alone country would place it around #7 in the world. So these 'messy subprime mess' that 'only affects' Ohio, Michigan, Florida, and California... (as the politicians put it), is so much bigger. Housing "only" affects 4.5% of GDP blah blah blah...

[Apr 25, 2008: Shoes Beginning to Fall in the States]

This is a theme I have been promoting for a while, and it's going to hit this year, next year, and 2010. Unlike the federal government who fixes all fiscal emergencies by simply printing money out of thin air or taking hat in hand to China, Middle East, or anyone who will buy our Treasuries, the states do not have that luxury.

All in good time folks... most of the economic issues of the real economy will take quarters to play out while Wall Street wants its solutions "now" and can't forecast out more than then their next paycheck cycle.... they continues to refuse to see the impact the real economy is happening on Main Street. Today, an AP article is stating these effects we predicted are now happening.

Again, I keep repeating this: The pundits who are telling you we either have shallow recession or are coming out of recession are the same fellas who denied recession was even possible 6 months ago. How the same people who denied a recession was even possible, now have the cajones to tell us don't worry, we are going to be out of it by end of summer, is beyond me.

[July 25, 2008: WSJ: States Slammed by Tax Shortfalls]

So here we are - the new fiscal year begins in July 2008 and CNBC's long touted 2nd half 2008 recovery is upon us! Oops. Not so much. As tax revenue from both the home "fake boom" and consumer spending "fake boom" dwindle, state and local budgets are now becoming an issue. And we have not even faced the real "unemployment" depths that will be hitting within the next 12-18 months. Budget year summer 09 to summer 10 is going to make this year look like a picnic.


[Nov 14, 2008: November 2008 Thoughts/Roadmap]

#1 State Budgets - I cannot reinforce enough the point I have made many times for the past 15 months. State budgets in 2009 are going to be a complete disaster. I truly think this will be one of the biggest emergencies in the year ahead - in the next 2 years I could see 15 or so states potentially defaulting. Remember state budgets are from middle of 1 year to the next. The bleep hits the fan in summer 2009 to summer 2010 budget year. Revenue comes from (a) real estate values (b) spending and (c) corporations. Based on my vision above - all these go into the tank - in fact they already have but rainy day funds and other things have been used to stem the flow. Next year many states won't have that option. We will have a disaster on our hands and unlike the federal government there will be no printing of money out of thin air to make up deficits. So you know the solution here - the federal government will be bailing out individual states. If not, we lose many services, we lose many schools, we lose many things people take for granted as a society.


The ironic thing about the federal government "stimulus" is it is rewarding bad behavior - in an article I read yesterday the governor of North Carolina said "we do not want to be punished for not having a deficit" - meaning they wanted their fair share of the federal stimulus and did not want to get less than if they had been running their state government into the ground like some of our other states. Isn't that just a perfect summation of moral hazard and ill intended consequences?

Kansas is the next to join California in some unprecedented steps...
  • Kansas has suspended income tax refunds and may not pay its employees on time, state officials said Monday. The ruckus left lawmakers uncertain where to secure millions of dollars owed Medicaid providers serving the poor, K-12 public schools, community corrections programs and the state's bioscience authority.
  • The game of political chicken places state taxpayers, workers and schoolchildren squarely in the middle of a politically charged battle over massive budget cuts. Republicans, who hold majorities in both chambers of the Legislature, blocked Sebelius’ proposal to borrow $225 million from healthy state funds to cover shortages in accounts used to meet the state’s payroll and issue tax refunds.
  • Republican leaders said they had no choice, that by law the state couldn’t borrow any more money from itself. Sebelius and Democrats disagree, accusing the GOP of playing politics with people’s paychecks.
  • Kansas’ cash-flow problem stems from the worsening recession and lower-than-expected tax revenues. As a result, the state had only $10 million in its checking account Monday morning. To make up the shortfall, Sebelius proposed borrowing from other healthy state funds. Such loans — called certificates of indebtedness — are routinely used when the state runs short on cash. State leaders already had authorized $550 million in certificates this fiscal year.
Meanwhile back in Cali... it's Terminator Tuesday!
  • California lawmakers were told to bring their toothbrushes and prepare for a long day Tuesday, with the goal of passing a budget as the state faces a $42 billion deficit and 20,000 layoff notices were set to go out to state workers Tuesday.
  • Lawmakers had missed a Monday night deadline to reach a budget deal, prompting Gov. Arnold Schwarzenegger's move on the layoff notices
And you know how this all ends for you dear taxpayer.... [Jul 2: Cook County, Chicago ---> Highest Taxes in the Nation: 10.25%] [Dec 4: Bloomberg - Hoboken New Jersey Increases Taxes 47%] [Dec 19: New York Times - States' Funds for Jobless Dry Up]

Again, let's thank the Gods of Printing Press we can print money forever to make up for incompetent self serving politicians who cannot look out past 1 election cycle and promise everything to everyone so that they can get re-elected. Eventually the sheeple of America will have their version of the Boston Tea Party - but for now we just continue to beg, borrow, and print and promise we can do it without any consequences. I don't know when the Rage against the Machine begins - but at some point the sheeple has to understand where this is all going.

[May 7, 2008: Vallejo California Votes for Bankruptcy]
[May 8, 2008: It Pays to be a Firefighter in Vallejo]
[Jul 31, 2008: Schwarzenegger Orders Cuts Amid Financial Crisis]
[Nov 24, 2008: WSJ - States Cut Services for Elderly, Disabled]
[Dec 6, 2008: How Bad is Minnesota's Budget Deficit? Mega-Bad]
[Dec 12, 2008: California - Missed the Budget Shortfall by THAT Much]

Bookkeeping: Layering in Some Long Positions Here

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I am slowly increasing long exposure here with a broad based buy list - most of these are increases of 0.4-0.7% each so nothing material in each but as a group they are pushing up the long allocation. The general markets have lost 9%+ in a week - that does not mean we don't fall another 9% from here, but we'll incrementally add down here as the market weakens, and then sell when Lucy puts down the football and everyone is screaming we are missing the buying opportunity of a lifetime.

I added to
  1. Mosaic (MOS) [replacing the portion I sold Friday]
  2. BHP Billiton (BHP) [replacing half I sold Friday]
  3. Ocwen Financial (OCN)
  4. Potash (POT) [replacing portion sold early last week]
  5. James River Coal (JRCC) [replacing portion sold middle of last week]
  6. AeroVironment (AVAV) [I had cut this to a 0.2% stake on the strength Friday so just replacing half of what I sold]
  7. HDFC Bank (HDB) [I had only a 0.1% stake going into the day so its back to the lower end of a recent range]
Also a long standing limit order to buy Allegiant Travel (ALGT) at $33 hit this morning so we're up to a 1.0% stake there (up from 0.1%). All together this is about a 5%ish increase in allocation to the long side.

To offset this I've added about 3% in index shorts - still shaking my head I came into the week with sub 10% short exposure; mother market smirks at me.

Both the Brazilian ETF (EWZ) and the Chinese A Shares (CAF) are back to support - so those are intriguing plays down here; if you are a believer in the Chinese miracle this is where you'd want to make a stand. But once again it shows you - you simply cannot buy breakouts in this market because they are reversing so quickly. I cannot stress how counter intuitive this is - "signposts" that we used to trade on no longer work.

Missed opportunities include gold/silver and that short on Mobile Telesystems (MBT). Capital One Financial (COF) is an amazing chart of death.

I'm incredibly intrigued to see if the market completely ignores Obama's "savior" speech on housing tomorrow.

Interesting note ---> The S&P is down about 28% from the 200 day moving average. 25% used to be "extreme" divergence. (i.e. buying opportunity for "reversion to mean" aka snapback rally) We hit an all time peak of 37% on that dark day in November 2008. So depending on where you sit we're either at an extreme (based on historical averages) or have a chance for another 8% down to match the new "normal" extreme. Food for thought.

Long all names mentioned execpt EWZ, CAF, MBT in fund; no personal positions

The Market Loves to Mock You

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First, this Mobile Telesystems (MBS) which had incredible strength last week during a bad tape - and which I finally covered my short late Friday afternoon, decides today to fall nearly 20%.

Then we decide to fall below S&P 800 when I have the lowest short allocation in 6 weeks.

Bah.

We have a weird divergence among the 3 main indexes - the DJIA is already at its November lows and sitting right on them... the S&P 500 broke below 800 but November lows still are a ways ahead (740s) and the NASDAQ is in its own gaga thesis land of "technology is a safe haven" so nowhere near November lows (1300).

Gold and Silver having very nice days, and people fleeing back to bonds - the "fear trade" is picking up again.

An interesting juncture as Obama speaks tomorrow on how he will save the housing market. We'll see how things shape out near the end of the day.

USA Today: CEO's Not Buying Stock in Their Own Companies

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You'd think with all the bargains galore CEOs would be snapping up stock left and right since the valuations are so "cheap". Instead we get (cue crickets chirping) Even now at these "bargain" levels the insiders are unloading at a rate of 4:1 (selling:buying). Once more it really makes you wonder what this stock market is all about sometimes - outside of a great transfer of wealth from the many to the few. [Feb 11: Sirius Heading for Bankruptcy; Don't Cry for Howard Stean - Just More Transfers of Wealth] The same insiders who use "company" stock offerings to unload their shares onto the people (rather than raise money for the company) but cannot find a few bucks under their Louis Vuitton couches to make a show of faith with purchases even at these levels? Instead most are still selling... nice.
  • It's not just regular investors who lack the guts to step up and buy stocks. Companies' CEOs do, too. Other than a few high-profile exceptions, including the heads of JPMorgan Chase and Bank of America, officers of U.S. companies aren't exactly lining up to buy their companies' shares. The dearth of so-called insider buying, despite a nearly 40% fall in stock values in the past year, is a potentially troubling development. CEOs arguably know more about their companies' future than anyone. (nah, stock market pundits know best... just ask them)
  • Because CEOs typically buy when their stock has fallen and is about to recover, the fact they're not heavily buying now is "a little disturbing," says Darren Roulstone, a professor of accounting at Ohio State University.
  • The buying of stock by company officers and directors remains modest relative to selling, according to Thomson Reuters. Over the past 90 days, insiders at U.S. companies have bought just $670.2 million in stock, while they sold $2.8 billion.
A few of the reasons CEOs and other officers may not be stepping up and buying include:
  1. Personal cash crunches. Some executives may not have the cash available to plow into company shares, says Leland Bettis at market research firm Gradient Analytics. (darn, better give them even higher salaries then - obviously they are under compensated if they cannot find it in them to buy some shares)
  2. Greater uncertainty about the economy.
  3. Fear the downturn could be prolonged. During past market downturns, such as the 1987 crash, executives were comfortable buying amid what they thought was a short-term correction. But the fear this downturn could drag on for years reduces the incentive for CEOs to buy, Roulstone says. (did the CEOs not get the memo that the 2nd half recovery of 2008...err, make it 2009 was just around the corner?)
"Clearly, it would be a favorable sign if insiders were actively buying their companies' stocks right now," Odean says. "The lack thereof is not good news."

***************

This is one of the reasons I was shaking my head in the logic of late 2007 - hey the Middle Eastern guys whose financial expertise is .... well, sitting on large loads of oil are buying financials - so should you! [Sep 9, 2008: "Smart Money" is Buying - So Should You! (Revisited)] But how come the bank CEO's weren't?

Bookkeeping: Weekly Changes to Fund Positions Year 2, Week 28

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Year 2, Week 28 Major Position Changes

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

Cash: 64.9% (vs 57.6% last week)
26 long bias: 28.3% (vs 21.3% last week)
8 short bias: 6.3% (vs 21.1% last week)

34 positions (vs 40 last week)

Weekly thoughts
These past two weeks have exemplified what we've been saying would be the trademark of 2009 - the battle between hope and reality. Two weeks ago the S&P rallies 5% on "hope!" - once more the government would ride in to save us from ourselves. It's not the first 312 plans that will save us, it's the 313th! Surely this will be the one. We sat there a weekend ago, and commentators were telling us with Sir Geithner (he who walks on water) ready to unveil his magic, it would be "the most important week of the year". And what did we get? A 5% drop in the S&P. So much for the most important week of the year.

It continues to be a [Feb 5: Charlie Brown Market] - each time these bulls get their excitement up, and the punditry breathlessly whispers about how we better be in, because if not we are going to miss the rally of a lifetime - Lucy pulls that ball away. And Charlie lands on his (edited for content)!! I will keep repeating the credo - only one time will it be incorrect to doubt the veracity of the "rebound" - ONLY once. Each and every other time it will be correct. Sure we might get 10% rallies here, or 15% rallies there - but only once will a true new bull market be born. Until then we just churn.

Fundamentally, the story frankly is bad and not improving - despite trillions thrown at the problem worldwide. Eventually people will come to the realization that the problem is larger than government. We've been in denial of this since August 2007 when sneaky Uncle Ben decided to smack shorts on the side of the head with a pre market "emergency" Fed rate cut. "They've" been doing the same song and dance for a year and a half now - pulling out all the stops to time things to inflict the most damage to shorts... but the market continues on its death spiral. It is ironic to be honest. I don't have much to add that I have not said for weeks on end. The market is very expensive on where earnings will be by the time we get to Dec 31, 2009 - consumers will continue to act defensively and in an economy we've transformed to live and die by the consumer; well it's not pretty. Now the government will be stealing from our grandchildren to pump consumption today - the sheer amount of money will have some effect and goose GDP to some degree in 2nd half 2009 and early 2010, but it's a heavy cost to pay. I could get behind this stimulus plan to some degree if it all went to investments the country has ignored for multi decades ("can't afford it!) but instead it's simply a free for all as our politicians continue to push our country down the hill into ruin. So our policy will be throw as much money against the wall and let's hope some of it sticks.

We've noted the range we've been in on the S&P 500 for a month now (800 to 870); it's looking more and more like December 2008 -- a sideways churn underneath resistence with an ultimate resolution downward. The only thing "saving" this market are the CNBC news breaks and D.C. announcements "perfectly" timed to squeeze shorts each time we hit a major support area. Government intervention at its finest. I'm glad they are allocating resources to important things such as how to manipulate markets from their ultimate destination. Wednesday we'll hear about the NEXT plan to save us, this time from President Midas himself (who also walks on water) and how our taxpayer money can go to subsidize those who are in trouble with their mortgages - all under the guise "you don't want the value of your home going down anymore, now do you?" Dear sir, it will go down no matter what you do - stop wasting my money trying to stop it.

The news overseas is horrific - Japan, Russia, Eastern & Western Europe. Heck, even people living in the French Caribbean are protesting in the Streets. America? We still have American Idol to keep the sheeple distracted.
  • Strikes that have nearly frozen everyday life on France's Caribbean islands burst into clashes on Monday as police battled protesters angry at high prices and resentful of a tiny white elite on lands better known for beach-side vacations. The leader of the LKP Collective that organized Guadeloupe's strike warned that deadly escalation is possible. The strike also is exposing racial and class tensions on islands where a largely white elite that makes up 1 percent of the population controls most businesses.
  • On the sister island of Martinique, 100 miles (160 kilometers) south of Guadeloupe, police said that as many as 10,000 demonstrators marched through the narrow streets of the capital to protest spiraling food prices and denounce the business elite.
As this global recession intensifies, class warfare will increase. In the U.S. the stocks of commercial real estate (we've been long time bears) are finally joining the deathbed that are retailers, Las Vegas casinos, consumer discretionary - and the like. The Federal Reserve will be stepping in to provide a place to camp the bad debt from the CRE companies, but the stocks still falter. And so we go - but hey the Baltic Dry Index is up the past month... can't be all bad.

For the fund, the weekly allocation looks a lot more bullish than it appears. Into the dread that was last Tuesday I cut some good portion of short exposure - and as the week rolled on I expected "news leaks" to save the market each time it got near S&P 800. Lo and behold, my government did not disappoint me. We're just marking time to an eventuality in my book unless we believe it is going to be worth it to pay 25x earnings on the S&P during the 2nd worst crisis of the past 100 years. So I'm underinvested on the short side and hoping for YET ANOTHER hope rally as Obama speaks Wednesday... not counting on it; but hoping for it so I can buy short exposure at higher prices. To reiterate - below S&P 800 we're bears, above S&P 880 we're "bulls" (only on price action) and in between we're just trading while keeping large parts of our capital away from this nonsense market.

As to specific positions, it has been a funny two weeks - we actually lost money the week the market was up 5% because (a) lots of our money is sidelined (b) our short positions went against us (c) our largest position, Sequenom (SQNM), took a big hit (d) our type of stocks were leadership stocks that have been abandonded while people chased into China/Tech/commodities and (d) we did not own much of China/Tech/commodities. This week, as the market fell 5%, we were up a tad... despite a hammer being applied to Life Partners Holdings (LPHI) which was one of our few 2%+ positions. Thankfully we escaped before Jim Cramer jumped in during Mad Money to dance on the grave and pushed the stock down an additional 21% Friday. At this point, I am tempted to get back in since an already cheap stock has now been cut in half in two weeks - maybe not for the long run but certainly a trade is forming.

We did see some rotation back INTO the January leaders as people rotated AWAY from commodities/China (to some degree)... but wow, this market still loves technology no matter what amount of bad news you throw at it. Other than large cash hordes I am not buying any of the reasoning for the tech trade - they rely on either the (a) consumer or (b) the corporation... both of which are pulling back. Looking at our holdings, I did add "some" exposure to the China/commodity trade just to have skin in the game over and above the 1 coal/1 fertilizer name we already had - we added BHP Billiton (BHP) and Mosaic (MOS) late in the week - these are all trades as far as I'm concerned. I like what I saw in Emergent BioSolutions (EBS) late in the week - it finally broke out of a $20-$24 range ... however let me repeat buying "breakouts" in this market has led to failure 90% of the time

American Science & Engineering (ASEI) after taking a hit from a Motley Fool Story rebounded nicely and is back just over support after falling below - if it begins to break out I'll get more constructive.

Thoratec (THOR) north of $28 interests me....

I added a bit to a starter position in First National Financial (FNF) [title insurance] after it bounced off support nicely

And Quality Systems (QSII) seems to be showing signs of life

AeroVironment (AVAV) has been very good to us - I let some go Friday as "$40ish" has been the ceiling of late but then it went to $41 and I thought I might of missed the next leg up. But this one is now VERY rich on a valuation basis.

Again this market seems strange to me - it is almost as if there is not enough money to push up multiple sectors at once... either the leadership stocks of January can do well, or everyone has to run into China/commodities. Weird. On the short side we have a conundrum - the stocks we dislike the most from a fundamental standpoint are in complete free fall. Just as in bull markets you sit with jaw open watching how far things can go up - even I, as a bear on some of these groups, watch in fascination at how badly the sectors we've been targetting have fallen. I keep waiting for some counter trend rally to put shorts on against these names - but they have no life to them. So the conundrum is whether to chase them "down here" knowing a "squeeze" can happen at any moment (and these beaten down stocks move 30%+ on squeezes) or bide our time and instead chase stocks we dislike more from chart formation and try to scalp a few bucks here or there.

So those are my thoughts for the week... it is a very frustrating market and has been for any and all of those with a timeframe greater than 2-3 days (or hours). Buy and hold long ago died, and now even trend trading has been disallowed. It's all about daytrading and front running government announcements... obviously not an environment for a mutual fund to thrive. But, with all that said - I'm happy with performance the past 6 weeks, even if it takes every trick in the book just to stay afloat.

Monday, February 16, 2009

Is China Pulling an Alan Greenspan?

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Some very interesting data out of China of late in terms of loan growth - in fact staggering data. Aside from being a very important economy to follow, it is worthwhile to dispel much of the bunk and hype coming from the punditry with reality checks. [Feb 9: China and the Baltic Dry Index - What is Really Going On?] Remember, 40%+ of this economy is export driven - and all Chinese customers are simply falling off a cliff - the largest economies of the U.S., Europe, and Japan are simply free falling.
  • Japan's economy slumped at a larger-than-expected 3.3% in the October-December period from the previous quarter as the impact of the global financial crisis hit its exports hard, according to data released Monday. The steep fall reportedly represents the biggest drop since 1974. On an annualized basis, the gross economic product slumped 12.7% during the quarter.
So just to stay at 0% growth, the "domestic" Chinese economy (sub 60%) would need to make up for massive shortfall in the export economy (40%+) And with imports to China also showing massive contraction (40%+! in January) - you simply cannot make any suitable business case. It is just lazy to say "baltic dry index" this or "Chinese stimulus plan" that - but that's what the pundits do and we can create a nonsense "thesis" to drive stocks up. Again let me reiterate - I do think China has the best balance sheet and will be the nexus for the EVENTUAL global economy. But we're nowhere near that point. So let's be a bit more rigorous than the folks who show up on TV with their 10 second sound bites to explain things and see what is really going on.

First, a quick refresher of an Economics 101 lesson we laid out two months ago.

I'll spare you the economic formulas but if you are interested, click here. Right now we have a problem of money flow - both the amount of "money" in the system, and the velocity of said money. In the simplest terms, just think of velocity as the amount of times money changes over. The higher the better. About 4-5 months ago both these areas (amount and velocity) were lacking. Capital was being destroyed in an over levered system; much of it unregulated in a "shadow banking system". For every 1 "actual dollar" in the system, 10-20-30x was "lent". Much of it was based on the housing bubble. So as the 1 actual dollar is destroyed, the capacity to lend 10-20-30x of that dollar is also destroyed - and your velocity of money crumbles. As we've outlined the past few months, our money supply is now going off the charts - the Federal Reserve has made it clear they will create money at any cost. They are going to do everything and anything in their power to liquidate the system, assuming I suppose that a currency crisis is a better outcome (or predicting no currency crisis will happen) than a financial crisis. It is very sad how we lurch from emergency to emergency in this country - but it is what it is.

The Federal Reserve balance sheet which used to consist of staid Treasury Bills was at $800Billionish last year, it is now approaching $2.3 Trillion and much of that is now the junk, I'm sorry - "the undervalued assets that once the market returns to normalcy will return to their rightful value- which will be MUCH higher" - that banks want to get rid of. It is now to the point the Federal Reserve will take it said "undervalued assets" off the books of hedge funds so our shadow banking system can re-emerge (the one that got us here in the first place) They are desperate and they will do anything.

So that's half the picture; the other is the even more tricky question of velocity. We are handing the banks (and other parts of the financial system) dollars by the wheelbarrow, but if they do not get circulated within the economy there are useless to everyone but banks. So we have one half the equation being force fed by the Fed/Treasury - the money supply will be ballooning - no matter the potential cost to the currency, and the other half of the equation is based on the belief that at some point so much money will be provided to said financial institutions that even the most risk averse will lend a portion. And we can begin anew. I won't even touch the long term questions this brings since we only deal with one crisis at a time.


Before I write the rest of this entry don't take it as bashing the Chinese. In fact they are learning from the masters of manipulation - the United States. They are following the Greenspan playbook - to forestall a normal economic cycle flood the system with dollars... which creates new bubbles. Keep kicking the can down the road, until one day it all implodes (which is what we are enjoying now after 20 years of kicking). Did we learn from this? No... in fact the implicit policy of the Bernanke Fed is to do the same exact thing as I outlined above. The problem is the mechanisms to create "velocity" of money have been in many cases nearly destroyed (securitization) or impaired (think our banks). So Bernanke is no different than Uncle Al G. He just is hampered by lack of conduits that saved Uncle G's grits. And this is why the gold bugs are awaiting the "Great Inflation". But first we have to work through the capital destroying deflation we are enjoying... before the master government plan happens (again).

At it's basis this plan relies on a financially illiterate populace (check!) - because the massive infusion of money pumps up the "price" of all assets ... including stock returns (and houses). So if you devalue your currency by 30% (which is not as easily 'measured' by the financially illiterate) but pump up the value of homes and stock markets by 30% (which on the other hand IS very easily 'measured' by the financially illiterate) the powers that be can say "mission accomplished". Because the peon class is satisfied as the government has succeeded in pumping up asset values (easily measured) while destroying their purchasing power by an equal amount (hey, why does bread cost 30% more than a year ago??) So you can tell your neighbors and work mates this is what has been happening to them the past few decades, and this is what the government plan is now and in the future.

But now we see China is embarking on the same game plan - which in the long run will lead to bad outcomes, but in the short(er) run can goose values. (see United States of Leverage example above) Let's take a closer look at what is going on. (special thanks to reader Adam [Prudent Capitalism, Chinese style] for sending me an email to goose my brain into seeing the light)

AP: China's Bank Loans Double in January to $237 Billion

  • Chinese banks extended a record 1.62 trillion yuan ($237 billion) in loans in January, more than double the year before, as lenders heeded government calls to loosen credit controls to help revive the economy. Facing an abrupt slowdown due to plunging demand for China's exports, regulators have sought to boost liquidity after years of trying to rein in lending. Banks made 771.8 billion yuan ($113 billion) in new loans in December, figures show, up nearly 15 fold over the same month a year before.
  • Money supply, as measured by M2, climbed 18.8% at the end of January from a year earlier, accelerating from the 17.8% rise at the end of December, according to the PBOC.
Sounds great! Surely this is a good plan right?
  • The government has ordered them to make credit available to help battle the downturn which hit last fall. But with many industries facing overcapacity and demand slowing for many products, analyst warn the state-owned banks risk letting policy, rather than profitability, guide their lending decisions.
  • Analysts said the structure of lending in January, with short-term financing accounting for two-thirds of the total, does not bode well for a sustained expansion. The trend suggests that demand for "attractive project finance is still insufficient to absorb excess bank liquidity, leaving banks to still pursue low risk, low return businesses in large scale," Citigroup Global Markets economist Ken Pang said in a report issued Thursday.
Let's check in with Michael Pettis to get his views...
  • Reuters has just announced that net new lending may have actually been and even more surprising RMB 1.6 trillion – twice the previous monthly record and an amazing one-third of credit growth in all of 2008. We will know by February 15 at the latest, when the PBoC publishes lending data, but if this is true (and the report was seen as highly credible by one of my friends at Reuters) it will probably goose the stock market up further while making people like me more worried then ever.
  • Since for me much of the Chinese growth explosion of the past several years was caused by a badly allocated credit boom, the idea that the solution to a slowdown is to jack up the credit boom even further is very worrying. It is a little like the idea that the best way for the US to adjust to the decline in its debt-fueled household consumption binge is to replace it with a debt-fueled government consumption binge, although perhaps the US and China would choose very differently in the possible trade-off between long-term growth and short-term social stability. (Bingo)
The closest investment Americans have to the Shanghai A listed shares (which is a closed system to foreigners and does not allow shorting) is Morgan Stanley A Share Fund (CAF) which we noted was showing some serious giddy up ... it has pulled back a bit but continues upward in nice fashion.


So let's tie this puppy together... as we said at the top of the piece - if you throw enough money into a system the basic laws of supply and demand take over. There are limited amounts of stock certificates (supply) and a tsunami of new RMB (or US dollars when this happens in America) - so the basics of economics 101 take over. Fixed supply, huge demand = higher prices. And *magic* you have a rising stock market - which Cramer and associated pundits can scream about as "signs all is well". Boo Yah!

CBSMarkewatch: China's Banks Show How to Lend
  • If you look at the numbers, the 1.62 trillion yuan ($237 billion) lent in January already amounts to 40% of the value of the stimulus plan promised last November. Still, the risk is that banks are churning out loans so fast proper controls will be forgotten, leading to surging bad debts down the road.
  • There is already speculation this new lending is behind the recent up-tick in A share turnover. Last week daily turnover in Shanghai and Shenzhen exceeded 200 billion yuan, taking it back to levels last seen in 2007.
  • Macquarie Research said in new note that corporate earnings numbers -- not GDP growth -- matter for a stock market recovery. It said it needs evidence that China is not merely growing but successfully "re-flating" and thus avoiding a late-1990s style margin collapse.
  • Exports appear to have fallen off a cliff after a 17.5% year-on-year decline in January, while imports have slumped a massive 43.1%. Even taking into account that Chinese New Year came in January, the results were well below market forecasts. The imports figures do not indicate much strength in China's domestic consumption. Nor does January's 23% jump in yuan deposits -- suggesting consumers are still saving, not spending.
AP: China's Shares Hit 5 1/2 Month High
  • China's benchmark stock index rose Monday to a 5 1/2-month high on investor enthusiasm about added liquidity amid rising bank lending, shrugging off declines in other Asian markets on news of Japan's economic contraction. The rise was driven not by economic fundamentals but by a surge in bank lending, which has sent money flowing into the market, analysts said. The government says lending hit a new monthly high in January, driven by a massive stimulus plan.
  • "The economic fundamentals are not strong enough to support the market's rise," said Zhang Xiang, an analyst for Guodu Securities in Beijing. "The market is in an irrational state, which is not going to last long."
  • The rise came despite a government announcement Monday that foreign investment in China fell 32.7 percent in January from a year earlier.
  • Turnover in Shanghai A shares rose to a nine-month high of 177.5 billion yuan ($26.0 billion) -- near levels last seen in the stock market bubble of 2007 -- from Friday's 164.1 billion.
  • There are many potential threats to stocks' bull run. Large amounts of shares will become tradable in coming weeks because of the expiry of lock-up periods for institutional investors, and this could add selling pressure to the market. Some analysts worry that the market's strength could prompt regulators to permit a resumption of large initial public offers of equity, which could add to supply pressure.
We talked about the following issue a lot in fall 2007 - some larger Chinese companies are traded in Hong Kong in an "open system" (i.e. foreign investors can partake); those shares are called H shares. In Shanghai (closed system) they are called A shares. We saw stratospheric diverengces between the A and H shares during the Shanghai bubble that eventually burst in late 2007 - and now we appear headed right back down that path. The way to read this is, the H shares are a reflection of a typical stock market - whereas in the monopoly money land of Shanghai; the A shares reflect a parallel universe. Yet commentators and pundits point to the A shares as some guiding light signal.... anything to create a thesis.
  • The average premium of A shares over Hong Kong-listed H shares in the same companies rose as high as 63 percent on Monday, its highest level since mid-November; such premiums may not be sustainable in the long run.
  • But the market has so much momentum that its uptrend may continue for a while, analysts said. "The trend of money pouring into the market because the market offers profit opportunities is unchanged, which could easily boost the index further," said Zhang Qi, analyst at Haitong Securities.
So is it "wrong" to buy the Chinese A shares now? Not really... momentum has a way of continuing far longer than anyone thinks. But let's just be intellectually honest on what the highest probability factors are behind such a rise and dispense with the Kool Aid being lobbed by the punditry.

AECOM Technology (ACM) Executing Well

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Continuing to work through last week's earning reports... on we move to infrastructure company AECOM Technology (ACM). We highlighted this name at the turn of the year [Jan 2: I like Zach's Idea on AECOM Technology] as a way to get a more direct exposure to our grandchildren's infrastructure money from New Deal 2.0.

A reader sent me some small water infrastructure stocks (read: Obama thesis) that are absolutely flying earlier in the week, so I am preparing a piece on those. My "mocking" of the thesis has been due to how little many of the companies investors are flocking to would actually be affected. [Dec 19: Citi Analysts Frowns on Obamamania; ABB Provides Reality Check] It is like buying General Electric (GE) for its wind business - yes you get the 0.5% of the business that is dealing with wind but you are stuck with the other 99.5% of the business.

The same goes for infrastructure - yes in a few of the names you might get SOME Obama dollars but as a % of their total business it doesn't mean much. But there is a huge irony here. 1 year ago at this time you wanted to buy internationally focused infrastructure stocks because the sexy thesis of the day was "decoupling" (foreign markets will run run run, while the U.S. will "slow" - remember, they denied there would be a recession in the U.S. a year ago - they just said we'll "slow"). So you wanted infrastructure stocks that focused on the world; and avoided the U.S..

But the irony is now you want to do the EXACT opposite... you want companies who have most of their business here because (trumpets blaring) President Elect Midas is coming.
{Zach's comment} Although large plays like the above mentioned names will likely get their share of business, I’m shying away from them in exchange for smaller companies that have the potential for much larger gains. But as a Corvette accelerates faster than an 18 wheeler on the new Obama highways, smaller project management companies will likely see more in the way of percentage increases. A company with a market cap of $300 million and annual revenue near $380 million will likely see its stock climb much more quickly than FLR with a market cap of $8.2 billion and sales of more than $20 billion.

Since that time of course New Deal 2.0 has been transformed into Pork Deal 329.0 but they decided to throw a few shards towards infrastructure for cosmetic purposes. I am not sure what exactly happened in terms of stock price but AECOM Tech took a major hit in mid January, falling from $32s to $22s in the span of 2 weeks. We will never know "why"; it could be a hedge fund exiting a position, some aggressive short tactic - etc. But at the time you just fear some bad news event is happening behind the surface; yet from the latest earnings release it seems thing are just fine. The earnings release gave a burst of life to the stock on Feb 10th, but as in 90% of the cases in this market when a stock "breakouts" you have to go against your training and not chase it - almost all these breakouts (which you traditionally want to buy) work against you in short order. And so it happened again, as the stock immediately faltered and fell back below its 50 day moving average (just under $27) - which once more displays how buying stocks even on technical analysis is not working well at all. Everything is a daytrade or couple of day trade since trends simply do not last.

One day fundamentals will matter again rather than CNBC breaking news or the "plans to save us all" hatched in D.C. so while it's mostly useless nowadays to look at company metrics I still do so for informational purposes.
  • First-quarter revenue increased to $1.5 billion, 35% higher than the first quarter of fiscal year 2008. AECOM’s gross revenue includes a significant amount of pass-through costs and, therefore, revenue, net of other direct costs, which is a non-GAAP measure, also provides a valuable perspective on its business results. AECOM’s revenue, net of other direct costs, increased 32% compared to the same period last year, to $889.5 million.
  • AECOM reported net income of $40.5 million for the first quarter, or diluted earnings per share (EPS) of 38 cents. These results represent an increase of 37% over net income of $29.5 million – and an increase of 31% over diluted EPS of 29 cents – for the same period last year.
  • Operating income for the first quarter increased 57% year over year to $69.7 million.
  • AECOM reports separate financial information for its two segments: Professional Technical Services (PTS) and Management Support Services (MSS).
  • The PTS segment delivers planning, consulting, architecture and engineering design, and program and construction management services to institutional, commercial and government clients worldwide.... a 38% increase in revenue and a 44% increase in operating income year over year.
  • The MSS segment provides program and facilities management and maintenance, training, logistics, consulting, technical assistance and systems integration services, primarily for agencies of the U.S. government.... represents a 19% increase in revenue and a 194% increase in operating income year over year.
  • We saw continued demand for our services globally throughout the infrastructure market, and this was reflected in our backlog growth during the quarter,” said Dionisio. “Projects such as our work in support of Zayed University’s new campus in Abu Dhabi, major transit expansions in San Francisco and Toronto, and five task order wins for the U.S. Air Force’s Contract Field Teams program, highlight the breadth and diversification of our success.”
With any infrastructure company comes lumpy results and we want to see a solidly growing backlog
  • AECOM announced backlog totaling $9.0 billion at December 31, 2008, a 32% increase year over year. “Our continued positive trends in margin improvement, where we saw a 107-basis-point improvement, and backlog growth, where we achieved a $2.2-billion increase in our year-over-year backlog, indicate continued solid momentum in our global end markets.”
Outlook
  • Based on its results through the first quarter of the fiscal year, as well as its backlog, AECOM has reaffirmed its EPS outlook for fiscal year 2009 of $1.60 to $1.70.
So we have some very nice growth rates and even if there are some cancellations in the future, we'd turn mid 30% growth into say mid 20%+; a solid balance sheet; and 30%+ backlog growth. For all this we only see a forward PE multiple of 15 (AECOM has a year "end" of Sep 2009, not December 2009) Further, any government stimulus should help a company like this in latter 2009 and into 2010.

HAL9000 and crew, the quant hedge fund computers, seem to trade all these infrastructure plays together - if commodities are hot; they tend to go up... if not, they all stink (together) regardless of individual metrics. This is just the market we are in and HAL dominates. I can't fault anything in the results and remain constructive from a fundamental standpoint. Hopefully HAL lets us return to normal investing at some point in 2011 or so.

No position

Circling Back to Look at Agriculture Equipment Stocks - Deere (DE) and Agco (AG)

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Agriculture is one of the most prominent long term themes from my investing standpoint; we've been involved in some shape since day 1 of the fund/blog. While I like to use fine instruments (individual equities) rather than broad (ETFs) in most cases.... for readers who wanted an easy "1 stop shop" way to play the theme we outlined Market Vectors Agribusiness (MOO) [Sep 7, 2007: This MOO for You? An ETF to Play the Global Agriculture Boom] Within this you get fertilizer, equipment, seeds, irrigation - the whole crew
One of the themes the fund is currently investing in is the secular agricultural boom as people in developing economies upgrade their food quality, as their incomes grow. Thus far, I have been focused mostly on the fertilizer companies, although the equipment and seed plays have also done great.


I saw the greatest disconnect between what analysts thought would happen versus what I thought would happen in fertilizer [Oct 23, 2007: Analysts Still Doubting the Fertilizer Stocks - I'm Adding Potash Ahead of Earnings] but I also made some equipment plays in both Agco (AG) and CNH Global (CNH). However (and this seems like a lifetime away but it's only 3 quarters ago!) by spring 2008 I became very nervous about the parabolic rise in steel and how it would hurt input costs [Apr 24, 2008: Three Agricultural Stock Earnings Reports this AM]
I sold my agriculture equipment makers to focus on fertilizer back in January 2008 [Jan 23: Closing Last of CNH Global]. Just easier to play the same trend in a more focused manner with the fertilizer. Input costs are rising for the equipment makers with costs of their raw goods rising


[May 14, 2008: Deere Earnings - Why I'm Avoiding Equipment Stocks]
Major ag equipment player Deere (DE) - I don't own the equipment stocks anymore; at some point the rising cost of steel, petrol products and the like will be hurting the bottom line unless they can pass all the costs along to farmers - over the next year if inflation does not abate this is the type of company who could see profit margins squeezed simply from the constant increase in input costs.


[May 17, 2008: WSJ - Fast Rising Steel Prices Set Back Big Projects]
Relentless increases in the price of steel are halting or slowing major construction projects world-wide and investments in shipbuilding and oil-and-gas exploration, setting the stage for a potential backlash against steelmakers.


This strategy allowed us to benefit from the "ag trade" for about 90 days longer than the average bear, as fertilizer and equipment stocks began to diverge in a sharp way February 2008 through the summer. And then the bottom fell out on the whole trade - we got hit on the tail end.

With Agco reporting last week, and Deere on tap this week - I thought it would be a good time to update where things stand from a fundamental basis.

Agco
  • Farm equipment manufacturer Agco Corp. said Monday that strong retail sales and improved margins helped push fourth quarter profit up nearly 26 percent, beating Wall Street expectations even as sales slipped.
  • But the company said it expects sharp declines in both earnings and sales in 2009 as a result of "significant uncertainty and softening demand in all major farm equipment markets." It said it expected industry sales to fall 5 percent in North America, 5 to 10 percent in Western Europe and 20 to 30 percent in South America and it warned that results for the current quarter would be "significantly lower" than those reported during the comparable quarter last year.
  • ....expected tight credit conditions to weigh on several key markets in 2009, including Eastern Europe, Russia and South America
A solid story via Reuters on Deere
  • But as the headwinds facing the farm sector intensify, analysts are beginning to warn the leaping deer may be headed for a hard landing. Last Monday, JP Morgan analyst Ann Duignan lowered her estimates for Deere's full-year 2009 earnings. Among her biggest worries: the "rapid deterioration" in South American demand reported by Agco in its quarterly results as well as a growing sense among farmers in North America that they should wait for the economic dust to settle before making any big capital purchases.
  • When the U.S. Department of Agriculture's Economic Research Service released its initial outlook for 2009 farm sector income two days later, Duignan, long a leading bull on the sector, jumped off the fence. With the agency estimating a 20 percent year-over-year decline in net farm income, Duignan declared "2008 ag machinery sales were likely a peak."
  • As part of a report issued last week, the USDA said that in addition to falling farm incomes in 2009, crop receipts are also expected to decline. Given the high correlation between receipts and equipment purchase, Robert McCarthy, an analyst at Robert W. Baird & Co, called the forecast "another negative indicator for machinery demand and manufacturers' production schedules."
  • The decline in U.S. farm incomes -- the first in a decade -- is not the only problem on the ag front for the Moline, Illinois-based Deere. The ethanol industry that sent grain prices soaring last year is looking wobbly, a victim of overcapacity, weak demand and poor margins. [NYT: Ethanol - Recently a Savior, is Now Struggling]
  • The trouble is no one is expecting that market to rebound in 2009. Last week, Terex warned [Feb 12: Terex Warns of Losses, Job Cuts, and Covenants] as it released disappointing fourth-quarter earnings that the deterioration in that market was in fact accelerating and that it was getting slammed by order cancellations and delays in acceptance of deliveries. (well no one, other than pundits who can see "the recovery in 6 months")
All this doom and gloom and we are just 4.5 months away from the beginning of the "2nd half 2009" recovery I've been hearing for 3-4 months now. July 1, 2009 - good times ... soon enough! (for newer readers I was mocking the exact same players A YEAR AGO who were telling me about '2nd half 2008' recoveries - just change the year, and repeat the Kool Aid; one day you are going to nail this call!)

No positions


New York Times: Job Losses Pose a Threat to Stability Worldwide

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I always love when the mainstream media catches a theme with such lag.... the following article hits on themes we were addressing in the 1st half of 2008: protectionism & social acrimony. We are already seeing this increasing sharply both domestically and abroad. Another sexy theme that investors were using to drive up certain stocks ... "decoupling" firmly debunked.
  • From lawyers in Paris to factory workers in China and bodyguards in Colombia, the ranks of the jobless are swelling rapidly across the globe. Worldwide job losses from the recession that started in the United States in December 2007 could hit a staggering 50 million by the end of 2009...
  • High unemployment rates, especially among young workers, have led to protests in countries as varied as Latvia, Chile, Greece, Bulgaria and Iceland and contributed to strikes in Britain and France.
  • Just last week, the new United States director of national intelligence, Dennis C. Blair, told Congress that instability caused by the global economic crisis had become the biggest security threat facing the United States, outpacing terrorism. “Nearly everybody has been caught by surprise at the speed in which unemployment is increasing, and are groping for a response,” said Nicolas Véron, a fellow at Bruegel, a research center in Brussels that focuses on Europe’s role in the global economy.
  • In emerging economies like those in Eastern Europe, there are fears that growing joblessness might encourage a move away from free-market, pro-Western policies, while in developed countries unemployment could bolster efforts to protect local industries at the expense of global trade. (count on it) Indeed, some European stimulus packages, as well as one passed Friday in the United States, include protections for domestic companies, increasing the likelihood of protectionist trade battles.
  • This is the worst we’ve had since 1929,” said Laurent Wauquiez, France’s employment minister. “The thing that is new is that it is global, and we are always talking about that. It is in every country, and it makes the whole difference.”
  • In Britain, refinery and power plant employees walked off the job last month to protest the use of workers from Italy and Portugal at a construction project on the coast. Some held up signs highlighting Prime Minister Gordon Brown’s earlier promise of “British jobs for British workers.”
  • In France last week, President Nicolas Sarkozy agreed to supply low-interest loans of 3 billion euros, or $3.86 billion, each to PSA Peugeot Citroën and Renault in exchange for an agreement not to lay off French workers.
  • To a greater extent than in past European downturns, highly trained white-collar workers are pounding the pavement, too.
  • Even India, whose startling rise to the forefront of the global economy was portrayed in the hit movie “Slumdog Millionaire,” has hit a wall. About 500,000 people lost jobs between October and December 2008, according to one recent analysis.
  • Many newer workers, especially those in countries that moved from communism to capitalism in the 1990s, have known only boom times since then. For them, the shift is especially jarring, a main reason for the violence that exploded recently in countries like Latvia, a former Soviet republic.
[Jan 29: CNN - French Take to Streets to Protest Against Economic Solutions]
[Dec 22: WSJ - Protectionism on the Rise]

WSJ: Nationalism and Protectionism Continue to Accelerate Across the Globe; including the U.S. (another of our long held predictions now is coming to fruition - protectionism and social acrimony) also UKTimes Online: Dawn of New Age of Industrial Unrest and NYT: British Unions Stage Walkouts Over Use of Foreign Workers

Thoratec (THOR) Acquires Heartware

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Thoratec (THOR) made an acquisition Friday, in which it stated would impair earnings through 2011.
  • Heart device maker Thoratec Corp. said Friday it agreed to buy HeartWare International Inc. of Australia for $282 million in cash and stock. Pleasanton, Calif.-based Thoratec said half the price will be paid in cash, and the other half in Thoratec stock.
  • Thoratec and HeartWare both make ventricular assist systems, or small implanted devices that help the lower left chamber of the heart pump blood. The devices are used to help patients with end-stage heart failure.
  • On Jan. 30, HeartWare said regulators approved its HeartWare device for sale in the European Union. The company said it was beginning preparations for the commercial rollout of the product, starting with the hospitals where HeartWare was tested and expanding to key hospitals over the coming months.
  • Thoratec said will record one-time charges totaling $15 million to $20 million in 2009 from the buyout, and that the acquisition will reduce its profits into 2011.
Interestingly the market still liked it (the stock was up) - which had me scratching my head on the surface since I'm a bottom line type of guy. However, this article by Reuters sheds some light on the subject...
  • Cardiac-device maker Thoratec (THOR) will buy Australia's HeartWare International (HIN.AX) for about $282 million in a cash and stock deal, which could give Thoratec a stronghold over the market for machines that help pump blood in patients with a weak heart.
  • "It's a brilliant move, with the number-two player Ventracor Ltd (VCR.AX) in financial distress. By acquiring HeartWare, Thoratec has essentially consolidated its market leadership position," SMH Capital analyst Suraj Kalia said. Australia-based Ventracor, which makes an implantable blood pump called the VentrAssist Left Ventricular Assist Device (LVAD), said it was seeking interest from firms wishing to take a stake or buy the company.
  • "Thoratec is the current leader in developing Left Ventricular Assist devices, and HeartWare has the most exciting next generation products currently in the development," Pacific Growth Equities analyst Duane Nash said.
  • HeartWare was significantly undervalued, and at a premium of about 112 percent, Thoratec gains a longer pipeline and HeartWare gains decades of experience in developing and commercialising these devices, said Nash.
Thoratec has been another January leader which has been hit of late, but thus far has been able to hold over the 200 day moving average. Friday's news sent the stock up to near the 50 day moving average - we'd like to see it north of $28 as a sign of strength. For now, it remains as a minor position until we see a trend develop.

[Feb 6, 2009: Thoratec Beats; Market Yawns]
[Dec 5, 2008: Thoratec with Positive Data]
[Oct 30, 2008: Thoratec Smashes Earnings; Somehow Guides Up]
[Aug 4, 2008: One for the Radar - Thoratec]

Largest mutual fund owners of Thoratec by share ownership are
  1. 9.8% - Fidelity Growth Company (FDGRX)
  2. 1.0% - Vanguard Small Cap Index (NAESX)
  3. 0.8% - Vanguard Total Stock Market Index (VTSMX)
  4. 0.8% - Lord Abbott Developing Growth (LAGWX)
  5. 0.7% - American Century Heritage (TWHIX)
Long Thoratec in fund; no personal position


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