Tuesday, December 08, 2009

Home At Last

By Vahan Janjigian - I'm finally back from the 16th Forbes Cruise for Investors. I got off the ship in Aruba on Sunday and took a long flight home. The Internet connection on the ship was not always reliable, so I did not get a chance until now to post my comments about Jack Ablin's presentation.

Jack is the Chief Investment Officer at Harris Private Bank. We first met in 1996 when I was on the faculty at Northeastern University. I signed up for a course to prepare for the Level II Chartered Financial Analyst exam and Jack was one of my instructors. He was an excellent lecturer.

It was nice to see that he hasn't lost his presentation skills. Jack is a quantitative analyst. One of his comments should give college students majoring in business something to think about. He said he only hires people with strong quantitative skills. He especially likes engineering majors. This is because he finds it easier to teach an engineer how to do finance than to teach a business major how to do quantitative analysis.

Jack is fond of using a momentum approach to investing. There are plenty of investors who are skeptical of this approach, but it really does work. Sheridan Titman, now a professor at the University of Texas, was one of the first to document that stocks exhibit momentum. One approach Jack relies on is to compare an index or sector to its moving average. In general, he avoids buying stocks until they start moving up. He is happy to miss the opportunity to buy at the bottom until he is confident that an upward trend has begun.

Jack believes the market is currently at a fair to full valuation. He thinks inflation will eventually become a problem, but says we will have about two to three years to prepare for it. He expects the Fed to sit tight through much of 2010. He mentioned two ETFs he currently likes: The S&P International Small Cap (GWX) and the WisdomTree International Small Cap Dividend (DLS).

Jack recently authored a book: Reading Minds and Markets: Minimizing Risk and Maximizing Returns in a Volatile Global Marketplace. He gave a copy to all attendees. I am putting it on my reading list.

Thursday, December 03, 2009

Visiting St. Bart's





By Vahan Janjigian - We took two days day off from our seminars to enjoy the cruise. We also got off the ship at a couple of ports. I went on a five-mile hike today in St. Bart’s. Nonetheless, I also managed to hold a number of impromptu discussions with several attendees about the economy and markets. Most of these people are retired and have a high net worth. Many are sophisticated investors. Yet I have not spoken with anyone who I would call bullish. They are all cautious about the economy and extremely skeptical about the strength of the recent rally in stocks. They are also worried that the government’s efforts to revive the economy will ultimately fail, especially since there is so much talk about increasing both taxes and spending.

I was thrilled to meet Ed Breen, CEO of Tyco International (pictured above left). Ed and I had an interesting discussion about the interaction between equity research analysts and corporate managements. We agreed that since the SEC promulgated Reg FD, there is little value to one-on-one meetings between these two parties. Corporations are disclosing a lot more information these days in their SEC filings. I personally find that my research is much more objective if I do not meet the management team. Unlike Warren Buffett, I am not trying to marry good companies. I am just trying to buy good stocks. Nonetheless, I am glad I had the opportunity to meet Ed personally. He is doing an excellent job of bringing Tyco back from the disgrace it suffered several years ago.

Also pictured above (right) is Barry Ritholtz. He always manages to provide an original point of view on the markets. One of my friends went to law school with Barry some years ago. She claims he was one of the smartest students in the class. I can believe it.

Tuesday, December 01, 2009

The Voyage Continues

By Vahan Janjigian - Gary Shilling gave his talk today while we continued our voyage toward St. Croix. Gary said we will not have a V-shaped recovery as many economists expect. He talked about how household net worth has plummeted due largely to the sell-offs in stocks and residential real estate. Gary also explained that corporations are cutting wages and forcing employees to take unpaid furloughs. He says this is the first time since the 1930s that this has happened on such a large scale. Furthermore, not only has unemployment risen, but it has also become much more difficult to find a new job. Gary expects slow economic growth for several years. He projects annual growth of 2.1% for the decade ending in 2018. However, he claims that 3.3% annual growth is needed just to keep the unemployment rate constant. As a result, he expects to see the government taking much more aggressive actions in order to try to create jobs. He advised investors to stick to Treasury securities and dividend paying stocks.

There was some discussion about whether investors needed to worry more about deflation or inflation. Both Gary and I relied on the same graph that showed how capacity utilization has fallen to explain why the Fed is not worried about inflation. You do not typically see much inflation when capacity utilization is so low. Nonetheless, in my presentation, I argued that the Fed should start raising interest rates right away. A quarter-point increase in the fed funds rate will not do anything to slow economic growth, but it would send a strong signal to investors that the Fed actually believes its claim that the economy is getting better. It would also help strengthen the dollar and turn investors away from commodities such as gold and oil. By keeping rates so low, the Fed is creating another bubble in commodities.

Monday, November 30, 2009

Seminars on the High Seas




By Vahan Janjigian - As promised, I am reporting on today’s speakers on the 16th Forbes Cruise for Investors. We spent the day at sea on our way to St. Croix and listened to three excellent presentations.

Steve Forbes gave a compelling talk defending capitalism. He argued that the financial crisis was the result of misguided government policies. He explained how the Federal Reserve drove interest rates excessively low and kept them low for too long. This prompted investors to channel money to housing and commodities, causing bubbles in those asset classes. He also blamed Fannie Mae and Freddie Mac for guaranteeing $1.6 trillion worth of suspect mortgages. These two government-sponsored entities were not subject to same reporting rules that other public corporations had to abide by. He warned that the Federal Housing Administration is now falling into the same trap by guaranteeing mortgages with only 3% down payments. He even blamed George W. Bush for pushing the idea of home ownership for everyone and promoting no money down mortgages. He blamed mark-to-market accounting and government sanctioned credit agencies that were not subject to market forces. The government simply ignored contract law during the GM bankruptcy, which made investors very wary to lend. As a result, the Fed is the only entity today willing to buy mortgage-backed securities.

Bond expert Marilyn Cohen explained how corporate balance sheets are getting stronger. Several years ago, corporations were engaging in share repurchases. Today, they are issuing stock, paying down debt, and rolling over high interest rate debt at much lower rates. At the same time, municipalities around the country are struggling with lower tax revenues. As a result, she considers corporate bonds safer than municipals right now. She also explained how the Build America Bonds (BABs) are crowding out traditional municipals. BABs are taxable municipal bonds. The interest rates are higher, but the municipality gets a subsidy from the federal government. As a result, there are fewer traditional municipals bonds available. This has caused investors to bid up their prices and reduce their yields even though credit quality has deteriorated.

Barry Ritholtz also gave a compelling talk. Barry is a political independent and is frequently criticized by members of both major parties. Barry believes tax rates in the U.S. are low in comparison to rates in most other countries. He thinks this is not compatible with the high level of spending. This is why the government has had to borrow so much money. He argued that either tax revenues must go up or spending must go down. He is worried about the employment situation. Average work hours per week have fallen to just 33. This means that we are likely to have a jobless economic recovery. Corporations will not have to hire new workers for a long time because they could easily ask their current employees to put in more hours. Barry also argued that from a historical perspective, the current rally in stocks is only about three-quarters of the way through. He expects the stock market to eventually roll over and go lower, but until it goes higher first.

Sunday, November 29, 2009

All Aboard the Crystal Serenity



By Vahan Janjigian - I just arrived in Miami and boarded the Crystal Serenity for the 16th Forbes Cruise for Investors. The Internet connection is not always reliable, but I will try to keep you up to date on the discussions aboard. Steve Forbes gives his talk tomorrow morning.

Thursday, November 26, 2009

Thanksgiving in the U.S. and Turkeys in Dubai

By Vahan Janjigian - Dubai shook global financial markets today when it announced its intention to delay payment on some of its debt. This caused investors worldwide to suddenly demand greater compensation for taking on risk. They sold stocks all over the world. U.S. markets were closed due to the Thanksgiving holiday, but all the European indexes closed at least 3% lower. This is the kind of event that could shake confidence in the hope that global economies were beginning to recover. If Dubai were to actually default on any of its debt, stocks worldwide will go much lower.

Friday, November 13, 2009

Trade Deficit Climbs; Sentiment Falls

By Vahan Janjigian - Two pieces of economic data that came out this morning were not particularly encouraging. First, the Commerce Department said September's trade deficit rose to a greater-than-expected $36.5 billion. The good news is that exports were up from $128.3 billion in August to $132.0 billion in September. However, imports surged from $159.1 billion in August to $168.4 billion in September. While it is certainly nice to see that world trade is picking up, we still are a long way from where we were a year ago. In September 2008, exports and imports amounted to $152.0 billion and $212.1 billion, respectively. Furthermore, given the tremendous devaluation in the U.S. dollar, it is extremely disappointing that exports are not rising faster than imports.

The second item was November's Michigan Sentiment Index, a measure of consumer confidence. This metric was expected to climb marginally to 71.0, but instead dropped to 66.0. The rising stock market, which typically makes consumers feel better, wasn't enough to offset their anxiety over the lack of jobs. As yesterday's initial claims report showed, corporations are still laying off workers at a rapid clip.

All in all, there is not much economic news to explain the strong rally we've seen in stocks. Things might be getting worse at a slower rate, but they are getting worse nonetheless. A few corporations are reporting year-over-year revenue gains, but most are telling us that business is down. They are squeezing out profits by cutting costs. In other words, they are eliminating jobs. With more and more people out of work, I don't see where the consumer spending that is needed to revive the economy is going to come from.

Thursday, November 12, 2009

Buffett Authors Appear on CNBC

By Vahan Janjigian - Warren Buffett and Bill Gates appeared together today at a forum at Columbia University. At the same time, I appeared on CNBC with Alice Schroeder, the author of another Buffett book. It made for an interesting discussion. Click here to watch the video.

Thursday, November 05, 2009

Hey Fed: Put Your Money Where Your Mouth Is

By Vahan Janjigian - If Ben Bernanke and members of the Federal Open Market Committee really believed that "economic activity has continued to pick up", they would have increased interest rates by now. They can say the economy is on the mend until they are red in the face, but serious investors won't believe them until they actually start tightening.

Monday, November 02, 2009

Like the Nobel Peace Prize, Q3 GDP Report was Undeserved



By Vahan Janjigian - Economists hoping for signs of an economic recovery were not disappointed when the third quarter Advance GDP report showed 3.5% growth over the second quarter on an annualized and seasonally adjusted basis. Perhaps the biggest surprise was the 3.4% jump in personal consumption expenditures. Despite rising unemployment and a shorter average workweek, consumers somehow managed to find the resources to go shopping.

However, this GDP report felt like the Nobel Peace Prize—somewhat undeserved. It turns out that taxpayers subsidized much of the shopping. Spending on durable goods surged 22.3%, but that was in large part due to the “cash for clunkers” program. Unfortunately, for the United Auto Workers, most of those sales went to foreign manufacturers. As a result, imports jumped 16.4%. That outweighed the 14.7% rise in exports. Now that every person who entertained the idea of buying a new car in the next year or two has probably done so, auto sales in the current (fourth) quarter will no doubt plummet.

Furthermore, the rise in exports is probably due to the 20% plunge in the U.S. dollar over the past year. Economic adviser Lawrence Summers argues that exports are key to an economic recovery. That may be so, but debasing the currency to boost exports does not sound like sound economic policy. Summers insists that the White House is committed to a strong dollar policy, yet I suspect that at least some members of the Obama administration are not too upset to see the dollar lose its value.

While government subsidies helped boost car sales, the $8,000 first-time homebuyer tax credit appears to have been less effective. New home sales had risen five months in a row through August, but they unexpectedly fell to just 402,000 in September. One prominent economist who advises the White House in an unofficial capacity said he was surprised to see how weak the figure was. No doubt, it would have been worse without the controversial tax credit, yet the fact that it was this bad is a sign that the housing market is still very sick. Although the 20-city composite S&P/Case-Shiller Index, which measures housing prices, is up four months in a row, it continues to fall on a year-over-year basis. According to the latest figures, housing prices were 11% lower in August than they were a year ago.

These are just some of the reasons why I suspect this recovery lacks legs. The recession may have indeed ended sometime during the third quarter, but I fear the chances are good that a second (double-dip) recession is on the way. While I realize that employment is a lagging indicator, I do not see how an economy as dependent on consumer spending as ours can grow in a long-lasting manner until consumers feel secure about their jobs. As I recently pointed out on my blog, small businesses are still having trouble accessing capital on reasonable terms. Because they account for most of the job growth in this country, the employment picture cannot improve until small businesses start hiring again. The long-awaited sell-off in stocks has not yet arrived, but I still advise maintaining a conservative asset allocation for the time being.

Friday, October 23, 2009

The Financial Crisis is Benefiting the Large at the Expense of the Small

By Vahan Janjigian - The financial crisis was brought upon us largely by big institutions that used too much debt. In particular, they used leverage to buy lots of mortgage-backed securities. Of course, thanks to exotic mortgages, some of which required no down payments, those mortgages themselves were already leveraged much more so than they had been historically.

Ironically, the crisis appears to be helping large institutions at the expense of small ones throughout all sectors of the economy. The credit crisis caused havoc for all companies and made it impossible for them to borrow. However, credit spreads have come down and large, investment grade corporations are having no trouble borrowing money at reasonable rates. Although the banks are still reluctant to lend, large corporations can go to the capital markets and issue debt.

Small businesses, however, don't have this option. They rely heavily on the banks for financing. But they can't get financing from the banks on reasonable terms. The inevitable result is that the big are getting bigger and the small are being driven out of business.

This should be extremely troublesome to politicians who are concerned about the rising rate of unemployment. According to the Census Bureau, there were just over 6 million firms in 2006 that employed people. Small companies (i.e., those with less than 500 employees) provided jobs for just over half the nation's workforce that year. More importantly, according to the Department of Labor and summarized by the Small Business Administration, small businesses account for most of the job growth. They were responsible for 64 percent of the 22.5 million net new jobs created from 1993 through the third quarter of 2008.

You don't find many small businesses that are publicly traded. Furthermore, most stock market indexes are market-capitalization weighted. As a result, the stock market provides a reasonable picture of how large businesses are doing, but it does not tell us much about small businesses. The strong rally from the March lows could be an indication that large businesses are successfully managing the economic crisis. The unemployment rate, however, is not likely to go down until small businesses get healthy again. That is not going to happen until the feds make sure that small businesses can also access capital at reasonable rates.

Tuesday, October 20, 2009

Forbes Article: Hold Cash, Sell Stocks

By Vahan Janjigian - I had an interesting lunch today with Kurt Schacht of the CFA Institute and Ravenel Curry of Eagle Capital Management. In February, the three of us traveled to Abu Dhabi and Dubai to lecture to the Abu Dhabi Investment Authority, Mubadala, and the CFA Institute's local chapter in Dubai. Today's lunch was an opportunity to catch up on that trip and learn about some new initiatives. Kurt is headed back to the U.A.E. in two weeks. This time he is taking Tom Keene of Bloomberg fame and Jason Trennert of Strategas Research Partners.

During lunch, we discussed the markets and economy. Both Ravenel and I remain skeptical of the recent rally. In my view, there is a good chance we will see a double-dip recession with the second phase coming in the first or second quarter of 2010. Government stimulus appears to have brought us out of the first recession, but I doubt the gains will last. I talk a little about this in my column in an upcoming issue of Forbes magazine. In the meantime, you can read my views on the market and the views of several others as recently published in Hold Cash, Sell Stocks.

Thursday, October 08, 2009

Not So Jolly Holiday Sales?

By Taesik Yoon - The National Retail Federation (NRF) recently released its forecast for sales for the upcoming holiday shopping season. The trade group projects sales covering the 55 days in November and December to decline one percent from the prior year to $437.6 billion.

Despite the expected decline, this would be a marked improvement over the 3.4% drop experienced in 2008—the first decline in holiday sales since the NRF began tracking industry sales in 1992. There are probably some that believe sales will be even better. They point to the recovering economy, the rise in equity values, and the reduction in overall consumer credit balances as reasons why Americans may be more optimistic about their financial security heading into the holiday season. This could induce greater spending than in 2008 where all of these metrics were trending in the opposite direction. Additionally, there is an extra shopping day between Thanksgiving and Christmas, which should also provide a boost.

But I don’t see it. In fact, I think it is quite possible that holiday sales will be worse. There are several reasons for my pessimism. The most significant of these is the pervasion of the value/bargain hunting mentality that has swept across the country. A recent article by the Associated Press titled Great Time for U.S. Consumers: America on Sale highlights this shift in mindset. Examples mentioned include everything from rare discounts on Tiffany engagement rings to lower spending on premium dog food.

Some may call this a trend. But I view it as more of a lifestyle change, which is typically longer lasting. This change has been fueled throughout the year by an absurd level of promotional activity. Value is everywhere. Airfare is cheaper, rents have come down… Heck even the Yankees just cut the price of certain seats at Yankee Stadium by about half. As such, I believe it will be difficult to get consumers to pay full price for anything during this holiday season.

Furthermore, it is possible that promotional activity may not be as heavy as consumers are expecting. A portion of the deals that consumers have come across over the past year have been due to aggressive inventory management. Retailers have been clearing out excess or past-season merchandise at sharp discounts as a way of improving cash balances and the overall health of their balance sheets. But many of these retailers are now very lean on inventory. This reduces the likelihood of excess supply as well as the associated markdown activity.

For example, it may be valid to question whether a consumer that paid $20 for a pair of jeans regularly priced at $69.50 during a denim sale (a promotion the Gap ran the first week of July) would be willing to pony up more during the holiday season. But perhaps an equally valid question may be whether the Gap will even run such a generous promotion during the holiday season now that inventories have come much more inline with the expected level of sales.

The change in tender mix is also very telling. Credit card usage (as a percentage of payment methods during the holiday season) rose in 2006 and 2007 while cash fell in both those years. The opposite occurred last year with cash usage rising and credit card usage declining. I believe the same trend will occur this year due to the aversion to credit many consumers have adopted over the course of the year. Credit card companies have also been extremely aggressive at reducing credit limits and become more stringent in approving new credit cards applications. These actions reduce the total pool of resources available to consumers to pay for purchases.

Then there are also the additional job losses since the 2008 holiday season. Indeed, according to the Bureau of Labor Statistics, the U.S. has lost 5.55 million jobs in the 12 month period ending in September. The number of workers that are underemployed also continue to climb, hitting 17% last month. No doubt this will also negatively impacting holiday spending.

The combination of all of these factors—value mindset, potential for less promotional activity, a shrinking pool of consumer credit/credit aversion, and the continual rise in unemployment—could prove costly for holiday retail sales. But more importantly, it could also prove costly for owners of retail stocks, many of which have fared extremely well so far this year. Indeed, the S&P Retail Index is up 36% year-to-date and a whopping 66% since its March 9th low. Some profit taking may be prudent. And while I would normally advocate booking profits in January in order to defer taxes on capital gains, in this case, that will probably be too late.

Wednesday, October 07, 2009

How to Get Investors Focused on the Long Term



The following commentary is from the October issue of the Forbes Growth Investor, released to subscribers on October 1.

By Vahan Janjigian - As stocks bucked the trend by rallying in September, President Obama was out in force trying to sell healthcare reform. Unlike previous presidents who liked to keep a low profile, this one keeps popping up everywhere. He even appeared on just about every possible television program. However, the talk among financial regulators focused on the short term versus the long term. They want less of the first and more of the second. Corporate directors apparently feel the same way. According to Agenda, a newsletter for corporate directors published by Financial Times, independent directors claim that pressure to focus on short-term results is the biggest corporate governance issue they face.

Clearly, running a corporation with a long-term perspective in mind is better than trying to maximize earnings or the stock price during any particular quarter. For example, management could easily boost earnings this quarter by delaying capital expenditures or investments in research and development. Doing so, however, could prove costly over the long term. While we all want to see more long-term thinking, how best to achieve that goal is subject to debate.

One proposal that comes up repeatedly is to ban quarterly earnings guidance. Many observers blame guidance for fostering a myopic investment and management style. However, as I explain in chapter 10 of my book Even Buffett Isn't Perfect, eliminating guidance is a bad idea. Research studies show that ending guidance not only reduces the amount of information disseminated to shareholders, it also increases uncertainty and the disparity between actual earnings and the consensus estimate. In addition, it results in a statistically significant loss in shareholder wealth; and it does nothing to reduce the focus on short-term results or increase the emphasis on the long term.

Other proposals to encourage long-term thinking make more sense. For example, in the U.S. we currently tax long-term capital gains at lower rates than short-term gains. If we want investors to pay more attention to long-term results,we should reduce the tax rate on long-term gains even further. If we want to be serious about this, let’s eliminate taxes altogether on any gains that are accrued over periods of 10 years or longer.

Let’s also look at voting rights. As things stand today, any investor with deep pockets can buy a bunch of shares and have as much say as the investor who has owned the stock for years. Why not consider a weighted-average voting scheme; one where the number of votes you get is tied not just to the amount of shares you own, but also to how long you have owned them?

Proper executive compensation can also make a difference. Let’s tie bonuses to long-term metrics and reward executives with stock they cannot sell for several years; and let’s take back bonuses based on financial results that are later determined to have been bogus.

A stronger focus on long-term results makes sense. While there are many effective ways to achieve this goal, eliminating guidance will not do the trick.

Tuesday, September 15, 2009

"Favorable" Foreign Exchange...

By Sam Ro - …is one way of saying that a weak U.S. dollar helps boost quarterly revenue and earnings. This observation is made by companies with significant international sales and who report financial results in U.S. dollars.

This is an important consideration for equity investors using the S&P500 as their benchmark. According to Standard & Poor’s research, around 48% of S&P 500 company revenues are generated outside of the U.S.

So, I'd argue that the weak U.S. dollar partially explains why the S&P 500 has done so well in the last six months. In March, the S&P hit its low of the year when the dollar hit its high. When you overlay a chart of the S&P500, which is now trading at a year-to-date high, with the U.S. Dollar Index (DXY), which is now trading at a year-to-date low, you will easily notice the inverse correlation.

The U.S. dollar was actually at lower levels for much of Q3 2008, which means it should have an unfavorable impact on year-over-year comparisons this year. However, most corporate managers assume stable foreign exchange rates when issuing guidance. As such, if the U.S. dollar weakened since the last time earnings guidance was issued, Q3 2009 sales and earnings will be better-than-expected…ceteris paribus.

But based on the persistent divergence in stocks and the dollar, this may already be priced in.

If you’re unwilling or unable to sell your internationally exposed equity positions and you’re concerned that a rising dollar could eat into earnings, then you may want to hedge your position by going long the dollar. You can do so with an ETF like PowerShares DB U.S. Dollar Bullish Fund (UUP).

Thursday, September 03, 2009

Location, Location, Location

By Taesik Yoon - The other day I walked past the empty store front of what was a Circuit City location until the consumer electronics retailer went bankrupted this past spring. Taped on the inside of the windows were signs that read:

Best Buy Coming This Fall

The thing about this particular store front is that it’s across the street from Union Square Park—an extremely popular area in downtown Manhattan coveted by retailers due to the heavy foot traffic. This is evident in the sheer number of branded retail chains that line the Square, which include McDonald’s, Staples, DSW, Filene’s Basement, Forever 21, Diesel, Puma, Petco, Barnes & Noble, Babies “R” Us, Au Bon Pain, and Whole Foods.

The location’s significance is certainly not lost on Best Buy (BBY), which specifically highlighted the Union Square site in a recent press release announcing plans to open 22 new locations in the U.S.

This is a great move by Best Buy. Despite its desirable location, given the state of the commercial real estate market, it’s quite possible—even likely—that the lease terms were more favorable than they were for the former tenant. Residents are already used to seeing the location as a seller of consumer electronics, which should help the store assimilate quickly into the neighborhood. The location also bridges the gap between its two closest stores, which are nearly two miles away from each other—a fair distance in Manhattan terms. Yet at the same time, it’s probably not close enough to the other two to result in significant sales cannibalization. An added benefit is that the store is expected to open in enough time to take advantage of this year’s holiday shopping season.

In similar fashion, other retailers, such as specialty menswear seller Jos. A. Bank (JOSB) and discount chain Big Lots (BIG), have recently come out and said they plan on accelerating the pace of new store openings in order to take advantage of real estate deals in prime locations left vacant due to store closures by financially troubled retailers.

On the surface, accelerating store openings at time when consumer spending is weak and under duress seems counterintuitive. It goes against conventional wisdom, which would advocate profit preservation at existing stores versus adding new ones. And certainly this approach is not without risk. The most pressing would be the persistence or worsening of weak consumer spending trends, which could result in lower than expected returns from these new stores in the initial years of their existence.

However, a common trait found in all these retailers is their strong financial position. At the end of fiscal Q1, Best Buy has total debt of $2.14 billion, which represented just 13.2% of total assets and 28.0% of total capital. The associated interest expense in the quarter was $23 million or just 7.8% of total operating income, resulting in a healthy interest coverage ratio of 13. The financial positions of Jos. A. Bank and Big Lots are even more robust. Both companies are debt free and have seen their cash balances double over the past year. The strong finances not only allow these retailers to seek out these opportunities, they also provide a strong cushion should these new stores under-perform over the near term.

Over the longer term, the benefits of these real estate actions should prove their worth. Location may not be the only thing that leads to a retail store’s success, but it certainly is among the most important. Being able to obtain prime locations as discount prices should help these retailers get the most out of the eventual recovery in consumer spending and could result in strong sustainable growth that trend well above the industry average for years to come.

Given the rise in these stocks year-to-date—Best Buy is up 36% while both Jos. A. Bank and Big Lots are up about 70%—much of these expectations already seem priced in. But that might be more a reflection of the strong operating results these companies have turned in so far this year and not necessarily due to the long term growth potential the capturing of these prime locations offer. In my view, that makes them merit strong consideration even now, especially for anyone with a long-term investment horizon.

Mega Millions Mentality

By Sam Ro - Last Friday, I did not win the $336 million Mega Millions jackpot. But I played. Sure, the chances of hitting the right numbers are only 1 in 175 million. Even if you hit the numbers, you may have to split the winnings. And this is all before taxes.

But how often are you presented with an opportunity to earn a 336,000,000% pre-tax ROI on a minimum investment of $1? And in the worst-case scenario, you lose a buck.

Obviously, playing the lottery is not a prudent investment strategy. But the mentality of taking unreasonable risks for unlikely returns exists in the stock markets. Consider bankrupt companies whose stocks are worthless. Lehman Brothers (LEHMQ.PK) hit 32 cents on August 31, just a day after trading at 5 cents. Motors Liquidation Company (MTLQQ.PK), formerly known as the old General Motors, traded as high as $1.20 on August 12. Each stock sees millions of trades every day. But neither is trading on fundamentals. Even if a company were to emerge from bankruptcy, the old common equity is almost always cancelled. In other words, the stock price movements of bankrupt companies are not signs of life; they’re more like postmortem muscle spasms during rigor mortis.

However, if you were savvy enough to buy low and sell high in August, you could’ve gained up to 700% on LEHMA and 140% on MTLQQ.

Then there are the stocks on government-sponsored life-support including Freddie Mac (FRE), Fannie Mae (FNM), and AIG (AIG). Even after significant declines in recent days, these stocks are up between 260-350% in just six months. However, many question the rationale behind these price moves. Some analysts have suggested the common equity in these companies could be worth nothing. Even the more bullish arguments for these stocks come with warnings of high uncertainty.

My favorite pitch goes like this: “FRE and FNM were $60 stocks two years ago! They’re trading at under $2 right now! I could see them at $10. But if I get $5, that’s still a pretty good return.” It’s an unsound argument but not unused. Structurally, it’s very similar to the rationalization that goes into buying a lottery ticket: limited downside and tremendous upside. And you have to pay to play.

Perhaps you’re disciplined enough to avoid irrational investment decisions. But it would be totally irrational to ignore the existence of irrational behavior in the markets. According to La Fleur’s World Lottery Almanac, Americans spend around $50 billion each year on lottery tickets. Surely this includes a lot of amateur and professional traders and money managers who are unknowingly bringing that mega millions mentality into the stock markets. They get the newswires about FRE, FNM, and AIG. Some might also follow the pink sheet action of bankrupt companies. They know these are not good investments. But the allure of outlandish gains is irresistible, even if those gains are highly unlikely.


Full Disclosure: Author is long FRE and 1 Mega Millions lottery ticket.

Wednesday, September 02, 2009

From "Cash for Clunkers" to "Dollars for Dishwashers:" A Waste of Taxpayers' Money.

The following commentary appeared in the September issue of the Forbes Growth Investor, which was previously distributed to subscribers.

By Vahan Janjigian - The U.S. Department of the Treasury produces a document called "The Budget in Brief." Don’t take the word "brief" literally. The one for fiscal year 2009 runs 100 pages long, yet the word "deficit" is nowhere to be found. The one for fiscal 2010 is 124 pages in length. It mentions the "d" word just once, but only to let us know that transactions with the International Monetary Fund do not affect the deficit. Do the officials responsible for producing these documents think the deficit will disappear if they simply ignore it?

The budget deficit for fiscal 2009 is $1.6 trillion. The cumulative deficit for the next 10 years is expected to run around $9 trillion. The federal debt is currently $11.7 trillion, or about 90% of real GDP. Common sense dictates that something is wrong here. Despite its inability to keep its finances in order, the government insists on spending more taxpayer dollars on attempts to save certain favored industries. For example, it recently brought us the "cash for clunkers" program to help the automobile industry. Because it apparently thought that program was such a huge success, it is now considering doing something similar for appliance makers. It may sound like a bad joke, but "dollars for dishwashers" is really under consideration.

However, programs such as these are not likely to do much good over the long term. Obviously, if you have an old car or refrigerator you would like to replace, you are more likely to do so now if other taxpayers are going to pay part of the bill. Why would you not take a subsidy when it is being offered? Yet the bottom line is that what you buy today, you will not be buying tomorrow. Such government-subsidized programs simply bring future sales into the present. They do not increase demand over the long run.

The proof, as they say, is in the pudding. The Car Allowance Rebate System (the formal name for "cash for clunkers") went into effect on July 1, so it should be no surprise that personal spending went up slightly in July. Consequently, you could say the program worked as planned. Unfortunately, once we adjust the July numbers for spending on motor vehicles and parts, it turns out personal spending actually declined. Since the program expired on August 25, chances are we will see similar results when the personal spending figures for August are released at the end of September. However, the more important question is how spending holds up in September. Now that consumers have to foot the entire bill themselves, auto dealerships will likely look like ghost towns and personal spending will likely plunge.

Speaking of September, it is not a particularly good month for investors. While most investors fear October (due to the 23% one-day plunge in the Dow on October 19, 1987), the fact is that, on average, September is the worst month for investing in equities. Sam Stovall of Standard & Poor’s recently showed that since 1929 the average September decline in the S&P 500 was 1.3%. Furthermore, the index has fallen more often in September than in any other month. Although stocks have shown incredible resilience in recent months, given their robust gains since the market bottomed on March 9 of this year, and the fact that the economy is still struggling, a significant sell-off is long overdue.

Thursday, August 27, 2009

Cash Now, Suffer Later?

By Taesik Yoon - Yesterday’s stronger-than-expected new home sales data was encouraging. But the stock markets barely reacted to it. Perhaps, more investors are becoming as skeptical as I am of any sales data that is currently benefiting from some form of federal subsidy.

In this case, I’m referring to the $8,000 tax credit for first time home buyers the government is providing. That, in and of itself, is a strong motivator for any potential home buyer still on the fence. But there’s also the added benefit of alleviating the initial cash burden of ownership. This is because the FHA has allowed qualifying homebuyers to monetize the credit and apply it towards the down payment. This last point should not be minimized, especially now with many buyers required to put up a down payment of at least 20%.

This would also apply to the strong sales enjoyed by automakers in recent months, which has benefited from the highly visible cash-for-clunkers program. In fact, I’m even more skeptical of these numbers due to the magnitude of the incentive. A credit of $3,500-4,500 is nothing to balk at. Coupled with additional incentives and promotional offers by automakers and dealerships, the actual savings to the consumers were far greater.

While the stock markets have reacted mostly favorably to the performance of these programs so far, I don’t believe this reaction is deserved. One of my concerns pertains to just how much stimulus (if any) these programs will actually create.

Economist and Noble Laureate Gary Becker and respected judge, economist and law professor Richard Posner recently posted highly critical opinions on the cash-for-clunkers program on their coauthored blog. Of all the comments, I found this statement by Posner to be the most compelling and concerning:

"It is true that people who participated in the "cash for clunkers" program couldn't pocket rather than spend the money they received from the government, as they could with the other transfer payments included in the stimulus program; they had to use it to help them buy a new car. But that is different from paying a road contractor to build a new highway. The contractor as I said has to go out and hire people to build it, so unemployment falls (on the assumption, correct with regard to construction, that there is a high rate of unemployment in the industry). The purchase of a new car merely reduces a dealer's inventory, and whether the reduction leads to new production will depend on estimates of future demand."
What makes me even more skeptical are the lackluster results stemming for other tax credit/rebate programs implemented in recent memory designed to stimulate consumer spending—specifically, the tax rebate checks that were sent out last year. Like the current programs, these checks boosted consumer spending levels over the near-term. But the benefits over the longer-term were minimal.

This is not to say these tax credit programs won’t work. As my colleague, Sam Ro, pointed out in a recent post, many consumers used the tax rebate checks to pay down debt. But these programs reward only those who spend. As his post implies, a key benefit of cash for clunkers (or any program that encourages spending) is the multiplier effect that spending has on the economy. I agree that these programs will be more effective than the stimulus checks at creating more overall spending over the near term. My concern is what it will do to future demand.

As Becker writes:

“Unfortunately, that the subsidies are popular is no measure of its public value, and I am afraid there is little to be said at any level in defense of a cash-for-clunkers program. Hundreds of thousands new cars will be purchased under the program, but many of these purchases would have occurred later in 2009 or in 2010 instead of during the five week window of the clunkers program. There is little value to the economy in subsidizing consumers to buy cars a few months earlier than they would have bought them anyway.”
If Becker and Posner are correct in their assessment that these programs will simply pull potential sales forward—that is, induce those would have bought eventually into buying sooner—then you’re just sacrificing future growth for growth today. As such, there is a real risk that the programs could actually retard the current economic recovery efforts in future years.

There are beneficiaries of these programs to be sure—car buyers, automakers and dealers, home buyers, homebuilders, and even the environment. But I wouldn't put the economy on that list quite yet.

Tuesday, August 25, 2009

What Trillion Dollar Deficits Mean

By Jeff Diamond - The OMB now projects a deficit of $9 trillion by 2019, but if you really want to understand what that means just consider that 80 percent of the deficit in 2019 will go to interest expense! Yes, 80 cents of every tax dollar will be going to service our debt... As the excellent blog ZeroHedge points out, "We are now officially a vassal state of China."

No doubt that the wars in Iraq and Afghanistan have contributed to our national debt, but it was really the reckless banks overseen and egged on by a reckless Federal Reserve that caused the financial crisis and the gargantuan bailouts.

Enjoy the stock market rally while it lasts... We have paid dearly to engineer this pop in the markets... But, hey, at least Ben Bernanke gets to keep his job!

Sunday, August 23, 2009

Financial Jenga

By Jeff Diamond - So, the improbable stock rally of 2009 continues… Kudos go to the Federal Reserve and their global cohorts. They have implemented all kinds of previously unimaginable liquidity facilities and other monetary props so as to once again levitate global stock markets. The rally has been parabolic in nature, and alas, unsustainable in the long run. In the meantime, however, the financial media is closing ranks in order to spread Ben Bernanke’s and Wall Street’s message far and wide: “The recession is over!” The only problem is that the recession may be ending for the ivory tower economists who devour government economic statistics with little doubt to their accuracy, but for the rest of us who live in the real world all we can see is the economic ruin left by the bursting of the last central bank induced bubble(s)…

If we set aside the smoke and mirrors of Ben Bernanke’s green shoots for a moment, then it is apparent that credit is still contracting, retail sales are still weakening, global trade is still declining, real estate foreclosures are still rising (though not as much as they should since banks are reluctant to swallow the costs and admit the losses associated with foreclosure these days), and sadly, unemployment is still worsening… All this is occurring in the face of the largest global fiscal and monetary money-pump in the history of mankind.

The recent history of cheap money and bubbles seems completely lost on central bankers. Their only answer to one burst bubble is to create a new bubble that is even bigger than the last. I must admit that I lack the imagination (and the chutzpah) to ever succeed at the current game of central banking. Back when Greenspan was chairman, he started off modestly when he engineered the bailout of Long Term Capital, but then cranked things up when his Y2K money pump induced the dotcom bubble. I didn’t foresee the real estate and credit bubble that he was going to foment back in 2002 as the stock market was bottoming in October . It wasn’t long, however, before I realized that the securitization markets were removing risk (supposedly) from lenders and freeing them to pursue business with little concern for the borrowers’ ability to ever repay. What baffles me is central bankers’ complete inability to foresee the consequences of their reckless behavior. So, here we stand in 2009 as the Jackson Hole powwow concludes with these same men patting themselves on the back for acting decisively in averting financial meltdown over the last 12 months while refusing to admit their role in creating it in the first place.

Again, I did not foresee a new global initiative among these men to once again bail themselves out with something even bigger than the housing and credit bubbles. Not only do we have the central bankers creating money at warp speed and shoveling it into what should be failed financial institutions, but we have deficit spending by politicians around the world hellbent on saving their own behinds from the wrath of their economically displaced constituents. But, a funny thing happened on the way to economic recovery. All this newly minted money was highjacked by the same gang of market operators who brought us the last asset bubbles in stocks, bonds, real estate, commodities, artwork, etc., etc… No wonder the real economy isn’t recovering!

So, just in case a central banker or high government official cares, let me say this as clearly as possible… We cannot print and deficit spend ourselves to prosperity. So why would anyone think that zero percent interest rates, government monetization of debt, “too big to fail” bailouts, and government stimulus might work this time? I do not know when the current rally will collapse. It may continue for weeks or months to come. Heck, maybe it could continue longer! It will, however, end in tears just as the last one and the one before that ended, because it is not based on a healthy, wealth-producing economy, but rather a game of financial Jenga that grows ever taller even while the building blocks are disappearing from the foundation.

Update 8/25: It's official... President Obama does not blame central bankers for the current financial crisis. Otherwise, why else would he nominate Ben Bernanke, one of the main architects of easy money since 2002, for a second term as Chairman of the Federal Reserve? It's the safe move politically for the President today, but I guess we'll just have to see how it plays out...

Saturday, August 22, 2009

Cash For the Credit-Worthy

By Sam Ro - Cash for clunkers will not generate major incremental sales for automakers like Ford (F). Some of the 489,000 cars sold under the program were made by consumers who were already in the market to upgrade their vehicles. Some represent future sales that have been pulled forward. This sentiment is shared by J.D. Power and Associates, who recently boosted their 2009 auto sales forecast by 300,000 units, but cut their 2010 forecast by 100,000 units. This reflects a net gain of 200,000 over a two year period, during which 21.8 million cars are expected to be sold.

However, on a per dollar basis, cash for clunkers will be more effective in stimulating the economy than the 2008 tax rebate checks. While much of the tax rebates went toward paying down debt, the clunker cash is more likely to go back into the economy through personal consumption.

Consider those who are participating in cash for clunkers. If Jane Smith qualified for a $4,500 rebate and purchased a $15,000 Toyota Corolla, she has to make a $10,500 financial outlay. This is not a small amount of money. She is likely to take out an auto loan, which is only available to the credit-worthy. Furthermore, if she were in a tight financial situation, she would probably stick with her clunker, which is in driveable condition.

Jane is a confident consumer who won’t save that $4,500. She will spend it on a big screen TV, a family vacation, or a fancy dinner--all good for the economy right now.

This isn’t the only government program that rewards credit-worthy consumers who are likely to spend before saving. There’s also the $8,000 first-time homebuyer tax credit. The Wall Street Journal recently reported on a pending cash for appliance program. Again, this program will not provide a major long-run incremental sales boost to Whirlpool (WHR) and Electrolux (ELUXY). It just puts extra cash in the pockets of the customer, who can spend it on something else.

Obviously, I’m not happy that my tax dollars are going to people who don’t need it. But when it comes to economic stimulus, I prefer programs that reward the credit-worthy and encourage them to spend over programs that bailout the debt-laden.

Friday, August 14, 2009

It Ain't Over 'til It's Over

By Vahan Janjigian - A growing number of economists apparently believe the recession is over. According to the Wall Street Journal, 27 of 47 economists surveyed say the recession, which began in December 2007, has already ended. Another 11 economists say the recession will end by September.

Well, Thursday's retail sales figures threw some cold water on that idea. At the very least, if the recession has ended, the retail sales numbers suggest a double-dip is in the works.

The consensus expectation was for a 0.8% rise in retail sales in July. Turns out, however, that sales fell 0.1%. They fell 0.6% if you take out autos sales, which got an artificial boost from the "cash for clunkers" program. That program is merely bringing future sales forward. It is not going to create a long-lasting increase in auto sales.

Of course, some retailers are doing better than others. Wal-Mart (WMT), where it seems most of America now shops, is doing better than others. Yet even Wal-Mart is struggling with second-quarter U.S. sales falling 1.2%.

High-end retailers that are trying to hold the line on pricing are really getting hammered. For example, Abercrombie & Fitch (ANF) reported a 30% drop in same-store sales for the second quarter. Some of its competitors are doing better, but only because they are willing to discount their merchandise.

U.S. GDP is heavily dependent on consumer spending. Just as stock prices are often pressured by investor sentiment, consumer spending is strongly influenced by psychology. Some economists and government officials seem to think that consumers will believe the recession is over if we just tell them its over. Then they will start spending again and the recession really will be over. In other words, we will have a self-fulfilling prophecy. However, at this point, declaring the recession over is simply premature.

Friday, August 07, 2009

Employment Report Is Less Bad, But It's Not Rosy

By Vahan Janjigian - This morning's better-than-expected labor report was welcome news. Although non-farm payrolls continue to fall, job losses of 247,000 were better than expected. July marks the fourth month in a row that payrolls have fallen by less than 600,000. The employment picture is still ugly, but at least it's moving in the right direction.

Yet the strength of the recent rally in stocks already prices in a big improvement in the economy. While today's labor report is encouraging, it only provides further evidence that things are not getting better; they are simply getting worse at a slower rate.

According to the labor report, there are now 796,000 discouraged workers in the economy. These are people who have simply given up looking for work because they believe no work is available for them. That's more than twice as many as a year ago. This partly explains why the official unemployment rate fell from 9.5% in June to 9.4% in July. When people lose hope and stop looking for work, they are no longer counted as unemployed.

Wednesday, August 05, 2009

Do Blue Dogs Democrats Drink Beer?



The following commentary is from the August issue of the Forbes Growth Investor, which was released to subscribers on August 3.

By Vahan Janjigian - Is the recession over? With Q2 GDP falling just 1%, many economists are asking themselves this question. There is a general sense that the economy hit bottom during the second quarter and is already on the mend. While some corporations have been reporting better-than-expected results, the evidence for an economic recovery is not entirely convincing.

Corporations that beat their earnings estimates did so largely because of cost cuts, not because of higher revenues. In fact, in many cases the year-over-year revenue declines were simply frightening. While some CEOs claim to see signs of stabilization in their markets, almost no one is saying that things are getting better.

The decline in GDP was better than expected, but only because net exports and government spending contributed 1.38 and 1.12 percentage points, respectively, to growth. Ordinarily, a contribution to growth from net exports would be good news. However, exports did not rise in the second quarter. They fell. Net exports rose only because imports fell even more. This slowing of international trade is due to the weakening dollar as well as to consumers saving a greater share of their income. In fact, personal consumption expenditures, the largest component of GDP, fell 1.2% as the personal savings rate surged to 5.2%. As for government spending, there is no comfort in the fact that its role in the economy is growing. Even so-called Blue Dog Democrats are beginning to ask if this makes sense.

Measured in 2005 dollars, second quarter seasonally adjusted real GDP was $12.892 trillion, down almost 4% from its peak exactly a year ago. You have to go back almost four years to find a lower figure. If economic growth hits the top end of projections made by Federal Reserve economists, it will take well over a year to get back to where we were one year ago. Ironically, while those Fed economists have become slightly more bullish about growth, they have become considerably more bearish about employment. They now expect the unemployment rate to peak at 9.8-10.1% this year, an estimate that could easily prove conservative. Even by 2011, they don’t see it dipping below 8.4%.

Although rising unemployment puts a housing recovery at risk, the housing market may have already bottomed. Both existing and new home sales have climbed three months in a row and inventories have fallen. More importantly, prices are beginning to firm. The S&P/Case-Shiller Home Price indexes posted month-over-month gains for the first time since mid-2006. Because the most recent figures are for May, there is real hope that things are even better now than the data suggest.

The bulls got what they were looking for—evidence that the worst is over. They reacted by pushing stock prices to their highest levels since last October. I doubt the euphoria can last. Corporations can’t produce earnings by cutting costs forever. Eventually, they will need revenue growth. With consumers still cutting back on their purchases, the 46% rally in the S&P 500 from its March 9 low seems premature. Stocks are already pricing in a strong economic recovery. Evidence contradicting this thesis will likely cause a significant sell-off.

Monday, August 03, 2009

Cash for Clunkers Makes No Sense

By Vahan Janjigian - Although I hate taxes, I like the fact that taxes affect behavior. In general, if you want less of something, tax it. If you want more, provide a tax subsidy.

Americans used to smoke a whole lot of cigarettes. Today, they smoke less than they used to. No doubt, some gave it up for health reasons. Others, however, decided it costs too much. We have taxed the hell out of tobacco products and we got less smoking as a result. That's good news for health, but bad news for politicians who thought higher taxes would create more revenue.

On the other hand, many of our politicians decided long ago that home ownership was a good thing. They wanted to encourage people to buy more homes. So they decided to allow home buyers to deduct the interest payments on their mortgage payments. Those who don't own homes are subsidizing those who do. Things worked as planned and we got more ownership as a result--maybe more than was optimal.

Now our politicians want us to buy cars. So they came up with the "cash for clunkers" idea. Trade in your old car for a new one now and the government (read taxpayers) will pay a good part of the cost. So today's car sales figures should be no surprise. Stocks like Ford took a big jump.

Unfortunately, the sales jump will not last. All we are doing with this program is bringing future sales forward. The more cars we buy now, the fewer cars we will buy later. Auto stocks that surged today will likely give up at least some of their gains tomorrow.

Friday, July 24, 2009

The Emperor's New 787 Dreamliner

By Sam Ro - Boeing’s 787 Dreamliner was originally scheduled to fly in September 2007. Just a few days before the maiden flight, management announced what would be the beginning of a 2+ year delay. That’s long even by airline standards. In its five or six announcements—it’s hard to keep count—management blamed everything from a shortage of fasteners to incomplete software to a labor strike.

The latest delay was announced on June 23, 2009. Management said, “first flight of the 787 Dreamliner will be postponed due to a need to reinforce an area within the side-of-body section of the aircraft.” I’m not an aerospace engineer, so I won’t say how I really feel about that. Regarding first flight and aircraft deliveries, they said, “It will be several weeks before the new schedule is available.”

Several weeks later on July 22, 2009, Boeing announced their Q2 financial results. Regarding the 787, they said “The company expects to complete its assessment of the schedule and financial implications during the third quarter.” Not only have they delayed first flight, they have also delayed the new schedule for first flight. They also added that they recently completed “low-speed taxi tests on the first flight test aircraft.” I guess you learn to walk before you run…or fly. Again, I’m not an aerospace engineer.

At this point, I have lost confidence in management and I am only 99% sure that the Dreamliner will eventually get off the ground. While I think it would be risky to bet against BA stock at current levels, I would not recommend you buy it either. If that 1% disaster comes true, shares will take a Black Swan-style swan dive

Another Reason Why a Buy/Hold Strategy is the Way to Go, Part 2

By Taesik Yoon – In a post last Friday I wrote about a white paper written by Sal L. Arnuk and Joseph Saluzzi of Themis Trading LLC that discussed specific trading strategies designed at “exploiting new market dynamics” and how this has negatively affected real investors.

My coworker Sam (another contributor here) sent me a link to a front page article on today’s New York Times titled Stock Traders Find Speed Pays, in Milliseconds.

Click HERE for a link to the article.

The article essentially deals with the same topic--how traders are able to profit from high-frequency/high speed trading due to incentives, loopholes, and speed advantage in order placement. However, it’s more reader friendly. It also provides a very detailed real world example of how such a trading strategy led to higher prices being paid by regular (i.e. slower) investors for shares of Broadcom, a semiconductor company, on July 15.

As I noted in my prior post, the best way to minimize the impact of such strategies is to follow a simple BUY/HOLD strategy. Even in the example presented in the article, the exploitation in Broadcom’s stock price was within the range of $26.20 and $26.40 per share. For portfolio managers attempting to get the best execution for large blocks of share purchases, this probably will lead to inflated prices paid. But for an investor willing to hold long-term, paying $26.20 or $26.40 doesn’t make much of a difference if you expect the stock to be at $40 in a couple of years.

Of course, no one wants to pay more than they have to. Nor should they. But until these practices are curbed, the risk that you may pay higher prices on stock purchases does exist. Let’s just hope that these strategies don’t result in the persistence of (or worse yet, growth in) artificially inflated stock prices over longer periods. The last thing we need is the development of another bubble.

Thursday, July 23, 2009

What? No Green Shoots?

By Jeff Diamond - On Tuesday, in response to Rep. Bachus' question on the poor condition of the commercial real estate market, Fed Chair Ben Bernanke said, "As the recession’s gotten worse in the last six months or so, we’re seeing increased vacancy, declining rents, falling prices -- and so, more pressure on commercial real estate."

Let's recap... In a moment of unscripted candor, Ben Bernanke said that the recession has worsened over the last six months! Despite all his spin about green shoots and stabilization, he very matter of factly stated that things are continuing to worsen. He went on to say that our government is considering measures to help out commercial real estate in the future. Is there any sector of the U.S. economy that will be allowed to correct? Does everything pose a systemic risk? I continue to be amazed at what lengths the Fed and the Treasury will go to prevent markets from imposing discipline or penalties on poor risk decisions.

If you listen carefully, however, you can occasionally glean the truth even from Bernanke... The economy is still worsening. It's a matter of fact. No one questioned Bernanke's description, since we all know it's true. Green shoots are a lie, a very convenient lie, but a lie that our government considers necessary. They need to provide the rationale for more ill-considered risk-taking among investors. That's the only hope they've got to whip this recession that has "worsened over the last six months."

Tuesday, July 21, 2009

Exit Strategy?

By Jeff Diamond - The Fed's exit strategy to its unprecedented monetary easing and money printing depend on the economy and our financial markets returning to normal. A happily expanding GDP, a receding of the credit crisis, a reduction in the massive levels of debt in both the public and private sectors, and several other dream-like occurrences. Now, let's consider the likelihood of that versus the likelihood of another crisis developing... Which do you think will happen first?

My personal prediction is for fireworks (i.e. severe selloff) to occur in either the Treasury market or the U.S. dollar. I will not recap the horrendous fundamentals that make this a possibility, since they are so widely described elsewhere...

So, I predict that the best laid exit strategies for the Fed will not come to be. Just as they were forced to take extraordinary actions to prevent a meltdown of the financial system, they will have to respond to a market spike in interest rates and/or a freefall in the U.S. dollar. That will preempt their plans for an orderly return to "normal."

We can listen to Ben Bernanke wax poetic today and tomorrow in front of his Congressional audience, but I think it's a waste of time. Whatever plans he outlines today will not come to pass in the manner that he is going to describe...

Friday, July 17, 2009

Another Reason Why a Buy/Hold Strategy is the Way to Go

By Taesik Yoon - A friend at work gave me a white paper written by Sal L. Arnuk and Joseph Saluzzi from Themis Trading LLC, an independent brokerage firm, titled Toxic Equity Trading Order Flow on Wall Street.

I had seen Mr. Saluzzi a few times before on Bloomberg TV speaking about the overvaluation of the equity markets and the rampant manipulation of stock prices by program trading. The paper expands on the latter by outlining the specific “toxic” trading strategies traders employ by “exploiting new market dynamics” and how this has negatively affected real investors.

Click HERE for a link to the PDF.

The strategies outlined and examples given provide a very good understanding of how these market exploitations work. And unlike so many other critical articles I’ve read in the past, the authors provide two clear recommendations as to what can be done (from regulatory standpoint) to stem these types of trading practices.

I agree that these practices occur. They highlight the fact that some financial institutions will do anything to make a profit—even at the expense of their own clients. And I’ll admit that while generating profits by inducing false price movements is not a new concept, being able to profit by simply buying the right to place your server in the NYSE or NASDAQ server room certainly is. (Though in this age of ever evolving technology I really should know better.)

As for the impact on the individual investor, it probably does result in some investors paying a slightly inflated price on their stock trading transactions. But over the longer-run, what are a few pennies?

If anything, this is just another reason why following a BUY/HOLD strategy is the way to go. I’ve long been a proponent of this simple investing method. If my analysis concludes that a particular stock is worth $30.00 per share in two years, then does it really matter whether I buy it at $20.01 or $20.03 today?

Of course, if these strategies somehow result in the artificial inflation in equity values over longer periods then it could jeopardize any investing strategy, including BUY/HOLD. But as someone who has seen this strategy work time and time again during his ten years of buying and selling stocks, I’ll take my chances.

S&P 500's Stealth Earnings Growth

By Sam Ro - How could analysts expect S&P 500 earnings to grow from $49 in 2008 to $55 in 2009 and to $74 in 2010? One explanation is turnover on the index.

Let's consider the impact of General Motors. According to data compiled by S&P's Howard Silverblatt on June 2, the S&P 500's consumer discretionary sector earnings were expected to fall 75.6% year-over-year in Q2. This was due to the massive loss estimated for GM. But now that GM has been removed from the S&P 500, Q2 consumer discretionary earnings are expected to jump 36.6% year-over-year. It's clear how changing a constituent can have a material impact on the index's earnings estimates and valuations.

And GM isn't the only money loser that got booted from the index in the last year or so. Lehman Brothers, Freddie Mac, and Fannie Mae bled money for the S&P 500 in 2008, but they're not in the index today. This could at least partially explain the expectation for 300% year-over-year earnings growth in the S&P 500's financials sector in Q2.

Thursday, July 16, 2009

Stocks Will Give up Their Recent Gains

By Vahan Janjigian - What should we make of the 7% rally in the major market indexes over the past four days? In my opinion, not much. Stocks will likely give up those gains, and possibly more, in short order.

On the plus side, we saw an upbeat report from Intel. And today, the market rallied on news that Nouriel Roubini, one of the biggest bears on or off Wall Street, thinks the worse is over. But don't get your hopes up. Turns out Dell, one of Intel's biggest customers accounting for 18% of Intel's net revenue in 2008, is not so optimistic. As for Roubini, he quickly refuted comments attributed to him saying they were taken out of context. He hasn't changed his outlook at all.

Google's earnings announcement, which came after the market closed, was much better than expected. However, the sell-off in the stock in after hours trading is a clear indication that this market has rallied too far too fast.

IBM Has Got a Magic Potion

By Jeff Diamond - IBM beat estimates! What a surprise... Not! I haven't been counting, but Bloomberg just announced that this was the 17th quarter in a row that IBM has "surprised" to the upside! Sweet! I wonder how they surprised this time? Did they cut their pension contribution again? Maybe a few acquisitions or a lowered tax rate? Oh, or maybe a favorable FX conversion? IBM has got more tricks up its sleeve than a Las Vegas magician.

Nothing much has changed on Wall Street. Enjoy the rally while it lasts, but as we have seen in the past these games have mostly lead to tears, and no one ever sees it coming!

July 17th UPDATE - So, riddle me this: How does earnings-per-share at IBM rise 18 percent year-over-year while revenues fall 13 percent during the same period??? I don't know the answer, but with the stock closing up over 4 percent on the day the market doesn't seem to mind. Clearly, IBM does possess a very powerful potion!

What Comes to Mind

By Jeff Diamond - All I can think when watching the Paulson hearing is that so much of this mess would have been self-correcting if our government had not bailed out all the bad players. AIG and some banks would have failed. Our government could have used that $700 billion TARP money to bail out the non-risk seeking depositors and policy holders. The surviving banks (and investment banks) would have gotten religion and reeled in excessive behavior while having had a less competitive playing field in front of them for the future. Boards of directors at all sorts of public companies would have become more activist to protect shareholders, and many CEO's would have been replaced by the boards (rather than all this questioning of the former Treasury Sec'y as to why the government didn't replace more CEO's.)

As it stands our government is doing everything within its power to maintain the status quo and put back the "broken" system that allowed this crisis to develop in the first place. Capitalism has been circumvented, and many of the correction mechanisms within a capitalist system have not been allowed to work.

In my opinion, our system is still sick. We are not well positioned for more than a temporary recovery. The cancer is still there. The government has essentially covered up the symptoms but not done anything to cure the patient. In fact, it is standing in its way of healing.

Tuesday, July 14, 2009

Higher Tax Rates Do Not Result in Higher Tax Revenues

By Vahan Janjigian - It is absolutely mind boggling how people continue to confuse higher tax rates with higher tax revenues. Numerous pundits continue to argue that we need to raise tax rates to fund the growing budget deficit. But raising tax rates is one sure way of making sure the budget deficit grows even larger.

There are only two ways to shrink a deficit: 1) Spend less money. 2) Generate more revenue. Spending less money is a great idea, but given all the promises the government has made to various constituents, this is not likely to happen in the near future. Therefore, we must raise more revenue, but that will not happen by raising tax rates.

Higher tax rates are a recipe for reduced employment and slower economic growth (or a more severe recession). Time and time again, we have seen how tax rate cuts have spurred employment, economic growth, and tax revenues. Budget deficits during such lower tax rate/higher tax revenue eras are the result of uncontrolled spending, not the result of less revenue.

Politicians should be clear and honest. Tell us we need more tax revenue, not higher tax rates. Then lower tax rates to make sure we get the revenue we need.

Monday, July 13, 2009

Morgan Stanley and the Future of Research

By Sam Ro - The Financial Times recently reported Morgan Stanley tapped a 15 year old summer intern for some insight into "How Teenagers Consume Media." The introduction reads, "Without claiming representation or statistical accuracy, his piece provides one of the clearest and most thought provoking insights we have seen."

So, as the requirement to provide independent third party research expires in the next few weeks (Global Research Analyst Settlement), is this a preview of research to come? It's cheap (Hello, cost savings!), it has no statistical basis (Nassim Taleb would be proud), and it's independent (How corrupt could a teenager be?).

Of course, I don't really expect research departments to be taken over by high school kids. However, I do expect to see an increasing use of unconventional research. Surely, statistical study will reveal that conventional research has made you very little, if any, money in recent years.

Friday, July 10, 2009

Enough Already!

By Jeff Diamond - I’m getting tired of Tim Geithner, Ben Bernanke, Barney Frank, Larry Summers, and President Obama making false promises about what our government can accomplish with all of this intervention. The intervention spans markets, private enterprise, government, and even the judicial system (as they make end runs around bankruptcy law and contract law, etc.)

When in the world are they going to admit that we’ve got problems that the government can’t fix? When are they going to allow some of the “too big to fail” institutions to fail? You know it’s coming. They know it’s coming (or at least they should!) Bad risk-takers should fail. That’s the way capitalism works, and if you intervene on the downside, then don’t expect capitalism to work to the upside either. Sure, we might get bouts of improved economic activity, but don’t expect a lasting recovery. Just look at Japan. We are looking a lot more like them all the time. They started intervening back in the early 1990’s and look how far that has gotten them.

Bubbles form when capital is misallocated, and they burst when that misallocation leads to unsustainable price levels. Admittedly, the bursting is no fun. It’s damn painful. So, I understand the desire and willingness of politicians to step in to alleviate the pain (and I have no doubt that we would be in the same position if George W. Bush were still President and Henry Paulson in the Treasury.) The problem is by not allowing the markets and the economy to “clear,” our government just delays the day of reckoning.

The topic of stimulus package II keeps resurfacing since there is general dissatisfaction with the continuing malaise. Now, I guess I should distinguish between bailouts and stimulus. I am vaguely sympathetic to a well-structured stimulus plan. The problem is that the stimulus money isn’t getting spent on stimulus. The biggest share of Stimulus Package I was given to the states who are using it to support their bloated and unsupportable state budgets. Revenues have fallen off a cliff in most states around the country and they aren’t going to bounce back big enough and quick enough to avoid painful cutbacks. Just look at California, even with the stimulus money from the federal government they can’t make ends meet! Federal, state, and local governments are attempting to provide too many services and benefits that they cannot (and never could) afford.

So, when is the greatest capitalist society in the history of the world ever going to allow capitalism to work? The first step is allowing the bad actors to fail and suffer their due (and that includes the states.) Yes, asset prices will fall and people will lose more jobs, but it will happen anyway. Just pick your timeframe… One or two years of pain? Or, one or two decades? If you picked the latter, then I hope you are prepared for all sorts of unintended consequences. We are already seeing the bad actors that the government has propped up undercut their competition who didn’t need a bailout. The explosion in government debt is going to lead to something bad. I’d guess higher interest rates and a weak currency, but who knows? And who knows what the unintended consequences of the unintended consequences will be, but in general, I’d guess that they won’t be pleasant.

So, this grand experiment in government intervention needs to grind to a halt. Let’s take our medicine and get on with it! The average American isn’t getting much out of all this anyway. I can see how the “too big to fail” crowd with all of its lobbying money is getting something, but it’s hardly trickling down. In fact, banks are rushing to cut credit lines, raise minimum payments and interest rates even on its customers in good standing. If the government wants to offer incentives for investment so that money flows rather than being hoarded, then maybe you can convince me, but enough of the money printing and exploding debt. That’s going to lead to nothing but trouble.

Wednesday, July 08, 2009

The Madoff Affair on PBS

By Vahan Janjigian - Last night I took time to watch The Madoff Affair, a video production by Frontline that aired on PBS not too long ago. The entire investment industry has been following events related to the world's largest stock fraud ever since news of it first broke in December 2008.

The Frontline production does an excellent job of covering Bernie Madoff's career from the time he graduated from Hofstra University in 1960 to his conviction. His fraud began soon after he married his high school sweetheart and took an office in her father's accounting firm. Madoff first started a market-making operation, which he grew by paying for order flow.

However, he also started an investment advisory business without registering with the SEC. He did what he knew how to do very well: He paid for investments. In fact, he paid big bucks to so-called feeder funds to send him their clients' money. Amazingly, these feeders did virtually no due diligence on Madoff.

As all Ponzi schemes are prone to do, Madoff's fraud blew up when the long bull run in equities ended and stocks started falling fast. His clients started asking for their money back; not because they were unhappy with his performance, but because they needed their money to cover loses in their other investments. Of course, what they didn't realize at the time was that their money was gone and Madoff's outstanding performance was nothing but fiction.

One of the most tragic events of the Madoff fraud was the suicide of Thierry Magon de la Villehuchet. He was a money manager from France who had invested everything with Madoff. He killed himself shortly after Madoff's fraud became public. Frontline interviews Villehuchet's brother who calls the suicide honorable.

I urge you to watch the video if you would like a more complete understanding of how Madoff earned the trust of investors and got away with his fraud for so long.

Tuesday, July 07, 2009

The Blame Game

By Taesik Yoon - One of the things that has bothered me most in the aftermath of the financial mess that we are still digging ourselves out of is the blame game that so many seem to be playing. Sure, there is plenty of blame to go around and plenty of participants to share in that blame. However, to wholly place blame on any single one of these players is both narrow minded and a sorry attempt to absolve others of their share of responsibility.

The latest ire of these finger pointers comes in the form of a recent, now widely-circulated, article written in the latest issue of Rolling Stone magazine by contributing editor Matt Taibbi.

Here’s a link to the article: The Great American Bubble Machine

In it the author trashes Goldman Sachs. He blames the financial institution and the reach of its not-so-invisible hand (through company alums that have managed to infiltrate key positions in our government) for engineering “every major market manipulation since the Great Depression.”

In reality, the article focuses more on the present decade—specifically on how Goldman’s “unprecedented reach and power have enabled it to turn all of America into a giant pump-and-dump scam” beginning with the tech/dotcom bubble, moving on to the housing bubble, then the bubble in commodity prices. It even highlights how Goldman rigged the federal bailout.

My problem with the article has little to do with the facts presented. Generally, I found it to be well-researched. The specific examples of how Goldman profited from these bubbles both legally and illegally were compelling and enlightening.

But Mr. Taibbi was not above distorting the truth to make a stronger argument for his thesis. For example, he notes that Goldman converted from an investment bank to a bank holding company specifically so it could participate in the taxpayer-backed TARP funding. The author is right that Goldman received $10 billion in TARP funds. However, what he conveniently omits is the fact that Goldman never wanted (or likely even needed) these funds. It has also been among the most vocal at wanting to pay the funds back as soon as possible. In mid-June, it did just that, repurchasing $10 billion in preferred shares from the government, as well as paying an additional $425 million in dividends, which is expected to reduce second quarter earnings by 77 cents.

In other words, Goldman not only gave back the taxpayer money it borrowed less than three quarters after borrowing it, it also paid an additional $425 million to taxpayers. If the company was as brazen as the article suggests or if the money provided was, as he states, “…10 billion free dollars in a paper bag to buy lunch,” then why pay it back so soon or at all?

What makes this particular omission so egregious is the fact that a key reason why Goldman wanted to payback TARP funds so quickly was because of all the restrictions on compensation set forth in it. This, in fact, is completely consistent with Mr. Taibbi’s argument that Goldman is all about greed and paying fat bonuses. The only reason I can see for leaving this out is because it would invalidate his more important argument that the funds were provided to Goldman by its chummy government buddies without impunity. This sort of data mining is dangerous. It serves the exact same purpose he claims Goldman is guilty of: duping the uninformed.

And speaking of the general public, Taibbi does not note their participation in this mess. I, on the other hand, am not as kind. In the end, it all comes down to supply and demand. For example, with regard to the housing bubble, he notes how Goldman’s influence helped lead to a regulatory environment which allowed the CDO market to explode. But that only represents the supply side. You still need mortgage demand to drive the CDO market. This demand is driven by consumers. If we would have been more disciplined there would have been no pool of sub-prime loans to package together as CDOs. Whether or not financial institutions or government agencies helped perpetuate an environment of easy credit and mortgage lending practices, it was ultimately up to the consumer to decide to take that credit or leave it.

This is not to shift the blame entirely on individuals, but rather to highlight just how easy it would be to do so. Nor am I trying to absolve Goldman of wrong doing. There is no denying the company profited immensely from each one of the bubbles Mr. Taibbi lists at the expense of the American public. Additionally, there is no way to defend some of the unscrupulous tactics Goldman used to generate profits during these bubbles.

But Goldman certainty was not the only one to employ such tactics. Indeed, investment banks are like drug dealers. Only instead of selling crack or heroin, they sell a much more potent intoxicant—the promise of wealth and quick riches—all while doing their best to mask the risk inherent. And I would agree that Goldman was probably the biggest dealer on the street. But there is no doubt in my mind that if you could not buy from it, there would plenty of others more than willing to take your money. In other words, these bubbles would have occurred with or without Goldman’s involvement. The problem for Goldman was that it was among the last dealers standing after the raid and that makes it an easy target.

Mr. Taibbi ends by stating, “This is the world we live in now. And in this world, some of us have to play by the rules, while others get a note from the principal excusing them from homework until the end of time… It’s gangster state, running on gangster economics… And maybe we can’t stop it, but we should at least know where it’s going.”

This to me is the ultimate cop-out. It essentially boils down to saying here’s the problem. Unfortunately, I can provide no solutions—not even one; the reality of the situation is that there is not much we can do about it.

Well, I’ve got one solution for him and anyone else who shares his view: buy Goldman Sachs’ stock. After all, if Mr. Taibbi is correct in his assessment, then Goldman’s stock is what we in the industry refer to as an arbitrage (risk-free) opportunity. By his account, Goldman already owns all the air it needs to inflate the cap-n-trade bubble he is so certain will be the next to take place. Therefore, Goldman should be the biggest beneficiary. As an owner of Goldman shares, so should you.

Monday, July 06, 2009

July 1 Commentary From FGI


The following commentary appeared in the July issue of the Forbes Growth Investor, which was made available to subscribers on July 1.

By Vahan Janjigian - June was a bad month for celebrities. Ed McMahon, Farrah Fawcett, Michael Jackson, and Billy Mays all passed away. June was also a bad month for Federal Reserve Chairman Ben Bernanke; although he presumably is still in good health.

I have blamed the Fed in the past for many of the bubbles our economy experienced in recent years. Its easy monetary policy caused the technology bubble of the late 1990s, the housing bubble that peaked in 2006, and the commodities bubble that followed shortly thereafter. Nonetheless, I would also argue that Ben Bernanke has done an admirable job of responding to the financial crisis that began shortly after he took over as Fed chairman. Under Bernanke’s leadership, the Fed responded quickly and decisively by slashing interest rates and increasing the money supply. While these actions increase the risk of inflation and threaten to erode further the value of the U.S. dollar, I believe they were necessary to restore confidence and prevent a total collapse of the financial system.

However, Bernanke now finds himself in political hot water. Congress recently grilled him amid allegations that he coerced Bank of America CEO Ken Lewis to consummate the Merrill Lynch acquisition against his better judgment. Bernanke even stands accused of urging Lewis not to disclose the poor state of Merrill’s health to his shareholders. Democrats and Republicans attacked him with equal ferocity.

As I explain on my blog, I believe Bernanke’s days as Fed chairman are numbered. President Barack Obama appears reluctant to give him a strong endorsement. Obama recently said Bernanke is doing a “fine” job. When questioned during a press conference, he refused to say if he would reappoint Bernanke as chairman. Soon after Bernanke’s grilling in Congress, the White House issued a tepid statement saying it had “confidence” in Bernanke. As the nearby cartoon illustrates, when praise from your boss is this impassive, it’s time to shop your resume. Besides, I believe Larry Summers is hungry for Bernanke’s job and I believe Obama would like to give it to him.

As for the economy, I still see no evidence that things are getting better. At best, they are still getting worse, but at a slower pace. According to the S&P/Case-Shiller Index, housing prices fell 18% year-over-year in April. The good news, if you can call it that, is that prices are no longer falling at an accelerating rate on a nationwide basis. Unfortunately, price declines are accelerating in some key markets, which until recently had been holding up well. These include Charlotte and New York.

In addition, according to the Conference Board, after three consecutive monthly gains, the Consumer Confidence Index fell more than five points in May. Consumers became more pessimistic about their present situation. They also grew more wary about their near-term outlook for jobs and income. This is not what hard-hit retailers were hoping to hear.

Overall, I continue to believe there is a significant risk for a near-term sell-off in equities. Keep some cash on hand to take advantage of the sell-off when it occurs.

Sunday, July 05, 2009

Preview of Q2 Earnings Season

By Sam Ro - Based on my reading of Q1 earnings announcements, I think corporate managers may have been a little too optimistic in their expectations for economic recovery. Below is some language I expect to hear during the Q2 earnings announcement season.

(Company XYZ) Reports Second Quarter Results
Q2 net revenue was weaker than we had initially anticipated. April and May were inline with our projections. However, demand fell significantly in June. Year-over-year comparisons were particularly challenging due to last year’s stimulus checks. Top line weakness was partially offset by favorable currency movements since the beginning of the year (i.e. the weaker dollar).

Net income was in the low end of our previous guidance due to weak volume. However, the operating profit margin benefited from cost saving restructuring initiatives, which included idling factories and laying off employees. Thanks to significant reductions in capital expenditures, the company had significant free cash flows which were used to repurchase shares. Adjusted for restructuring charges, earnings per share was in the high end of our guidance.

“Our company has performed well in this challenging macroeconomic situation,” said the CEO. “We continue to take actions to right-size our operations in response to the evolving demand environment. We believe we will be in a stronger competitive position when the recession ends.”

“Because economic conditions continue to deteriorate, we believed it was prudent to revise downward our full year earnings guidance range. We continue to see further deterioration in consumer confidence due to weak employment conditions and higher-than-expected gasoline prices. Raw material and energy costs are higher than we had initially budgeted, which is pressuring our gross profit margins. Projected weakness should be partially offset by the benefits of a weaker dollar.”

We look forward to speaking to you again in three months.