Stocks are selling off as the yield on the 10-year note climbs. At last look, it's standing at 5.26%. Just a couple of months ago, it was down around 4.5%. My expectation that interest rates would rise was one reason I cited for my bearishness on stocks in the June 18 issue of Forbes magazine.
Many economists have been betting that the Fed would cut short-term interest rates. I've been saying that what the Fed does is largely irrelevant. The yield on the 10-year note is much more important. I believe the Fed was hoping that the 10-year yield would rise so it would not have to raise short-term rates anymore. Now that it has, the Fed can breathe more easily.
The Fed's next opportunity to change rates comes on June 28. Now that the yield curve is cooperating with its wishes, my guess is that the Fed will take no action. The higher 10-year yield will keep a lid on inflation by keeping the economy from overheating. The bigger risk right now is too much of an economic slowdown.
Tuesday, June 12, 2007
Wednesday, June 06, 2007
Here Comes the Bear
The June 18 issue of Forbes magazine contains my column explaining why I am bearish on stocks. Although Google is one stock I panned, it just keeps going up. I firmly believe that the growth rate assumptions built into Google's valuation are unsustainable. After all, if Google's growth doesn't slow, it will eventually own all the assets in the world. When a high growth firm realizes that growth is slowing, it often starts acquiring other high growth companies. That often ends in trouble. Google seems to be going down this path.
The two other stocks I panned, Starbucks and Whole Foods, are already showing signs of weakness. I've been bearish on Starbucks for a while--largely because of rising gasoline prices. I just don't see how anyone but the very rich can afford to buy $5 lattes on a daily basis.
The two other stocks I panned, Starbucks and Whole Foods, are already showing signs of weakness. I've been bearish on Starbucks for a while--largely because of rising gasoline prices. I just don't see how anyone but the very rich can afford to buy $5 lattes on a daily basis.
Giving Thanks to the Military
I'm spending the week in Carlisle, PA at a National Security Seminar at the U.S. Army War College. Civilian guests such as myself have been put into small seminar groups that consist primarily of military officers from all the various branches. The groups also include a small number of officers from select foreign nations. We've been debating all kinds of issues from the war in Iraq to the economy. The experience has been absolutely outstanding. I would say that the most surprising--and pleasant--thing I have discovered is the tremendous degree of independent thought and diversity of opinion that exists in the military. While I have always held in high esteem those who serve our country through military service, my respect for them has grown tremendously. It is extremely comforting to know that our military ranks are filled with so many intelligent individuals. Knowing how much these people sacrifice for our country, I can't help but feel a little ashamed that I have never served in the same way.
Friday, June 01, 2007
All News is Good News
The market is in one of its euphoric phases where all news is good news. Gasoline prices set all-time highs and stocks rally. Oil prices go higher and stocks rally. The housing market shows signs of falling apart and stocks rally. GDP growth all but disappears and stocks rally. The yield on the 10-year note closes in on 5% and stocks rally.
In fact, other than a fairly robust jobs market, there really isn't a lot of good news out there. Yet investors keep pushing stock prices higher. As I explain in the new issue of the Forbes Growth Investor, demand for shares is strong thanks to private equity firms, M&A activity, and share buybacks. And in my column in the June 18 issue of Forbes magazine, I explain why I'm bearish on the market. I also pan some stocks that I think could get hurt when consumer spending slows.
In fact, other than a fairly robust jobs market, there really isn't a lot of good news out there. Yet investors keep pushing stock prices higher. As I explain in the new issue of the Forbes Growth Investor, demand for shares is strong thanks to private equity firms, M&A activity, and share buybacks. And in my column in the June 18 issue of Forbes magazine, I explain why I'm bearish on the market. I also pan some stocks that I think could get hurt when consumer spending slows.
Tuesday, May 22, 2007
Gasoline Above $3.20 Per Gallon
According to the AAA, the national average price for a gallon of gasoline broke through $3.20 per gallon. This is an all-time high even on an inflation-adjusted basis.
I have been interviewed on MSNBC at least a half dozen times in recent weeks about rising gasoline prices. I have to admit, I am surprised by the extent of this increase. I thought we might see about $3.10 or so, then slide back down. The fact that we're still going up tells me that drivers don't yet feel the pain. Demand for gasoline is actually rising despite the higher prices. Prices will keep rising until drivers start making adjustments. For example, if they are convinced that high prices are here to stay, they will consider buying more fuel-efficient cars. But as long they are willing to drive SUVs, and long as demand for gasoline goes up, that tells me prices are not too high.
What about supply? Some say refiners need to produce more gasoline. Perhaps they could have done a better job maintaining refineries and making the seasonal switch to summer blends, but they are not likely to invest in more capacity. If you were a refiner would you be keen to invest $2 billion or so and several years building a new refinery when you know you will have to battle regulators and environmentalists? Furthermore, you see that our government is promoting and subsidizing alternative fuels such as ethanol. After investing all that time and money to build a new refinery, you might find there is too much gasoline on the market and not enough demand. Before you know it, gasoline prices may go much lower and your investment will provide no payback.
In the short term, our best hope for more supply is imports. As a result, we will become dependent on foreign gasoline as well as foreign oil. The alternative is to get serious about cutting demand. The best way to do this is to put a high floor on gasoline prices. However, just about all politicians are looking to do the opposite. They want to find ways to decrease price rather than increase it.
Nonetheless, it looks like consumers will have to adjust to higher prices whether they like it or not. The long-predicted effect on consumer spending may finally materialize. Companies like Starbucks and Whole Foods that sell overpriced and unnecessary goods might find that growth will slow. These two stocks have already fallen well off their highs. Chances are they will go lower still.
I have been interviewed on MSNBC at least a half dozen times in recent weeks about rising gasoline prices. I have to admit, I am surprised by the extent of this increase. I thought we might see about $3.10 or so, then slide back down. The fact that we're still going up tells me that drivers don't yet feel the pain. Demand for gasoline is actually rising despite the higher prices. Prices will keep rising until drivers start making adjustments. For example, if they are convinced that high prices are here to stay, they will consider buying more fuel-efficient cars. But as long they are willing to drive SUVs, and long as demand for gasoline goes up, that tells me prices are not too high.
What about supply? Some say refiners need to produce more gasoline. Perhaps they could have done a better job maintaining refineries and making the seasonal switch to summer blends, but they are not likely to invest in more capacity. If you were a refiner would you be keen to invest $2 billion or so and several years building a new refinery when you know you will have to battle regulators and environmentalists? Furthermore, you see that our government is promoting and subsidizing alternative fuels such as ethanol. After investing all that time and money to build a new refinery, you might find there is too much gasoline on the market and not enough demand. Before you know it, gasoline prices may go much lower and your investment will provide no payback.
In the short term, our best hope for more supply is imports. As a result, we will become dependent on foreign gasoline as well as foreign oil. The alternative is to get serious about cutting demand. The best way to do this is to put a high floor on gasoline prices. However, just about all politicians are looking to do the opposite. They want to find ways to decrease price rather than increase it.
Nonetheless, it looks like consumers will have to adjust to higher prices whether they like it or not. The long-predicted effect on consumer spending may finally materialize. Companies like Starbucks and Whole Foods that sell overpriced and unnecessary goods might find that growth will slow. These two stocks have already fallen well off their highs. Chances are they will go lower still.
Monday, May 07, 2007
The Bearish Case
Last week on Kudlow & Co. on CNBC, I explained why I am bearish on the markets. It boils down to three things: 1) Slowing earnings growth, 2) Rising interest rates, and 3) Higher taxes.
There is no question that earnings are strong. Corporations have been doing great. Those that do a significant amount of business abroad have been doing particularly well. Some of this is due to strong foreign economies, but much of it is due to a weak U.S. dollar that keeps weakening on a regular basis. More importantly, however, corporate earnings growth is actually slowing. Furthermore, the growth in net earnings is significantly less than the growth in earnings per share. This is because of all the share buybacks going on. Corporations know investors focus on EPS. They also know they can easily boost EPS by buying back shares. I will interview S&P's Howard Silverblatt about earnings tomorrow. This MoneyMasters interview will be posted on Forbes.com on May 17.
Interest rates are a bit more interesting. I actually think there is a better chance the Fed will lower rates than raise them. But as we've learned in recent years, what the Fed does has little influence on the longer end of the yield curve. GDP growth has slowed considerably, and the most recent employment figures were disappointing. Results like these should make the Fed feel more comfortable about lowering interest rates. However, I continue to worry about rising energy prices. Gasoline prices are near an all-time record. Although I expect them to back off a little from this level, they certainly aren't going to plummet. Eventually they will feed inflation causing the yield on the 10-year note to rise. Furthermore, I also believe credit spreads will widen.
Finally, there are taxes. I often laugh when I hear liberals rail against the Bush tax cuts. I really haven't noticed any tax cuts. When you factor in my state and property taxes, and the fact that I can't deduct these on my federal form because of the AMT, my taxes have risen quite a bit. And now that the Democrats control Congress, it's pretty much a sure bet that taxes will not be going lower. Even if the Republicans manage to hold onto the White House, the best we can hope for is a veto of any tax increase. Don't hold your breath for a cut.
So why do stocks keep going up? Investor sentiment has a lot to do with it. That's really all that matters in the short run. Add to that hedge funds using lots of leverage, private equity firms buying public companies, the new merger wave, and all those share repurchases. The demand for stocks is greater than the supply. This may go on for a while, but it won't last over the long term.
There is no question that earnings are strong. Corporations have been doing great. Those that do a significant amount of business abroad have been doing particularly well. Some of this is due to strong foreign economies, but much of it is due to a weak U.S. dollar that keeps weakening on a regular basis. More importantly, however, corporate earnings growth is actually slowing. Furthermore, the growth in net earnings is significantly less than the growth in earnings per share. This is because of all the share buybacks going on. Corporations know investors focus on EPS. They also know they can easily boost EPS by buying back shares. I will interview S&P's Howard Silverblatt about earnings tomorrow. This MoneyMasters interview will be posted on Forbes.com on May 17.
Interest rates are a bit more interesting. I actually think there is a better chance the Fed will lower rates than raise them. But as we've learned in recent years, what the Fed does has little influence on the longer end of the yield curve. GDP growth has slowed considerably, and the most recent employment figures were disappointing. Results like these should make the Fed feel more comfortable about lowering interest rates. However, I continue to worry about rising energy prices. Gasoline prices are near an all-time record. Although I expect them to back off a little from this level, they certainly aren't going to plummet. Eventually they will feed inflation causing the yield on the 10-year note to rise. Furthermore, I also believe credit spreads will widen.
Finally, there are taxes. I often laugh when I hear liberals rail against the Bush tax cuts. I really haven't noticed any tax cuts. When you factor in my state and property taxes, and the fact that I can't deduct these on my federal form because of the AMT, my taxes have risen quite a bit. And now that the Democrats control Congress, it's pretty much a sure bet that taxes will not be going lower. Even if the Republicans manage to hold onto the White House, the best we can hope for is a veto of any tax increase. Don't hold your breath for a cut.
So why do stocks keep going up? Investor sentiment has a lot to do with it. That's really all that matters in the short run. Add to that hedge funds using lots of leverage, private equity firms buying public companies, the new merger wave, and all those share repurchases. The demand for stocks is greater than the supply. This may go on for a while, but it won't last over the long term.
Friday, April 27, 2007
Investment Newsletter Performance
Subscribers to my investment newsletters sometimes ask exactly how well our recommendations are doing. They don't have to take my word for it because our performance is regularly monitored by the Hulbert Financial Digest, which also tracks the performance of almost 200 other investment newsletters. According to Hulbert, the Forbes Special Situation Survey (SSS) returned 26.5% (excluding dividends) over the year ending March 31, making it the third-best performing investment newsletter during that period. In comparison, the Dow Jones Industrial Average gained just 11.2%. What’s more, if you compare us to newsletters that focus only on domestic equities like we do, we are actually No. 1.
Furthermore, SSS has been consistent over the long term. Ever since Hulbert began tracking us in January 2002, we have produced an annualized return of 14.6%. The annualized return on the Dow during the same time is only 4.1%. It is true that a handful of newsletters managed to beat us, but at least some of them relied on the use of margin, short selling, or derivatives. Their performance is not necessarily due to good stock picking. It can be explained at least in part by market timing and the use of leverage. In contrast, SSS does not assume that subscribers buy stocks on margin or employ other kinds of strategies. Our returns are solely the result of stock-picking ability.
The Forbes Growth Investor (FGI), which relies on a quantitative, momentum-based model also did well, significantly outperforming the market averages since Hulbert began tracking it. It has produced an annualized return of 9.0% since January 2002. Because this newsletter has a diversified recommended list of 50 stocks, it tends to be less volatile than SSS.
We credit these outstanding results to our disciplined screening process. Most importantly, for SSS, we rely on our proprietary discounted cash flow (DCF) model. We are sometimes told that our model is not realistic. This is absolutely true. Indeed, our model is overly conservative. For example, if we believe a company can realistically grow revenues by 10% each year, we might model only 5% growth. If we believe the operating profit margin is likely to be around 15%, we might model only 10%. We do this because we are not trying to determine what a stock is actually worth. Instead, we are trying to determine what it is worth at a minimum. In other words, our methodology is designed to find reasons not to recommend a stock. However, if despite all our conservative assumptions we derive a minimum intrinsic value that is greater than the stock’s market price, that stock becomes a candidate for recommendation.
It is interesting to note that Warren Buffett, perhaps the greatest investor of all time, also relies on a DCF methodology to determine a company’s intrinsic value. He points out, however, that two analysts using this methodology will rarely derive the same intrinsic value. This is because DCF analysis is as much art as it is science. It is prone to error because it requires making assumptions about the future. It is precisely for this reason that we try to make our assumptions as conservative as possible.
DCF analysis does not always work. For example, during the dotcom boom of the late 1990s stocks that DCF analysis flagged as overvalued continued to go up. This was because of overly optimistic investor sentiment. Barring such unusual periods, we believe a conservative DCF approach is the best way to pick undervalued stocks over the long term.
For FGI, we rely on a proprietary quantitative model. This product is more short-term oriented and puts a lot of weight on price and earnings momentum.
Furthermore, SSS has been consistent over the long term. Ever since Hulbert began tracking us in January 2002, we have produced an annualized return of 14.6%. The annualized return on the Dow during the same time is only 4.1%. It is true that a handful of newsletters managed to beat us, but at least some of them relied on the use of margin, short selling, or derivatives. Their performance is not necessarily due to good stock picking. It can be explained at least in part by market timing and the use of leverage. In contrast, SSS does not assume that subscribers buy stocks on margin or employ other kinds of strategies. Our returns are solely the result of stock-picking ability.
The Forbes Growth Investor (FGI), which relies on a quantitative, momentum-based model also did well, significantly outperforming the market averages since Hulbert began tracking it. It has produced an annualized return of 9.0% since January 2002. Because this newsletter has a diversified recommended list of 50 stocks, it tends to be less volatile than SSS.
We credit these outstanding results to our disciplined screening process. Most importantly, for SSS, we rely on our proprietary discounted cash flow (DCF) model. We are sometimes told that our model is not realistic. This is absolutely true. Indeed, our model is overly conservative. For example, if we believe a company can realistically grow revenues by 10% each year, we might model only 5% growth. If we believe the operating profit margin is likely to be around 15%, we might model only 10%. We do this because we are not trying to determine what a stock is actually worth. Instead, we are trying to determine what it is worth at a minimum. In other words, our methodology is designed to find reasons not to recommend a stock. However, if despite all our conservative assumptions we derive a minimum intrinsic value that is greater than the stock’s market price, that stock becomes a candidate for recommendation.
It is interesting to note that Warren Buffett, perhaps the greatest investor of all time, also relies on a DCF methodology to determine a company’s intrinsic value. He points out, however, that two analysts using this methodology will rarely derive the same intrinsic value. This is because DCF analysis is as much art as it is science. It is prone to error because it requires making assumptions about the future. It is precisely for this reason that we try to make our assumptions as conservative as possible.
DCF analysis does not always work. For example, during the dotcom boom of the late 1990s stocks that DCF analysis flagged as overvalued continued to go up. This was because of overly optimistic investor sentiment. Barring such unusual periods, we believe a conservative DCF approach is the best way to pick undervalued stocks over the long term.
For FGI, we rely on a proprietary quantitative model. This product is more short-term oriented and puts a lot of weight on price and earnings momentum.
Thursday, April 19, 2007
China vs. India
This is the final day of the Forbes cruise. We are actually pulling into Hong Kong at the moment. I see a lot of mountains and many beautiful tall buildings. I will spend one more night on the ship then fly back to New York tomorrow afternoon.
Jim Michaels, former Editor of Forbes magazine, moderated a spirited discussion yesterday about the merits of investing in China and India. John Dessauer, who travels to China frequently, was not keen on investing there. He thinks there is insufficient transparency. He would not even recommend buying ADRs of Chinese companies. He prefers to invest in large U.S. conglomerates such as Citigroup and Wal-Mart that are conducting business in China. But Arjuna Mahendran was willing to pick a few Chinese stocks. He particularly favors oil company CNOOC. Warren Buffett also likes Chinese oil, but he prefers PetroChina.
Despite all the excitement over China, Jim Michaels thinks India offers better opportunities for investors. He said the Chinese are focused on manufacturing low-cost items, but the Indians are specializing in high-skilled services.
Jim Michaels, former Editor of Forbes magazine, moderated a spirited discussion yesterday about the merits of investing in China and India. John Dessauer, who travels to China frequently, was not keen on investing there. He thinks there is insufficient transparency. He would not even recommend buying ADRs of Chinese companies. He prefers to invest in large U.S. conglomerates such as Citigroup and Wal-Mart that are conducting business in China. But Arjuna Mahendran was willing to pick a few Chinese stocks. He particularly favors oil company CNOOC. Warren Buffett also likes Chinese oil, but he prefers PetroChina.
Despite all the excitement over China, Jim Michaels thinks India offers better opportunities for investors. He said the Chinese are focused on manufacturing low-cost items, but the Indians are specializing in high-skilled services.
Wednesday, April 18, 2007
Bulls on Board
Forbes magazine Publisher Rich Karlgaard started off the 11th Forbes Cruise for Investors this morning with an excellent presentation. He said Americans seem to hate a good economy, but that’s a good thing for investors because it keeps expectations low. He pointed out that there is a correlation between one’s view of the economy and one’s view of President Bush. He also talked about the media and how it tends to lean left and focus on the negative. He even made some predictions about real estate. He said the gap between real estate prices on the coasts and prices in the interior is greater than it has ever been. He believes that baby boomers will increasingly retire to interior regions of the country. He favors college towns in low tax, non-union states.
John Dessauer spoke next. He was extremely bullish about the stock market. He sees stocks going much higher primarily because of corporate earnings growth. He says stock price appreciation has lagged earnings growth rates. Therefore, he believes it will require a strong rally in stocks to straighten things out. According to Dessauer, those who warn about slowing earnings growth are simply wrong.
In addition to the presentations, the cruise has been wonderful. As usual, the food is great. However, the seas have been extremely rough the last couple of days. Running on a tread mill was all but impossible. I finally had to give up after half a mile. In fact, most people look drunk simply walking around on board trying to keep their balance.
John Dessauer spoke next. He was extremely bullish about the stock market. He sees stocks going much higher primarily because of corporate earnings growth. He says stock price appreciation has lagged earnings growth rates. Therefore, he believes it will require a strong rally in stocks to straighten things out. According to Dessauer, those who warn about slowing earnings growth are simply wrong.
In addition to the presentations, the cruise has been wonderful. As usual, the food is great. However, the seas have been extremely rough the last couple of days. Running on a tread mill was all but impossible. I finally had to give up after half a mile. In fact, most people look drunk simply walking around on board trying to keep their balance.
Cho Was Purely Evil
Now we know his name. Cho Seung-Hui is the Virginia Tech student who in just a flash of time killed 32 innocent people, injured 14 others, and disrupted the lives of tens of thousands. He was a loner who talked to no one and had no friends. Today he is world famous and will never be forgotten by the loved ones of those he killed. By the time the media is through, we will know all his deepest and darkest secrets. And we will hear all the experts theorize about what went wrong and how an immigrant Korean child could grow up to become one of the greatest evil doers in American history.
Just a couple of days ago I briefly wrote about my favorable impression of Koreans. I have no doubt that Koreans all over the world are absolutely shocked by Cho’s crimes. I am sure many are now feeling shame and trying to understand how one of their own could have done so much evil. This is nonsense. Cho was not one of their own. He was not one of anyone’s own. The fact that he was of Korean descent is about as relevant as his height or his weight or the color of his hair. This guy was pure evil. And as we know, evil comes in all colors, lives in all countries, and practices all religions.
Just a couple of days ago I briefly wrote about my favorable impression of Koreans. I have no doubt that Koreans all over the world are absolutely shocked by Cho’s crimes. I am sure many are now feeling shame and trying to understand how one of their own could have done so much evil. This is nonsense. Cho was not one of their own. He was not one of anyone’s own. The fact that he was of Korean descent is about as relevant as his height or his weight or the color of his hair. This guy was pure evil. And as we know, evil comes in all colors, lives in all countries, and practices all religions.
Tuesday, April 17, 2007
Investing Like Buffett
The 11th Forbes Cruise for Investors continues. Today we heard from Marilyn Cohen, a fixed-income specialist who also writes a regular column in Forbes magazine. We also heard from Arjuna Mahendran, Chief Strategist Asia Pacific at Credit Suisse. Both made excellent presentations. I also gave a presentation, which focused on my research on Warren Buffett. For the past several months I have been writing a book about Buffett. While there are a number of books already in publication, they are all “love” stories. I believe my book is the most objective one by far. While I criticize Buffett for advocating certain views that I believe hurt investors, I also conclude that he is clearly the greatest investor of all time. My respect for him has grown immensely since I began this project. If all goes according to plan, the book will on the market by next spring.
Horror in Blacksburg
I’m on the high seas cruising from Osaka to Hong Kong. I woke up Tuesday morning at 5:00 am our time (which was 5:00 pm Monday in New York) and turned on the television to find out how the stock market had done. Instead, I was horrified to hear news of what was being called “The Virginia Tech Massacre.” I was stunned. I spent five years of my life studying at Virginia Tech where I earned two graduate degrees. Blacksburg is one of my favorite places in the whole world. I absolutely love it. I also considered it one the safest places to live. I couldn’t believe this kind of horrible tragedy could occur in such a wonderful place. I extend my deepest sympathies to the families and loved ones of all the innocent victims of this terrible crime.
Sunday, April 15, 2007
Polite Societies
I'm in Osaka, Japan. I just boarded the Crystal Symphony for the second half of the 11th Forbes Cruise for Investors. I arrived Saturday evening, which of course, was Saturday morning in New York. I'm still jet-lagged.
I haven't been in Asia long, but I have made a number of observations. Let me start with the flight. I took Korean Airlines from New York to Seoul then changed planes for Osaka. The service was outstanding. The stewards and stewardesses were wonderful. The food was as good as anything you would expect to find in a fine restaurant. I had steak for lunch and an arrangement of seafood wrapped in phyllo dough for dinner. I had a second codfish dinner on the flight from Seoul to Osaka. Both planes were Boeing 747s. Since I flew business class, there was plenty of leg room. The seats reclined to an almost horizontal position, making it much easier to get some sleep.
Getting from Kansai International Airport in Osaka to the Westin Hotel was easier than I expected. The airport is not near the city and I heard cab fare runs around $200. So I took a bus to the New Hankyu Hotel and a taxi from there to the Westin. That cost about $25 in total. The Westin was very nice, but there was no wireless Internet access and no wired access in the rooms. The next morning I had a delicious traditional Japanese breakfast. I'm not exactly sure what I ate, but I do know there was a lot of seafood involved. In any case, I really liked it. I've had plenty of sushi back home, but this was the first time I ate a real Japanese breakfast. By the way, the tea was excellent. It was much better than what I've had in typical Japanese restaurants in American.
After breakfast, I returned to my room and read The Daily Yomiuri, an English-language newspaper. One story really caught my attention. It turns out that "more than 400 Osaka municipal government workers lied about their academic backgrounds when they applied for posts designed for workers who had only graduated from high school or middle school." That’s right; these people actually denied having graduated from college! I've heard plenty of cases of people embellishing their resumes in order to secure better jobs than they were qualified for, but these workers had done exactly the opposite. They had purposely downplayed their qualifications. Either finding a job in Osaka is very difficult, or this is a society that suffers from an extreme case of humility.
Perhaps the one thing that strikes me most about the Koreans and Japanese is how incredibly polite they are. I realize my perception may be skewed. After all, I was primarily exposed to people working in service industries. They are required to treat customers nicely. But the workers here seem to be in a league of their own. Of course, we are all aware of what happened to all those manufacturing jobs that used to be found in the U.S. If customer service jobs could be outsourced as easily, I'm not sure what kind of work would be left in America.
I haven't been in Asia long, but I have made a number of observations. Let me start with the flight. I took Korean Airlines from New York to Seoul then changed planes for Osaka. The service was outstanding. The stewards and stewardesses were wonderful. The food was as good as anything you would expect to find in a fine restaurant. I had steak for lunch and an arrangement of seafood wrapped in phyllo dough for dinner. I had a second codfish dinner on the flight from Seoul to Osaka. Both planes were Boeing 747s. Since I flew business class, there was plenty of leg room. The seats reclined to an almost horizontal position, making it much easier to get some sleep.
Getting from Kansai International Airport in Osaka to the Westin Hotel was easier than I expected. The airport is not near the city and I heard cab fare runs around $200. So I took a bus to the New Hankyu Hotel and a taxi from there to the Westin. That cost about $25 in total. The Westin was very nice, but there was no wireless Internet access and no wired access in the rooms. The next morning I had a delicious traditional Japanese breakfast. I'm not exactly sure what I ate, but I do know there was a lot of seafood involved. In any case, I really liked it. I've had plenty of sushi back home, but this was the first time I ate a real Japanese breakfast. By the way, the tea was excellent. It was much better than what I've had in typical Japanese restaurants in American.
After breakfast, I returned to my room and read The Daily Yomiuri, an English-language newspaper. One story really caught my attention. It turns out that "more than 400 Osaka municipal government workers lied about their academic backgrounds when they applied for posts designed for workers who had only graduated from high school or middle school." That’s right; these people actually denied having graduated from college! I've heard plenty of cases of people embellishing their resumes in order to secure better jobs than they were qualified for, but these workers had done exactly the opposite. They had purposely downplayed their qualifications. Either finding a job in Osaka is very difficult, or this is a society that suffers from an extreme case of humility.
Perhaps the one thing that strikes me most about the Koreans and Japanese is how incredibly polite they are. I realize my perception may be skewed. After all, I was primarily exposed to people working in service industries. They are required to treat customers nicely. But the workers here seem to be in a league of their own. Of course, we are all aware of what happened to all those manufacturing jobs that used to be found in the U.S. If customer service jobs could be outsourced as easily, I'm not sure what kind of work would be left in America.
Wednesday, April 11, 2007
Ethanol Is Not The Solution
With crude oil and gasoline prices at high levels, it makes sense to look for alternatives. President Bush seems convinced that ethanol is the best solution to our energy problems. Ethanol certainly has a lot going for it. Most importantly, it is relatively easy to manufacture automobile engines that can run on high ethanol-content fuel.
But like gasoline, ethanol comes with its own share of problems. For example, it isn't as efficient as gasoline. As a result, it takes more ethanol than gasoline to drive the same number of miles. Also, growing demand for ethanol is pushing up food prices all over the world. This is because today's ethanol is made from sugar or corn. Both products are widely used in all kinds of foods. President Bush says we should make ethanol from switch grass, but that's not so easy.
So in the end, will we be trading our dependence on expensive gasoline for even more expensive ethanol? In order to protect U.S. farmers, our government taxes ethanol imports, but can the U.S. even make enough ethanol to meet its expected needs? And what will happen when those tariffs are eventually reduced or eliminated? Instead of being dependent on the Organization of Petroleum Exporting Countries (OPEC), will we become dependent on a new Organization of Ethanol Exporting Countries (OEEC)?
I'm not saying we should not use any ethanol. Ethanol certainly will help reduce our reliance on oil and gasoline. That's a good thing. But I am saying that ethanol by itself is not the answer. What we really need are technologies that allow us to drive more miles at a lower cost. One way to achieve that is with more fuel-efficient cars. Don't get me wrong. I am not in favor of government mandates that dictate how many miles per gallon cars must get. Rather, I prefer market forces. Let gasoline rise to $4 or $5 per gallon and we will quickly see new solutions. In my opinion, the best solution in the near term is the plug-in hybrid vehicle. Since most people drive less than 50 miles a day, a car that can go that far on electricity before having to switch over to gasoline will significantly reduce our appetite for foreign oil.
Of course, a more immediate solution is to drive smarter. The last time gasoline prices topped $3 per gallon, demand actually fell. That's because people took matters into their own hands. Many who own gas guzzling SUVs also own more fuel-efficient passenger cars. They parked the SUV and drove the car. Some started car-pooling. Others began using public transportation. Those who couldn't do these things began planning better to minimize the number of miles driven.
Unfortunately, when people respond in this manner and demand falls, gasoline prices also fall. After a while, people notice the lower prices and revert to their old ways. Demand rises again and so do prices. We end up in a vicious cycle. If we really want to get serious about energy conservation, perhaps it is time to consider a floor on gasoline prices. This is a solution many economists favor, but you certainly won't find any politicians talking about it.
But like gasoline, ethanol comes with its own share of problems. For example, it isn't as efficient as gasoline. As a result, it takes more ethanol than gasoline to drive the same number of miles. Also, growing demand for ethanol is pushing up food prices all over the world. This is because today's ethanol is made from sugar or corn. Both products are widely used in all kinds of foods. President Bush says we should make ethanol from switch grass, but that's not so easy.
So in the end, will we be trading our dependence on expensive gasoline for even more expensive ethanol? In order to protect U.S. farmers, our government taxes ethanol imports, but can the U.S. even make enough ethanol to meet its expected needs? And what will happen when those tariffs are eventually reduced or eliminated? Instead of being dependent on the Organization of Petroleum Exporting Countries (OPEC), will we become dependent on a new Organization of Ethanol Exporting Countries (OEEC)?
I'm not saying we should not use any ethanol. Ethanol certainly will help reduce our reliance on oil and gasoline. That's a good thing. But I am saying that ethanol by itself is not the answer. What we really need are technologies that allow us to drive more miles at a lower cost. One way to achieve that is with more fuel-efficient cars. Don't get me wrong. I am not in favor of government mandates that dictate how many miles per gallon cars must get. Rather, I prefer market forces. Let gasoline rise to $4 or $5 per gallon and we will quickly see new solutions. In my opinion, the best solution in the near term is the plug-in hybrid vehicle. Since most people drive less than 50 miles a day, a car that can go that far on electricity before having to switch over to gasoline will significantly reduce our appetite for foreign oil.
Of course, a more immediate solution is to drive smarter. The last time gasoline prices topped $3 per gallon, demand actually fell. That's because people took matters into their own hands. Many who own gas guzzling SUVs also own more fuel-efficient passenger cars. They parked the SUV and drove the car. Some started car-pooling. Others began using public transportation. Those who couldn't do these things began planning better to minimize the number of miles driven.
Unfortunately, when people respond in this manner and demand falls, gasoline prices also fall. After a while, people notice the lower prices and revert to their old ways. Demand rises again and so do prices. We end up in a vicious cycle. If we really want to get serious about energy conservation, perhaps it is time to consider a floor on gasoline prices. This is a solution many economists favor, but you certainly won't find any politicians talking about it.
Thursday, April 05, 2007
Forbes Investors Roundtable Discussion
Last week we hosted a Roundtable discussion with a few notable investment experts at our headquarters at Forbes. Participants included Barbara Marcin, Mike Holland, Joe Battipaglia, and Nikhil Hutheesing. Our discussion began with an overview of the economy and stock market. Barbara, Mike, and Nikhil were all bullish. Joe and I were bearish. Each of the participants also presented some of their best investment ideas for the year. The full report is available only to subscribers of the Forbes Growth Investor and Special Situation Survey investment newsletters.
Monday, March 26, 2007
Largest Supply of New Homes Since 1995
Just a few days ago, I heard an analyst defend the home building industry. He said home builders were cutting back on construction in order to reduce inventories. He seemed certain business would soon pick up.
Not soon enough according to today's report from the Department of Commerce. It turns out that on a seasonally-adjusted and annualized basis, only an estimated 848,000 new homes were sold in February. That's down 3.9% from the revised January estimate, which is itself down 5.9% from the initial January estimate reported a month ago. At this rate, we could conceivably see today's figure eventually revised to less than 800,000.
Regardless of any future revisions, it is clear that problems persist in housing. While home builders may be reducing inventories, they are also selling fewer homes, which means supply is actually rising. In fact, according to the latest report, there is now an 8.1 months' supply of new homes on the market. That's the highest amount of supply since December 1995.
Amazingly, prices are holding up. In fact, February's median price of $250,000 was up 2.8% from January. But prices should be taken with a grain of salt. Home builders are making all kinds of concessions to move houses. They are throwing in every conceivable upgrade to hold the line on price.
What does this mean for the economy? I think the Fed will worry more about slowing growth than rising inflation. In my view, today's report raises the odds of a Fed rate cut by year-end.
Not soon enough according to today's report from the Department of Commerce. It turns out that on a seasonally-adjusted and annualized basis, only an estimated 848,000 new homes were sold in February. That's down 3.9% from the revised January estimate, which is itself down 5.9% from the initial January estimate reported a month ago. At this rate, we could conceivably see today's figure eventually revised to less than 800,000.
Regardless of any future revisions, it is clear that problems persist in housing. While home builders may be reducing inventories, they are also selling fewer homes, which means supply is actually rising. In fact, according to the latest report, there is now an 8.1 months' supply of new homes on the market. That's the highest amount of supply since December 1995.
Amazingly, prices are holding up. In fact, February's median price of $250,000 was up 2.8% from January. But prices should be taken with a grain of salt. Home builders are making all kinds of concessions to move houses. They are throwing in every conceivable upgrade to hold the line on price.
What does this mean for the economy? I think the Fed will worry more about slowing growth than rising inflation. In my view, today's report raises the odds of a Fed rate cut by year-end.
Saturday, March 24, 2007
American Superconductor May Soon Turn the Corner
In the interest of full disclosure, let me first say that I am an American Superconductor (AMSC) shareholder and have been on and off since the late 1990s. The stock has been one of my favorites—and most profitable—even though the company has yet to make any money. But now I am starting to believe that profitability is just around the corner.
AMSC has three segments: Wires, SuperMachines, and Power Electronics. Power Electronics, the largest by far, recently turned profitable on an operating basis. However, profits in this segment are dwarfed by operating losses in the other two segments. This is because management is pouring a ton of money into R&D. It is no longer manufacturing its first-generation high temperature superconducting wires. Instead, it has moved on to making second generation (344 and 348) wires, which will provide superior performance and eventually incur much lower manufacturing costs.
Another promising area is ship-propulsion systems. AMSC has been working on a 36.5 megawatt superconducting motor for the U.S. Navy. Superconducting motors deliver the same power as conventional motors, but are much smaller and lighter. They are quieter, too. That is particularly important in military applications.
The company's January acquisition of Windtec is one the primary reasons I am turning more optimistic about future profitability. Windtec is an Austrian company that designs wind turbine systems that rely on AMSC's PowerModule systems. The acquisition makes strategic sense and already appears to be paying off in the form of major orders from Sinovel Wind Corp. of Beijing. Windtec is also receiving orders from South Korea.
Warning—this is an extremely risky and volatile stock. It has already run up about 50% so far this year. And the company is still burning cash. This means management may decide to take advantage of the recent rally by issuing more shares, which would likely push the price back down. Nonetheless, I think there is a good chance the company may break even in fiscal 2008, which begins next month.
You can view a MoneyMasters interview I conducted with CEO Greg Yurek back in December. It's called "Powering the Future."
AMSC has three segments: Wires, SuperMachines, and Power Electronics. Power Electronics, the largest by far, recently turned profitable on an operating basis. However, profits in this segment are dwarfed by operating losses in the other two segments. This is because management is pouring a ton of money into R&D. It is no longer manufacturing its first-generation high temperature superconducting wires. Instead, it has moved on to making second generation (344 and 348) wires, which will provide superior performance and eventually incur much lower manufacturing costs.
Another promising area is ship-propulsion systems. AMSC has been working on a 36.5 megawatt superconducting motor for the U.S. Navy. Superconducting motors deliver the same power as conventional motors, but are much smaller and lighter. They are quieter, too. That is particularly important in military applications.
The company's January acquisition of Windtec is one the primary reasons I am turning more optimistic about future profitability. Windtec is an Austrian company that designs wind turbine systems that rely on AMSC's PowerModule systems. The acquisition makes strategic sense and already appears to be paying off in the form of major orders from Sinovel Wind Corp. of Beijing. Windtec is also receiving orders from South Korea.
Warning—this is an extremely risky and volatile stock. It has already run up about 50% so far this year. And the company is still burning cash. This means management may decide to take advantage of the recent rally by issuing more shares, which would likely push the price back down. Nonetheless, I think there is a good chance the company may break even in fiscal 2008, which begins next month.
You can view a MoneyMasters interview I conducted with CEO Greg Yurek back in December. It's called "Powering the Future."
Wednesday, March 21, 2007
Chances of a Rate Cut Are Better Than you Think
With the Fed wrapping up its two-day meeting, investors are betting on the outcome. Conventional wisdom is calling for no change in interest rates. Indeed, CBOT futures are pricing in a 98% probability that the Fed will stand pat and just a 2% probability that it will cuts rates by a quarter point.
I believe chances for a rate reduction are higher than the numbers indicate. I am convinced the Fed is seriously concerned about the housing market. Fed officials are fully aware that higher rates at the longer-end of the yield curve could accelerate the pace of mortgage defaults and foreclosures. The sub-prime market has already been hit. If troubles spread to the alt-A and prime markets, the economy would easily be thrown into recession.
So is the Fed willing to risk a little inflation in order to prevent a housing meltdown? Inflation is currently running a bit higher than the Fed's so-called comfort zone. That's why many investors believe the Fed won't cut. But inflation is still quite low by historical standards. As a result, the Fed can feel comfortable about cutting rates at this time. A rate cut, however, would scare the markets and could result in a significant sell-off because it would send the message that recession is a likely possibility.
Of course, like most investors, I'm betting against a rate cut. Nonetheless, I won't be surprised if it happens today.
I believe chances for a rate reduction are higher than the numbers indicate. I am convinced the Fed is seriously concerned about the housing market. Fed officials are fully aware that higher rates at the longer-end of the yield curve could accelerate the pace of mortgage defaults and foreclosures. The sub-prime market has already been hit. If troubles spread to the alt-A and prime markets, the economy would easily be thrown into recession.
So is the Fed willing to risk a little inflation in order to prevent a housing meltdown? Inflation is currently running a bit higher than the Fed's so-called comfort zone. That's why many investors believe the Fed won't cut. But inflation is still quite low by historical standards. As a result, the Fed can feel comfortable about cutting rates at this time. A rate cut, however, would scare the markets and could result in a significant sell-off because it would send the message that recession is a likely possibility.
Of course, like most investors, I'm betting against a rate cut. Nonetheless, I won't be surprised if it happens today.
Tuesday, March 20, 2007
Housing Still Hasn't Bottomed
Housing starts for February came in at a better-than-expected 1.525 million. Several commentators jumped on this as evidence that the housing market has bottomed and that the economy is strong. They shouldn't celebrate.
Although the figure was 9% better than January's 1.399 million estimate, the 90% confidence interval is ±10.2 percentage points. In other words, there is a good chance housing starts did not rise at all. Furthermore, February's figure is 28.5% lower than it was a year earlier.
Housing is not out of the woods. The bust in the sub-prime mortgage market will continue, especially if the yield on the 10-year note starts to rise. This will force more homeowners into default as their monthly payments rise. The prime market, however, should be fine; unless the economy slows further and the unemployment rate begins to rise. At this time, I don't expect current problems in housing to cause a recession. Yet there is little doubt that economic growth will be more anemic than many economists had previously expected.
Although the figure was 9% better than January's 1.399 million estimate, the 90% confidence interval is ±10.2 percentage points. In other words, there is a good chance housing starts did not rise at all. Furthermore, February's figure is 28.5% lower than it was a year earlier.
Housing is not out of the woods. The bust in the sub-prime mortgage market will continue, especially if the yield on the 10-year note starts to rise. This will force more homeowners into default as their monthly payments rise. The prime market, however, should be fine; unless the economy slows further and the unemployment rate begins to rise. At this time, I don't expect current problems in housing to cause a recession. Yet there is little doubt that economic growth will be more anemic than many economists had previously expected.
Sunday, March 18, 2007
Less Guidance Means More Risk
Earnings guidance is a topic that is near and dear to my heart. I have written a number of articles that criticize efforts to ban guidance. The first two, In Defense of Earnings Guidance and Is Buffett Hazardous to Your Wealth?, were published in 2003. The third, Gimme Guidance, was co-authored with Mike Ozanian and published in 2006.
Guidance is in the news again because the U.S. Chamber of Commerce recently came out with a report encouraging companies to put an end to the practice. Even Warren Buffett, perhaps the most successful investor of all-time, opposes guidance.
There are a number of objections to guidance. However, the one that gets the most play is that guidance encourages executives to focus on the short term rather than the long term. As a result, managers worry more about managing earnings than they do about managing the business. For example, it is argued that managers who provide guidance are more likely to reduce R&D spending in order to "meet the number." Doing something like this will boost short-term profits at the expense of long-term profits. Everyone, include myself, agrees this is a bad idea.
The problem with the argument is that it falsely assumes that "short-termism" is caused by guidance. It isn't. The fact is that investors will form expectations whether guidance is provided or not. They currently form quarterly expectations simply because the SEC requires corporations to report earnings every quarter. If the SEC required monthly reports, investors would form monthly expectations.
Guidance plays a valuable role because it ensures that investor expectations don't get out of hand. I have theorized about this in the past and said that without guidance, the disparity between actual earnings and the consensus estimate will only be larger than it already is. Now there is empirical evidence that supports this theory. Baruch Lev of NYU and his co-authors, Joel Houston and Jennifer Tucker of Florida, have a very interesting paper in circulation called "To Guide or Not to Guide?" They find that earnings estimates do indeed become less accurate when companies stop providing guidance. What's worse, they find absolutely no evidence that those companies that end guidance increase the focus on the long term. Companies that end guidance do not increase R&D spending, they do not increase capital expenditures, and they do not provide investors with any additional information.
A second study in circulation by Shuping Chen, Dawn Matsumoto, and Shiva Rajogopal of the University of Washington called "Is Silence Golden?" finds that eliminating guidance destroys shareholder wealth. When companies announce an end to guidance, they suffer a statistically significant decline in stock returns.
There really is only one thing that can be said for sure about ending guidance. Less guidance results in less information. And all investors know that less information creates greater uncertainty, which means more risk. It seems odd in the post-dotcom era when regulators are trying to encourage more disclosure, that some of the most vocal corporate critics of the past are now telling corporations to keep mum.
Guidance is in the news again because the U.S. Chamber of Commerce recently came out with a report encouraging companies to put an end to the practice. Even Warren Buffett, perhaps the most successful investor of all-time, opposes guidance.
There are a number of objections to guidance. However, the one that gets the most play is that guidance encourages executives to focus on the short term rather than the long term. As a result, managers worry more about managing earnings than they do about managing the business. For example, it is argued that managers who provide guidance are more likely to reduce R&D spending in order to "meet the number." Doing something like this will boost short-term profits at the expense of long-term profits. Everyone, include myself, agrees this is a bad idea.
The problem with the argument is that it falsely assumes that "short-termism" is caused by guidance. It isn't. The fact is that investors will form expectations whether guidance is provided or not. They currently form quarterly expectations simply because the SEC requires corporations to report earnings every quarter. If the SEC required monthly reports, investors would form monthly expectations.
Guidance plays a valuable role because it ensures that investor expectations don't get out of hand. I have theorized about this in the past and said that without guidance, the disparity between actual earnings and the consensus estimate will only be larger than it already is. Now there is empirical evidence that supports this theory. Baruch Lev of NYU and his co-authors, Joel Houston and Jennifer Tucker of Florida, have a very interesting paper in circulation called "To Guide or Not to Guide?" They find that earnings estimates do indeed become less accurate when companies stop providing guidance. What's worse, they find absolutely no evidence that those companies that end guidance increase the focus on the long term. Companies that end guidance do not increase R&D spending, they do not increase capital expenditures, and they do not provide investors with any additional information.
A second study in circulation by Shuping Chen, Dawn Matsumoto, and Shiva Rajogopal of the University of Washington called "Is Silence Golden?" finds that eliminating guidance destroys shareholder wealth. When companies announce an end to guidance, they suffer a statistically significant decline in stock returns.
There really is only one thing that can be said for sure about ending guidance. Less guidance results in less information. And all investors know that less information creates greater uncertainty, which means more risk. It seems odd in the post-dotcom era when regulators are trying to encourage more disclosure, that some of the most vocal corporate critics of the past are now telling corporations to keep mum.
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