A professor once joked that the best way to turn a Democrat into a Republican was to let him graduate, get a job, and see how much he has to pay in taxes. Indeed, when I was in college, most of my classmates had Democratic leanings. I preferred to remain independent. But as time went on I noticed I had more in common with Republicans, and that is the way I usually voted.
Many years later I took a job in Massachusetts. Almost everyone in the state was a registered Democrat, so I decided to register as a Republican. I did so just in time to help elect William Weld, a Republican, governor. I have been a registered Republican ever since.
This is why it pains me to see the Republican party struggling so much in recent months. The Bush administration, in particular, is falling apart. A number of high-ranking officials have resigned. Karl Rove and Alberto Gonzales are only the most recent.
It is becoming more and more difficult for me to believe that the Republicans will be able to hold on to the White House in 2008. There does not appear to be a single Republican candidate who can energize the core of the party and at the same time attract a critical mass of Democrats.
The Democratic candidates have many flaws, yet their constituents appear quite satisfied with them. In my opinion, unless the Democrats completely blow it, this election belongs to them, which of course makes me all the more bearish on stocks. I believe a Democrat in the While House, along with a Democratic Congress, spells higher taxes. I expect stocks to go lower as more and more investors reach the same conclusion.
Monday, August 27, 2007
Friday, August 10, 2007
2% Growth is Bullish?
Brian Wesbury wrote an especially amusing op-ed in yesterday's Wall Street Journal. He argued that the business media are giving too much time to those who are bearish. Citing numerous surveys, he claimed that the vast majority of economists are bullish. Therefore, according to Wesbury, by giving bears and bulls an equal amount of time, viewers are getting the incorrect impression that economists are torn about economic growth.
I found this amusing for a couple of reasons. First, his definition of a bull is one who is forecasting at least 2% GDP growth. Not too long ago, 2% would have been considered bearish. In fact, I've been portrayed as the bear on a number of television debates because I was forecasting less than 3% growth.
Furthermore, he ignores the fact that almost all economists have been ratcheting down their forecasts. They may still be predicting growth, but they are getting less and less optimistic.
He also ignores the fact that it rarely pays for forecasters to disagree with the masses. They want to make sure their forecast is not too far off from the average forecast. This way, if they are wrong, they can simply shrug their shoulders and say, "Hey, that's what everybody was expecting."
As for me, I still think the probability of recession is rather low. I think 2% GDP growth is still a reasonable estimate. So why am I a bear? It is not because I expect a recession. It is because I expect stocks to go lower. Despite the recent sell-offs we've been seeing in the markets, I think there is still a ways to go before we hit bottom.
I found this amusing for a couple of reasons. First, his definition of a bull is one who is forecasting at least 2% GDP growth. Not too long ago, 2% would have been considered bearish. In fact, I've been portrayed as the bear on a number of television debates because I was forecasting less than 3% growth.
Furthermore, he ignores the fact that almost all economists have been ratcheting down their forecasts. They may still be predicting growth, but they are getting less and less optimistic.
He also ignores the fact that it rarely pays for forecasters to disagree with the masses. They want to make sure their forecast is not too far off from the average forecast. This way, if they are wrong, they can simply shrug their shoulders and say, "Hey, that's what everybody was expecting."
As for me, I still think the probability of recession is rather low. I think 2% GDP growth is still a reasonable estimate. So why am I a bear? It is not because I expect a recession. It is because I expect stocks to go lower. Despite the recent sell-offs we've been seeing in the markets, I think there is still a ways to go before we hit bottom.
Saturday, August 04, 2007
Rising Volatility Means Stocks Can Go Lower
Given the sell-off in stocks we are now seeing, I decided to post my recent comments from the Forbes Growth Investor:
Volatility is back on Wall Street. There were 21 trading days in July. The range between the Dow’s high and low exceeded 100 points on 13 of those days. It exceeded 200 points on six days.
The CBOE Market Volatility Index is another way to monitor volatility. This index measures implied volatility from the prices traders are willing to pay for stock options. Implied volatility was rather low during the second half of 2006. It started rising in late February 2007, breaking through its 200-day moving average. It has now reached its highest levels since 2003. Traders love this kind of market. It gives them plenty of opportunity to make quick profits by jumping in and out of stocks. Long term buy-and-hold investors, however, may not pay much attention. They should. Rising volatility can sometimes signal a major turning point in the market. In 2003 it signaled the start of a bull market. Today, it may be telling us just the opposite.
Rising volatility means investors are getting nervous. They no longer feel confident about the market’s overall direction. Of course, much of the current volatility is being blamed on woes in the sub-prime mortgage market and on worries that those problems will spread to higher quality mortgages. Yet even today, there are those who seem to be completely discounting the deterioration in housing. They seem convinced that the housing market is about to bottom and that any further problems—if they do occur—will have only a minimal impact on consumer spending.
Economists will debate exactly how much investors should worry, but one thing is for
sure: This bull market is getting old. As a result, many investors are sitting on sizable gains. When they see stock prices gyrate excessively, they can’t help but think about taking profits. They probably should take some money off the table.
It’s likely that housing prices will continue to fall. In fact, the 10-city S&P Case/Shiller Home Price Index recently posted its biggest drop since 1991. Furthermore, oil is trading for more than $78 per barrel and some analysts predict it will hit $100 within a year. Yet so many otherwise meticulous market watchers are simply overlooking the price of this indispensable commodity. To them, the price of
oil does not matter—until, of course, when it does.
Despite seemingly strong GDP growth in the second quarter, stocks are likely to go lower. Those who are truly worried about further declines, but for tax purposes are reluctant to realize gains, should consider hedging their portfolios. One good way to do this is by buying one or more of the UltraShort ETFs. These move opposite in direction to the corresponding index, but by twice as much. For example, the DXD will rise 10% in value if the Dow falls 5%. The SDS provides a similar hedge against the S&P 500. Readers can learn more about these products at ProShares.com.
Volatility is back on Wall Street. There were 21 trading days in July. The range between the Dow’s high and low exceeded 100 points on 13 of those days. It exceeded 200 points on six days.
The CBOE Market Volatility Index is another way to monitor volatility. This index measures implied volatility from the prices traders are willing to pay for stock options. Implied volatility was rather low during the second half of 2006. It started rising in late February 2007, breaking through its 200-day moving average. It has now reached its highest levels since 2003. Traders love this kind of market. It gives them plenty of opportunity to make quick profits by jumping in and out of stocks. Long term buy-and-hold investors, however, may not pay much attention. They should. Rising volatility can sometimes signal a major turning point in the market. In 2003 it signaled the start of a bull market. Today, it may be telling us just the opposite.
Rising volatility means investors are getting nervous. They no longer feel confident about the market’s overall direction. Of course, much of the current volatility is being blamed on woes in the sub-prime mortgage market and on worries that those problems will spread to higher quality mortgages. Yet even today, there are those who seem to be completely discounting the deterioration in housing. They seem convinced that the housing market is about to bottom and that any further problems—if they do occur—will have only a minimal impact on consumer spending.
Economists will debate exactly how much investors should worry, but one thing is for
sure: This bull market is getting old. As a result, many investors are sitting on sizable gains. When they see stock prices gyrate excessively, they can’t help but think about taking profits. They probably should take some money off the table.
It’s likely that housing prices will continue to fall. In fact, the 10-city S&P Case/Shiller Home Price Index recently posted its biggest drop since 1991. Furthermore, oil is trading for more than $78 per barrel and some analysts predict it will hit $100 within a year. Yet so many otherwise meticulous market watchers are simply overlooking the price of this indispensable commodity. To them, the price of
oil does not matter—until, of course, when it does.
Despite seemingly strong GDP growth in the second quarter, stocks are likely to go lower. Those who are truly worried about further declines, but for tax purposes are reluctant to realize gains, should consider hedging their portfolios. One good way to do this is by buying one or more of the UltraShort ETFs. These move opposite in direction to the corresponding index, but by twice as much. For example, the DXD will rise 10% in value if the Dow falls 5%. The SDS provides a similar hedge against the S&P 500. Readers can learn more about these products at ProShares.com.
Wednesday, August 01, 2007
Taking a Gamble on Hooper Holmes
Several years ago, my wife and I decided to buy some life insurance. The insurance company sent a couple of paramedics over to our house to do a basic medical exam and take samples of blood and urine. These paramedics were employed by a company called Hooper Holmes (HH). Unfortunately, the company hasn't been doing so well. It has no profits and revenues are falling. The stock has been falling, too. It has fallen steadily for about seven years and currently sells for $2.65 per share.
Despite all these problems, I recently started accumulating shares of the company. New management took over more than a year ago and I'm betting the worst is over. The gross profit margin is already showing signs of recovery and there is hope that the revenue decline will moderate. Furthermore, the company has no debt outstanding.
This is not a growth story. HH is not operating in a particularly complicated industry. In fact, it's a rather boring business. It's the kind of stuff Warren Buffett might appreciate. There is nothing high tech about it. It should be relatively easy for this kind of company to make some money. Most importantly, HH needs to get expenses under control and bring them down to a level that is appropriate for the reduced amount of revenue it is now generating. At the same time, it needs to find ways to stem the revenue decline.
The company will probably announce second quarter results in about a week or so. I'm not expecting anything spectacular. If it can simply break even and show that revenues are holding steady, that will be enough to attract some buyers.
Despite all these problems, I recently started accumulating shares of the company. New management took over more than a year ago and I'm betting the worst is over. The gross profit margin is already showing signs of recovery and there is hope that the revenue decline will moderate. Furthermore, the company has no debt outstanding.
This is not a growth story. HH is not operating in a particularly complicated industry. In fact, it's a rather boring business. It's the kind of stuff Warren Buffett might appreciate. There is nothing high tech about it. It should be relatively easy for this kind of company to make some money. Most importantly, HH needs to get expenses under control and bring them down to a level that is appropriate for the reduced amount of revenue it is now generating. At the same time, it needs to find ways to stem the revenue decline.
The company will probably announce second quarter results in about a week or so. I'm not expecting anything spectacular. If it can simply break even and show that revenues are holding steady, that will be enough to attract some buyers.
Sunday, July 29, 2007
Ethanol Revisited
I recently read an excellent article in the May/June 2007 issue of Foreign Affairs, which is published by the Council on Foreign Relations. Professors C. Ford Runge and Benjamin Senauer argue in "How Biofuels Could Starve the Poor" that the push for corn-based ethanol is driving up global food prices.
High oil prices have prompted governments to subsidize the development of alternative fuels. Brazil uses sugar to produce ethanol. The U.S. has focused on corn-based ethanol. Although corn production is near record levels, an increasing portion is being dedicated to refine ethanol. This has depleted corn inventories. Furthermore, as farmers plant more and more corn, yields of other food crops are falling, pushing up their prices as well.
Ethanol is expensive to produce. Ironically, high crude oil prices are necessary for ethanol production to be profitable. The authors argue that if oil prices fell back to $30 per barrel (admittedly, not a very likely outcome), corn prices would have to fall to less than $2 per bushel for ethanol production to remain a profitable business. However, at $80 per barrel for oil, ethanol refiners could afford to pay more than $5 per bushel for corn and still make a good return. The tradeoff, of course, is more expensive food.
I commented on much of this back in April when I wrote Ethanol is Not the Solution. I argued that the most promising technology to address our transportation needs in the short term is the plug-in hybrid car. Since then several automobile manufacturers have announced plans to invest more money to research and develop this technology. The farm lobby may oppose these efforts, but success would not only significantly reduce our dependence on foreign oil, it would also bring food inflation under control.
High oil prices have prompted governments to subsidize the development of alternative fuels. Brazil uses sugar to produce ethanol. The U.S. has focused on corn-based ethanol. Although corn production is near record levels, an increasing portion is being dedicated to refine ethanol. This has depleted corn inventories. Furthermore, as farmers plant more and more corn, yields of other food crops are falling, pushing up their prices as well.
Ethanol is expensive to produce. Ironically, high crude oil prices are necessary for ethanol production to be profitable. The authors argue that if oil prices fell back to $30 per barrel (admittedly, not a very likely outcome), corn prices would have to fall to less than $2 per bushel for ethanol production to remain a profitable business. However, at $80 per barrel for oil, ethanol refiners could afford to pay more than $5 per bushel for corn and still make a good return. The tradeoff, of course, is more expensive food.
I commented on much of this back in April when I wrote Ethanol is Not the Solution. I argued that the most promising technology to address our transportation needs in the short term is the plug-in hybrid car. Since then several automobile manufacturers have announced plans to invest more money to research and develop this technology. The farm lobby may oppose these efforts, but success would not only significantly reduce our dependence on foreign oil, it would also bring food inflation under control.
Tuesday, July 24, 2007
Starbucks Raises Prices and Analysts Cheer
There seems to be little skepticism on Wall Street about Starbucks' recently announced price increase. The company admitted again that higher costs are pinching profits. It is struggling with higher dairy prices, higher fuel prices, and higher energy prices.
But consumers are also dealing with higher prices, leaving them with less and less income to spend on discretionary items like Starbucks coffee. So is the nine cents per cup price increase sufficient to preserve profit margins without depressing volumes? Or is it too much of an increase that will turn away some customers and make them wonder why they are paying so much for coffee? These are the questions Starbucks and analysts are grappling with.
Customers are getting squeezed by higher prices for all kinds of things. Food and energy prices in particular are taking a bite out of their incomes. I doubt even Starbucks believes that customers will finance their coffee purchases with stock market gains or home equity loans. The bottom line is that things don't look promising for Starbucks right now. We'll learn more about the company's financials on August 1. In the meantime, I'm sticking with my recommendation to short the stock.
But consumers are also dealing with higher prices, leaving them with less and less income to spend on discretionary items like Starbucks coffee. So is the nine cents per cup price increase sufficient to preserve profit margins without depressing volumes? Or is it too much of an increase that will turn away some customers and make them wonder why they are paying so much for coffee? These are the questions Starbucks and analysts are grappling with.
Customers are getting squeezed by higher prices for all kinds of things. Food and energy prices in particular are taking a bite out of their incomes. I doubt even Starbucks believes that customers will finance their coffee purchases with stock market gains or home equity loans. The bottom line is that things don't look promising for Starbucks right now. We'll learn more about the company's financials on August 1. In the meantime, I'm sticking with my recommendation to short the stock.
Thursday, July 12, 2007
The Real Cost of Living
Wednesday night I argued on Kudlow & Co. on CNBC that inflation is problematic. I mentioned soaring gasoline and food prices. Larry Kudlow took me to task saying those volatile components are rightly excluded when measuring core inflation. He said the prices of other things like televisions and cell phones have been falling. He didn't care for my argument that consumers buy gasoline and food every week, but that they might buy a cell phone only once every two or three years. He said I was being silly.
After thinking about it for a while, I realized that even the costs of watching television or making a phone call have risen. Take television. Granted, quality has improved dramatically, but the cost of watching television has gone up tremendously. I purchased a color television set in 1987 for $299 and paid an additional $200 to have a rotational antenna installed on my house. That allowed me to capture stations from Baltimore to Philadelphia. There were no additional costs involved. I received all my programming for free.
These days you would have to buy a high-definition television set. I know prices for HDTVs are falling, but they still cost about $1,000 or more. You also have to subscribe to premium cable or satellite services that cost at least $60 per month. And even though you can now get hundreds of stations, it is still difficult to find much that is worth watching. So, economists may argue that the cost of a television has fallen if you factor in the vastly improved quality. Yet the fact is that the cost of watching television today is much higher than it was in the 1980s.
As for cell phones, they were certainly a rarity back in 1987. Those who wanted one installed in their car had to pay a fortune. These days cell phones are ubiquitous. Yet I can't say that I have noticed a decrease in the price of making a call. Even cell phone prices don't seem to have fallen much in recent years. Yes, the phones are getting cooler and cooler. They do offer lots of features I never thought I needed. But when you consider all those hidden fees and taxes, the cost of making a call just seems to go higher and higher.
There are many such examples. Technology has brought us lots of products we couldn't even have imagined just a couple of decades ago. And if these products come with added features with only a marginal increase in price, economists actually consider that a price decrease. Yet the cost of daily life keeps rising. Think of all the things you do on a regular basis. You spend money on housing and clothing. You have to eat and drive to work. You might watch television and listen to satellite radio. You might go out to dinner and a movie. You might take a vacation. Perhaps the quality of the things you buy on a regular basis has improved, but the costs of daily life are certainly not falling.
After thinking about it for a while, I realized that even the costs of watching television or making a phone call have risen. Take television. Granted, quality has improved dramatically, but the cost of watching television has gone up tremendously. I purchased a color television set in 1987 for $299 and paid an additional $200 to have a rotational antenna installed on my house. That allowed me to capture stations from Baltimore to Philadelphia. There were no additional costs involved. I received all my programming for free.
These days you would have to buy a high-definition television set. I know prices for HDTVs are falling, but they still cost about $1,000 or more. You also have to subscribe to premium cable or satellite services that cost at least $60 per month. And even though you can now get hundreds of stations, it is still difficult to find much that is worth watching. So, economists may argue that the cost of a television has fallen if you factor in the vastly improved quality. Yet the fact is that the cost of watching television today is much higher than it was in the 1980s.
As for cell phones, they were certainly a rarity back in 1987. Those who wanted one installed in their car had to pay a fortune. These days cell phones are ubiquitous. Yet I can't say that I have noticed a decrease in the price of making a call. Even cell phone prices don't seem to have fallen much in recent years. Yes, the phones are getting cooler and cooler. They do offer lots of features I never thought I needed. But when you consider all those hidden fees and taxes, the cost of making a call just seems to go higher and higher.
There are many such examples. Technology has brought us lots of products we couldn't even have imagined just a couple of decades ago. And if these products come with added features with only a marginal increase in price, economists actually consider that a price decrease. Yet the cost of daily life keeps rising. Think of all the things you do on a regular basis. You spend money on housing and clothing. You have to eat and drive to work. You might watch television and listen to satellite radio. You might go out to dinner and a movie. You might take a vacation. Perhaps the quality of the things you buy on a regular basis has improved, but the costs of daily life are certainly not falling.
Wednesday, July 11, 2007
Life is Good Without a Car or Food
Is there or is there not an inflation problem in the U.S. economy? Anyone who buys gasoline knows inflation is rampant. Filling up the average sized gas tank costs about $50 these days. Just a few years ago you would have needed only about $30. Food prices are also way up. Even Starbucks is complaining that high dairy prices are pinching profit margins.
Yet Fed officials and most economists say inflation is not so bad because they prefer to focus on core inflation. In other words, they want to know how much prices are rising if we exclude gasoline and food. They believe gasoline and food prices are just too volatile to provide a meaningful measure of inflation, so they simply ignore them.
But investors are waking up to the fact that gasoline and food really matter. Consumers know these items are taking a bigger and bigger bite out of their paychecks. The effects are starting to show as consumer spending becomes strained. For example, Wal-Mart has been complaining for some time about higher gasoline prices weakening their customers' purchasing power. It turns out some of those customers are making up for this by resorting to the 5-finger discount. Wal-Mart is getting fed up with the increased levels of shoplifting activity it is seeing, so it announced plans to be more aggressive about prosecuting violators.
In the meantime the housing market continues to implode and foreclosures keep rising. Even S&P and Moody's have finally figured out that sub-prime mortgages are indeed risky. Housing prices are falling nationwide. Of course, the high-end of the market will probably fare well. But average prices are likely to fall enough to put some homeowners in a negative equity position.
As for jobs, so far so good. The economy is still creating jobs and the unemployment rate remains low. Nonetheless, incomes are not doing so hot. According to the Commerce Department, inflation-adjusted incomes actually fell in May. Of course, that's using overall inflation, which includes those volatile gasoline and food prices. Those of you who are lucky enough not to have to drive or eat, well it turns out you're doing pretty well!
Yet Fed officials and most economists say inflation is not so bad because they prefer to focus on core inflation. In other words, they want to know how much prices are rising if we exclude gasoline and food. They believe gasoline and food prices are just too volatile to provide a meaningful measure of inflation, so they simply ignore them.
But investors are waking up to the fact that gasoline and food really matter. Consumers know these items are taking a bigger and bigger bite out of their paychecks. The effects are starting to show as consumer spending becomes strained. For example, Wal-Mart has been complaining for some time about higher gasoline prices weakening their customers' purchasing power. It turns out some of those customers are making up for this by resorting to the 5-finger discount. Wal-Mart is getting fed up with the increased levels of shoplifting activity it is seeing, so it announced plans to be more aggressive about prosecuting violators.
In the meantime the housing market continues to implode and foreclosures keep rising. Even S&P and Moody's have finally figured out that sub-prime mortgages are indeed risky. Housing prices are falling nationwide. Of course, the high-end of the market will probably fare well. But average prices are likely to fall enough to put some homeowners in a negative equity position.
As for jobs, so far so good. The economy is still creating jobs and the unemployment rate remains low. Nonetheless, incomes are not doing so hot. According to the Commerce Department, inflation-adjusted incomes actually fell in May. Of course, that's using overall inflation, which includes those volatile gasoline and food prices. Those of you who are lucky enough not to have to drive or eat, well it turns out you're doing pretty well!
Friday, June 29, 2007
More Worrying Signs of Market Weakness
Yesterday the Fed said it would hold the fed funds rate steady at 5.25%. This was widely expected. But market traders were placing bets on the wording of the statement. They said if the Fed took "elevated" out when referring to inflation, we would see a nice rally. The dreaded word is gone, yet the Dow finished slightly lower for the day.
The Blackstone Group was one of the most highly anticipated IPOs in recent times. It went public last Friday. The offering price was $31 per share. As commonly happens with an IPO, the stock opened much higher. It finished the first day of trading at $35. That's considered a success. But the stock has closed lower every day since. Just two days later, it was selling below the offering price. That's considered a miserable failure. Compare Blackstone to Google, which never sold below its offering price.
In recent periods, investors were reacting positively to all news. Good news was considered grounds for a rally. So was bad news. But now there seems to be more skepticism in the markets. Even on days when stocks initially rally, they later give up much of the gains. This bull market is losing its steam.
The Blackstone Group was one of the most highly anticipated IPOs in recent times. It went public last Friday. The offering price was $31 per share. As commonly happens with an IPO, the stock opened much higher. It finished the first day of trading at $35. That's considered a success. But the stock has closed lower every day since. Just two days later, it was selling below the offering price. That's considered a miserable failure. Compare Blackstone to Google, which never sold below its offering price.
In recent periods, investors were reacting positively to all news. Good news was considered grounds for a rally. So was bad news. But now there seems to be more skepticism in the markets. Even on days when stocks initially rally, they later give up much of the gains. This bull market is losing its steam.
Tuesday, June 19, 2007
Speculating on a Microsoft and Yahoo! Deal
Google (GOOG), one of my favorite overvalued stocks, is a great company. It dominates internet search and makes a bundle selling ads. Microsoft (MSFT) and Yahoo! (YHOO) haven't been able to compete. Will they finally team up to beat Google?
This is pure speculation, but there is reason to believe that Microsoft and Yahoo! will be cooperating more closely in the near future. Yesterday, Yahoo! announced that CEO Terry Semel is resigning. He is being replaced by founder Jerry Yang. But the most interesting part of the management shake-up is that CFO Susan Decker is being promoted to president. The media is already speculating that one day soon Decker will be named Yahoo!'s CEO.
Decker's promotion is key to a Microsoft deal. I say this because Decker was recently appointed to Berkshire Hathaway's board of directors. Warren Buffett's board also includes Microsoft founder Bill Gates. This arrangement will give Decker and Gates plenty of opportunity to get to know one another much better. They will primarily be discussing Berkshire business at Berkshire board meetings, but you can bet they will also have lots of time to strategize about how Microsoft and Yahoo! can work together to battle Google.
This is pure speculation, but there is reason to believe that Microsoft and Yahoo! will be cooperating more closely in the near future. Yesterday, Yahoo! announced that CEO Terry Semel is resigning. He is being replaced by founder Jerry Yang. But the most interesting part of the management shake-up is that CFO Susan Decker is being promoted to president. The media is already speculating that one day soon Decker will be named Yahoo!'s CEO.
Decker's promotion is key to a Microsoft deal. I say this because Decker was recently appointed to Berkshire Hathaway's board of directors. Warren Buffett's board also includes Microsoft founder Bill Gates. This arrangement will give Decker and Gates plenty of opportunity to get to know one another much better. They will primarily be discussing Berkshire business at Berkshire board meetings, but you can bet they will also have lots of time to strategize about how Microsoft and Yahoo! can work together to battle Google.
Monday, June 18, 2007
Enlightened Leadership Should Encourage Guidance
Here we go again. The latest attack on quarterly earnings guidance comes from the Aspen Institute, a non-profit organization that according to its website is "dedicated to fostering enlightened leadership and open-minded dialogue." Promoting the elimination of guidance, however, is anything but enlightened. So in the hope of fostering some dialogue, here is my argument against eliminating guidance.
There is a widespread misconception that earnings guidance is bad because it causes investors and corporate executives to focus on short-term results rather than the long term. While no one doubts that running a corporation with the long term in mind is the better approach, it is wrong to believe that guidance is the problem. Investors certainly do focus on quarterly earnings numbers, but not because corporations give out guidance. They focus on quarterly results for only one reason--the SEC requires corporations to report results on a quarterly basis. It is because of this SEC requirement that investors form quarterly expectations. If the SEC told corporations to report results on a monthly basis, investors would form monthly expectations. This has nothing to do with guidance. Eliminating guidance will in no way stop investors from forming expectations.
Guidance is valuable information. After all, who knows better what a corporation is likely to earn, a bunch of Wall Street analysts or the corporation's own management? If guidance is not provided, analysts' earnings estimates will simply become more inaccurate. Earnings surprises would become bigger. By the way, there are at least two academic studies in circulation that prove this point. And in an era in which regulators are trying to promote more disclosure, how much sense does it really make to tell corporations to stop providing guidance?
The truth is that those who want to end guidance are upset about the volatility that occurs when corporations miss the earnings estimate by just a penny or two. They believe the ensuing sell-off is unjustified. They are probably right about this. However, instead of grabbing the opportunity to buy more shares at a lower price, as any self-respecting long-term investor should do, they want to eliminate volatility by eliminating guidance.
Furthermore, if they would really like to see a greater focus on the long term, perhaps they should petition the SEC to eliminate quarterly reporting altogether. There was a time when corporations had to report results just once a year. However, many corporations reported quarterly results long before a change in the law required them to do so. They did this for one simple reason: their investors demanded the information. This is exactly why corporations provide guidance. If investors want quarterly guidance, should we not be encouraging corporations to provide it?
There is a widespread misconception that earnings guidance is bad because it causes investors and corporate executives to focus on short-term results rather than the long term. While no one doubts that running a corporation with the long term in mind is the better approach, it is wrong to believe that guidance is the problem. Investors certainly do focus on quarterly earnings numbers, but not because corporations give out guidance. They focus on quarterly results for only one reason--the SEC requires corporations to report results on a quarterly basis. It is because of this SEC requirement that investors form quarterly expectations. If the SEC told corporations to report results on a monthly basis, investors would form monthly expectations. This has nothing to do with guidance. Eliminating guidance will in no way stop investors from forming expectations.
Guidance is valuable information. After all, who knows better what a corporation is likely to earn, a bunch of Wall Street analysts or the corporation's own management? If guidance is not provided, analysts' earnings estimates will simply become more inaccurate. Earnings surprises would become bigger. By the way, there are at least two academic studies in circulation that prove this point. And in an era in which regulators are trying to promote more disclosure, how much sense does it really make to tell corporations to stop providing guidance?
The truth is that those who want to end guidance are upset about the volatility that occurs when corporations miss the earnings estimate by just a penny or two. They believe the ensuing sell-off is unjustified. They are probably right about this. However, instead of grabbing the opportunity to buy more shares at a lower price, as any self-respecting long-term investor should do, they want to eliminate volatility by eliminating guidance.
Furthermore, if they would really like to see a greater focus on the long term, perhaps they should petition the SEC to eliminate quarterly reporting altogether. There was a time when corporations had to report results just once a year. However, many corporations reported quarterly results long before a change in the law required them to do so. They did this for one simple reason: their investors demanded the information. This is exactly why corporations provide guidance. If investors want quarterly guidance, should we not be encouraging corporations to provide it?
Tuesday, June 12, 2007
Interest Rate Sell Off
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.
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.
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.
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