Wednesday, April 30, 2008

Market insights from the top minds.

I was watching a CNBC interview with the top market minds and I thought they raised some valid points. (Catch the video interviews here and here)

Paul Mc Culley talked about how the Fed had severely reduced the fat tail by the Bear Stearns bailout. In the latest Bill Gross PIMCO missive though, he talks of PIMCO considering a possibility, not the probability, of a fat-tail. Clearly something these guys are watching closely.

Bob Doll talked about uncertainty being good, because maximum uncertainty usually coincides with a low.

I enjoyed listening to John Bogle. When a fundamental long term index investor like John Bogle talks of headwinds to the economy and a tough slog ahead, it pays to take note. With the S&P 500 yielding around 2.2% as opposed to the historical norm of 4%, and a price multiple of 16 to 19 times earnings, he’s clearly not optimistic about intermediate term returns. (He said that he’s been through 9 bear markets and never seen one like this before.) He’s worried about a weak financial system, and the slippage of financial concerns into the real economy.

On turnover in the stock markets:
Bogle talked of a huge speculative environment, with turnover in the stock market reaching 275% last year, as opposed to the 1929 peak of 140%. I’m not sure if a high turnover is a sign of excessive speculation. A lot of things have changed over the decades. We’ve had new financial instruments which are based on the underlying stock (ETFs, options, futures and other derivatives). Trades which are a combination of these tend to drive up the market turnover. Products which package and sell different types of risks and volatility are not necessarily a bad thing. 40% or more of the transactions are through program trading. A lot these are seeking out arbitrage plays amongst the different financial products, exploiting short term pricing inefficiencies. Turnover has enhanced market liquidity and made the markets more efficient. Hence I disagree with the fundamental assertion that turnover points to speculation. Also keep in mind that the cost of a transaction has come down to almost zero in today's world.

On commodities: Bogle: “What bothers me about commodities is that they have no internal rate of return. It is rank speculation. All that's behind is someone's willingness to pay more or less. In a booming world, people will pay more for everything, and I don't like the idea of speculating on price.”

Abby Joseph Cohen: “All commodities combined are about 10% of the business costs in the US industries. The impact here is not as high as compared to other countries “
Remained a long term bull on commodities, but with oil trading at $100 based on fundamentals.

On Inflation: Bogle complained about the understatement of inflation numbers, with inflation being a lot higher than the recorded numbers shown, and a lot higher than the expected numbers seen. For instance, he considered the inflation protected 10 year treasury yielding 2.3% “mind boggling conservative”.

An interesting exchange took place between Kennneth Heebner and Bogle, where Heebner remarked about the current situation reminding him of August 1982, and Bogle retorting back about the current valuations. Heebner’s response: Global opportunities are a lot greater today than they were 30 years ago. I think this is an important consideration in any historical study of valuations. Even Jeremy Grantham concedes that given the global linkages and the increased market liquidity, a higher long term price earnings multiple is warranted.

I certainly hope we don’t see 12 times earnings on the S&P 500. Could this be the fat-tail PIMCO is considering?

Full Disclosure: No position in any securities mentioned.

Read the rest of this entry >>

Sunday, April 27, 2008

Quotable quotes: The World this week.

This is a weekly update on what I've been reading and watching. Here's what the market gurus are saying and how they are positioning themselves in the near future.

Robert Shiller:

Yale University economist Robert Shiller, pioneer of Standard & Poor’s/Case-Shiller home-price index, said there’s a good chance housing prices will fall further than the 30% drop in the historic depression of the 1930s. Home prices nationwide already have dropped 15% since their peak in 2006, he said.
“I think there is a scenario that they could be down substantially more,” Mr. Shiller said during a speech at the New Haven Lawn Club.

Joseph Stiglitz: US facing long recession:

The U.S. economy is already in recession -- and may echo the 1930s, Nobel Laureate Joseph Stiglitz said Friday.

"This is going to be one of the worst economic downturns since the Great Depression," said Stiglitz.

Other downturns were primarily caused by excesses in inventories or inflation; but this slowdown is due to the condition of "badly impaired" banks and financial entities, which are unwilling and/or unable to lend capital -- stymieing the very borrowers who usually drive the country back to vitality, Stiglitz said. And the Federal Reserve may have used up its ammunition -- and the faith investors and planners have put in it.

"The savings rate as we go into the recession is zero. Which means [savings] will go up, " he said -- decreasing consumer spending and weakening retail further.

"If you really wanted to stimulate the economy, increase unemployment insurance," he suggested.

Economy has been impaired by Bush tax cuts. These, plus the Iraq war, are to blame for the majority of the mess we are in.

Jeremy Grantham rips Greenspan: (Must read)

It’s not that the former Fed boss Greenspan was incompetent that is remarkable. Incompetence is common enough after all, even in important jobs. What’s remarkable is that so many people don’t seem, even now, to get it. Do people just believe high-quality self-justifying blarney?
Greenspan came onto my radar screen in the late sixties as a seller of economic and financial advice to the investment industry. To be brutally honest, he was considered run of the mill by anyone I knew then or have met later who knew his service then. His high point in most memories, certainly mine, was a famous call in January 1973 that, “it is rare that you can be as unqualifiedly bullish as you now can,” a few days before a market decline of over 60% This was one of the first of a long line of terrible prognostications for which he has remarkably not been remembered.

Greenspan’s book and, even more disgraceful, articles in the Financial Times (and that’s a very high hurdle!), sidestep all blame and admit few errors. His article described housing “as an accident waiting to happen.” Actually it’s brilliant when you think about it: take a distant, almost academic tone and perhaps people will ignore the facts that: first, you allowed the situation to develop; second, did not apparently see it forming (despite 2½ to 3 standard deviation data for housing that suggested a 1 in 80-year event); and third, obliquely or directly blame others. It really is shameful!

Looking back at the evidence (strong circumstantial evidence is all you can often get in economics), we can see that the two great economic setbacks of the 20th Century – the 1929-34 Depression and the rolling depression in Japan since 1989 – were both preceded by major asset bubbles and speculation. Milton Friedman and his troops can maintain that this suggested relationship between bubbles and troubles is nonsense and that all that was needed was good monetary policy. My response is that this view represents a touching faith in economic and financial theory of which tricky humans make a mockery.

Equities, though, are the Mr. Hyde to fixed income’s Dr. Jekyll. Where poor Dr. Jekyll sees drawn out problems, Mr. Hyde sees opportunities and quick recoveries. The animal spirits of the stock market have been nurtured by strong fundamentals and generous credit globally and fertilized by increasing quantities of moral hazard since 1982. Stocks refuse to worry that this is indeed the end of an era, as we believe, and apparently as much of the fixed income market believes. This has been a classic case where secondary, low-quality companies that have fundamentally thrived in this extended boom ended up with both peak margins and a premium P/E. Because of this past favorable set of circumstances, the low-quality companies are exposed to a triple threat: their absolute and relative margins decline; their P/Es fall relative to the market, multiplying their pain; and they are far more exposed than average to a severe credit crisis. still believe that the U.S. market will not bottom for some time – 2010 still looks good – we must be prepared for plenty of rallies to fill in the time. High animal spirits, fortified for so long by good times and moral hazard, will not give ground easily.

David Kotak (Cumberland) :

The minimum bid in the most recent auction (April 21) was 2.05%. In the previous auction (April 7) the minimum bid was 2.11%. In the most recent auction the stop out rate which was awarded to all bidders was 2.87%. In the previous auction the awarded rate was 2.82%. So the minimum bid went down while the award rate went up. The spread widened by 11 basis points. That is not suggestive of a market returning to normalcy.

Remember that this auction occurs when the Discount Window rate is 2.5% and when the targeted Fed Funds overnight rate is 2.25%. And it is important to understand that the minimum bid specified is a market based price of the expected Fed Funds rate over the 28 day term. We should also note that the TAF auction rate was very close to LIBOR. And LIBOR has been the subject of much negative press recently as followers of money markets know.

Our conclusion is that credit markets are still dysfunctional and the process of normalcy restoration has a long way to go. And there seem to be reasons why banks are reluctant to borrow and extend credit to others in the banking fraternity. Some suggest that there is distrust of banks by other banks. They call this counter party risk. Others suggest that banks are hoarding cash and quoting higher interbank lending rates in order to discourage borrowing.

We offer this final note. Various measure of spread based risk premiums have been at extraordinary levels since last June when the turmoil started. These widened spreads are taking an economic toll. We expect that the Fed will persist until it gets them to narrow.
If the Fed fails, we will have a difficult and protracted deflationary recession. If the Fed succeeds, the slowdown will be shorter and shallower. The Fed’s success will be easily measured in the narrowing of spreads. In the case of the TAF one will see the stop out rate fall to a level closer to the Discount Window rate.

John Mauldin: (Money Velocity mean reverting)

Now, why is the velocity of money slowing down? Notice the real rise in V from 1990 through about 1997. Growth in M2 (see the above chart) was falling during most of that period, yet the economy was growing. That means that velocity had to rise faster than normal. Why? Primarily because of the financial innovations introduced in the early 90's like securitizations, CDOs, etc. It is financial innovation that spurs above trend growth in velocity.

And now we are watching the Great Unwind of financial innovations, as they went to excess and caused a credit crisis. In principle, a CDO or subprime asset backed security should be a good thing. And in the beginning they were. But then standards got loose, greed kicked in and Wall Street began to game the system. End of game.

What drove velocity to new highs is no longer part of the equation. Its absence is slowing things down. If the money supply did not rise significantly to offset that slowdown in velocity the economy would already be in a much deeper recession.

Bill Miller :

I think the credit panic ended with the collapse of Bear Stearns, and credit spreads are already much improved since then. If spreads continue to come in, the write-offs at the big financials will end, and we may even have some write-ups in the second half instead of write-downs. Valuations are attractive, and valuation spreads are now about one standard deviation above normal, a point at which valuation- based strategies usually begin to work again, and momentum begins to fade. I think likewise we have seen the bottom in financials and consumer stocks, but not necessarily the bottom in headlines about the woes in those sectors. Although the economy is likely to struggle as it did in the early 1990s, the market can move higher, as it did back then.

The wild card is commodities. If commodities break, or even just stop their relentless rise, equity markets should do well. If they continue to move steadily higher, they have the potential to destabilize the global economy. I agree with George Soros that commodities are in a bubble,
but it also appears he is right when he describes it as one that is still inflating, and we still have the summer driving and hurricane season with which to contend.

The Fed, in my opinion, needs to focus on the value of collateral and not on the price of credit.

Michael Kahn (Barron's getting technical):

Helping the bullish argument: The S&P 500 index has been able to hold its ground over the past few days. Mild pullbacks are often due to profit-taking rather than an urgent desire to get out of the market or sell it short. Contrast recent action with the January, February and early April peaks when the market sold off sharply within only one or two days. Strong markets tend to pause at resistance levels as they prepare to break out to the upside.

Market bears point out that volume over the entire March-April rally declined. I am always harping on how a rally without volume is like a car on an empty fuel tank. It can coast, but powering higher is unlikely.

But the index made a slightly lower low in March than it did in January, while technical indicators such as momentum made a higher low. This divergence between price and indicators is somewhat bullish and that makes resistance at 1395 for the S&P 500 important from a long-term point of view as well as from the short term.

A move above that level would also resolve a long-term pattern to the upside at the same time as breaking out from a shorter-term pattern. It is decision time for the market. There is technical evidence favoring both bulls and bears so we have to let the market decide who is right. Drawing a conclusion while the S&P 500 and many other indexes are in four-day pauses below key resistance levels is a bit hasty.

John Thain:

On the capital side, we've increased our stated capital from $36.7 billion at the end of the fourth quarter to $41 billion. We are well capitalized under the risk weighted asset tests. And, for those of you who like to blog, we do not have any plans to raise any additional common equity, and Nelson actually agrees with that.

Deutsche Bank:

Germany's biggest bank today banned staff from visiting brothels on expenses and putting hotel TV porn channels on their company credit card.

The crackdown came in new rules issued to executives as Deutsche Bank cuts costs after losing at least £2billion so far in the global credit crunch.

"Deutsche Bank does not approve of any adult entertainments and such expenditures will not be reimbursed", according to the memo leaked to news magazine Spiegel. According to Spiegel, the new edict was aimed at senior staff in the bank's communications and social responsibility department.

Read the rest of this entry >>

Saturday, April 26, 2008

Weekend indicator review: continuation of the uptrend.

I was looking at some of the indicators I have reviewed before, and I see a continued rotation among asset classes.

In the last review, TIPS had started breaking down and the ten year bond yields had just started breaking out. This review is a continuation of the trend I had first highlighted in the earlier post.

Yen is up. Carry trade is back, or at least the unwinding of the carry trade is over for now. I won't be surprised to see Yen hitting 108 on the dollar with the current momentum.

VIX looks oversold. The last time it was as much under the 200 day MA as it currently is, equities performed well for quite some time (late 2006). (No chart) . VIX bottoming indicator is not as reliable as when VIX reaches new highs, so take this with a pinch of salt.

Ten year yields have also broken out, suggesting this might just be a little more than a counter trend rally, and we'll at least break the previous trading range.

Similar conclusion with the TIPS. Breaking down, after being an asset class of choice for the past few months.

All the indicators look like they will hit the 200 day moving averages of their respective charts. Stocks should be headed up/sideways at least until that happens.

Note that I use these indicators to get a broader feel of where we are on an intermediate term basis. These are the supporting arguments, not the main ones. You know you should have been playing on the long side given the panicky investor sentiment earlier this year: supported by the oversold readings, high put-call ratios, record bearish AAII sentiment reviews, and VIX levels in excess of 30.

My gut feeling is that this a momentum driven rally because of the oversold conditions we had earlier this year. Since we have some ways to go before hitting the 200 day MAs, I would be comfortable being long for the next two weeks. Remember to have those stop losses! A Fed week, and the month-end window dressing makes me even more certain of that.

There’s a bunch of cash sitting on the sidelines. The rotation which I highlighted above suggests that this is being deployed in the markets. A break above 1400 on the S&P 500 should see a fresh surge towards 1430. Position yourself before the crowd does.

Given the low volatility numbers, it might be an interesting trade to load up on long straddles on the Spiders (SPY). We either break out, or go back towards the lower end of the trading range.

Adam chimes in with his thoughts. He is reminded of April 2001.

Watch the breadth or momentum indicators for possible divergences. Stock charts has a nice market summary page which I find very useful. Or just check out what Brett is saying about his money flow indicators!

On a fundamental/sentiment analysis level:

-I don’t think we’ve seen capitulation yet. There’s been no blood on the street, just an orderly ~15% decline.

-Investors who forget about CDS, ARM-resets, Fannie Mae leverage ratios, do so at their own peril!

-Valuations don’t look that great either.

-I think 1350-1400 could possibly be a year-end target, suggesting a possible late summer shakeout.

-Mean reversion in profit margins, with high commodity prices and a tough consumer environment.

If you're in it for the long haul, just stay invested and ignore these gyrations. Market declines like the ones we've seen have always been excellent investment oppurtunities with a five-year time frame.

If you found this useful, please drop me a note. I'm compiling my weekend quotable quotes list. Will send it out tomorrow night.

Stay tuned.

Read the rest of this entry >>

Thursday, April 24, 2008

Analyzing TI's current quarter

This is the first of a three part series.

This post discusses Texas Instruments Incorporated (NYSE:TXN) just concluded F1Q08 quarterly results. A later follow up post will discuss TI’s product offerings and a SWOT analysis of their competitive strengths based on their technology and market strategy. Finally, I’ll discuss TI as a stock investment thesis.

In the current quarter just concluded, TI reported revenues of $3.27 billion and an EPS of $0.49. The highlight was the growth in their high-performance analog segment, with revenues up 20% year-over-year (YOY). Overall, revenues declined 8 percent sequentially primarily due to weaker sales into cell phones, especially in the high-end segment.

Expenses: R&D expenses were down 6.8% YOY, primarily due to sourcing of the digital process technologies from foundry partners.
-SG&A was up 7.4% as they have been investing in Field Applications Engineers and customer support to accelerate analog sales growth, especially in the application specific area.

Margins: Gross margins were up due to higher sales of high margin analog products.
- Management has set a long term goal of achieving gross margins of 55% and operating margins of 30%.

DSP revenues: Declined due to lower sales into cell phone applications (75% of the DSP revenue is through handsets).
- DSP security and surveillance market sales were up 63% YOY.
- Their ultra low power microcontroller product line MSP 430 should potentially deliver higher revenue growth going forward due to its prevalent use in an increasing number of new applications. (They didn’t break out the revenue component)

Analog: Their analog revenues were up 6% YOY, driven by stronger demand for high-performance analog products. 45% of their analog revenues were from the high performance analog segment, which grew 20%. This was across all major product categories: amplifiers, power management, data converters and interface. There were gains in hard disk drives, automotive as well as battery management products.

New product introductions included medical ultrasound diagnostic equipments, Class-D audio amplifiers, and a prototype cell phone based on Google’s Android using TI’s OMAP processor. TI entering the application specific space in a big way is definitely not good news for smaller players in niche analog markets.

Raw material costs: I see a risk here of high raw material costs impacting their gross margins.

Cashflow: Business is throwing off nice cash flow and rewarding patient shareholders with buybacks and dividends.

Share count: Diluted share count down 8.3% YOY (Nice!)

Auction rate securities alert! Time for the “Oops! I know what you did last summer” moment!

TI had invested approximately $1 billion in auction-rate securities, essentially student-loan pools. They could offload only $473 million, and are left with $551 million. To avoid taking a mark-to-market hit on their quarterly profit reports, they reclassified these securities from short-term to long-term investments. These will be held to maturity at their cost value, which will be checked periodically for an impairment charge. Their net income could have taken a $20 million hit had they not done this. (They’ve already recognized a $20 million impairment on their balance sheet). Assuming a worst-case situation of a 20% hair cut on the ARS securities and TI's inability to offload the remainder of the ARS, you're looking at a $100 million loss which investors should watch out for in the shareholder equity on the balance sheet. Definitely not chump change!

- Herb Greenberg had an article about this discussing a Merill Lynch report in February, which was categorically denied by TI's investor relations department as 'superficial'. I thought TI gave a very reassuring reply to this situation.

-Auction rate securities information was mentioned in the press release for the quarter, but no mention of any impairment charges. In the conference call remarks, they did disclose the impairment charge to the shareholder equity.

- I did not see a separate line item on the balance sheet for breaking this out. If you look at Palm's 10Q, they have a line item for this impairment in both the income statement and the balance sheet. (TI didn't release their 10Q yet though, so this might change.)

-While reclassification to long term debt is ok, just want to point out that Palm and MetroPCS took an income statement hit from the ARS impairment. On the other hand, TI's ARS are mostly student loans and so they really should be fine. My 2 cents: the due diligence at TI was more rigorous.

High inventory risk alert! TI reported inventories of $1.58 billion. A third of the inventory build up was related to the wireless business, due to unexpected build to plan changes (not good). Translation: A customer just backed out/delayed their order. We hope they’ll be back and not go to the second source for their supplies! In their defense, this sounds like a softness-in-the-market issue.

“As we explained in our mid-quarter update that product was already being manufactured when we received the changes so we carried more inventory of this product than we had initially expected at the end of the quarter.”

That’s about $526 million. Even a 20% inventory writedown would imply a $100 million charge: something investors should keep an eye out for. While too early to speculate, it’s important to factor in a possibility of that in your valuation models, and hence demand the appropriate risk premium for it in your DCF valuation.

(Note that two thirds of their inventory (the analog inventories) should be fine, as analog products tend to be stable with long life cycles. )

Outlook: Hold recommendation on TXN. With Nokia Corporation (NYSE:NOK) and Ericsson(ERIC) looking at second source suppliers for their chips, it’ll be difficult to model TI’s wireless revenue stream. That, coupled with the difficult macroeconomic environment, colors me cautious on their near term to intermediate term prospects. Caveat: Since analog revenues tend to be more resistant to fluctuations in the economic cycle, TI's revenue stream might be less volatile than some of the other chip vendors.

Ticker symbols mentioned : TXN, NOK, ERIC

Full Disclosure: No positions in any of the securities mentioned above. Opinions expressed are my own.

Read the rest of this entry >>

Wednesday, April 23, 2008


A shout out to Abnormal Returns for carrying my earlier post on overanalytical Apple reporters as one of the blogosphere posts for the day. It also got published on SeekingAlpha and Yahoo Finance.

I appreciate the interest, and would welcome any suggestions / comments. Writing this blog has been one heck of a learning experience so far.


Read the rest of this entry >>

Tuesday, April 22, 2008

Apple analysts: Reading too much into daily stock market gyrations?

It's not very common to see two different media outlets come out with two different explanations behind a stock's decline. Especially if the stock is a market darling like Apple.

Apple Inc.’s(NASDAQ:AAPL) finished Tuesday down 4.73% (7.96) to 160.20. Let's see if we can find out why. Before the market open, Apple's shares were downgraded by AmTech Research.

Marketwatch ran a story, attributing the decline to the downgrade.

"This was a very tough decision as we have been bullish on Apple for the past several years," Wu wrote in a note to clients, adding that the stock has more than tripled in that time.
The move seemed to cool some of the enthusiasm around the stock. Apple shares slid $7.96, or 4.7%, to close at $160.20. The stock has come up from the $120 range seen last month but is still off its all-time high of $200 seen at the end of 2007.

Eric Savitz also blogged in the morning, seemingly pointing to the same conclusion.

In the meantime, AT&T Inc.(NYSE:T) released their earnings, and had an earnings call. Apple kept drifting down. Techcrunch came out with the headline: "Apple shares slump as AT&T Gives Vague Details on iPhone Growth"

Were both of them right? Or were both of them wrong?

Remember, the earnings downgrade was before the opening bell. If the downgrade had been such a negative event, I would have expected the stock to gap down. However, Apple opened only about a $1(0.6%) lower than it's Monday's closing price and continued drifting downwards till a little after noon. This was inspite of the Lehman Brother's upgrade, that too as a top pick with a $195 price target, which kicked in around 10.45 am EST..

Interestingly, the S&P 500 gapped down by a similar percentage at the open(0.6%), and continued to move downwards till around 1 pm, after which it drifted sideways.

Remember, Apple is a high beta high flyer (Beta of 2.9 from Yahoo finance). A decline of 3% in Apple on a 1% down day would be par course given it's historical volatility and high beta. Could the real reason be a decline in line with the market, in addition to some profit taking in an overbought stock? Remember, Apple is up nearly 45% since bottoming early this year.

So what do you think was the real reason for Apple's downward movement?

1. AmTech downgrade?

2. AT&T being vague about iPhones?

3. The market being down on Tuesday?

4. The market being down AND profit taking in an overbought stock?

The truth be told, no one really knows the reasons behind the daily gyrations of the stock market. Investors will be wise to shut out the short term noise and focus on the long term signals. Freakanomics has an interesting post on over analyzing short term market gyrations.

Ascribing a cause and an effect to every short term market fluctuation reminds me of our ancestors who would sit under a starlit night and point out shapes in the sky: the Orion, the Big Dipper.

This ain't too different.

Except the constellations at least served as navigational aids. These constant rationalizations and explanations only confuse the average investor.

As Benjamin Graham famously said: In the short term, the market is a 'voting' machine. In the long-term, the market is a 'weighing' machine.

Ticker Symbols mentioned : AAPL, LEH, SPY, T

Disclosure: No positions in any securities mentioned above.

Read the rest of this entry >>

Laid off AMD employees eligible for conference discount.

In a kind and considerate gesture, The Austin Conference on Integrated Systems & Circuits 2008 announced a special price for the AMD engineers who lost their jobs in the recent round of layoffs.

The regular registration price is $175, but the ex-AMD employees can register for a student price of $50, which includes admission to the conference, meals, and embedded tutorials. This should be a great networking and learning oppurtunity.

That’s a nice gesture on the part of the conference chair members. Except why limit it to only AMD? Why not also include other companies who have had announced/unannounced layoffs this year? (I know of at least one company where ~8% employees based in Austin were quietly let go, with no press announcement.)

Austin tech sector is in a funk. You only need to look at Freescale, AMD and Dell to realize this.

Disclosure: None

Read the rest of this entry >>

Monday, April 21, 2008

Profiting from the market gurus: quotable quotes.

This is a weekly update on what I've been reading and watching. Here's what the market gurus are saying and how they are positioning themselves in the near future.

  • Lakshman Achutan (ECRI) : "There is a recession here. The earliest the recession would end would be the end of this year, but first we're going to see job losses, more foreclosures, and the credit situation is not going to be helped."

    • Warren Buffett: What Warren thinks..

      1. On the current turmoil:

        "It seems everybody says it'll be short and shallow, but it looks like it's just the opposite. You know, deleveraging by its nature takes a lot of time, a lot of pain. And the consequences kind of roll through in different ways. Now, I don't invest a dime based on macro forecasts, so I don't think people should sell stocks because of that. I also don't think they should buy stocks because of that. "

      2. On investment strategy:

        "You don't want investors to think that what they read today is important in terms of their investment strategy. Their investment strategy should factor in that (a) if you knew what was going to happen in the economy, you still wouldn't necessarily know what was going to happen in the stock market. And (b) they can't pick stocks that are better than average. Stocks are a good thing to own over time."

      3. On if people are fearful, and if this was a good time to be greedy.

        "You're right. They are going in that direction. That's why stocks are cheaper. Stocks are a better buy today than they were a year ago. Or three years ago. "

    • David Kostin, the chief US investment guru for Goldman Sachs : Expects the S&P 500 index of Wall Street equities to plummet a further 15pc over the "near term" as companies scramble to lower their outlook for this year. Expects the S&P index to reach 1,160
    • Scott Anderson, chief economist of Wells Fargo:
    1. "The equity markets have not yet priced in a prolonged downturn in economic growth in my opinion. We are still in the early stages of the credit crunch. Earnings estimates for the second half of the year are likely still far too high" He described the bullish views of some market players as "bordering on delusional".
    2. Mr Anderson said investors should pay attention when the International Monetary Fund cuts its global growth forecast for 2008 three times in less than five months. The Fund has put the odds of a world recession at 25pc and predicted $945bn in losses from the credit debacle spread across banks, hedge funds, pension funds, and insurers.
    3. "Even more alarming, the IMF estimates that only a quarter of these potential losses have been recognized," he said.
    1. Housing recession is getting worse not better.
    2. US consumer is shopped out and saving less, buffeted by falling housing prices and rising oil prices.
    3. Credit crunch

    Monetary policy will be less effective. Problem in economy is not of illiquidity but of insolvency. We have problems due to bankrupt households, bankrupt mortgage lenders, bankrupt corporates, bankrupt financial institutions, and bankrupt homebuilders.

    Jim O Neill on recession: The recession is in US domestic demand. Overall GDP is getting a big help from overall exports. This is softening the blow, and hence US recession will be shallow.

    Roubini on global coupling: Global coupling/decoupling depends on whether we have a severe or shallow recession. In a severe one, the transmission mechanism through the trade channel, credit crunch, weaker dollar, and the financial institutions would lead to a severe slowdown of the global economic growth.

    Roubini on Europe: We have the slowdown, deflation of the housing bubbles, the high oil prices, and a Fed that is cutting while ECB is on hold. A lot of Europe's growth was based on extra demand rather than income growth. The credit crunch is effecting European firms ability to borrow.

    • Gerard Minack, Morgan Stanley strategist: After-tax corporate profits relative to U.S. gross domestic product are "well above sustainable levels. A U.S. recession and increased competition will cause earnings to decline. " "If profits fall as much as I think they could, then markets are not cheap,'' Minack wrote.
    1. Healthy rotation, with techs, financials stepping up.
    2. Commodities lagging.
    3. Options expiration induced heavy volumes.
    4. Improving technicals:
      a) Dow breaks through Feb highs
      b) A/D line advancing
      c) New highs expanding
      d) VIX falls to four month low.

    1. Rotblut: Can earning’s momentum continue this week? More positive surprises than negative surprises. Lot’s of rallying in financials off negative news.
      Q1 scorecard: Median EPS growth 8.6%. Average EPS growth: -27.2%
    2. Mike: Big Pharma reports next week. Growth drivers are company specific. Most big pharma are bolstering earnings by huge cost reductions and buybacks on the back of the weak dollar.
    3. Charles: Hitting against some pretty tough resistance, especially with oil at $116 and inflationary pressure. Fed officials worried about inflation. Not sure if economic backdrop strong enough to sustain a rally. There is optimism that the second half will be better. Any upside breakout will be extremely bullish.
    4. Jim: Bar for the tech companies has been set really low. Meeting expectations should be a slam dunk. Based on what we saw from Intel, IBM and Google, this momentum should continue and take us right upto HP’s earning.

    1. Caution a bullish sign to contrarians
    2. As of Friday night, the HSNSI stood at 27.5%.That's exactly where the sentiment gauge stood Thursday night, and the previous Friday night as well.

    • Bill Gross on hedge fund pay:

      Well, it's a lot of money. I'm all for capitalism. PIMCO is a great capitalistic firm

      We make money. We sell lemonade. We sell it at 50 cents a glass however and hedge funds sell them at 5 bucks. If you're going to sell lemonade for 5 bucks you better have a shot of tequila or a shot of vodka in there to juice it up. And my point is that hedge funds over time don't have that vodka or tequila in that glass, and they are overpricing their products. That's fine, but over time the public will get wise and their lemonades will go to the PIMCOs of the world.

    1. On Profit Margins: Because CPI growth rate (4%) is less than PPI(7% growth), profit margins are falling from 12.5 cents on the dollar to 10 cents on the dollar, or roughly 20-22% fall, in parallel with the non financial domestic earnings fall. Business prices are higher than consumer prices, and businesses have to eat that difference
    2. Real wages are falling.
    3. Coincident indicators point to a flat economy, not a recession.
    4. Stefan Abrams: Domestsic profit margins are under pressure. International profit margins are expanding.
    5. Bad policy to fight the fed. Tbills are yielding almost nothing. This should encourage a movement into risky assets. It’s all about globalization.
    6. Kevin Kerr: Profit margins squeezed primarily because of energy costs.
    7. High LIBOR: cost of borrowing just went up.

    1. We think markets made a bottom in the middle of January. If we are going to have a shallow recession, markets will move before the end of the recession cycle. If that is a bottom, you should be invested and be a buyer of stocks, and we are fully invested in our accounts.
    2. We think it could go back and retest the bottom. If we go lower, then it would suggest that we are in a prolonged and protracted deflationary environment. There is just so much force at work in a stimulative way to avoid that, and I think that force will work.
    3. Big tech cycle ahead of us.

    • Teun Draaisma( famous for calling the market top in June 2007) :
    1. “2008 the Best Period for Shorting Since 2002"
    2. "You can expect years of deleveraging as leverage in the financial sector is very high," said Teun Draaisma, strategist at Morgan Stanley, adding that he expected markets to stay bumpy for a while.
      "On a 12-month view, earnings expectations are too high, but equities are quite cheap and there's no massive downside. We expect volatile markets that won't go anywhere for the next year," he said.
    3. Expects a reasonable first quarter but forecasts a 16% drop in earnings over the whole year.
    4. Predictions for the bear market rally till July 17th "The trigger for a bear market rally is invariably dramatic action by authorities. The ‘financial end of the world’ has been avoided, we believe, but that still leaves us with a big earnings recession. At some point, the earnings recession takes over again as the driving force in this market, but possibly not in the upcoming reporting season yet, as this one will not reveal the full extent of the earnings recession."

    1. S&P Midcap Index is the first of the major US indexes to break above the 200 day MA. This is a continuation and validation of the up move we've had since April 1st. Some of it is short covering. I Suspect we have further to go on the upside. Looking at 1450 on the S&P 500.
    2. Gold has made at least an intermediate term top.

    1. UBS: Gearing for a big rebound, convinced that the Fed's move to shoulder $30bn of Bear Stearns liabilities has changed the game. In its latest report -"Ready for a Rally" - it said financial shares rose 448pc in the 12 months after the Swedish rescue in 1992, 88pc after Japan's Revitalisation Law in 1998; and 82pc after Roosevelt's Emergency Banking Act in 1933.
    2. Societe Generale: Pessimistic. "We expect global equity prices to fall by up to 75pc from their peaks as a deep global economic downturn unfolds over the next few years," said Albert Edwards, their global strategist. He fears a 50pc collapse in earnings, compounded by an "Ice Age derating of equities".

      It may echo the Lost Decade in Japan, where stocks fell 80pc. The yields on state bonds kept falling as debt deflation engulfed the banks, thwarting efforts to nurse lenders back to health by the usual device: "steepening yield curve". The authorities were left chasing their own tails. Having lived through this, Japan's chief regulator Yoshimi Watanabe has advised Washington to go for a quick taxpayer rescue, rather than trying "to fix the hole in the bathtub".

      Whatever happens, there will always be tactical rallies. Mr Edwards cites four Wall Street bounces above 25pc in the 2001-2003 bust. The buying cue is when investor gloom nears black despair. The put/call ratio on options is now at a bearish extreme of 0.90.

      "That would historically suggest that a joyous 25pc spring rally is close at hand," he said. Yet Mr Edwards remains wary as long as analysts cling to their belief that earnings will rise 11pc in 2008. This is not the sort of "washout" level of gloom required to clear the air.

    3. Draaisma: Expects the current rally to boost Europe's MSCI 600 index by 21pc from its trough in late January, with similar moves on the S&P 500. Prefers builders and banks

      "The Federal Reserve's actions have averted financial Armageddon, but they cannot avert an earnings recession. We don't expect a new bull market until early 2009,"

      Morgan Stanley says earnings will fall 16pc this year as debt leverage kicks into reverse.

      "Bear markets are terrible for the human psyche. You get one profit warning after another. People see their hopes dashed so many times that they stop believing," He is not predicting a bloodbath along the lines of 1929-1933 (-88pc) or 2001-2003 (-49pc): just a long slog, with failed rallies.

      For now, the markets are flashing a tactical buy signal. Mr Draaisma's "capitulation indicator" has crashed to the lowest level since the 1998 LTCM crisis: the share "valuation indicator" is near an all-time low.

    Disclosure: None

    Read the rest of this entry >>

    Thursday, April 17, 2008

    The bullish thesis for a rally: a technical indicator review.

    While we could be in for a rough period for the remainder of the year, there is a growing conviction that at least an intermediate term bottom has been set, and we could be due for a rally. A few indicators point towards increasing risk appetites amongst investors. Here's a review of some of them:

    • The yen carry trade(JPYUSD) trade is extremely oversold right now, and below 200 day MA. There's always a reversion to the mean with respect to the 200 day MA. Resumption of the carry trade has been bullish for equities in the past.

    • Tips look like they've entered a period of downtrend, indicating growing risk appetites.

    • Bond yields rallied and broke their downtrend, at least for now. (Hat tip: Bespoke group) Previous bear rallies failed at this level. That's a positive.

    • S&P broke through the 50 day MA decisively and has been making a series of higher highs and higher lows since the March lows.

    • VIX in some sense anticipates future stock market volatility. The 200 day MA has acted as support ever since the credit turmoil began. VIX dropped below the 200 day MA. This should imply lower volatility for the next few weeks, which in turn is bullish, assuming of course that it stays below the 200 day MA. It looks like a correction in the long term upward trend in volatility (that's not a clever way to look at this though) .

    • Credit default risk on the investment banks has declined dramatically. (Hat tip to the excellent folks at Bespoke again) Is it time for a rally in the financial sector?
    • Traderfeed has some more thoughts on why we could have hit a market bottom.

    If Dow Industrials can close above 12,750, it will trigger a Dow Theory buy signal. (Refer to this post on the strength of the transports). Alongwith a break of the S&P 500 above it's overhead resistance at 1390, that should pull in new money, and help the averages up another 5-10%, if we can close above these numbers.

    Disclosure: None

    Read the rest of this entry >>

    Wednesday, April 16, 2008

    Dissecting Intel's quarter.

    The investment thesis in Intel consists predominantly of :

    1. Competitive wide moat 45 nm strategy, and aggressive pursuit of Moore’s law.
    2. Low cost differentiator due to economies of scale.
    3. Margin expansion due to lower ongoing costs and operating expenses.
    4. Potential growth by targeting new markets like Consumer Electronics (CEs), Mobile Internet Devices (MIDs) and Ultra Mobile PCs (UMPCs).
    ( Discussed in a later post. This post discusses their current quarter)

    Intel posted mildly positive results, which was good enough given the lack of optimism. Intel breaks out their results into the digital enterprise group (servers, PCs) and the mobility group(notebooks, netbooks).

    Revenues came in at $9.7 billion, with a net income of $1.5 billion. Revenues were impacted by a higher tax rate, and asset impairment charges. Company guided to a $9 – 9.6 billion revenues for Q2, and gross margins of 56%. For 2008, the company’s expects $5.2 billion in Capex, $6 billion in R&D and $5.9 billion in SG&A expenses.

    Let’s dig a little deeper.

    North America: Strongest growth this quarter (up 17%), thanks to a strong demand for high end 45 nm server chips. Their new quad core is their competitive strength here, (helped with the delay in Barcelona). Flat ASPs (average selling prices) in microprocessors.

    Growth drivers in this segment were large internet datacenters and infrastructure build out for cloud computing. The important question to ask is this: Will the IT spending in the US remain resilient? If a business slowdown in the latter part of the year/next year occurs, any effect in IT infrastructure budgets could potentially impact sales in this segment. A justification was made based on the return on investments because of the energy efficient solutions, but color me skeptical. It can also be argued that in a slowdown, IT spending would go up because of productivity gains. It didn’t happen the last time around, and IT spending remains correlated with business spending. It’ll be interesting to see if virtualization and cloud computing have any effect on sales of microprocessor chips.

    Margins: One reason margins were higher was because of higher utilization of factories for inventory buildup.The 45 nm ramp in shipments was predominantly in the high-end server segment.

    Margins for the desktop group ticked up because of high end server chips, while the mobility group saw a decline in their margins. Since mobility comprises an increasingly larger part of Intel’s revenue source, they will also shoulder a bigger chunk of the cost of production. Moreover, there was an increase in advertising for the mobility (Centrino) based product line. Mobility has had sharp ASP declines, and this trend should continue or accelerate with the introduction of their mobile internet devices/ Ultra-mobile PCs. Intel is pursuing a cost reduction strategy in this segment by introducing a lower bill of materials solution. It needs to do this in order to maintain it’s margins.

    Shift of expenses from SG&A to R&D for qualification of 32nm could depress gross margins in coming quarters. This is possibly the biggest reason I could be negative on Intel, and adopt a wait and watch strategy for at least two quarters. I see limited upside if they can’t use their operating leverage. Caveat here is that their cost reduction turnaround has produced good results so far. Also, in the ramp to qualify their earlier process technology in 2006 (45 nm), they were locked in a bitter price war with AMD, which really affected their profitability. Will history repeat? I don't think so.

    Buybacks: Intel has had a strong buyback for the past few years(it bought back $2.5 billion this quarter). Unfortunately, the buyback hasn’t shrunk the share count yet, because of stock dilution caused due to employee stock options. Given that Intel started awarding more stock based incentives sometime in 2005/2006, I would expect that going forward 18 months or so, buybacks would actually start shrinking share counts, and be accretive to the EPS figures.

    Currency affects: Intel gets 75% of their revenues from outside the US. A strong Euro/Asian currencies and a weak dollar is good for Intel. Since their components are priced in dollars, it simulates demand in the European economy, and is responsible for the above trend growth there.

    Emerging markets: For emerging markets, appreciating local currencies drive PC and notebook penetration by making Intel’s products more affordable to a wider population. Increasing wage growth in India and China should accelerate this trend as well. Laptops are a fashion accessory (all across the world actually).

    Restructuring: Intel’s restructuring program is producing good results. Employee head count is down to 84 thousand. They are conservative on Capex, R&D and SG&A. This should help in mitigating costs while they qualify 32nm.

    Volume growth: Since notebooks have a quicker replacement cycle than PCs, this should drive volume growth, offsetting the ASP erosion. This trend towards volume growth should accelerate with Intel’s foray into new markets, more than offsetting the ASP declines.

    Netbook launch: Should open up new markets with their aggressive price points. Most sales will be in mature markets and tier one cities in places like China. This needs a separate post. I’ll just add that in this segment, the wireless connectivity solutions and added functionality, and not the microprocessor strength, is what will drive adoption rates. Intel has been going down the WiMax route. We could see a sharp deacceleration of growth or even a decline in the notebook segment should these $200-$300 products catch on. This market is not the duopoly like the notebooks/PC markets were. Is Intel’s microarchitectural strength a valid edge here? (I’ll address this in another post)

    Intel needs the new markets. PCs are in a decline. Laptops will be increasingly replaced by smaller form factor wireless mobile devices. Like the notebook became the replacement for the desktop, I view their Atom line as a replacement to their notebook products at some level. Only difference is that notebook chips were low volume high ASP, while the UMPC segment will be at a lower ASP. It would be nice if going forward they broke out that revenue segment in a separate category.

    Technicals: I like Intel’s chart. It looks neutral in the intermediate term, given that it’s below 200 day MA, and broke it’s upward trend channel. However, it’s been consolidating for a few months now. There looks like a long term support on their chart going back to 2002, and a potential double bottom. MACD is ticking up to a potential crossover, but I’d hold off for now.

    Conclusion For long term investors, I like the risk-reward situation with Intel. Given its generous yield, share buybacks and competitive moat, the company has maybe a 10-15 % downside in the worst case situation, and plenty of upside with new markets, international growth and operating leverage. That’s an attractive proposition in this volatile environment. Intel remains one of the best names for new money in the blue chip investment universe.

    Disclosure: No positions in any securities mentioned above.

    Read the rest of this entry >>

    Sunday, April 13, 2008

    Market commentary by Citigroup’s chief strategist.

    I saw this interesting interview of Tobias Levkovich on CNBC last week. He shared some good points:

    • Market Valuations: His price target is 1550(S&P 500), based on valuations, sentiment, and implied earnings growth. Predicts flattish earnings(~$86) in 2008 and 2009 for S&P500. Energy and materials will underperform in 2009 (because of declines in the commodities sector). This would be offset by outperformance in the financials and the consumer discretionary. Refused to discuss specific valuations. Valuations need to be discussed based on risk premiums, historical context, and bond yields; and not in a vacuum. Pointed out that homebuilders looked deceptively cheap in 2005.

    • Commodities: Cyclical conditions will effect the commodity trade severely. To put it simply, commodity prices do go down in a recession. (Note: I discuss this in my post here). A similar thing happened during the inflationary 1970s recession. Agriculture, fertilizers and the chemicals look like the dot-coms.

    • Savings rate: This is going to get worse in the next 5-10 years because of demographics. Retiring baby boomers would be using their savings. (This would be worldwide.) Not really a problem because wealth is growing enormously. Implication: Savings rate isn't a useful metric anymore. This could potentially have negative implications for the markets?

    • Elections: Current year would be the first time since 1928 that sitting President or VP isn't up for reelection. So the administration doesn't have the motivation for election year stimulus that normally happens. Conclusion: Historically, election years have been good for the stock markets. May not be true this year.

    • Asia: Asian companies have really low return on equities (ROEs), even though asset turnover is at a 16 year high. Whenever this turnover goes low, the ROEs will collapse. Don't want to be there when that happens. Not sure where this data point came from, but this is interesting if true. (Note: To understand the DuPont ROE breakdown, refer to this entry)

    • Real estate: Real Estate bubble and appreciation are far worse outside the US. So you cannot point to the US selectively. I agree. Except the problems in the US are not just about house price appreciation, but caused primarily due to negligent and fraudulent lending practices.

    • Post-elections: Critical issue for the post election year is this: are we moving towards more protectionism? Will we abrogate on tax treaties? What about tariffs/ protection quotas? Could be very devastating for markets. Asserts that taxes will go up across the board regardless of who gets elected. This is because they will look to fix AMT before they extend the Bush tax cuts.

    • Markets: He talked of a W shaped pattern in the markets. Things will get worse before they get better. The worsening credit conditions effect the economy with a 9 month lag. Hence mid-year to year end, we'll still have problems and will see a slowdown in the industrial side of the economy. Earning estimates for the year end are still too high. Note that there has been some chatter about a double-dip recession. See this and this. Double dip is essentially a W pattern.

    • Industrial sector: Talked about an industrial sector slowdown. Even though people talk of resilience in the US exports and the BRICs, two thirds of the “international” for US companies is in Europe. This could hence slow down.

    Disclosure: None.

    Read the rest of this entry >>

    Sunday, April 6, 2008

    On the strength of the transports, and commodity weakness..

    From the video interview of Barry Ritholtz, came across this interesting comment:

    Coal is a huge story. Strength of the transports does not mean economy is getting better. Thanks to a weaker dollar, we are exporting a lot more fertilizer and coal. North America is the Saudi Arabia of coal. (Likes ACI)

    The basic point is that the transports reflect the underlying strength of the agricultural(commodities) and the energy sector, which the industrials don't. Dow theory as practised in the past may not be a relevant barometer of domestic stock market strength in a globalized world. Though this is an interesting point, I'm not completely convinced, yet! The Dow industrials are composed of companies who predominantly sell outside the US, alongwith commodity names like Caterpillar. Are the higher commodity(fertilizers) and energy(coal) demand a result of a weaker dollar, or the secular demand from the engines of India and China? I would argue for the latter.

    The commodities and energy sectors are going through a speculative blow-off. They are cyclical sectors disguised in a 'secular term' trend. While I don't dispute the 'secular' uptick in demand due to consumption in the emerging markets, to expect the commodities sector to be impervious to a global slowdown is baloney.

    Here's the punchline and a prediction (for what it's worth!): The current correction in the commodities space is not a multi-week phenomena. I'd argue that this time next year the commodities sector will be lower than where it is today. Given the cyclicality of the commodities sector, I would expect the transports to roll over and join the industrials.

    The positive divergence we have seen in the transports is at best a short to an intermediate term bullish signal. The Dow theory sell signal of 2007 is still very much valid, and the rollover in the commodities space is only a confirmation of that.

    Secondary point: While I'm positive on coal, I'm even more positive on natural gas and LNG(and would prefer holding CHK to ACI) . Carbon trading and emissions control(whenever that happens in the next 5-10 years) will make these more profitable and desirable energy sources, when compared to coal. (But maybe they'll come up with a way to make 'clean coal', and this point would then be no longer valid. )

    Ah! The joys of investing and identifying secular term trends!

    Read the rest of this entry >>