Ming's Investing Blog

Marketwatch: Andy Xie on the China Bubble

2010-02-15T21:19:00.000-08:00

Andy Xie, the former Morgan Stanley economist, has been one of the most vocal articulators of the case for a China bubble. Here’s a summary of his comments from two interviews. The first was released on February 6, 2010, with Bloomberg’s Haslinda Amin:

- Andy expects China’s economy to be okay this year because liquidity is still plentiful. On the one hand, there’s a boom, especially on the property side. On the other, poor employment in the US is likely to limit China because the export sector is so large. Nevertheless, the domestic side is overheating, and China needs to tighten or the bubble can get out of hand.

- The US Treasury yield will have to rise because the appetite for US Treasuries is not as strong as it was before. There’s a price for everything, you just need higher yields to buy the same amount or more.

- the China situation is very related to the property sector and government spending. If banks continue to lend, then the situation can get out of hand. If the banks stop lending, then many projects will be put on hold. So the situation is very delicate. You don’t want to cut back funding quickly. Currently, the loan growth rate is 17%, which is about a “7 trend”, compared to a “10 trend” last year (it’s not clear to me what he means by “7 trend” vs. a “10 trend”). So the government has cut back on lending, but it’s not a significant cutback.

- China has not yet increased interest rates, but the market is now expecting it, perhaps a 2-3% increase. But it won’t be dramatic, and it may not be enough. Before the market didn’t expect monetary tightening, which is why it reacted so sharply to credit tightening (i.e., the increase in reserve requirements and the pullback in lending).

- The data on China property is difficult to ascertain, but property sales are 14% of GDP, which is an unprecedented level. Rental yields are 2-4%, and the vacancy rate is very high, in fact “humongous”. Prices might be as much as 100% overvalued.

- China’s property bubble is in new properties, not existing. In China, the local government is the seller, it’s really a fund-raising operation for them. About half of local government revenue comes from the property sector. In a sense there is a struggle between central and local governments. The fiscal situation is very dependent on property sector.

- The government is taking steps, such as limiting mortgages on 2^nd and 3^rd flats. Demand is very speculative, so it’s very difficult for demand to continue without bank lending. Developers who are paying record prices for land may get trapped. In the last 7 years, land prices are up over 10x, and in some cities it’s up over 20x. The bubble is about to burst.

- The resource trend is more land lasting than others. China has a resource shortage and has huge reserves, a significant amount of money will be put into resources. This is the only story that Andy has faith in. The resource story will continue for several years.

These notes are from another Bloomberg interview on 2/12/10:

- China has again increased reserve requirements, but this isn’t enough to stop inflation.

- China will have to stop inflation, rental ratio is under 3%, the price income ratio in major cities is 20x or higher. They’re hoping for a softer landing but Andy Xie is skeptical

- Interest rates are too low – demand deposit rate is 0%, long term deposit rates are 3%, economy is growing at 8-10% and inflation was reported as 2% in January. Andy Xie considers this not reliable. Plus, saving incentives have gone down.

- With excess liquidity, these moves to increase reserve requirements are not enough. The government actions are only reducing excess liquidity, not turning it around. The loan deposit ratio is 67%, and the deposit reserve ratio is less than 17%. This is not enough to turn around the excess liquidity.

- Also, there is hot money going to China, which will continue. China will have to raise interest rates to show that they’re serious about tightening.

All material presented herein is believed to be accurate but I cannot attest to its accuracy. The writings represent the opinions of the author, and all readers are urged check with their investment counselors before making any investment decisions. This information is for educational purposes only and do not constitute investment advice. There is no certainty that any of the information, charts or graphs presented here would result in profits. Opinions expressed may change without prior notice. The author may or may not have investments in the stocks or sectors mentioned.

Stock Gurus: Robert Prechter

2010-02-09T18:45:00.000-08:00

Written Wednesday, January 27, 2010

Robert Prechter, President of Elliot Wave International, is known for the Elliot Wave Theory, as well as for predicting the 1987 stock market meltdown. He appeared on CNBC on Wednesday, January 27, to issue a new warning: that we were headed into the next bear phase. I always like to listen to the “Gurus” and see how they assess the market, what indicators they look at, etc.

Back in late February, early March 2009, as few as 2% of traders were bullish. At that point, Mr. Prechter believes that the market is coming out of something, and it’s time to look to the upside. They had an upside target of 10,000 on the Down, and that was exceeded.

Today, they’re seeing a lot of signals that are similar to the ones they saw at the top in 2007, as well as in the earlier top in 1999 and 2000. He’s quoted as saying, “this is the last chance to get out of the Dow in quintuple digits”. He characterizes the tops as follows:

- extreme optimism; advisors 3x bulls over bears, biggest ratio since 1987
- extreme valuation, dividend yields as low as 2.8% for Dow
- PE ratio is higher than it’s ever been in last few quarters; even if you adjust for future earnings, still expensive
- downside momentum loss in November, December and January

By the way, he published the second edition of Conquer the Crash in December, to give people time to get out.

Not interested in commodities, that run has already occurred. Expects repeat of 2008, when real estate, stock market and commodities went down together, and safest place is in the dollar. Dollar bottomed in November, has stealth rally and they remain positioned in the dollar.

Mr. Prechter is looking for another wave, so he’s being safe. They’re staying in cash and cash equivalents.

How much weight to put on Mr. Prechter’s comments? I did a little more research to get more information on Mr. Prechter’s point of view. It turns out, he’s quite extreme. He believes that US stocks will fall below their 12-year lows hit in March 2009 and that the S&P will fall below 666. He sees bonds falling to lower levels than the panic of 2008, and gold falling 40% off it’s peak value, especially if deflation sets in.

If you look back, he did call the crash of 2008 and that he did call the bottom in late February 2009, telling traders to exit their shorts when the S&P was near the 770 level. But you’ll also find that Mr. Prechter is a perma-bear. He called for traders to be 200% short in November 2009. He also was very bearish in August 2009, although at that time he admitted that just the reliable part had past, and that he could not time the turn. But the last time he called for traders to be long stocks before 2009 was in 1997, and so he’s missed lots of good stuff. According to the Hulbert Financial Digest, his newsletter is in last among all market timing strategies.

Still, he does have some interested points to consider. Here’s a comparison of the 1987 market and the market on October 19, 2007 from an interview on Bloomberg (available on YouTube):

Markets: 1987 vs. October 19, 2007 - 1987 vs. 2007

DJIA Annual Dividend Yield - 2.6% vs. 2.0%

Price of $1 Dividend - $39 vs. $50

Duration Dividend < in 1929 - 3 mos. vs. 13 years

Price/Book Value - 1.73 vs. 4.04

Advisors Net Bullish (>97%) - 156 weeks vs. 468 weeks

Daily Sentiment - % Bulls vs. Bears - 3x > 90% vs. 51x > 50% in last 13 mos.

The dividend yield measure is interesting, because I think that is a valid indication of a bullish market. Still, one thing to consider today is that a lot of companies eliminated the dividend following the 2008 crash. You could argue the measure is still valid despite that fact.

The third item measures how long it has been since dividend has been less than it was in 1929. The argument is that when people don't want dividends, they think they’ll make it up in capital gains.

“Advisors” refers to newsletter advisors.

You’ll notice though, it’s very hard to use this to time the market – the bullish readings in 2007 lasted a very long time. Mr. Prechter was bearish for the two years leading into the 2007-2008 crash. In this interview on October 19, 2007, he cited the fall in commercial paper and the decline in Asian buying of US Treasuries as the indicators of cracks in the stock market.

In sum, it’s interesting to look at some of his indicators, but it’s hard to make bets based on his perspective. As always, he’s one of many points of view to consider.

Marketwatch: A January 2010 Mini-Greek Odyssey

2010-02-09T17:03:00.000-08:00

In January, a troika of worries knocked down the market: credit tightening in China; regulation in Washington; and sovereign debt problems in Europe, and particularly in Greece.

Over the last month, we’ve had a litany of explanations and opinions. As usual, the challenge is to make sense of the mess of “answers” that come at you everyday in the media:

- the long-term view – Greece is a small percentage of European GDP – about 2.5%. It won’t go under, they’ll fix it, all the market hoopla is just noise. Use the dips as an opportunity to buy. Many long-term fundamentalist and value players are in this camp.

- the contagion view – where there’s one cockroach, there’s more. Greece is just the first in many, Portugal, Ireland, Iceland and Spain are next (the PIIGS countries). Credit default swaps (CDS) prices are exploding (this is the cost of insurance on debt), this is just like Lehman Brothers in 2008. Get out of the market and stay out. Many traders are in this camp.

- the macro bull – this point of view says, we’ve been up huge in 2009. It’s about time for a correction. We’ll correct 10-15%, and then we’ll resume our upward path toward recovery. Ride it out, we’ll be up by the end of the year.

- the macro bear – this view says that it’s just the beginning of the second half of a double dip. Stimulus is being withdrawn around the world, and we’ve got nothing but problems ahead of us: more real estate losses; consumer is dead in the water; productivity is up but demand is not; unemployment remains high. Sell and put your money in cash or short term bonds.

These perspectives are all over the map. Is there a right answer? Is there a best course of action? If there is, it’s not clear by any means. And truth is, several o f these views are correct – depending on what your time frame and your risk tolerance is.

Let’s start with the hold approach. Truth is, this will all blow over – eventually. But that “eventually” could be a long time from now, and in the meantime, your stocks could be down 10-15% from where they were in January. As of today, the S&P is down 5.2% year-to-date (the S&P was 1,115.10 on 12/31/09; today it’s at 1,070.52) and 6.9% off the year-to-date high of 1,150.23 recorded on Tuesday, January 19, 2010. Being down can be no fun; handling it takes a strong stomach and lots of patience.

For me, the other problem with the hold approach is that it’s a bit simplistic and could lead you to ignore several fundamental changes in the market. Last year, a weak dollar led to a strong dollar, a rally in commodities and rising gold. This pattern, which governed trading in 2009, no longer applies. Now, we have a different set of relationships in market:

- With problems in the Eurozone, capital is moving into dollars for safety. This causes the dollar to rise and the Euro to fall. If you think about it, there’s really no where else to go; Asian, Latin American and Russian currencies are all worse choices.

- The rising dollar means lower commodities prices, because commodities are traded in dollars. This explains the fall in commodities investments, and implies that you should stay out of commodities as long as the dollar is rising.

- The rising dollar also means an unwind of the carry trade. Because the US has near zero interest rates, money was borrowed in US Dollars and financed investments around the world. As the dollar rises, borrowing becomes more expensive because borrowers have to convert back to dollars to repay their debt. A rising dollar forces the borrowers in the “carry trade” to sell off their stocks and repay their US Dollar obligations before their debt becomes more expensive. For now, the rising dollar puts selling pressure on stocks.

- Finally, the rising dollar causes the price of gold to fall. Gold is intricately linked to currency movements and rises in two scenarios: when major such as the US Dollar are low and declining, because gold becomes a greater store of value than the currency; and when there’s inflation, because again, gold becomes a better store of value. So as the dollar rises, it becomes a better store of value relative to gold, causing gold prices to fall.

As you can see, these are major trend reversals, and has significant implications for investing. These relationships affect a number of stocks, so it’s not at all clear that you should hold on to all stocks as these relationships shift.

The sell approach has its advantages and challenges. First, if I can spot the decline, I’d like to avoid as much of the 5-7% decline in the market as much as possible. And keep in mind, some sectors are already in correction range, well in excess of a 10% decline. So if you hold such sectors (commodities, financials), selling would definitely save some red ink. If I can’t spot it, it’s not terrible, but it does mean looking at significant pullbacks in your positions for a while.

The next challenge is, when to buy? And should the money be re-allocated into different investments?

Unfortunately, we are likely to face a choppy period, governed primarily by a downward trend. Consider the European sovereign debt situation. Today, the market rallied because it seemed likely that some kind of bailout for Greece was forthcoming. If so, we will rally. Still, it will not be long before investors start to pressure the other European weak links – Portugal, Iceland, Ireland and Spain. So we’ll have more market retreats sparked by European debt fears. Meanwhile, the Euro should continue to decline, and the dollar should continue to rise. Because this will continue for some time, there is no clear “re-entry” point for buying stocks. There’s no clear case for saying that current market levels will hold; any one of these alarms could send markets below today’s levels.

As for the re-allocation question, this is a key consideration. The relationships described above imply the following:

- commodities will remain under pressure, especially if more bad news comes out of China (such as further credit tightening)

- gold will be limited by the rising dollar

- long dollar, short Euro – this is basically the trend for both currencies so long as Eurozone problems are at the forefront

- equities as a whole will remain pressured by the continued unwind of the carry trade. At some point, traders will find another source of funding, but that will take some time

- financials tend to be pressured by sovereign debt fears; as long as these continue, financials will be under pressure

- cyclicals should also be pressured as economies around the world retreat. It’s now a fair question whether 2010 earnings targets will be achieved.

- long short-term Treasuries in the near-term. When fear grips the markets, investors want dollars and US Treasuries. The short end of the yield curve is the favored place to put money in times of stress. The longer end of the yield curve is problematic because European debt now sells for higher yields, and will have a bit of a spillover effect for all. Also, all countries are withdrawing stimulus and tightening credit, which will cause the longer end of the yield curve to rise.

ETF Watch: PGF

2010-01-13T03:00:00.000-08:00

I inherited a portfolio that contained the PGF. At first blush, the PGF looks great: it has a 9% yield. Pundits like Cramer love it. But let’s get serious and do some homework.

The ETF. So if you look up the PGF (http://www.invescopowershares.com/products/overview.aspx?ticker=PGF), it's the PowerShares Financial Preferred Portfolio. It’s a fund based on Wachovia’s Hybrid & Preferred Securities Financial Index (WHPS Financial Index). You can’t invest in an index, so the PGF seeks to track the WHPS Index. The fund will invest at least 90% of its total assets in securities that are in the base index.

Fund Holdings. So the first obvious question is, what’s in this thing? When you go to the product homepage (above), there’s a little link that says “Fund Holdings”. That takes you to this page: http://www.invescopowershares.com/products/holdings.aspx?ticker=PGF. You’ll see that as of 1/12/2010, there were 39 holdings and the top holdings were Bank of America, Barclays, ING, Wells Fargo and JP Morgan Chase preferreds. Looking over the list, there’s a few banks whose financial condition I’m not familiar with, such as AEGON, ING and REPSOL; and many banks that I’m comfortable with, such as BAC, Barclays, Wells Fargo, JP morgan, HSBC, Credit Suisse, Goldman Sachs, Santander and Prudential. There’s a couple holdings whose stock I wouldn’t buy – Royal Bank of Scotland and National Bank of Greece.

Overall, I’m fine with the holdings because I believe that the worst of the financial crisis is over. There could still be problems this year, particularly this summer. But in the long-term, we’re on an uptrend in financials. While I wouldn’t buy Royal Bank of Scotland and National Bank of Greece, I don’t think they’re going under.

Fund Yield, Price and Expenses. Other key facts include a 30-day yield of 7.59% and a 12-month yield of 8.39%. It trades at $17.12 and has an expense ratio of 0.68%, a bit high but much lower than a mutual fund.

Risks. So let’s look at the risks and downsides. First, let’s start with the equity risk. The PGF is comprised of financials (as the name implies). Critics say that you would be getting a 8-9% yield but would be risking a 100% loss. Still, as mentioned, I believe the worst of the financial crisis is over. We may still have a dip in the medium-term, but in the longer-term, we’re on an uptrend as the recovery continues. In my opinion, the biggest risk is a dip in the medium-term as latent financial problems (e.g., foreclosures) surface.

Later, banks could also take a hit when the yield curve flattens. Longer-term rates will rise. Because banks borrow short and lend long, this will, at first, help banks. But eventually the Fed will raise short-term rates, causing the yield curve to flatten. This will lead to lower margins for banks. This is something to watch out for, particularly toward the end of the year

Second, let’s look at the preferred security itself. Preferred stock has a fixed dividend, and that makes it vulnerable to interest rates. So when interest rates rise, new securities are a better investment because they offer a higher rate of return than existing preferred. This would imply that the price of the preferred stock would fall. On the other hand, banks perform better with a steeper yield curve, and that could increase the value of the preferreds. So the impact on the PGF itself is unclear. More than likely, the PGF will have to sell off declining securities and reinvest in newer securities, leading to some losses in the fund. Truth be told, all this is theoretical at this point. We will have to see what happens when rates rise, be vigilant and be prepared to exit if the value drops significantly.

Eventually, the yield on preferred stock will drop. An 8.5% to 9.0% yield is a reflection of our times, when financial stocks are worth less than they are in “normal” times with normalized earnings. Another factor to watch out for in the longer term.

Other Considerations. So here are some other pluses and minuses of preferred stocks:

- Preferred shares are higher in the capital structure than common stock

- Dividends must be paid to preferred stock owners before being paid to common stock holders

- Dividends are fixed

- Preferred stock holders have no voting rights

- Because preferred shares have debt characteristics (fixed dividend, like a bond), they also have less potential for share price appreciation

- Many preferred shares dividends are qualified dividends taxed at 15%, unlike bond income, which is taxed at regular rates. The tax treatment of dividends may change the coming years.

Managing the Investment. Tom Lydon, an ETF guru and author of the ETF trend Playbook, has three rules for managing ETF investments:

- maintain an 8% stop loss on ETFs

- if the ETF falls below the 50-day moving average, that’s a red flag. If it falls below the 200-day moving average, then sell

- don’t chase markets that are too hot, such as in 2000.

He also says that you should only invest in ETFs trading above their 200-day moving averages. If you look at a chart of the S&P since 1994, it was best to stay out of the market when the S&P traded below it’s 200-day moving average.

Here’s an example of applying one of his guidelines. If you buy an ETF trading 15% above its 200-day moving average, then you should have an 8% stop loss.

Interestingly enough, these guidelines could apply to more than just ETFs. Not a bad set of guidelines to work with.

Other ETFs. So the PGF isn’t the only preferred game in town. There’s the iShares S&P U.S. Preferred Stock Index (PFF), created in March 2007. As the name implies, this tracks the S&P U.S. Preferred Stock Index. It invests at least 90% of assets in securities that comprise the index, which includes stocks listed on the NYSE, AMEX or NASDAQ. Companies have a market cap of at least $100 million and the fund is non-diversified. The PFF’s expense ratio is 0.48%, a low turnover of 12% and the yield is about 8.58%. Currently, it trades at $37.63.

There’s also the PowerShares Preferred (PGX), which seeks to track the Merrill Lynch Fixed Rate Preferred Securities Index, established in January 2008. At least 80% of total assets are invested in the Merrill Lynch Preferred Index. The expense ratio is 0.5%, it has a high turnover of 52% and its current yield is 8.09%. As of today, it trades at $13.68.

Conclusion. Generally, I like the preferred stock ETFs at this point in time. There’s some risk that prices may fall after this point, but eventually, in the longer-term, prices should rise as we get closer to normalized earnings. At that point, yields will fall, so it will have to be re-evaluated as an investment. In the meantime, I will be holding on to the PGF in the portfolio I’m managing. And of course, watching out for the risks outlined above.

Stock Gurus: Bill Miller

2010-01-12T14:28:00.000-08:00

Legendary stock guru Bill Miller appeared on CNBC today. He manages a Legg Mason fund, and holds the record for beating the S&P (15 years), until the crash of 2008, that is. His portfolio has since rebounded as much as 40-80% (depending on what you’re looking at).

Mr. Miller is just behind Warren Buffet in the world of value investing. I respect his opinion, but like everything else, I think you have to keep things in perspective. For example, if you’re down 70% one year, and then up 100% the next year, you’re still down 35%. So don’t let these percentages fool you.

Also, you have to keep in mind that value players favor looking at valuation, which creates a bias. In Mr. Miller’s case, he may tend to underestimate the macro picture. I’ll give two examples. The first is real estate. Mr. Miller is long real estate and argued for a recovery. He’s down on that investment – he joked about being “early”. But oddly, no one on the desk of reporters (which is why I think it’s such a shame that reporters are asking questions) asked what happens when interest rates go up. Real estate will go down again, I believe, and how much depends on how much inflation there is. If that’s true, it means that he’s very early on real estate, the cycle isn’t over. On the same day, Professor Shiller of the well-known Case-Shiller Index admitted that there’s better than a 50% chance that real estate prices will go down again.

The other example lies in the 2008 crash. Mr. Miller didn’t see it coming, and that’s because he was looking more at valuation (price-to-book, PE, etc.) than at macro trends (in my opinion, he didn’t say that). In this interview, admitted that they’ve learned a lot. Before, he would have said that the depression scenario was off the table. Now, he has a different view: there are two different kinds of downturns – liquidity , as in 1987, when the Fed pumping money into the system was enough; and asset or balance-sheet downturns, where the value of assets decline and this is what the Great Depression was. This actually makes lots of sense. Consider the post dot.com period, when savings went down, but employment held up relative to 2008; and individual’s assets – such as real estate actually gained. In 2008, both savings and assets took a hit. So that’s a good way to look at it, I think.

Mr. Miller does think that there are still great values in the market, and of course, that’s the interesting part. He believes that the worst is over, but the recovery is far from complete. And the risk after a major event such as the 2008 crash is relatively low.

Mr. Miller’s example was IBM, which trades at 12x this year’s (2010) earnings. The company has top line growth of close to GDP levels, so not much exciting there. It’s the bottom line that’s interesting – it produces cash, so IBM buys back stock and earnings go up. It has performed consistently, even in this down market. I agree, lots to like there, especially for retirement portfolios.

Other picks include regional banks, that are trading at discounts to book value with good capital ratios; GE, Walmart, JP Morgan (with earning’s power of $6 or so, implying a $60 stock at 10x PE); Bank of America (with earning’s power of $3.50, implying $35 stock at 10x PE); JNJ, Pfizer; Merck and MGIC (which provides mortgage insurance, trades at about half of what it’s worth, and will someday make money in mortgages again).

I am long General Electric, JP Morgan and Bank of America.

January Stock Article

2010-01-12T14:26:00.000-08:00

Here's my January investing article at www.asiancemagazine.com:

http://www.asiancemagazine.com/2010/01/03/investing--the-shifting-landscape-

Stock Gurus: Doug Kass on Calculating the Bottom

2009-11-18T09:03:00.000-08:00

Doug Kass appeared on Fast Money on 10/28/09 and discussed how he calculated the bottom this last March.

- Looked over 7 decades of S&P data. Market is valued at about 15x usually, 11.5x at the bottom.

- Book value of the S&P = $560 at the time. The average industrial earns 12%, or $67.

- $67 x 11.5 = 770, or about 800 on the S&P

- On March 9, 2009, S&P was at 685, way below. 685 is 9.7x (actually, 10.2x if you do the math)

- PE was also very low, especially in a time of quantitative easing.

And thus he called bottom in March.

Stock Gurus: Meredith Whitney

2009-11-18T00:25:00.000-08:00

Meredith Whitney appeared on CNBC on Monday, 11/16, on CNBC's Closing Bell after Bernanke’s speech. I don’t always agree with Meredith, but she’s always insightful and her opinions are backed up by solid analysis. The only caveat is that timing may be an issue for her. For me, her comments make sense, question of when things will happen, and perhaps if they will be as severe (which is related to timing. Timing more spread out, less severe). Here’s the highlights of her comments:

- Mortgage Backed Securities. Bernanke didn’t say much. She wanted him to talk about the agency mortgage-backed purchase program, and he didn’t. The Fed has been buying Fannie, Freddie agency mortgage paper, and it’s 1/3 of their balance sheet, was zero at the beginning of the year. Fed is probably buying more than 100% of what’s available. Through these programs, rates are low, 20% of the banks’ capital has been created (estimated), allowed bank asset values to rise. Program almost done. When Fed exit, interest rates go up dramatically (probably more than 10%), affordability goes down, credit losses spike again, another leg down in the housing market. “I haven’t been this bearish in a year.”

Other programs have wound down, except for agency MBS. Extend program, Fed becomes one of the largest buyers of junky debt. Deed for lease program. If you can’t afford modification, then gov will rent house. So does gov become direct owner of US real estate?

- Consumer. Doesn’t Understand Why Stocks Are Up. Particularly in the consumer space. No fundamental reason. Plus contraction in consumer credit. Never been so much consumer credit contraction, even in Great Depression. In 1990-91, contraction, but securitization provided liquidity to consumers, consumer actually had more liquidity during that time. $1.5 trillion of credit lines pulled from the system. Is now re-accelerating. Not a good Christmas coming. “There’s nowhere to hide at this point”.

Retailers have reduced inventories, so that may be better. But so many credit lines cut, the middle class is getting squeezed the hardest. Worry about that most. Also getting kicked out of banks.

- Banks. To pay back TARP, banks will have to raise capital again. Adequate capitalized today? No way. Trade has been short regionals, long capital markets banks. Works because government behind capital markets. “If the lifeguard is on duty, people will jump into the pool”. Lifeguard will go off duty, just don’t know when. Capital markets volumes will be down. Equity volumes down, fixed income volumes are down, so big banks are converging closer to the regional banks. Reducing weightings on big banks.

But still, their stocks are rallying, doesn’t make sense. No root in fundamentals. Money on sidelines – never underestimate, usually goes to smarkt places. But now money not going to agency MBS. No substitute buyer. Money going to hard assets, businesses, gold. No one is buying mortgage backs.

Dip like last year? Don’t think so because before had mark-to-market accounting, makes big difference. Don’t think BAC will go back to $3. But thinks banks will go back to tangible book value. Have said this for 2.5 years now. Only trade above when there are core earnings. But increasingly clear, core earnings will not be what they claim. Likely will be ½ to ¾ of that, some fraction. Implying estimates will go down. Therefore, sell the banks.

- States. States need money. 44-48 states underfunded, and will be progressively more underfunded.

- Real Estate. Surprised Bernanke talked about real estate. Still residential real estate, many people have glossed over the fact that there will be another leg down in commercial real estate. Home ownership stands at 67.8%, will normalize at 65%. “Still the great sucking sound of liquidity coming out from the market.” Mortgage modifications – only 1% of trial modifications have gone to permanent modification status. Just waiting, 1^st quarter, when numbers show up, mortgage rates spike and fewer people qualify for mortgages, another leg down. Residential still much bigger threat than commercial. Banks assume real estate doesn’t go down further, 10% unemployment – already there. And states are still firing people.

- Where Put Money? Sit on cash for a little bit because you have to wait for leg down, S&P expensive across the board. Estimates have to come down, look opportunistically. Banks that are asset-sensitive to consumer credits are not where you want to be. Some core business that benefit from transaction services will benefit. Everything’s expensive now.

- Double Dip? Not as severe on second part of dip.

- What does it take to become more positive? Valuation, all about price.

Stockwatch: Goldman, Sachs & Co.

2009-10-15T15:38:00.000-07:00

So early today, Goldman announced Q3 earnings, and again, it blew away the numbers. Still, the market has gotten used to Goldman outperforming and had high expectations, especially after JP Morgan’s great numbers the day before.

First, the numbers. Goldman earned $3.19 billion, or $5.25 per share, compared to the average analyst estimate of $4.24 per share. Revenue was $12.37 billion, again, far in excess of analyst estimates of $11.02 billion. The firm’s return on equity was 21.4%, despite high capital levels that would drag down the return on equity.

Next, the more interesting part: the business model and its sustainability. This is the part of the analysis that they never talk about post earnings. A quick look at the income statement tells you the following:

- Increased Fixed Income Share. The key was trading and principal investments, and in particular, fixed income. But in addition to skill, Goldman’s revenues in this area were driven by the disappearance of its competitors Lehman (a bond house), Bear Stearns and to a certain extent, Merrill Lynch. As Goldman’s CFO Dave Viniar said on the conference call, “we’re getting a bigger piece of a smaller pie.” Consider the Trading and Principal Investments line for the last three quarters: $5.7 billion in Q1; $9.3 billion in Q2; and $8.8 billion in Q3.

- Cost Cutting. The media coverage never talks about this, but cost cutting made a significant contribution to the bottom line. Again, look at the operating expense line: $6.8 billion in Q1; $8.7 billion in Q2; and $7.6 billion in Q3.

- Investment Banking Declined. Investment banking fell from $1.4 billion in Q2 to $899 million in Q3 , mostly due to a decline in leveraged loans. While a negative, investment banking is traditionally lowest in the 3^rd quarter because of slow IPO and merger activity during the summer, and because of vacations.

All this speaks to the trend in earnings: $3.49 per share in Q1; $4.93 per share in Q2; and $5.25 per share in Q3. Today, the stock closed at $188.63. And look at the profit margin by quarter: 17.6% in Q1; 19.8% in Q2; and 24.5% in Q3.

Today, the stock closed at $188.63. Based on 2009 estimated earnings of $17.74, that’s 10.6x PE. Based on 2010 estimated earnings of $18.05, that would be 10.5x forward earnings (these are today’s numbers, so these are pre-Q3 earnings estimates).

Now we get to the big question – what does Goldman look like in the long term? Are these numbers sustainable? It’s very possible.

- Investment Banking. Next year, in 2010, IPOs and mergers and acquisitions activity should pick up as the big fish with cash buy out the small fish that are still struggling upstream.

- FICC (Fixed Income, Currency and Commodities). You would think that a compression in the yield curve would hurt revenues here, but Meredith Whitney asked this exact question on the earnings call: “When the government stops buying assets (Such as mortgage securities. The government’s buying keeps prices high, yields low, expanding the yield curve), who will be the substitute buyers and how will that reduced buying affect Goldman’s business?” Dave Viniar’s answer: “There’s plenty of other buyers with lots of cash to spend. It won’t affect us because our profits are not based on positioning, but on velocity.” Meaning volume, and the commission earned on the turnover, is what is generating profits. If we are to take him at his word, this means that the fall of Lehman and Bear brought them business which can be expected to continue into the future. Time will tell, but for the moment I think we can take him at his word.

- Principal Investments. This is always a tricky line, because the company can manage this number, and what drives this number changes. This quarter, $344 million came from the sale of Goldman’s stake in ICBC (share in the Chinese bank) plus $911 from “Other corporate and real estates gains and losses.” Chances are, these are sales and mark-ups on assets. Whether this level will be maintained is hard to say. One fact that bodes well for this area is Goldman’s high level of capital. When the credit crisis recedes further, Goldman is likely to deploy the capital that it is holding in reserve. So no certainty here, but Goldman can probably find ways to sustain this number if necessary.

All in all, there’s no reason to think that Goldman couldn’t maintain $5 per share in earnings per quarter through 2010 (given $5.25 this quarter and $4.93 in the previous quarter). That would mean $20 per year in earnings, and with a 10x – 11x PE, that’s $200-210 on the conservative side.

Here’s one other way to calculate future share price. Book value per common share increased 4% to $110.75 this quarter. Based on today’s $188 close, the stock trades at 1.7x book. If we were to assume that book value could be increased at 4% per quarter, that gives us a $220 stock. And if Goldman increases its ROE, then of course, we get a bigger number.

If Goldman hits $220 within the next year, based on today’s $188 price, that would be a 17% gain. I’m currently long Goldman and would buy at this level. It may still trade down a bit as the stock rests, but that’s just another buying opportunity.

Monthly Investing Article

2009-10-15T15:36:00.000-07:00

My October investing article is up at www.asiancemagazine.com:

http://asiancemagazine.com/2009/10/12/investing--the-forces-at-work

Thanks for reading,

Ming

Stockwatch: Proctor & Gamble - September 19, 2009

2009-09-19T16:27:00.000-07:00

Recently, Proctor & Gamble stock has been on the move, reaching $57.32 this last Friday (up $1.79 that day). For most of the last year, P&G has been a disappointment. Since late April, P&G had been stuck in the $50-56 range. While the market has rallied nearly 60% off the March lows, P&G has only risen 27%. In early August, P&G reported 4^th quarter earnings of 80 cents a share, beating expectations of 79 cents a share by a penny but down from last year’s 92 cents a share. In addition, P&G forecast first organic sales growth of 0 to -3%. The stock immediately dropped from about $55.46 to $51.46 a couple days later.

Traditionally, P&G has been considered a solid defensive stock, one to buy in times such as the last year. However this time, P&G has been hit by two distinct problems. First, high commodity prices significantly increased costs, leading P&G to raise prices and to shrink its packaging. This led to the second problem: customers started to trade down – and have stayed there. As a result, P&G has been losing market share.

Now P&G is starting to sing a new tune. Here’s the new news:

- The new CEO, Robert McDonald, took over from A.G. Lafley, the man who drove P&G’s acquisition of Gillette as well as the push toward faster growing, higher margin businesses. For Mr. McDonald, who took over on July 1^st, the fourth quarter (P&G reported 4^th quarter results the first week in office) was just at the beginning of his term.

- For 1^st quarter 2010, P&G still estimates $0.95 - $1.00 in earnings and the Street is at $0.97. Organic growth is still expected to be 0% to -3%. However, for the second quarter, Mr. McDonald anticipates 1-4% organic sales growth. Second quarter will begin in October, 1^st quarter reports should be in the beginning of November.

- P&G sold its drug business to Warner Chilcott fror $3.1 billion on August 24. This is a good sign, meaning P&G is focusing on it’s core businesses.

- P&G has long feared cutting prices on its premium products, but in recent weeks, the company has announced its willingness to cut prices and to reposition its brands. This reflects – finally – a recognition that the landscape has changed, and that price cuts will be necessary to bring back volume and growth.

- The company reaffirmed 2010 earnings of $3.99-$4.12 for 2010. This includes a one time $0.44 benefit and a $0.10 – 0.12 dilution from the sale of its pharmaceutical business. Before, analysts were expecting $3.65 - $3.80.

With the stock trading at $57.12, this places P&G’s current valuation at about 14x 2010 earnings (excluding the benefit from the Warner Chilcott sale and using $3.80, P&G would trade at 15x 2010 earnings). Compare this to the current S&P index, which stands at 1068 and has projected earnings of $72.96 for a 14.6x PE. Debates about S&P projections aside, P&G still trades at a slight discount to the S&P today.

How far can P&G stock go? In the short term, assuming P&G keeps pace with the general market, a 15x multiple on $4.05 2010 earnings would place the stock at $60.75. If we use Colgate Palmolive’s 16x PE ($76.10 / $4.77 = 16x), then P&G would trade at $64.80.

In the longer term, if P&G can return to the days of 6-9% growth and a premium PE of 22x (22x from 2004-2007; as high as 40x from 1999-2001), then we’re talking a stock that would be $80-90 (a conservative $3.80 x 22 PE = $83.60).

Still, that would be some time away. Right now, we’re looking at the likelihood that P&G has seen the trough in sales and the expectation that it can regain growth and stabilize share. Proof, via performance in Q1, would go a long way toward rebuilding confidence and creating upward momentum.

Ming is long PG.

A TBT Trade

2009-09-14T02:42:00.001-07:00

I’ve long advocated a trade in the TBT. The thesis has been straightforward: over the long-term, money will have to come out of Treasuries. In times of fear, investors buy Treasuries because it’s the safest security, even though interest payments are very, very low. At some point, risk appetite will come back, and those investors will sell their Treasuries. The TBT is short Treasuries.

This is a long-term trade. The issue is, of course, that in the short term, this trade has a lot of variability. So let me be upfront, this trade is not for the beginner or the part-time player. This is really for someone that takes the time to understand what’s going on in Treasuries.

In the short term, the TBT should see a lot of variability. Given the market’s tremendous run since March, there has been growing fear of a correction. If that occurs, then the appetite for risk will recede and investors will go back into Treasuries. This has already occurred a somewhat, and the TBT, which was as high as the high $50s, is now trading at $46. A run up into the end of the year will cause the TBT to rise, a fall in markets will cause the TBT to decline.

Given that, the TBT can also become a trading vehicle. Again, this is not for novice players, be advised.

If you watch the TBT, it has, in recent months, fallen immediately after the sale of the 4-week Treasury. Then it has risen until the 30 year is sold, and has immediately retreated as soon as the results of the 30-year Treasury auction has been announced. That’s because people expect demand for short term Treasuries to remain high. So the short has performed well, and the TBT retreats after the 4-week Treasury sells well. Then the possibility that longer term Treasuries will not sell well infects the markets, and the TBT rises. In recent weeks, this fear has been unfounded. Fear of a correction has actually caused the longer term Treasuries to sell well. As a result, the TBT retreats after positive 30-year results have been announced.

So here’s the short-term trade hypothesis: buy the TBT after the 4-week auction, and sell just before the 30-year auction. Again, this is for active traders who understand the risk, not for novices. As always, put a stop loss in somewhere around your acquisition price to prevent pain from sudden downward moves.

I am currently long the TBT.

Natural Gas Gets A Bump

2009-09-14T02:19:00.001-07:00

Last week, natural gas got a bit of a bump. Much has been said lately about the massive oversupply of natural gas and how natural gas has tracked the cost of oil rather than reflecting fundamentals. In short, recent natural gas discoveries have led to an overabundance of the fuel in the last few years. Surprisingly, the price of natural gas has fallen, but not as much as expected given the oversupply. Instead, natural gas has followed the cost of oil. Analysts believe that if the price of gas falls far enough, producers will eventually be forced to stop production. The market estimates that natural gas will be in the $6-7 range next year, compared to the $2-3 range of recent weeks. If the market is right, then natural gas stocks should be a buy. A small decline in inventories last week created the bump in natural gas last week.

It makes sense that natural gas should bottom as storage reaches maximum capacity. Exactly when that will happen is unclear, and I won’t claim to know. As for investing in natural gas, I am, for the moment, just watching to see if how supply and demand actually works the way we think it does.

I am long XTO (a trade, as opposed to an investment).

Morgan Stanley’s New CEO

2009-09-14T02:08:00.001-07:00

I’ve written about and recommended Morgan Stanley through much of this year. Over the last several months, Goldman Sachs has led, taking risk in trading and reaping profits. On the other hand, Morgan Stanley was more conservative, and ironically, suffered as a result. I was encouraged to hear a month or so ago that the firm was beefing up its trading operations and hiring more traders.

This week, the firm announced that John Mack would be stepping down as CEO, and that James Gorman, the head of Morgan Stanley’s brokerage unit, would take over. The problem here: Gorman was a former McKinsey & Co. consultant and currently manages the retail sales side of the house. He has no investment banking experience. This seems to indicate that the board wants to stay conservative and stay away from the risk that is yielding profits for Goldman Sachs. While selling stocks and bonds to retail investors can be profitable, it’s not as profitable as trading.

Of course, we can’t really know until Mr. Gorman has a little time in his job. Still, this wait and see situation changes my position on Morgan Stanley. I’m long, and it’s not a sell, but with any new money, I think it makes much more sense to toss it toward Goldman Sachs. They’ve proven that they can manage risk and profit in this environment. Mr. Gorman may yet try to follow Goldman’s lead, but if the firm remains conservative, it’s likely to lag the market. So why invest in a maybe when you can invest in the proven performer?

I’m long both Goldman Sachs and Morgan Stanley.

September 14, 2009: The Coming Week

2009-09-14T01:43:00.000-07:00

After a bit of a run up, it would be reasonable to expect a bit of selling pressure this week. There’s not much expected in terms of market-moving news, just small indicators of trends. We have some tech news with Oracle reporting, and some consumer indicators with Best Buy and Kroger reporting. On the macro side, market watchers will be looking toward retail sales numbers and housing starts. Unless these numbers are significantly out of line, there seems to be little reason to anticipate significant market moves.

September Investing Article

2009-09-14T01:39:00.000-07:00

My latest investing article is up at www.asiancemagazine.com. I'd post it here, but it's several pages. Here's a quick overview:

The Next Few Weeks. Over the next few weeks, I don’t expect significant movements in the market. We’re capped by skepticism above and a floor created by recent buyers unwilling to sell. Still, many in the market are positioned for a correction.

A Vulnerable Q3. A quick scan of sectors shows that we’re likely to have mixed earnings, but there’s no convincing case for a bad quarter. Still, we have to account for the possibility of a negative earnings surprises and given the nervousness of markets, we need to be ready for this possibility.

Managing A Position. A look at managing a position in the TBT (short Treasuries) and Apple. Trading with stops is can be a good thing.

Looking Ahead: Financials

2009-09-02T00:51:00.000-07:00

I like looking at financials for two reasons. First, they are very indicative of the economy. Their exposure to residential and commercial real estate, credit and capital markets are all mirrors of our economy. Second, the financials will move with the markets, and the long-term thesis remains: over the next 3-5 years, I believe that the financials will offer substantial returns for investors.

The real question is how to handle the short-term. Over the next couple weeks, a correction, probably in the 10-20% range, is likely. Of course, such a correction needs to be confirmed by follow-through (several consecutive down days) and can depend greatly on data, such as unemployment reports (the next is Friday, September 3, 2009). Still, if it occurs, such a correction would actually be a good thing: it allows financial stocks to regroup and continue moving forward.

Personally, I plan to buy into the correction. To be clear, I’m not saying that it’s all clear in the financials, not by any means. As investors, we have to watch out for events or news that could turn stocks in one direction or another.

So here are the things I’m looking at. First, let’s take a look at the capital markets operations – the investment banking side of the equation. This applies to the pure plays – Goldman Sachs and Morgan Stanley, as well as the banks with substantial investment banking operations: Bank of America, Wells Fargo, JP Morgan and even Citigroup.

Over the next couple quarters, investment banking operations should continue to bring profits. In part, the investment banks should do well just because there are now fewer of them. With the fall of Lehman and Bear Stearns and to a certain extent, Wachovia, investment banking business falls to the few remaining players. Meanwhile, trading in government securities, corporate bonds and high yield debt remains very strong. Equity underwriting remains slow, and those that have retail brokerage operations and asset management divisions will see some weakness there. Still, propects remain good here. And, the government continues to support profits in this sector. This all bodes well for Goldman Sachs, Morgan Stanley (to a lesser extent, because it is less aggressive than Goldman), and the investment banking divisions of the banks.

Greater questions emerge in the last quarter of 2009 and going into 2010. Eventually, government support will have to be withdrawn, and if substantial profits are reported through year-end (already, there’s talk that 2009 might be a very strong year for bonuses at Goldman Sachs), withdrawal of support becomes more likely. A tightening of interest rate spreads may also make it harder for these companies to finance their operations. And if the second half of the double dip occurs, trading, debt and government securities operations may very well slow. Remember that in 2009, the investment banks will benefit from companies re-capitalizing their balance sheets and credit markets returning. Much of that may fall away in 2010.

For the more traditional banks, the picture is more serious and I believe that the possibility of a double dip is fairly strong. 2009 has been an usual year because of the need to stabilize the banks. As we go into 2010, the Fed will feel the need to start withdrawing support from the system. Truth be told, the Fed probably wants to support the banks for a long as possible, but I suspect that there will not be the political will to do so because everyone believes the crisis has past. And Washington does not work well without a crisis.

On the economic side, all indications are that foreclosures are now affecting the prime and jumbo market, and these are mortgages that can’t be worked out because these homeowners are having trouble paying their mortgages (due to job losses, etc.). Reports this week say that the number of homes in foreclosure are increasing, not decreasing. Commercial real estate is also beginning to hit the point where they have to be dealt with, and so that will be another hit to the banks. In 2009, banks have delayed recognizing losses by trying to work them out, providing extensions and so forth. We will soon reach the point where delaying tactics won’t work anymore; it will be time to face the music.

Other macro factors will test banks. Eventually, the Fed will have to start exiting the quantitative easing strategy. That means interest rates may start to rise and banks will not benefit from the fat spreads that they’ve seen in the last year. Foreign banks may very well slow their purchases of US debt, and inflation may also start to rear it’s head.

All in all, there are several reasons to be concerned about the banking sector going forward. So what would be the game plan? I still like Goldman Sachs and Morgan Stanley to a lesser extent, especially if their prices dip because of a correction. For the banks, I plan to buy the next pullback, but with two qualifications: much depends on the individual bank, and these banks have to be owned with a careful eye to the obstacles mentioned above. JP Morgan remains the strongest; Wells Fargo has great earnings power but needs to figure out how to pay back TARP; US Bancorp is solid, well managed bank, but has lending exposure; Bank of America and Citi are interesting but risky because their balance sheets are weaker. All can are subject to the headwinds mentioned above, so if things start to turn the wrong way and we get the second half of a double dip, it may mean stepping out and then stepping back in later.

For those that don’t want to trade in and out, I still think that dollar cost averaging, or buying on pullbacks, remains the best strategy. For example, if you are conservative and don’t want to spend too much time watching the markets, you could buy JP Morgan on dips, and dollar cost average if we enter the second half of the “W” recovery. This will give you a lower cost, and JP Morgan will probably emerge as a very strong bank in 3-5 years with most of its troubled assets off its books. This is a conservative, long-term strategy that has a strong probability of working.

For the regional and smaller banks, these are more-lending based, and so they are exposed to all the headwinds mentioned above without the benefit of diversification into the capital markets. Most analysts expect as much as 500 more banks to fail by the time this is all over. For me, this is a steer clear area, or a lot of work to make sure a smaller bank is a good investment.

All in all, the entire banking sector still faces challenges ahead. But for the patient investor, that could very well mean opportunity.

I am long Goldman Sachs, Morgan Stanley, JP Morgan, US Bancorp, Bank of America and Citigroup. I have no position in Wells Fargo at the current time.

Trading AIG: Playing the Walking Zombies

2009-08-29T00:41:00.000-07:00

If you’ve been watching the markets at all, you will undoubtedly have heard that AIG has had a massive run. It was not long ago that the stock was trading for a little more than a dollar. So the company engineered a 20-for-1 reverse stock split, meaning that if you at 20 shares valued at $1.00 each, you now had 1 share valued at $20.00.

On June 30^th, the company proceeded with the reverse stock split and the new shares started trading at $23.20 – the equivalent of $1.16 before the split. Within days, the stock plummeted and stockholders cried foul. By July 10, AIG had fallen to $11.74. The press had a field day, and the chorus of “who thought that one up?” was loud and persistent.

But then something curious happened. After drifting in the $11.00 -$13.00 range for almost a month, the stock took off, hitting $22.00 on August 5, 2009. No big deal, many said. After all, $22.00 was equal to $$1.10 on a split-adjusted basis. But the stock kept going up, hitting $28.70 within days. A few days later, it had drifted down to $23.42. And then, the stunner – the stock took off, hitting $50.23 today. Some are saying that AIG could hit $100 soon.

So before going on, let me state clearly why I’m even bothering to look at this. Let me say straight out, I’m not recommending this stock and if I were managing a client’s portfolio, I wouldn’t even mention it. But I think there’s a lot to be learned about the markets here, and I’m always interested in seeing what the logic might be behind the behavior. After all, someone, somewhere, is making these decisions. So mainly, it’s about seeing what we can learn. A secondary reason is that we will see similar situations come up again – Citi is looking at a reverse split, and that might be just around the corner.

Now a couple facts for context. There was a huge short interest in AIG. Even as of August 15, 24 million shares were sold short. As of today, the stock has a total market cap of $7.25 billion, even after the run to $50 a share. That’s far, far outweighed by the $180 billion of credit that the government has extended to the company. In late July, Catherine Siefert, an S&P equity analyst, estimated AIG’s common tangible common equity at negative $336.62. In Q2, reported early August, Siefert thought that tangible common equity had inched into the black, but that was due more to accounting than to any change in fundamental value. Still, the trading in AIG is rampant, and according to CNBC, it’s the retail investor at work: the average number of shares traded is 219.

So given all these negative facts, why the climb in AIG stock? Reasons are swirling, including talk of a debt-to-equity swap, a new CEO, promises by the new CEO to slow down asset sales. I find all these explanations unsatisfactory. What makes much more sense to me is that traders are taking advantage of short sellers squeezed into a corner.

Consider this. If you had a lot of money, you would buy shares of AIG and drive the price up. The short sellers would have to cover, driving the price up further. And you would buy the shares knowing that if the stock starts to move up quickly, other day-trading buyers would jump in, and the short sellers would have no choice in the matter. That would spark the move up. After that, the momentum guys would jump in. And more short sellers would cover. And more momentum guys would follow, too. And then, the retail guys would jump in. And then you would sell. If you had lots of money to play with, and were close enough to the markets to react quickly, this would be a pretty good formula for making some dough.

One precedent to support this theory: look at Citi before the conversion of government debt early this year. Everyone knew that Washington would convert their debt (actually, preferred shares) into common, flooding the market with shares and diluting existing shareholders. Short sellers piled in, so much so that it was pretty much impossible to find any more shares to short. The government’s conversion rate had been announced, and a little math would value Citi in the $2-3 range. Despite all the short interest, the stock climbed to the $4 range, squeezing the shorts. Months later, when the government converted its shares, Citi eventually drifted back to the $2-3 range in July. Somebody made a lot of money squeezing the shorts.

So does AIG go to $100? It’s within the realm of possibility. Keep in mind that $100 is only $5 pre-split. Still, it’s a risky game. AIG could go to $100, or it could go to $10. And at some point, the run has to end. Those that got in early will take profits, and that will put significant downward pressure on the stock. Also, many bought AIG when it was a $3-4 stock. So as AIG rises to the $60-80 range, a lot of those players will be looking to exit. I think AIG has some more to go, but somewhere in the $70 or greater range, it could swing the other way.

A lot of people wonder why you would buy a stock that is worth nothing when you do the math. Someday, the government will make a decision about what to do. But frankly, that day could be a long way off, and forcing a reconciliation of the books anytime in the near future would just put a huge loss on the government’s books. No one wants to do that.

So in the meantime, AIG is a big trading vehicle. And something else to notice: the move in AIG comes when other options have been exhausted. The good stocks have had their move and have stalled. Take Goldman Sachs, best in breed: it’s stalled in the $160-165 range for several weeks now. The market is not ready to take the “good” stocks such as Goldman any further, and so it’s picking through the trash.

If this interpretation of AIG is correct, then we should see similar action in Citi if it does a reverse stock split. We may also find similar action in other forsaken zombies, Fannie Mae and Freddie Mac. Perhaps the moral of the story is that even in trash, there’s some opportunity. Time will tell.

Ming is long Citi and Freddie Mac, and has no position in AIG or Fannie Mae.

August 26, 2009 - Caution Recommended

2009-08-26T19:14:00.000-07:00

In the lazy days of August, it’s easy to not do much. The market, while still trending up, is fairly lethargic: volume is low, indices see little movement. People are on vacation, and it’s easy to let our attention drift.

Still, wisdom dictates that it’s the best time to look at the porfolio and plan for the coming year. The September to November period has historically been a tough time for the markets. I used to wonder why, but it makes sense: it’s only human nature to take this time and look at the prospects for the next year. Our New Year might be in January, but psychologically, we still carry the “school year” starting in September.

The markets have had an amazing run. So much so that the S&P is trading at a recent PE high of 19x (based on diluted earnings from continuing operations), according to research firm Bespoke Investments. To give you perspective, the S&P’s PE has been as low as the 10x range in the last year , and hasn’t been as high as 19x since the 2002-2004 period.

The recent run has also driven out the short sellers in the market. Bespoke also calculates that short interest as a percentage of float for stocks in the S&P is now at 6.9%. The last time short interest was this low was in February 2007, before the recent market turmoil. Back in early August 2008, short interest was nearly 12%.

In sum, the market hasn’t been this bullish in a long time, and that alone is enough to bring out the contrarians and the bears. Despite the year recent year highs of the indices and the failure of bears to drive the market down, calls of froth in the market abound. Many are saying that we are topping.

The bears may very well be right, but I prefer to look at things in several different ways and see if I can come up with the same answer. The one thing that favors the bear argument: the market needs good, hard economic news to drive it higher. In recent months, we’ve had a rally based on cost cutting, “less bad” news and money on the sidelines playing catch-up. All of these market drivers will eventually exhaust themselves, and we will need new catalysts to keep things moving upward.

And what would those catalysts be? Earnings and industrial production statistics in Q3 would have to be favorable. At this point, that would mean revenue increases, as opposed to cost cutting. That in turn means somebody has to be spending. And thus the problem – who would that be? I think the consumer will be in hibernation for years to come. For the consumer, it’s like gaining weight: very easy to put on several pounds quickly; it takes a long time to take the weight off (believe me, I know). Another way to think of it – consumers are headed to Target and Wal-mart before they go to Saks, Nordstrom’s or Bloomingdale’s.

And what about businesses? It’s not clear by any means that they’re spending. The decline in unemployment would say that businesses are cutting less aggressively, but the fact remains, unemployment is still high. Last quarter’s earnings reports still showed year-over-year revenue declines for companies selling to businesses, so there’s no clear catalyst there. The only thing we can be sure of at this point is that costs have been cut and inventories are being worked off.

And finally, what about emerging markets and the much talked about China? Here, I think the talk of China as an engine of growth is overblown. China remains export dependent, and despite its high rate of growth, is not yet a consumer economy on the scale of anything in the West. True, China has been buying commodities, but it hasn’t been just for production. China has been a trader and a speculator, buying and stockpiling commodities when prices are low. That means China will eventually stop, or at least slow down purchases, especially as prices rise. I think that relying on China for further growth would be too much.

In commodities, there is a dynamic that could eventually support prices, and that’s basically the depletion of inventories. As we work off supply, we will eventually have a situation where we will have demand but limited supply, and that would drive prices up. I don’t think that would happen immediately, but markets could react to the expectation of this kind of condition within the next 3-6 months.

So today, we have a situation with a big rally behind us and no clear catalyst for a continued rally ahead of us. In the short term, we also have no clear catalyst that would drive us down, and given the amount of buying in recent months, coupled with very low short interest, it would take significant bad news to bring us down as well, in my opinion. The bears haven’t had much success in recent weeks, and that situation could continue.

Still, with lots of space below, the situation calls for caution. That means placing stops under stocks, buying puts, and/or taking profits. For the moment, caution is highly recommended.

July 15, 2009 – An Interesting Week

2009-07-16T22:58:00.000-07:00

So this is turning out to be an interesting week. Tomorrow, Thursday, we have some biggies reporting - JP Morgan Chase, who will give us a sense of how the commercial banking side will be doing; Google, a tech indicator; and IBM, another tech-ish indicator. Obviously, weakness in earnings or outlook will pressure stocks, strong earnings and outlook will give the market another lift.

On Friday, we have Bank of America, General Electric and Citigroup. On the whole, these are more likely to underwhelm and are unlikely to lift the markets unless they provide major surprises to the upside. Also on Friday we have options expiration, but with lots of shorts being covered today and probably tomorrow, there may not be that much activity on that front Friday.

Looking into next week, the companies of note are Halliburton, Coca-Cola, Apple, Altria, Boeing, Amazon, McDonald's and Schlumberger - all interesting, but none with the weight of the companies reporting this week. With the S&P at 933 today and facing upward resistance of 950, keeping the market moving up and through the 950 mark would seem challenging. I think we would need a sense that a recovery in the second half is definitely forthcoming to keep the market moving up past 950. I would think that next week will be mixed - Apple will do well; Amazon might; consumer-driven companies Coca-Cola, Altria and McDonald's will perform respectably but will be hit by currency issues; and for Schlumberger and Halliburton, I doubt that world industrials are on the verge of a recover. In sum, mixed.

As I said earlier this week, I favored the optimistic side going into earnings. If we have good reports tomorrow (Thursday), I would remain optimistic through Friday and then expect momentum to be challenged going into next week. For any positions that have had a bit of a run, I'd consider trimming over the next day or two.

July 14, 2009 – JNJ Earnings

2009-07-16T22:54:00.000-07:00

The Results. Today, Johnson and Johnson reported the following:

- Revenue fell 7.4% to $15.24 billion from $16.45 billion last year. $1 billion of that decline was due to two drugs, Risperdal and Topamax, that came off patent. Sales of each of these drugs was down two-thirds or more. Excluding these drugs, sales would have been up $770 million, or 4.6%

- Earnings were $3.21 billion, or $1.15 per share, compared to $3.33 billion, or $1.17 per share a year ago

- The company confirmed its 2009 forecast of $4.45 to $4.55 per share, excluding items

Analysts expected $1.11 per share on revenue of $15 billion. As of 12pm today, the stock was up $0.28 to $58.

Other factors that impacted earnings included

- global recession

- unfavorable currency exchange rates, which cut total revenue by 6%

- Cuts in spending of 13% on sales, administration and research, and 6% in production costs

By product area, pharmaceuticals sales fell the most, by 13%; consumer products were up operationally, but down due to exchange rates, leading to a decline of 4.5%; and medical devices fell 3.1%. In consumer products, some sales were also affected by the switch to private label brands.

Recently, JNJ also made investments in Cougar Biotechnology for a prostate cancer drug and took a stake in Elan Corp for an Alzheimer’s drug. The FDA also recommended reducing dosage of Tylenol, a drug that brings in $1 billion a year for Johnson and Johnson. About half of the $1 billion is related to the extra-strength 500-milligram dose, the dosage that would be affected.

The Stock. Consensus estimates are $4.51 for December 2009 and $4.88 for December 2010. Based on today’s current price of $58.15, that would be 12.9x 2009 earnings and 11.9x 2010 earnings. Current estimates imply 8% growth year-over-year, and the current dividend is 3.4%.

Historically, the stock has traded in the 17-18x range in the last few years, and in the low to mid-20s before that. On a PE basis, JNJ is trading at historical lows.

There is no question that this is a quality company; its track record speaks for itself. Over the next year, we can expect the recession and currency issues to continue to affect earnings. Moreover, it may take some time for new drugs in the pipeline to boost sales. If JNJ hits its targets, we would have 8% growth plus a 3.4% dividend for a 11.4% return. To get a higher return, we’d have to see an expansion in the PE, something which may not occur this year, but is more likely to occur in later years as the economy rebounds and JNJ comes closer to harvesting its pipeline. So all in all, a respectable stock for a conservative portfolio, but don’t expect any fireworks soon.

The Coming Week - July 13, 2009: Earnings at the Doorstep

2009-07-13T22:36:00.000-07:00

So earnings really starts in earnest tomorrow, Tuesday, as Goldman Sachs reports. Other key companies reporting are Intel, Dell and CSX tomorrow; Best Buy and Yum on Wednesday; and Bank of America and General Electric on Friday.

Goldman will set the tone for the week. I fully expect Goldman to beat, and this morning, Meredith Whitney’s positive call on Goldman set off a 185 point rally in the Dow and a 22-point rally on the S&P. The rally also helped the S&P bounce off a key technical resistance level of 874.

The rally in Goldman sets up a bump in the stock going into earnings, and depending on how much Goldman beats by, there could be either a little more after earnings, or a sell-off on the news. There is a fair segment of the market that will argue that Goldman’s performance will be a one-time event, and that keeping it up through the rest of the year will be hard to do. I remain a long-term bull on Goldman, and do expect the company to beat earnings for the year. So I would look at any dip or sell off as a buying opportunity. My thesis is two-fold: first, Goldman makes money any time money is raised. So as long as there is activity, Goldman will be a beneficiary, either as a facilitator of equity raises, debt financing or even principal investing. Second, Goldman, as one of the last investment banks standing, will benefit from the fall of Lehman and Bear, and the flight of high-paid bankers from the remaining competitors. I see Morgan Stanley in a similar vein, although not as much of a risk-taker as Goldman. As one pundit called it, Morgan Stanley is Goldman Sachs light.

As for the other major banks – JP Morgan, Wells Fargo and Bank of America – they will all benefit from mortgage refinancings and restructurings, as well as from government support. Accounting changes may also benefit these banks. The commercial side should be weak, but the investment banking side (Wells will probably benefit the least, but Wells is planning on beefing up that side) should do well. Finally, the sale of assets, such interests in China Construction Bank, could bump earnings as well. On the downside, the repayment of TARP and share dilution will counteract some of these pluses. All in all, there’s a lot of “stuff” in this quarter’s numbers. I personally think that overall, the banks, in the short term, will not be terrible, and may even give some strength to the market.

In other sectors, we’ve lost the oil trade for the time being, and I don’t expect any earnings reports to be catalysts for the commodities market. Gold is weakening, and many believe that gold is headed toward the 880 range. The consumer will remain weak, and I find it unlikely that industrials will see a recovery around the corner. So at least, barring a surprise, I don’t see any short-term, predictable catalysts for commodities.

Tech remains an area of interest. In certain parts of the market, we have product cycles driving sales – smartphones (Apple, RIMM) and computers (Windows, Intel, etc.). Today, Dell put a damper on that product cycle by saying that Q2 margins will be lower and that customers are delaying purchases. Not a good sign, but it’s not yet clear whether that will be indicative of the next couple quarters. In conclusion, I think, of the stocks mentioned, Apple has the strongest product cycle, driven by iPhones and iMacs. I do think the Windows product cycle will give some lift to these stocks, although how much remains to be seen.

Otherwise, the remainder of earnings season should be mixed. Once we get past Goldman’s numbers, we will get some positives (perhaps the banks), but some negatives, like Dell today. Which way the market will go remains indeterminate, in my opinion, but now market direction is less important than picking winning stocks.

I am long Apple, Intel, Dell, Goldman Sachs, Morgan Stanley and Bank of America.

The Coming Week – July 6, 2009: A Dose of REality

2009-07-06T09:56:00.000-07:00

Earnings season starts off this week, and the biggest name reporting will be Alcoa on Wednesday after the closing bell. However, next week, we will have JP Morgan Chase, Intel, Bank of America, Citigroup and Nokia reporting between July 13 and July 17^th. That means this week will be relatively quiet – newswise - compared to the activity next week.

Still, the market is positioning itself – to he downside. If you look at the market technically, the bulk of stocks are moving to the downside, and many are breaking technical resistance levels. Whatever the pundits may call it, a correction is in progress.

A couple of things happened on the way to earnings season. Mainly, the market had been overly enthusiastic following the last quarter’s big rally. The market was willing to indulge itself until the reality of earnings was upon us. The most glaring evidence of this was in commodities – the rally in oil, and in commodities in general, wasn’t really based on demand as many claimed. It was based on China buying reserves for its own strategic reserve, and on China stockpiling for future use. Money looking for a return was willing to pile on top of that trade. By my definition, the commodities trade of the last couple months was speculative. By the end of June we all knew this to be true, but the market was willing to play the trend until it was forced to do otherwise – regardless of the fundamentals. Faced with the reality of earnings, the market now has no choice but prepare for the reality that the consumer is weak, and as a result, the demand for oil and commodities is fundamentally weak as well. With demand weak, flares of fear about inflation turned out to be premature. As a result, the dollar has declined, but not as much as feared. That has helped quell the commodities trade of the last few months. Thus we see oil today at $64 today, off its high of $73 only a week ago.

Financials have declined in the last couple weeks, but they were recently trading at prices that reflected close to fair value to 2010 earnings. We’ve lost the commodities trade, and enthusiasm in tech will have to await confirmation from earnings. That leaves little to lead the market at the moment. And thus we wait. Personally, I expect this quarter to be very mixed. Unlike the last couple quarters, where entire sectors traded together, I think this quarter we will see individual stocks differentiate themselves within each sector. In other words, we’ll see the strong separate from the weak, and we’ll have to be stock pickers.

One other reason I see a mixed earnings season is the lack of earnings pre-announcements. Remember last quarter, when Wells Fargo was doing so well that it had to pre-announce its record quarter? Well, this time, we don’t have anyone jumping the gun and announcing great upside news. By the same token, we haven’t seen earnings warnings either. In fact, this quarter is notable, so far, for the lack of pre-announcements saying that earnings or forecasts will be missed. In sum, so far, not much black, not much white, just gray. So a pullback, or a correction as we await news. Which is not bad by any means. Pullbacks are necessary, and often opportunities to buy for the long term.

The Coming Week – June 22, 2009: Awaiting Earnings

2009-06-29T10:49:00.000-07:00

The second quarter officially ends tomorrow, Tuesday, and investors anxiously await earnings releases starting next week. In the meantime, non-farm payrolls and jobless claims released this Thursday will be the data highlight of the week. One estimate calls for 375,000 jobs to be lost.

The week is also expected to be relatively uneventful, especially given the holiday on Friday. Many traders will disappear Thursday for the long weekend.

The market saw a brief pullback last week that became a very difficult-to-catch trading opportunity as the markets rallied back. Still, the direction remains indeterminate as we enter second quarter. Personally, I expect earnings season to be varied and mixed. The consumer remains weak, and while the savings rate climbed to 6.9% - a 15-year high – spending rose only 0.3% according to reports last week. In many sectors, there are positive and negative forces at work, making it difficult to say whether one outweighs the other.

Take financials, for example. We know there will be losses coming in credit cards, loans and commercial real estate. Still, the banks continue to benefit from a favorable yield curve and a boom in re-financings that lasted until interest rates crept up a few weeks ago. Finally, accounting rules could force banks to write down assets in some cases and write up assets in others. All in all, the situation is directionally unclear.

Trading and investing wise, I think the guidelines remain the same: be a stock-picker, look to valuation, build a position over time in themes that you believe in.

The Coming Week – June 22, 2009: The Markets Want to Correct

2009-06-22T08:46:00.000-07:00

The markets are in retreat. Last week, we lost the commodities trade, and those holding commodities generally have to watch out below. In the weeks before, the sideways market kept rotating funds from sector to sector. Eventually, with no major news that would drive markets higher, investors decided that the rally couldn't last much longer.

In the long-run, this is healthy. The market needs take a breather and correct. A rest would give the market more confidence that an upward trend could continue in the longer run - barring any major negative news, that is.

This week, many are watching the Fed to see what it will say, particularly in regard to whether it will start withdrawing some of the special financing programs initiated in the last year. Rates are not expected to change any time soon, and inflation is not expected to be an immediate problem. A slow recovery is the general consensus.

As I always say, it's impossible to say how far down markets will go, or whether this will be the last pullback. Still, it's a good time to put together a list of stocks you would want to buy for the longer term, and at what price you would buy them.

The Coming Week - June 15, 2009

2009-06-15T01:47:00.001-07:00

At the beginning of the June, I wrote my monthly investing article entitled, “Directions, Please”. The theme was basically the lack of direction – the market trading sideways, unable to decide what to do. Then on June 10, I wrote an update on the blog, entitled, “The Long-Awaited Correction?”. That article spoke of the potential for a weak Treasury auction to spur a long-awaited correction. I proposed that a weak auction of the 30-year note, combined with a rise in interest rates, would signal a downward turn in the markets. Well, despite a challenging auction of the 10-year notes, the 30-year notes actually sold well, and interest rates did not rise substantially following the 30-year auction.

That leaves us back in sideways land, and the market barely budged in either direction last week. Up about 100 points on Dow was the bottom line. Still, the bulls and the bears are essentially stalemated, and money is rotating through various sectors, as most stocks seem to be range-bound.

This week there is likely to be more of the same, because no major news events are expected. Some housing and CPI data will be released, but unless the news is strong either way, the most likely result is more sideways activity. So what to do, I say wait and see – but with a strong bias toward caution.

The Long-Awaited Correction?

2009-06-11T01:05:00.000-07:00

Wednesday, June 10, 2009

We have long talked about the possibility that weak Treasury auctions could cause a change in market direction. Today, that possibility took a big step closer to reality.

Today, US 10-year Treasury notes were auctioned at a yield of 3.98%. A little more than a month ago, on April 30, the same 10-year Treasuries yielded 3.16%. That means the cost of borrowing is rising – fast. Today, the rate on 30-year mortgages hit 5.79%, up from 5% two weeks ago.

A bit of mechanics as background. The Fed sells Treasuries and uses the cash received to finance spending. During the credit crisis, investors – among them central banks around the world – poured into Treasuries because they were the safest place to be. This was fine with the Fed, because the Fed needed money to finance Washington spending. This includes not only the bucketloads of money used to save the financial system, but Obama’s planned spending, on top of an already mountainous pile of debt created during the Bush administrations.

This last month, there were signs that the worst of the financial crisis was over and the market started thinking that there might be a recovery later on in the year. The irony is that the positive signs have been the engine of the next big worry: inflation. As the economy stabilized, two things happened. First, the market became more willing to take risk, and so money started coming out of safe Treasuries and back into riskier equities. Second, a more stable economy meant to many that inflation would soon be around the corner. Inflation makes long-term fixed-rate Treasuries worth less, reducing the demand for Treasuries. Still, the Fed has to sell more and more Treasuries to finance its spending. To achieve those sales, the Fed has to offer higher yields.

And it all comes down to this: Treasury yields drive interest rates, which is why the rate on 30-year mortgages rose to 5.79% today. Tomorrow, the Treasury will auction 30-year notes. Demand should be weak, and yield on the 30-year Treasury should rise.

The consequences of this are enormous. Rising interest rates would choke of mortgage re-financings, new home sales and already tepid consumer spending. The cost of commodities would increase as well, because inflation weakens the dollar. Most commodities are priced in dollars, making them more expensive as the dollar declines. Also, investors prefer to put their money into hard assets, such as commodities, rather than a depreciating paper asset such as the dollar. This is what China has been doing: rather than use its money to buy long-term Treasuries that would decrease in value as inflation rises, China has been stockpiling commodities that should rise in value instead.

Also expect financials to be hit by rising rates. First quarter earnings were positive because banks made a mint off the yield curve; they borrowed short-term at near zero rates and lent long-term at 3-4%. Rising short-term rates would put a dent in those margins. The banks also made a bundle off a high volume of mortgage re-financings. Many analysts believe that 30-year mortgage rates in excess of 4.75% will severely reduce this business. Keep in mind that after more than a 30% run up in the market over the last couple months, many financials are already priced at a level that assumes next year’s earnings targets will be achieved. Anything that interrupts that expectation could cause a pullback in stock prices. And finally, many banks are trading close to recent secondary offering levels. In theory, no buyer wants to sell so soon after buying, so there should be substantial resistance. Still, fear of inflation – and reduced earnings – could cause the stock price to fall under those recent secondary offering levels. As of today, many banks are approaching those levels. If they break through and stay there for more than a very short period, a significant correction becomes very likely.

In sum, the scenario becomes short financials, short upscale consumer, long consumer necessities, long commodities and short Treasuries.

How likely is all this? The short term is always difficult to predict, so my strategy is to keep the possibilities in mind and look for signs. We could continue sideways, but there are indicators that could tell us if we’re headed toward that long-awaited pullback. First, tomorrow, Thursday, watch the 30-year Treasury auction; a weak auction and rising yields means weakness for equities. Second, look at the financials and see if they break below their recent secondary offering prices, as mentioned above. Third, look to see how far commodities go. For example, many analysts believe that oil that remains above $70-75 for any extended period of time will eventually hurt the consumer. I agree, so if commodities remain high for a while, this becomes a very bearish sign.

Fourth, and finally, look to see what the Fed can do to counteract rising rates. The Fed can buy securities, which would push up prices and reduce yields (price and yield are inversely related). The Fed could also increase interest rates, although many think the economy is too fragile for the Fed to do this. And the Fed to cancel non-essential bailout programs, thereby reducing spending. If these measures work, we could have at least a temporary reprieve. If not, the bears will lead the market.

What's Next?

2009-06-07T20:53:00.000-07:00

What’s Next?

Excerpt from my June 5th investing article, published at www.asiancemagazine.com

So what’s next? So far, the market has continued to defy the naysayers, the ones that say a correction is imminent. Each time the bears thought the rally was over, new money came into the market.

As much as I’m a fan of analysis, I will be the first to tell you analysis doesn’t tell you much about today’s short-term outlook. The fundamentals would say that we are either fairly valued or overextended in many cases. If you do the math, for many companies we are trading at reasonable market multiples to next year’s earnings. Meaning, in many cases we’re trading at a prices that assume the company will hit next year’s earnings targets. That’s actually a pretty high bar, and anything that gets in the way of that could send a stock in the other direction. In commodities, we’re definitely beyond today’s fundamentals. We’re trading at levels that assume either a rebound in the economy by the end of the year, or inflation that will support the current run in commodities prices. In sum, we’re at prices that assume our future predictions will come true. Knowing all this doesn’t really say a whole lot the short-term direction of the market. As we get higher, the likelihood of a pullback increases. Still we could go higher for a while before that happens, or we could go sideways for a while. Or some event could take the wind out of the market’s sails.

At the moment, I think the technicals are also indeterminate. Take a look at the following longer-term chart of the S&P.

As mentioned, the rally broke below its trendline during the second week of May, traded sideways, and established downward resistance at about 875-885. There’s some minor upward resistance levels of about 950, but significant resistance at about 1,000. So we have a fairly open range of, say 875-950, or perhaps 875-1,000, where the S&P could trade and not bump into significant resistance.

Also notice that the current close of 942.46 is above the 200-day moving average of 921.62. While this is a positive, the market would have to stay above the 200-day moving average for at least a week (based on historical experience) for this to be meaningful. All in all, the technicals don’t indicate that the market would definitively head one direction or the other.

Treasury Auctions. So what could cause the market to move either way? This week, the Treasury will sell $65 billion in 3-, 10- and 30-year securities. In total, the Treasury expects to issue $2 trillion in 2009 to finance its deficit. The market is very worried about the longer-dated Treasuries, the 10- and 30-year notes. If the economy is getting better, the appetite for safe but low-yielding Treasuries diminishes. Also, inflation makes the longer-dates notes riskier, so investors are more likely to buy the short-term notes than the longer-term ones. A weak auction would result in higher interest rates, making it harder for the economy to get back on track. The Fed could try to keep interest rates low by stepping in and buying notes, but that would only be interpreted as a sign of weakness. On the other hand, a successful auction would give the market confidence and could boost the indices. All in all, an important week.

TARP Repayments. Another eagerly anticipated event this week is the TARP repayments. The Treasury is expected to announce which banks can begin repaying the TARP. Those that can repay will get a boost. Among the bigger banks, Goldman Sachs, Morgan Stanley, and JP Morgan are expected to qualify. There’s a small cloud hanging over Wells Fargo because the Fed has said that it can’t rely on earnings to fulfill the Fed’s capital requirements, but Wells Fargo is insisting on using earnings to help make up any shortfall. So it may not get the green light to re-pay TARP, and we will have to see how the Fed responds. As for Bank of America, I actually think the company should hold on to its TARP funds because of looming losses in loans, credit cards and commercial real estate. Here, I actually think returning the TARP funds might be a bit foolish, and I suspect the market may agree. Lastly, Citigroup will be holding on to its TARP funds for a while, and the firm is expected to convert the government’s money into common stock soon. On the whole, the announcement of TARP repayments should be positive, and banks, and perhaps the market as a whole, should get a boost if all goes as expected.

Investment Strategy

So for me, there’s a lot of uncertainty in the short-term. And the thing is, there’s lots of uncertainty in the medium- to long-term, too. As we’ve mentioned for several months now, we still have massive losses in loans, credit cards and commercial real estate coming. If they all hit within a concentrated period of time, then the losses could weaken bank balance sheets and cause significant pullbacks in the financials and the market as a whole. On the other hand, if the losses can be spread out over time, earnings and the recent capital raisings could potentially cover those losses, leading to a more stable market. In that case, pullbacks in the market could be relatively small, and the market is more likely to move sideways or be upward trending.

I’d like to note one other thing that makes the short-term direction of the market unclear. For the short-term investor looking for a run in a stock, most stocks look expensive. After a 30% run in the market, how much more upside can there be? And yet, for the long-term investor, stocks remain cheap. So even after a 25% run in the market, the long-term guys are willing to step in and drive the market to a 30% gain. If the news is good enough, or “less bad” enough as our current mantra goes, the long-term guys could drive us up a few more percent.

What should an investor do in this environment? Despite the uncertainty, it’s still possible to build an investment strategy to fit an uncertain environment.

The first thing I would say is that the long-term outlook remains good, and that in the lens of a 3-5 year time frame, stocks look cheap. That means that we should be looking to buy, not necessarily in the next week but anytime over the next year. So for me, it’s not a question of whether you should buy equities, but a question of when, or what’s the right entry point.

Second, because corrections and pullbacks are likely, especially as we hit the second and third quarters (where it becomes harder to live up to expectations), we should stage our investments rather than buying all at once. If there is a correction, our average cost will be lower, and we may be able to replace the higher cost shares with the lower cost ones.

After that, it’s a question of stock picking – looking at the individual stocks and picking a good entry level. Generally, I would stay with the leaders, the survivors, the ones that will excel in a downturn. Then, look for the pullback. Of course, this is no easy task, because who knows whether a 5%, a 10% or a 15% pullback is right – or will even occur. It can be easy to miss the pullback, or to enter too early in the pullback phase. Still, there are guidelines that can help us. And keep in mind, I’m of the opinion that it’s very difficult to pick the bottom; a low price is often good enough.

Update: Credit Cards

2009-05-27T00:57:00.000-07:00

At one point I had said I favored Visa and Mastercard. I had a position in Mastercard, but it fell below my stop and my position was automatically sold (which was a good thing, by the way - that was the purpose of the stop).

Given the recent legislation, I think these are good stocks but they will take some hit in transaction volume along with the rest of the credit card industry. As such, the right entry level has to be re-evaluated.

Mastercard's downward resistance is being challenged, but Visa seems more likely to hold downward resistance of $65. Now, it seems prudent to see how the situation evolves before buying Mastercard or Visa, especially given that no major upside catalysts are on the horizon. Also, recent legislation has put downward pressure on the entire industry, and if you look at the charts of the other credit card companies - Capital One, Discover and American Express - it looks like the trend is broken and that these stocks will break downward resistance.

Dan Fitzpatrick of thestreet.com has done a technical analysis of the charts, in much more eloquent fashion than I can. So here's a link to his work, very informative, I think

http://www.thestreet.com/p/_htmlrmm/rmoney/technicalanalysis/10505161.html

Bottom line, watch on the sidelines and see where things settle before committing any funds.

The Week Ahead: Monday, April 25, 2009

2009-05-25T21:54:00.000-07:00

After a three-day weekend, the market faces a week highlighted by economic news, a possible GM bankruptcy and a huge volume - $101 billion – of Treasury notes coming to auction. In terms of GM, no one expects the bondholders to walk quietly into the night, making bankruptcy highly likely, regardless of what happens on the union side. Also, the economic indicators are expected to be weak.

So unless there is surprise in the economic indicators, the Treasury auction and the dollar the centerpiece of the week. The last Treasury auction was just a bit weak, and given concerns about the amount of debt that the US has, this week’s auction could be even weaker. That could set off a series of consequences – the dollar could continue to weaken; interest rates, especially in the longer dated maturities, could inch up; commodities would rise; gold would gain; and weak dollar plays such as Proctor & Gamble, Coke and McDonald’s could rise. Some say that all this might trigger a general sell off in the market, but that remains to be seen.

Should interest rates rise, that could also spark a reaction by the Fed , which would start buying securities to keep interest rates low. That’s because the Fed’s priority has to be to keep the credit market working, and that only happens if interest rates stay low.

What does all this mean for an investor? Basically, it’s a trader’s week, because things could move very quickly. We could head one direction and then reverse, depending on how things play out. If you’re placing bets, a quick trigger finger may be necessary.

Longer term, I’m still watching certain stocks as a long-term investment. For the financials, which have been under pressure lately, I’m looking to see how much further they may retreat, and whether they will fall below their recent secondary offering levels. Again, I’m looking to build a position in the financials over time (meaning, no need to commit everything now), the favorites being Goldman Sachs, Morgan Stanley, JP Morgan and Wells Fargo. Bank of America is interesting, but requires caution. All of these banks face the possibility of increased losses over the next couple quarters. While I think the disaster scenario is unlikely, pullbacks actually remain very likely.

Market Update

2009-05-21T13:00:00.000-07:00

So it was fairly obvious that the market has been turning. We got a bit of a head fake Monday, but weak volume and selling into the close on Tuesday and Wednesday should make today's retreat no surprise.

I'm looking at the charts this morning, and it looks to me as if we have resistance around 8,000 on the Dow, 850 or so on the S&P.

For the financials, we have to start looking at individual charts to determine entry points. Generally, though, I think that we should look for opportunities in the diversified, big banks and trading houses - GS, MS, JPM, WFC, BAC. The investment banks, GS and MS, will do fine and will benefit from being the only two true investment banks standing. JPM, WFC and BAC are diversified, so while they will be hit by credit cards, loans and commercial loans, they will make money from other business lines, including refinancings and the investment banking side of their houses.

I continue to like BAC and think there is a decent chance that they will make it through without substantial government conversion of preferred shares. Still, BAC does have some risk - potential losses from Countrywide, credit cards, loans and commercial loans remain significant and could outpace earnings. So this is one that has to be watched very carefully, particularly at earnings.

Here's a couple levels I'm watching. Keep in mind that resistance is never a guaranteed floor, only a probably floor.

- GS: some resistance around $127-130; more around $120; it's capital raise was at $120

- MS: resistance looks to be around $26, it's latest capital raise was at $24

- WFC: resistance is around $24, the offering was at $22

- JPM: short term resistance of $34, next level is $32.00-$32.50. JPM is also approaching it's 200-day and 50-day moving averages.

- BAC: no clear resistance level, although $11 looks like a possibility. It's capital raise was at $10.

As for Citi, the government preferred conversion continues to hang over the stock, so don't expect much change until that transaction is executed. I've spoken about USB before, and I continue to like it, but it is a more traditional bank and exposure to credit cards, loans and commercial loans without investment banking revenue to offset pending losses. The same remains true for regional and smaller loan driven banks.

On the commodities side, caution is recommended. Let's start with copper. For a while Freeport McMoran (FCX) was driven by the belief that China might drive growth. Now that consensus opinion sees China's buying as nothing more than stockpiling, copper needs a reason to go higher, and I don't think there's a substantial demand reason to be buying copper.

With natural gas, in the long term it's a buy, but in the short term, huge supply remains, and natural gas prices took a major hit today. I would expect natural gas to correlate with the market in general and the economy; when stocks rise, the market believes the economy has better prospects, and natural gas usage will go up as it's used in homes and in manufacturing. When the market goes down, we obviously have the reverse.

Oil here is tricky. Technically, the chart isn't broken, so it may have more to go. Very possibly this is driven by expectations that demand will increase for the summer driving season. Also, the dollar is sinking. Both of these could continue to drive oil, but expect decent volatility here.

Finally, Treasuries are falling as supply continues to be high, and the Fed today bought less than expected. I missed a buying opportunity Tuesday and Wednesday in the TBT (short Treasuries), which was about $49-50 over the last two days. As we approach the close, the TBT is a little over $52. Longer term I continue to see the TBT as a buy.

I'm long GS, MS, JPM, BAC and natural gas stocks CHK and XTO. I do not hold shares of WFC, FCX and TBT.

Thoughts on Commodities

2009-05-21T12:43:00.000-07:00

The more I look at commodities, the more I think there is no fundamentalreason for oil to be rising. Consumer demand hasn't changed significantly,and supply is ample. The only real thing that has happened in recent months is that suppliers have tried to manage the price of oil (for example) to drive up the price of oil (same case with other commodities).

So why is oil rising? Let's incorporate the role of speculators in commodities. What I think has happened, in addition to suppliers curtailing production, is that speculators have seen a bottom in the pricing of oil. Because they can see a turn, they have decided that it's an appropriate time to accumlulate oil, thus helping to drive up the price of oil. I don't think anyone is consuming the oil. It is, as it did last year, sitting in tankers somewhere in the ocean.

The role of speculators also helps explain another thing that's been bothering me. Demand is flat, and by themselves, producers can't cut production enough to drive up the price of oil from $45 or so to $60. No one thinks that OPEC is an effective cartel and with Russians, Brazilians, Venezuelans and the like in the mix, there is no effective coordination of supply. The only explanation left is that speculators help limit supply and drive up the price of oil.

A similar example would be China stockpiling commodities. I never accepted the argument that a) China's economy was excelling while the rest of world was in crisis; or b) that China could save us from recession. China is wayto export dependent for a) to be true, and China's economy is not large enough to do b). So the stockpiling argument is the only one that made sense. So in effect, China is being a commodities speculator. Like the oil speculators buying oil and holding them off in tankers at sea, China is stockpiling needed commodities when they are cheap and holding them in storage. And you see the effect that it's had on the markets; if speculation is large enough, it can drive up the price of commodities, the way China helped drive up the price of copper and coal.

Add one other factor to the mix: the price of the dollar. As the dollar weakens, as it did today, the speculators (traders and china both) will buy and stockpile more because the lower dollar drives down the price of these commodities for some of these players.

So what does it mean? First, in terms of a model for understanding what is happening with commmodities prices, that would mean we have to take intoaccount the following:

1) "true" demand - what people are actually consuming

2) supply - and this could be OPEC; other countries; and the US reserves,such as the petroleum reserve (the US could release oil and increase supplyto drive down prices); and supply disruptions (violence in Nigeria)

3) speculators - China, traders, as mentioned above

4) the price of the dollar (lower dollar = higher commodities)

5) inflation (which is actually related to 4)

And in terms of what this all means for investing, it means the following to me:

1) Commodities require caution because volatility will be higher and not based on fundamental demand.

2) if this explanation is correct, this means that we have to TRADEcommodities rather than INVEST. Meaning we have to buy and look to sell and take profits when we think the speculators have stopped buying. For example, this means that the copper trade based on china's buying cannot last forever. It might last because the dollar weakens or inflation hits, but not because china is in economic recovery.

3) and it means that we can't assume the economy is recovering. Which I think is the more accurate picture. I think the recovery will be long and slow. That makes more sense to me than the idea that people will spend more and we'll recover sooner.

The Math on Bank of America (BAC)

2009-05-20T02:20:00.003-07:00

So Bank of America has so far sold $13.5 billion of stock. We know that the 825 million shares sold today was at $10 a share, the remainder sold in an ATM offering (at-the-market) over the last week or so, so that was probably at $12-$14.

Bank of America needs to raise $33 billion. So far it has said that it will raise $10 billion through asset sales, $17 billion from stock sales and from conversion of preferred to common, and the remaining $7 billion from earnings. BAC has said that it hopes to avoid converting government preferred to common, meaning that the conversion would come from non-TARP money.

BAC's current share count is 6.403 billion. If we assume that BAC raises the $17 billion from sale of common at $10 per share, then BAC would sell an additional 1.7 billion shares to cover the $17 billion. So the new share count would be 8.1 billion shares.

In 2008, BAC had net income available to common of $4.8 billion and EPS of $0.56. In 2007, net income available to common was $14.8 billion and EPS was $3.35.

Let's use the 2007 number as a proxy for more "normal" times. With $14.8 billion of net income and a share count of 8.1 billion, EPS would be $1.83. With a 11-12x PE in better times, the stock price would be $20.10 - $21.93.

This implies that even with the share dilution, the stock could hit $20 whenever the market stabilizes, the TARP is repaid and earnings are closer to "normal" Of course these are broad approximations, but $14.8 billion revenue of net income is conservative, so there is a fair chance that the stock price would be even higher. Even if that's in 4-5 years, that's a pretty decent return on an $11-12 stock.

So you can see why the market has been so bullish, and why BAC's has been able to raise $13.5 billion through stock sales.

I'm seriously looking at buying some BAC. I'm already long some BAC.

A Tactical Change

2009-05-19T10:09:00.000-07:00

A Tactical Change

May 19, 2009

Last week, technical analysis told you that the trend lines were broken, that the rally was finally going to see a pullback. Stocks sold off, but not as much as many expected. Monday’s 250-point advance on the Dow confused many, and it remains a bit difficult to interpret. Volume was low, but the advance was significant.

Because you can never deny price action, we have to try to understand it. It seems to me that there are buyers out there, and many continue to look at the long term and say that stocks – and especially financials – are cheap. Basically, they’re buying the dips.

And that’s a change from the past. As mentioned, for most of the past year, the approach was pretty straightforward – buy a dip and sell the rip. Be a trader, jump in and out, and do it very, very quickly because trading opportunities lasted for moments. Not always an easy thing for the retail investor, much better for the professionals.

Given the strength of the bears – and the lack of sellers, it seems, at least for now, that we will have pullbacks in the 5-10% range. Given the amount of buying that we’ve seen over the last month, we’d need significant reasons for bigger declines. To a certain extent, this makes sense. If you’d committed, you don’t want to jump out at a loss until you have to. Short sellers have also been forced out of the market, so they would also need a reason to set up their short positions again.

So that’s a possible explanation. Still, it’s no guarantee that there is a downside floor. We could be just testing the upside resistance before going down again.

So what to do? It seems to me that the best strategy given the uncertainty is to go back to the old style of investing – buy the dips, but in parts. Average your investments, not committing to a large position on any dip. Also, stick with the market leaders, the best in breed, the ones with good business models.

This is a change in tactics, which makes sense, because I think we’re in a different market. We’re back to stock picking, perhaps using technical analysis to spot downside resistance and buy at those levels. And building positions over time.

This change in approach is also supported by the VIX, which declined below 30 today. That means things won’t move as much as they have since last October / November, the market is slower. While still higher than the historical norm of 15-20, what’s important is to recognize the downshift as we approach the summer.

So for the moment, I’m not doing much, just waiting for the next dip. Snooze…

Pullback Time

2009-05-13T15:43:00.000-07:00

So it’s obvious now that the market is turning. The question is how far is the pullback. I think we’re just at the beginning. I can’t see many pside catalysts for a long time and I do think Q2 earnings will show the losses in loans, commercial loans and credit cards that have been having over our heads. So we have a period of time where we don’t have huge upside catalysts, we’re likely to pullback and drift one way or the other.

Over the weekend, and even Monday, I was putting in stops under all my recent buys. And so Tues and Wed, many of them were automatically triggered, and the emails from my brokerage account came flying at my blackberry. So now I’m out of my FIG (Fortress), MA (Mastercard), some GS (Goldman), some JPM (JP Morgan) and some BAC (Bank of America). All fine, because they look like they are headed lower. If you look at their charts, and charts for the market and for many stocks, they are all broken (from a technician’s point of view).

The good news is that we will see buy opportunities over the next several weeks. Timing of course is uncertain, but it’s definitely coming. There is a lot shopping to be done, so put stocks on the radar, get the cash ready.

Monthly Investing Article

2009-05-08T00:07:00.000-07:00

I sent out my monthly investing article yesterday. It should be on www.asiancemagazine.com as soon as tomorrow, and I've sent it out to my mailing list. If you'd like it emailed, please let me know at mtlo@post.harvard.edu.

Taking Some Dips: EWT

2009-05-06T13:36:00.000-07:00

EWT. So today I took another dip, this time into EWT, which is iShare MScI Taiwan. Simple idea, really. China can now invest in Taiwan, which should bring a lot of money into the market over the long term.

Generally, I don't like ETF's, I prefer individual stocks. ETFs tend to average out returns, as opposed to picking out the leader in a group, whose return should exceed the group. Still this is a country play, and a fundamental, structural change in how much money goes into this market.

Stress Tests. Once the stress tests are done, I have a hard time seeing what can drive the market higher, so it may very well be time to consider fading the rally.

Taking Some Dips: FIG, MA

2009-05-06T13:03:00.000-07:00

Tuesday, May 5, 2009 – 3:10 PM

Fortress Investments

So today I took a dip into FIG, Fortress Investment Group. Admittedly I'm a bit later than I want to be, but this thing is moving ridiculously fast. Tomorrow, Fortress has it's earnings call so we'll have a lot more information on how it's doing.

So the thesis on Fortress would be this: if you believe the worst is over, and that Fortress can make money buying assets at a discount, they they should do very well over the next few years, and even the next year.

The stock got hammered because it was a private equity play, and we all know what happened there. It was as low as the $2 range because in january, significant redemptions lowered their assets under management. Mark to market hit their books, and some of their companies had debt problems.

To believe fortress will do well, you have to look favorably on these factors:

1) the redemptions have stopped because the market is no longer staring at a downward spiral.

2) the companies that they've invested in have debt situations that are manageable. We'll get more info on this tomorrow, but in their last earnings call, they said they've taken care of a lot of it.

3) they will be participants in the TALF, meaning they will be buying assets with government backing for a heavy discount. If we assume they're pretty smart guys, they should come out making a profit. Regardless of what happens with the stress tests, these guys should be busy buying assets at a discount.

Fortress is a bit on the speculative side at the moment. Truth be told, earnings tomorrow is a toss up. They could beat, or there could be problems we don’t know about. The argument for beating is that a lot of the market has beat, and similar firm Blackrock is doing really well; the downside is that some other asset managers, like Legg Mason, reported today and didn’t do as well as expected. Still at $6-7, I don’t mind nibbling at FIG and being speculative.

Looking Past the Stress Tests

I still can’t tell you which way the market will go with the stress tests. Everything could be priced in, the market could use it as an excuse to take profits, or the sideline money could come in. In other words, I can’t tell. I’m inclined to think that there won’t be any huge sell off because we know that the stress tests will be positive, and recent buyers won’t have a reason to sell.

So I’m looking past the stress tests, and the only trade I see is being in the survivors, and especially those that will repay the TARP first. That puts Goldman and JP Morgan in front. Goldman, as I’ve said, I definitely like going into the stress tests. I can’t see how they’d come out badly, and the worst case I can see is profit taking. JP Morgan should do well also, and both are in discussions to repay TARP. Jaime Dimon has said discussions will start as soon as the stress test results are released. Morgan Stanley hasn’t said much about paying back the TARP, but there’s been no sign that they need to raise capital, and their fundamentals are fine, other than commercial real estate on their books. Also, Morgan Stanley has broken resistance at $26. On dips, I like all three, but in order, Goldman, JP Morgan, Morgan Stanley. Of couse, I’m watching Wells, BAC, C and USB carefully. I have positions in all except Wells.

There may also be a play in Bank of America if a conversion does not occur. Currently, the possibility of government conversion of preferred is priced in, at least in part, I would argue. If that doesn’t happen, BAC should move.

Mastercard

A few days ago, Mastercard was down as much as $13, from $183 because it lowered full year estimates. Today, it’s back at $183, which tells you how much the market likes mastercard. Put it on your radar screens, buy on any dip. I bought a little at $170, thinking I’d buy a little more if it went down more. Well, it didn’t.

Playing the Secondary Offering

We all know that there will be banks, and other firms raising money over the next several months. For the last year, there has been a play in secondaries. The most familiar case might be Goldman; it raised money at $123 or so around earnings time. For a moment, it drifted down to $120 or so before the secondary, and down to $115 after the secondary. Since then it’s climbed to $135 today. So the simple play is this: the secondary stock offering will drive the price of the stock down because of dilution. Usually, it’s occurred within a day or two of the announcement. The trade is to buy going into, or just after the secondary, because the stock recovers. You can only do this if the successful secondary stock offering is a sign of strength. Meaning that the company isn’t raising money out of weakness. Recently, Northern Trust (NTRS) and US Steel (X) has done the same, and both have a seen a quick rise in the stock after the secondary. Dow Chemical (DOW) just announced a secondary today, I wouldn’t trade that one because it’s coming out of weakness, not strength.

I am long FIG, GS, MS, JPM, C, USB, MA, . Those are my thoughts for the day,

ming

The Week Ahead: Where's the Pullback?

2009-05-04T00:43:00.000-07:00

It’s Sunday night, and the first thing I noticed is that there is no weekend bombshell that will affect markets. Citigroup will try to raise more money, Bank of America will do the same, and Buffett fesses up to a tough year. No shockers, no market movers.

And perhaps that’s indicative of the mood. Basically, optimistic. On Friday, the S&P broke – to the upside – the critical 875 support level. That doesn’t mean all clear, of course, but it does say that there is demand. And the base built at 875 is solidifying. Admittedly, the market could be getting tired of this upward push that began on March 9. But many had given up on the rally a long time ago. So everyday that the market doesn’t retreat is a victory for the bulls.

This week brings the stress tests, to be released May 7^th. For me, I always look at investing as a matter of probability. So I ask myself, what’s the probability of the markets reacting well to the stress tests? What’s the probability of the market reacting badly? The government will try to say that the banks are in good shape, that is clear. Some banks will need to raise money, and there will be a separation between the “good” banks and the “weaker” banks. But beyond that, I couldn’t tell you whether the market will go one way or the other. At least, not with any degree of confidence. So in other words, I’m not placing a bet either way. For me, there is no trade in the stress tests.

Truth be told, I tend toward holding or a bit to the upside, for no other reason than we will have clarity, and the cloud of the stress tests will be over (at least for some time). Clarity in itself is a positive for markets, and the only counterweight is that some banks will have to raise money. That’s not new news, so that’s why I lean in the direction I do. Still, I can’t see it being much of a trade.

For the banks I hold, if the basis is below where it is today, I’ve sold off that position (I have shares above today’s price, which are held over from before the crisis. Those I haven’t sold, and expect to hold for some time). The only exception is Goldman Sachs, which I believe will do well in the stress tests, and with any luck, has a shot of returning the TARP money.

The last month has also brought back a return to stock picking, and looking at the longer term. Before, the entire market and entire sectors would move together. Good bank, bad bank, it didn’t matter, the entire group moved together. Now, we’re starting to differentiate among the banks, and you have to pick stronger ones and leave the troubled ones behind. And that’s not only the banks, that’s the market as a whole.

I have said in my monthly article that I believe Visa and Mastercard will do well in the long run. After trimming the outlook for the year, Mastercard took a bit of a hit on Friday after earnings, and dropped about $10.55 to the $172.90 range. It may still decline, but I’m looking long term on this one, building a position, averaging. To be clear, even if Mastercard doesn’t decline much in the next week or two, there will be credit card problems in Q2, and perhaps Q3. Mastercard is a processor, and doesn’t extend credit, so it won’t have credit losses. But its transaction volume may very well be reduced, so the company could report weaker earnings in Q2. Still, it has a solid business model and good long-term prospects. I like Visa, too, but it’s had a bit of a run, and as a general rule, I don’t like chasing performance.

I’m beginning to look at Boeing as well. The company has been hit as all other companies, and has had a nice run recently. In Q2, it still expects to have the first flight of the Boeing 787, the Dreamliner. If it flies successfully, that will be a huge boost for the stock and it clears the way for years of sales. So I’m looking for a good opportunity to get back into Boeing.

And one more longer term play – IBM. It recently re-affirmed guidance of $10 a share (or so) in 2010. With a 12x PE, that would be $120. Today, it’s at $104.61, and has been climbing quickly over the last week. The bulk of IBM’s sales is service revenue, so that makes its income very stable.

And one other follow-up. I’ve said that as the market stabilizes, money will come out of Treasuries, and that will drive prices down. The TBT (double short Treasuries) was $45 last month when I recommended this trade. Credit markets have improved, and today, it’s at $45.20. There might be a pullback, but over the next year, the trend out of Treasuries should continue.

I’m long GS and MA, and do not hold Visa, Boeing, IBM or the TBT.

On the Radar: Sherwin Williams

2009-04-28T01:07:00.000-07:00

Not long ago, Barron’s came out with an article on Sherwin Williams (SHW) entitled, “Painting Over a Problem?” In that piece, Barron’s argued that at a price of $53.55 (on Monday, April 13, 2009), investors were ignoring pending problems in the stock. At that time, I hadn’t looked at the numbers yet, but the Barron’s article seemed fairly reasonable. So it was curious that after earnings were announced on April 16, the stock jumped from $51.11 to $56.96 on huge volume – 8.1 million shares, compared to a more normal trading range of 1.5-2.0 million shares. In fact, year-to-date, the only higher volume day was January 22, when Sherwin Williams missed earnings. That day, the stock traded 9.8 million shares and fell from $55.42 to $48.20. Afterwards, Barron’s re-affirmed its negative stance and so did others in the press.

Let’s take another look at the numbers. Sherwin Williams re-affirmed guidance of $3.00 - $4.00 EPS for 2009. Consensus is $3.54. At today’s (April 27) price of $58.25, that’s a 16.5x PE. Historically, Sherwin Williams has traded at a PE of 12-16x over the last ten years. That means the company is trading as if we were in the good times, as opposed to the uncertain bad times. Using a 12-14x PE on consensus earnings of $3.54, a price of $42.50 - $49.60 seems more reasonable for the stock.

Simply put, if you think the economy will continue to have problems through 2009, Sherwin Williams stock is ahead of itself. Commercial real estate losses in the second quarter, combined with a potential inflation-driven rise in raw materials costs, could be the catalysts that drive the stock down.

So why the big jump after earnings? The only thing that I can think of is that investors expected the situation to be much worse. So there was probably a huge short position, and those guys had to cover. Plus Sherwin Williams is a value stock (Buffett owns rival Benjamin Moore), and a good portion of those players who had dumped the stock after first quarter earnings decided it was time to get back in.

At the time of this writing, Ming is long SHW.

The Coming Week

2009-04-26T11:14:00.000-07:00

I don't have much new insight for the coming week. By all technical and

valuation indicators, we remain overbought. Still, the bulls seem to hold,

and it seems unclear what would shake the bulls from the trees.

To be sure, the rally seems to be getting a little tired. And yet, that

could simply be caution in front of the stress tests, which as of yet, have

not caused much stress in stock prices. On Friday, amidst a fairly broad

rally in financials, tech, oil and consumer staples, Wells Fargo was up 6.5%

to $21.40, tipping past recent resistance levels. As much as one might want

to say, "too far, too fast", the chart continues to look bullish. Which is

not to say go buy, but to say that the market continues, at least for the

time being, to confound the naysayers.

Earnings remain the focus this week, and any leaks that may come from the

stress tests. Officially, the results will not be public until May 4th, but

I'm sure the rumor mill will be buzzing. CNBC has already said at least one

bank will need capital. If that's a major bank, then that could stunt

the bulls. If it's a more limited regional bank, the bulls could hold.

At the moment, I remain neutral. Admittedly, I toyed with the buying the

SKF last week (shorting financials) ahead of the stress tests, but after

days of listening to not very substantive points of view, it seemed fairly

certain that most major banks would pass the stress tests. Geithner seems

to want to stay close to his claims, which are that most banks are well

capitalized. I'm also evaluating a quick play in GS and MS, on the thesis

that we will have a good bank / bad bank bifurcation. Truth be told, my

conviction is weak, meaning that I can't give a high probability that such a

trade would work, and I'm looking to protect any position with a tight stop.

All in all, an oddly unclear direction (in the short term) in the market

after months and months of staring at certain downside. Longer term, I still

think banks will have problems in Q2, but that seems quite far away today.

I don't own WFC, but am long GS and MS.

Stress Tests Cause Stress

2009-04-21T01:14:00.000-07:00

So now we know the answer to the question, "Where's the pullback?"

It now looks likely that the stress tests could cause some stress, weak pun

intended. Needless to say, Geithner has handled this badly, but it is what

it is. We now have a situation where stress test results will be released

over the two weeks. Apparently, the government will give the banks some

time, probably six months, to raise money. To improve capital ratios, the

government may convert preferred shares to common, as in the case of Citi.

This could be a major problem for the weaker banks. As long as there is a

threat of conversion, the weaker banks won't be able to raise capital - who

wants to buy with dilution hanging over their heads? If the government

converts first, then that will dilute the common and drive down the share

price. There is a possibility that the weaker banks could raise capital

after conversion of preferred shares, but the stocks of the weaker banks

won't be happy in the meantime.

So I am still researching the following possible trades:

1) buy AAPL on a pullback after earnings. If more bad news is in the making

I will wait until the bad news clears. The market is jittery, and any

significant bad news can take the entire market down.

2) GS and/or JPM, probably after release of stress tests. Difficult to call

timing on this, but the basic idea is that the stress tests could catalyze a

pullback, then it would be time to buy GS or JPM, especially if they could

pay back the TARP. I will wait on MS and WFC earnings to see where they

stand. Bank of America has the cloud of conversion over it.

3) If conversion of preferred is likely with BAC, then there could be a play

in the preferred stock, just as there was with Citi.

The Week Ahead: Where's the Pullback?

2009-04-18T18:35:00.000-07:00

Many are waiting for a pullback. Many think it should have happened already. And the case for a pullback is pretty strong. The fundamentals point to increasing loan, commercial loan and credit card losses in the banks. The technicals say that the market is overbought and that we're very close to upward resistance. And common sense should say that after more than 24% to the upside, the probability of down is higher than the probability of up.

That pullback may very well come this week, as the busiest week of earnings, with more than 140 companies reporting, comes upon us. There's not much possibility of surprises left in banking; Intel has indicated that tech is unlikely to lead to any market-moving surprises; and with the fundamental economy weak, it's doubtful that the industrials can lead the market higher.

Still, the market has defied the naysayers for the last two weeks. That includes me by the way - I positioned myself for a pullback two weeks ago and missed some really good upside. And I'm not a alone of course. Many have been waiting for the market to correct.

I still believe that it's extremely difficult to call the exact top or the bottom, so getting close is good enough. And the last two weeks are a reminder that the market often ignores our proclamations and confounds our expectations. So it's worth asking - is there a scenario where the market keeps rising?

In order for that to happen, I think we would need more good news over the next two weeks. Earnings would have to be better than expected, and outlooks would have to be non-negative. The stress tests would have to be non-events. That is, the government identifies the weaker banks, we figure out how much capital has to be raised, and we DO NOT go into a panic thinking that major banks will collapse.

Over the next couple weeks, just stabilization, the sense that things aren't collapsing, the sigh of relief that says the worst is over and we can move on - this is enough, I think, to move the markets up, or in the worst case, lead to a shallow pullback. If we can get that sense of safety, then the money on the sidelines would come in and help move the markets upward.

How likely is this scenario? Very hard to say. For me, the stress tests are a bit of a conundrum. If there are major banks that need lots and lots of capital, then wouldn't the bear attacks just start all over again? The truth is, we have to face the possibility that the stress tests might lead to the exact result that they were intended to prevent - an attack on the weakest banks. At the least, the market likes to worry. Give the market a reason to worry, and it will.

What does that mean for the investor? I think you have to position yourself for the downside, but be prepared to move if we see possible upside. This market wants to move up, and at the very least wants stay up. The coming catalysts could move things either way. I've been positioned for the downside by being on the sidelines for the last two weeks.

Two other things to keep in mind over the next couple weeks. First, we have begun to differentiate between the stronger stocks and the weaker stocks, especially among the banks. So far, Goldman Sachs and JP Morgan are among the strongest, and any pullback should be considered a buying opportunity.

Second, we may still have to face serious problems in Q2, and potentially in Q3. Those losses in loans, commercial real estate and credit cards aren't going away; all the banks have said they expect these losses to increase. The consumer remains weak and will be so for some time. There's a real possibility that the gains of this first quarter will wane, and that losses will increase. That's a very bad formula for Q2.

By the way, there's also some specific trades on the horizon. Apple reports this week. Apple typically sells off after earnings, because the company blows always the earnings and then gives really conservative guidance. I would look at any pullback as a buying opportunity because Apple is expected to have new iPhone models in the summer.

FYI, I am long AAPL, GS and JPM.

The Shape of Things

2009-04-16T11:34:00.000-07:00

Well, we now have a decent sense of earnings season. Banks did better than expected. Where to from here?

There's not much left in terms of potential surprises. We have Citi reporting tomorrow, and if the last few weeks are an indicator, Citi should do well in its lending and should surprise there. Writedowns remain a question. Also, tomorrow is options expiration, and given the heavy shorting in Citi, there's going to be a lot of short covering pressure. That says Citi should pop tomorrow, but the traders know this, and are getting ready to sell into any pop. For me, not much of a trade, because I can't sell faster than the guys on wall street. The traders will sell seconds into the open after earnings. I think I'll pass.

That leaves Bank of America. Again, they could do well because they have capital markets and lending exposure. Writedowns remain an issue, but if they used purchase accounting with Merrill the way Wells Fargo did, the worst of the Merrill writedowns might be past. That leaves loans, commercial real estate, and credits cards, where losses should be up. JP Morgan confirmed as much today. Still, they may make up for those losses by making money lending and in investment banking, like Wells, JP Morgan and Goldman.

So the question is whether Bank of America's run up to the $10 range is as far as it will go. It could be like JP Morgan today, where today's positive earnings led to negligible movement in the stock; it may have run as far as it can go for now. If you want to be really aggressive, there could be a small play in buying Bank of America ahead of earnings, and selling at the close before earnings. If Citi does well tomorrow, Bank of America could have a small pop, and at $10, small pops could be a decent percentage. Not worth a huge bet, but a possibility if your gambling bones are itching.

And finally, we may have a bit more information when Wells Fargo reports. We'll know about Wells' write offs. But there shouldn't be much new news there, and if anything, downside risk is higher because the quality of earnings could be weaker than expected.

Morgan Stanley also reports next week, but no one expects Morgan to do anything market moving. The best results are out, and Morgan, as mentioned, has commercial real estate exposure that will ding earnings. But that's about it; not as strong as others, but not bad is the expectation. In other words, not much of an event for the market.

After this week, there's not much in terms of upside surprises that are possible. Plus with options expiration, everyone will reposition next week. Right now, I think resistance is around 8,000 on the Dow, 850 or so on the S&P. I've heard people say 900 on the S&P, but every time I look at the charts, 850 seems to be the battleground to me.

The remaining known event that could move the market either way is the stress tests. Given what we know now, which is that the stress tests will tell us which banks are weaker and will give us a capital plan for helping those weaker banks, the release of the stress test results could actually be a positive. That's because we'll have clarity. It's now unlikely that many banks will go to zero, or that the government will let them do so. And a situation like Citi where the government converts its preferred shares to common and massively dilutes the common seems unlikely. The banks that have reported are in decent shape, Morgan Stanley should do fine, Citi's future has already been decided, leaving Bank of America as the last big bank that could face such a fate. There could be pluses in Bank of America's earnings, and there's no indication that it could be a disaster that warrants the government converting its shares from preferred to common.

So consider this additional possibility: the government recently flip-flopped, deciding to release results of the stress tests, where they had previously decided they would be mum about the results. One reason to release the results is that it sets the stage for banks to repay the TARP. As we know, certain banks have been clamoring to do so. If the government gives them the green light post stress test, Goldman and JP Morgan will pop, they're just itching to execute the wire transfer. Wells and Bank of America have had similar rumblings, while Morgan Stanley has said it might be several months. Regardless, if banks start repaying the TARP, the market should pop.

The other possibility is that we could get a sell-off and correction. For the most part, the banks, to date, have held their gains. So that argues for a shallow correction.

Is there a scenario with significant downside? We would need major bad news, which at this point seems unlikely. There is a possibility of a down leg in coming quarters if bank revenues aren't as high but losses continue. At this point, it's a possibility to keep in mind but not necessarily something to bet on.

One other theme. It's time to come back to stock-picking and medium or long-term investing. We are stabilizing, barring any major down legs in the market. The more we settle, the more the trader's market will recede, and the more the longer term investor returns. And yes, it's a great time to buy for the long term.

That's if for today,

Ming

Wells Fargo and the Week Ahead

2009-04-11T11:22:00.000-07:00

So, interesting week. Here's my current thoughts on the market. Please keep in mind that the trading notes are meant for short term traders, not longer term investors. And these are just my opinions given my investing style, please consult your own financial advisor before investing.

Obviously, the big event of the week was Wells Fargo (WFC), and what that means
for the rest of the market. Wells announced record profit, much to the surprise of investors. That helped send the Dow up 246.27 to 8,083.38 on Thursday. Wells itself was up almost 32% to $19.61, in a day. Needless to say, the day was very bullish for the other banks.

I still remain cautious and haven't put any money in the market in the last week. I can go over the reasons to question the Wells Fargo announcement, but the fact of the matter is that the market wants to go up, and yet conditions remain overbought. At the
end of the day, I can't give you a high probability that the market will go
up or down in the short term. I think in the longer term it will have pull back and correct. Still, earnings could pull things either way, and probably the only certain trade is a straddle (meaning you by options both ways, up and down, and one of them will work).

Longer term I think we're headed toward stabilization, so over the next
month, it's time to start looking at medium- and long- term investments, and it may be
time to shift from being a trader to actually looking at fundamentals -
i.e., which companies will start recovering first. Right now, I'd put the
probability of retesting the lows at 25%; a 25-50% retracement (meaning
25-50% of the 21% gain in the last few weeks) as 70%; a continued uptrend
without a correction at 5%. I'm putting out the numbers just as a ballpark,
of course, and these estimations could very well change quickly.

On the Wells situation, it's very like that during this quarter they were the
beneficiary of one-time effects, including:

1) the combined markets shares of Wachovia and Wells
2) purchase accounting, which requires them to write down assets to fair
market value. This means that the December write down would have been the
biggest, with less this quarter.
3) low interest rates, which drove mortgage originations and refinancings in
the quarter, plus huge spreads (they're making in the range of 4.1% on every loan - that's their net interest margin)
4) FASB 157x, which will affect securities, and may have allowed them to up
valuations relative to December, and reduce the reserve for loan losses.

Whitney Tilson, the value investor from T2 partners, said this week that the
revenue line was not the surprise for Wells. The bank's pre-tax provision profit came in exactly in the range expected, of $8-10 billion (actual was $9.2 billion). The
real surprise was that the reserve for losses was only $3.3 billion, compared
to $6.1 billion in December.

Why is this important? It just says that in the short term, the results
from the other banks can be very unpredictable, and positive surprises are
very possible as I mentioned in my note earlier this week. It also means that longer term, in Q2 and Q3, there will be more write downs and more reserves, and post stress test,
capital raising will probably be necessary. I suspect Wells, given it's
positive aspects this quarter, will eventually push for capital raising to
stabilize its situation.

Over the next week, key earnings reports will be Citigroup, GE, and Goldman Sachs. Again, I can't give you a high probability that things will be up or down on any of them. Positive surprises are very possible, and even not as bad as expected will be a good thing.

Goldman is likely to have a good report. They are thinking about a stock
offering. It stands to reason that they wouldn't be talking about a stock
offering unless they expect a very respectable report. If so, there may be
a play in the offering. A stock offering will dilute the shares, driving
the price down. Once the offering is done, expect the shares to rise again,
especially if the subscription is strong (which I would expect it to be).

Other reports this week are Intel, where I don't really expect much, because
I doubt that the computer market has turned the market yet; Sherwin Williams (SHW), which again, is unlikely to indicate that housing has turned; and same story for CSX. These are all demand-related stocks, and anything not as bad as expected is very good. Still, don't see a trade here pre-earnings - meaning that it's hard to predict either direction with any great certainty.

Those are the thoughts for the weekend. Have a great Easter.

By the way, I am long C, GS and SHW.

Why You Should Avoid the USO Right Now

2009-04-07T18:29:00.000-07:00

Tuesday, April 7, 2009 - 6:35 PM PST. Some time ago, a friend of mine was buying the USO as a way of playing oil. Turns out, the USO didn't quite track the price of oil. She asked me about it, but at the time, I didn't know why. Now I do.

So let's start with the facts. West Texas Intermediate (WTI) Crude was $46.34 per barrel on 1/2/09. Yesterday, on 4/6/09, WTI was $51.05. That's a 10.2% gain. In contrast, the USO has fallen from $35.63 on 1/2/09 to $30.23 yesteraday. Year-to-date, that's a 15.2% loss.

Why does this happen? That's because the USO doesn't actually trade crude oil, it trades crude oil futures. That's a whole different story. You might think that the USO takes your money, buys a barrel of oil, and then sells it later. Fact is, the USO trades futures, which are actually a derivative. It's like trading options, rather than the underlying stock. Like options, those futures expire. Because of that, the USO is constantly buying new futures contracts. If you think that costs more money, the answer is yes, it does.

In periods when the price of oil is expected to rise (called "contango"), longer term futures cost more the farther away they are in time. For example, today, the May '09 contract costs $48.18; the June '09 contract costs $51.08, and the July contract costs $53.57. The USO has to keep rolling forward its position in order to stay invested, but as you can, it becomes increasingly expensive to do so.

It makes sense then, that the USO should do well when the price of oil is expected to decline, a situation referred to as "backwardation". In this case, the price of futures contracts decline with time. So as the USO rolls its position forward, new contracts became cheaper, resulting in greater gains.

So for as long as we have contango, the USO can be expected to under perform relative to the price of crude. This applies to other similar ETFs. Before investing, you should read the ETF's prospectus carefully.

Differentiating Among the Banks for Q1 2009

2009-04-07T12:47:00.000-07:00

Tuesday, April 7, 2009 - 1:00 PM PST. This morning, a friend of mine emailed, saying that the market has underestimated how much trouble the banks are in. He wouldn't be alone, of course. Mike Mayo, the esteemed Deutschebank analyst that recently moved to Caylon, came out with a bearish note yesterday on the eleven major banks. The market sold off a bit, but not significantly, so the market seems a bit more optimistic then either my friend or Mike Mayo - at the moment.

I think they are basically right, but it's important to do two things: (1) differentiate among the banks; and (2) separate the trading world from the real, or fundamental world. Yes, those are two different things, I would say.

For now, I'm am dividing the banking world into three groups: (1) the investment bankers - GS and MS, who are technically banks but really aren't lenders; (2) the large-scale commercial banks with an investment banking component; and (3) the traditional lenders.

The Investment Banks. The investment bankers should do well as we approach earnings season. Consider first that most of Goldman's and Morgan's competition is gone, and fees for their services have gone up. These firms have also written down a large portion of their securities, so the FASB mark-to-market changes could actually allow these companies to write-up some of their securities. Worst case, they will probably take the opportunity to reduce additional write-downs. The public-private partners could also help these banks. If the TALF transactions occur at a price higher then their previous marks, theses guys could, again, write-up their assets. Finally, consider that they have low exposure (relative to other banks) to the pending problems in loans, credit cards and commercial real estate loans. Trading-wise, there's less of a case that the market has underestimated the impending losses in GS and MS.

The Commercial/Investment Bank Combinations. Then you have the major banks with an investment banking component, such as JP Morgan, Bank of America, Wells Fargo. The securities side should do well for the reasons mentioned above. And for them, mark-to-market could be of some help. The FASB changes, known as 157-x, apply in June, but banks have the option to enact these changes as of mid-March. Since it takes substantial modeling capabilities to make these changes, it's expected that only the large banks can make those changes in time for Q1 2009 earnings.

Also, these banks have been the beneficiaries of substantial government help. Not only in terms of direct financing, but also through programs such as the agency paper trade. The Fed has bought $250 billion of low-interest-rate mortgages guaranteed by Fannie Mae and Freddie Mac. This has driven up prices of these securities, leading to significant gains for them. Meredith Whitney estimates that total gains might be as much as $5.6 billion, with $1.6 billion for Bank of America and JP Morgan.

For these banks, it's the loan, credit card and commercial loan side that could be a problem. Mike Mayo estimates that on average, loans have only been marked down 98 cents on the dollar. Meredith Whitney estimates that real estate prices will drop 50% peak to trough, while consensus is only 40%. Whichever way you want to dice the numbers, the short story is that there's a long way to go down on the loan side.

So here, for these major banks, the picture is mixed. You have some pluses, and some minuses through earnings seasons.

By the way, Citigroup falls into this category, but it's stock is also in its own category because of an impending conversion of the preferred shares to common. That keeps the stock from moving freely.

The Loan Driven Banks. These banks could will have problems, not only in the next month, but also for the next several quarters. USB is an example: it's a conservative bank with high loan quality, and it avoided a lot of the derivatives investments that got so many other banks in trouble. They're a traditional lender. So while they've been risk adverse, it won't save them from the coming loan problems.

Small and medium size banks will also be at a disadvantage for a couple reasons. Unlike the larger banks, they won't have benefitted as much from government programs. Also, they probably won't apply FASB changes until June. And finally, they're less diversified, and won't have revenue from capital market operations.

The Trading World vs. The Real, Fundamental World. So we have a situation where we could get some positive news for the banks during the first quarter earnings season. And keep in mind, the news has skewed toward capital markets issues that affect the largest, most visible banks. Loan issues have gotten much less airtime, and the banks haven't dealt with these problems as much. That means the short term could be positive (and remember, not as bad as previously thought is positive in this market), while the fundamental, real world trend is probably down.

Trading Implications. I'm still on the sidelines for the moment. Because of all the rule changes and government programs, first quarter earnings may very well be more positive than expected for the banks. I think the greater "danger" area now lies at the end of April, when the results of the government stress tests become known. The Obama administration recently announced that they would wait for the first quarter earnings to be announced before revealing the results of the stress tests. So we have a possible scenario where Q1 earnings might be okay - or even slightly positive, but where end-of-the-month stress tests could throw some icy water on the market. Second quarter could also be a problem as more loans are written down.

All in all, it remains a trader's market. I do think we are more stable, and that is always a plus for the markets. Still, it's not a green light. The next few quarters will be very mixed, sometimes up, sometimes down.

Just Hangin'

2009-04-07T08:09:00.000-07:00

Tuesday, April 7, 2009 - 8:10 AM PST. So I'm just hangin' out, waiting to see which way the market goes. I still think there will be a pullback, but how much is very hard to tell. It could be shallow, it could be 10-15%. At the moment, a retest of March lows seems less likely, but that could change.

It may sound wishy-washy, but I think those are the real possibilities. The market doesn't want to sell, but will if the news makes it nervous. And the VIX is still above 40 - meaning that volatility is still here, it hasn't gone away. So at the moment, I'm on the sidelines. Hmm... what else is on TV...

Looking Forward

2009-04-02T20:31:00.001-07:00

So we've had a rally. Of course, the reigning question is, how long will it continue? Should we stay invested? Take profits and leave some in the market? Or sell everything?

I chose the last, sell everything. Or rather, sell everything that I had bought within the last few weeks - that is, everything purchased during the current rally.

I do this being fully aware that many say the rally has legs and will continue. Truth is, there is no way to be sure which way the market will go. We can only assess the probabilities. For now, I see the probability that we will pullback as fairly high. Even if I am wrong, the right decision (for me), given the information I have at the moment, is to sell.

And know that this not a bear call. It's simply a trading call - that it's more likely that we will retreat, for the moment, than advance.

So here's my rationale. We'll start with the technical, since it's the most straightforward. If you look at a chart of the Dow, we're sitting right at near-term resistance of 8,000. If you look at a chart of the S&P, we're at near-term resistance of 830-840.

What about the fundamentals? Although we've had better than expected news, the major fundamentals haven't changed. The consumer is still weak; unemployment is expected to be high; commercial mortage delinquencies will be hitting companies' books; credit card loses are looming. First quarter earnings begin next week, and hard numbers will come out.

Today, an analyst downgraded Morgan Stanley, which was actually weak compared to the other banks. The analyst actually predicted losses in the first quarter, and that held back the stock. Is this a sign of things to come?

And what about other indicators? Credit markets haven't significantly improved. The spread of corporate debt over Treasuries remains nearly 400 bps (4%). The VIX remains above 40.

The government stress tests still loom, and whether the public-private partnership will work remains to be seen.

In other words, significant uncertainty remains. We have not isolated or fire-walled the problems in this economy. And after such a run-up, a breather and a pullback is very, very likely.

The FASB 157x Trade II: Buy the Rumor, Sell the News

2009-04-02T19:40:00.000-07:00

So today, FASB announced that 157-x, the mark-to-market revisions, were approved. There were two parts, and the first was approved at 9:30 AM EST, and the second at 10:30 AM EST. For the most part, the financials were up pre-market. Not long after, at 10:30 AM EST - when the second vote was announced - the financials sold off. In case you're curious to see more detail, see the charts for Bank of America, Citigroup, Goldman Sachs and US Bancorp.

This was a classic "buy the rumor, sell the news" trade. If you read my articles, you'd know that I'm always interested in what we can learn for the next time. So here are my guidelines for this kind of trade:

- the trade is well-known in advance

- there is a definitive event or moment where we know "yes" or "no"

- buy several days before if you can (in this case, monday afternoon or tuesday morning would have been best)

- sell immediately before the decision, or at the latest when the decision is made

In this case, the financials recovered from the "sell the news" sell off. That's not true in every case. So best to sell just before.

I bought several financials on Tuesday, and this morning, sold off everything I had bought on Tuesday.

The FASB 157x Trade

2009-04-02T00:01:00.000-07:00

Thursday, April 2, 2009 - 12:03 AM. Much is being said about tomorrow's mark-to-market (let's call it M2M for short). I think it's likely to pass. And I think it will help banks, although it will not be a cure-all by any means.

I can't see FASB blocking FASB 157-x. Many blame M2M for the current crisis, and the political pressure is high. If FASB votes against 157-x, the backlash would be severe. Plus bank stocks would immediately drop, and that would only add to the reaction.

Still, FASB 157-x isn't a panacea. When faced with the M2M controversy, FASB actually argued that they had drafted the proper rules, but that people had applied them improperly. If that is the case (that's a big if), then the most generous interpretation is that the rules were very vague. That led the accountants in the field to be conservative and to mark down assets to firesale prices, fueling the current crisis. It's possible that even if the current FASB 157-x is passed this morning, then it could be equally murky, and the result could be almost as imperfect.

As for the actual impact, estimates have run as high as a 20% increase in earnings for a company such as Citigroup. Definitely a plus, but probably still not enough to save Citigroup from effective government control.

Ironically, FASB 157-x is anti-Geithner, which explains his aversion to M2M changes. Let's say a bank is asking 60 cents on the dollar for an asset, and the buyer is offering 30 cents. Geithner's program subsidizes the buyer, so with the program, the buyer can offer 45 cents. Geithner's hope is that a bank will come down to 45 cents, buyer and seller will find a mutually agreable price, and a sale will occur. This will take the assets off the banks' balance sheets.

M2M will allow banks to have higher marks and to hold assets longer. So now the banks might mark that same asset to 70 cents rather than the previous 60 cents. In that case, they may only be willing to go down to 55 or 50 cents on the dollar while the bid remains at 45 cents. So M2M actually threaten's Geithner's plan.

So what's the trade? Well, I bought ahead of today's decision. I think there will be a bump, the question is - how much, and how long. On something like this, it's just best to run all the outcomes, be prepared to move, and exit if necessary.

A Little Window Dressing

2009-04-01T01:16:00.000-07:00

Wednesday, April 1, 2009 - 1:15 AM. So today's market caught people by surprise. Most expected Tuesday action to follow Monday's 254-point on the Dow. Instead, the Dow ended up 86.90 today, and at one point the market was up almost 200 points.

I would think that today's upward move was simply end-of-the-quarter window dressing by funds. That means funds that had been sitting in cash wanted to be invested at quarter end. Many of these funds want to show that they're in the market. Otherwise, investors might say, why should I keep my money with you?

So the upcoming catalysts:

1) I expect mark-to-market, if there is any relief, to be a positive on Thursday, perhaps Friday.

2) The G-20 meets on Thursday. Lack of action could be a negative for markets.

As I mentioned yesterday, I am playing some banks going into Thursday's mark-to-market decision. Still, I would be cautious because sentiment for financials are negative as we enter the Q1 earnings season. Also, many of the banks have had run-ups recently. Some are still near their recent highs, while others have given back some territory. So I'm playing the banks that have had a bit of a pullback.

Sentiment for oil and commodities are also negative going forward. Whatever drove the commodities rally in recent weeks has probably run its course. OPEC can't keep cutting production to drive prices up, and more money has to come into the market to keep pushing prices up.

Earnings season starts as soon as Monday, so we won't have much time before the market starts swinging all over the place. Generally, people expect Q1 to be very weak.

They Said They Wouldn't, But...

2009-03-31T00:35:00.000-07:00

Tuesday, March 31, 2009 - 1:35 AM. So Obama keeps saying that he doesn't want to the government to run a company, but that's what he's doing. Last night, Washington announced that Rick Wagoner, CEO of GM, would be stepping down. This is a landmark step and yes, sets a possible precedent for what Washington will do with the banks. That's really it in a nutshell.

The news was enough to stop the recent rally and sent the Dow down 254.16 to 7,522.02. I sold off several positions that had gained in the last couple weeks. As I said to a couple friends, the risk of more downside is now higher than the probability of upside. I don't expect much "good" news in the next couple days, and stocks have had a good run. More buyers have to jump in to continue the upside run. So, sideways and declines are now much more probable than upticks in the market.

There probably is a play in the acceptance of FASB 157-X, the rule that will allow for more discretion in mark-to-market accounting. FASB is expected to vote on that this Thursday, April 2nd. I will probably gamble on buying some bank stocks over the next day or two, ahead of the vote, and look to see if I should sell almost immediately.

I also spent the weekend writing my monthly investing article. The full text will be up on www.asiancemagazine.com or you can email me at mtlo@post.harvard.edu for a copy.

Sleep well,

Ming

The Rally Expands

2009-03-27T01:18:00.000-07:00

Friday, March 27, 2009, 1:18 AM. So the Dow is up 174.75 today to 7,924.56. The S&P is up 18.98 to 832.86. Both the Dow and the S&P are above their 50-day moving averages and are approaching their 100-day moving averages.

The interesting thing is, the financials didn't really do much today. The XLF ended at 9.43, pretty much where it started the day. Financials went sideways, even a little bit down, which in theory is positive for the rally. That's because you want the financials to hold and consolidate; if the financials go up too fast, they'll just come back down fast.

The action today was in tech. The NASDAQ, which closed at 1,587, is actually positive for the year. At year-end 2008, the NASDAQ was at 1,577.03. That the current rally has spread from financials to tech is also a bullish sign. At the very least, the shorts are coming out of tech, and it's very possible that the mutuals funds are buying.

There are still concerns that this rally is only a bear market rally, and that it's temporary at best. Credit markets haven't really budged, and the bond market is still pricing in a high likelihood of default. Some argue that the bond market gets it right more often than the equity market does.

Still, it's very hard to fight the tape, and the optimist would say the bond market is catching up. As a practical matter, I'm going to hold my positions and follow the tape, but be ready to get out if necessary. And I might even take some profits. I may lose out on some upside, but profits are hard to argue with.

This next week may make a big difference. President Obama will meet with the major banks soon. There's been lots of talk about repaying TARP money, and it's very possible that Obama will ask the banks to hold on to their TARP funds. Any repayment will favor those that repay, and will stigmatize those that don't. If Obama asks the banks to hold on to their money, that may force a pullback in Goldman Sachs and Morgan Stanley, two companies that have been vocal about repaying the money.

Another major event would be a resolution of the mark-to-market issue. FASB, the board that governs financial accounting standards, is expected to end feedback on it's mark-to-market revisions on April 1st. Any decision favoring a suspension of mark-t0-market, or any form of relief, would be a huge boon for the banks and the market as a whole. Of course, it's possible that FASB decides that mark-to-market should remain unchanged, and that the government should relax reserve requirements instead. That would be huge negative for the markets.

In the meantime, the markets seem to be favoring the upside.

One quick follow-up. Last Friday, I sold the Citigroup that I had purchased for under $2.50, largely because of the impending conversion of government preferred shares to common. The conversion is expected to significantly dilute the common and keeps downward pressure on the stock. On Monday, Citigroup shot up to $3.00 or so and I thought I had made a mistake. Since then, it's fallen to $2.81, while other banks stocks continued to rise. So with hindsight, it seems to have been a good call.

The mistake I made last Friday was in Bank of America. I had bought some for under $6. Not expecting Geithner's plan on Monday, and with the market still wrapped up in the anger over AIG bonuses, I sold my the shares purchased for less than $6 for a little over $6, ending up with a negligible profit. Today, BAC is at $7.58, so I missed out on that gain. Basically, I was thinking that BAC was closer to Citigroup, and the market has since told me otherwise. That shouldn't really be a surprise, since BAC does not have an immediate preferred-to-common conversion hanging over its head. Should mark-to-market relief come, BAC should do very well.

Still Holding

2009-03-26T01:52:00.000-07:00

The technicians would love this day. At first the S&P was up in the 825 range. Starting just after noon, the bears drove the market down, right down to the 50-day moving average of 793. And then, in the last hour, the S&P shot up to close at 813.88. Again, I'm not a technician, but sometimes, technical analysis can be very useful.

Holding and not falling below resistance remains bullish for the market. I'm looking for opportunities, but I'm not inclined to chase the run by buying here. I would need a clear upside catalyst to recommend jumping in after such a big run.

I think oil is vulnerable to profit-taking. The recent run-up has been driven by 1) the cut in supply by OPEC and other producers; and 2) the inflationary effects of the government banking plan (and other expansionary plans) announced Monday. Still, inventories are up and all indications are that demand remains weak.

After the Big Run-Up

2009-03-24T23:17:00.001-07:00

So the Dow was up nearly 500 points yesterday, driven by positive reaction to Geithner's banking plan. No surprise, then, that the Dow dropped 115.65 to 7,660.21 today.

So what's next? Looking at the S&P, resistance is about 805 or so. Today the S&P is at 806.25, basically sitting at resistance. It's also just above the 50-day moving average of 794. The Dow is also just about the 50-day moving average of 7,630.57.

For the moment, the market favors the bulls. The shorts have been forced to unwind their positions; the fund managers, who have been staying out, are in the unenviable position of jumping in late or risk missing out on a rally; and the government finally seems to be getting its act together.

Still, that doesn't mean all clear. Tomorrow, I'm looking to see if the market will move up or at least hold. If the market starts to break downward - especially below resistance or significantly below the 50-day moving average, then you I'd re-evaluate. The bank rally could easily fade tomorrow, and the absence of any expected good news over the next few days could mean more profit-taking and downward pressure.

On the longer-term side, here's a couple trends I believe in. And repeat, these are long-term:

Treasury bonds will fall as the market stabilizes. That means being short bonds or buying the TBT, which goes up if Treasuries go down.
Books will begin to fall by the wayside. Companies such as Barnes & Noble and Borders will be headed toward bankruptcy, much like music stores and newspapers.
Video downloads will increase. Akamai, which facilitates downloads, should do very well over time.

How Can We Be Sure We've Bottomed?

2009-01-23T02:16:00.000-08:00

Someone asked me at lunch today, "What do we need to see to be bullish?" In other words, how can we be sure we've bottomed? Here's my answer:

- We need to hold technical support. Currently about 8,000 or so on the Dow (give or take). If we fall through this level (in any significant way), then we have major problems.

- We need to be certain that the government will provide support to the banks, and that the banks' common won't be wiped out (regardless of the form of the bailout). As the new administration settles in, it's becoming clear that despite more severe restrictions, TARP II is unlikely to crush the equity. Still, there will be resistance in Congress, and our leaders will need to posture and "not be rushed", so decisions will take. In the absence of positive forward momentum, we can expect continued pressure on the market.

- The current round of writedowns, losses and layoffs in Q1 and Q2 of 2009 will not lead to major losses in excess of what we saw in October through December of 2008. The beginning of 2009 will see major layoffs; bankruptcies; companies with debt due in will be in trouble; losses in commercial real estate, credit cards and auto loans. At the moment, I'm inclined to believe that the beginning of 2009, as bad as it is, will not be worse than Q4 of 2008 (when the Dow went from 11,000 to the 8,500 range.

- International events may pressure US stocks. Nationalization of banks in Europe, disruptive behavior from Russia, continued Arab-Israeli fighting or Iranian intransigence could all pressure US markets. Still, US markets are likely to see themselves as relatively insulated from these world events. I'm inclined to agree, because severe spillover is unlikely. In other words, international events will affect US markets, but they will not drive US markets. (For example, if the Brits nationalize a few banks, it's unlikely that the US will follow suit. The Obama administration has not indicated that it favors nationalization).

Nokia

2008-09-06T01:49:00.000-07:00

This week, Nokia announced that it expects to lose market share this quarter in part because it chose not to follow price reductions enacted by its low-cost competitors. Last quarter, Nokia had projected 40% market share in Q3, unchanged from Q2. Following Nokia's warning, the market promptly punished the stock, which fell 13% to $20.10.

Before going on, I should let you know that I have a bit of history with Nokia. Back on January 29, 2004, I had bought Nokia at $20.60 on the advice of a friend who was an analyst at a major Wall Street research firm. A few months later, in April 2004, Nokia promptly announced that it would miss earnings targets, and the stock plunged to the $13 range in May 2004, and even further to the $11 range in August 2004. It wasn't until 2006-2007 that Nokia came back to the $20 range. Then in early 2007, Nokia took off, hitting a high of $40 or so in October to November of 2007. I sat down and analyzed the stock in December 2007, and came to the conclusion that I should sell. Still, I was lackadaisical, but finally sold in April 2008 at $28.73. So lost out on $10 or so of gains, but well, I guess I can be happy I didn't hold until today. At the end of the day, I had about 40% gain over four years, so I can't really complain.

Now, I'm not reviewing this to toot my horn. As always, the question is, what could I have done better? What have we learned? There are actually several lessons that I want to jot down and remember.

Let's start with a review of my notes from December 2007. At that time, I looked at five factors that were needed to drive further growth:

- faster than expected market growth

- continued market share growth

- continued margin expansion

- new models that drive revenue or pricing

- diversification, or new revenue sources

On the first, faster than expected market growth, predictions at the end of 2007 were that the market was well ahead of expected growth trends. Nokia expected the world market to be 4 billion subscribers by 2010. but the consensus was that we would hit that target in 2009. Still, I was concerned that a slowdown in the Americas and Europe, plus a correction in China, would weaken the consumer and pressure sales. As everyone knows, the latter has turned out to be the more critical trend.

As for continued market share growth, I thought in December that this was unlikely. I thought that Nokia would be pressured by a revived Motorola, and also by other competitors, such as Samsung, Ericsson and even Apple or RIM. Moreover, I thought much of Nokia's share gain in 2007 was due to the failure of Motorola, so further share gains were going to be harder to obtain.

As it turns out, I was wrong about Motorola, which basically is stuck in the oblivion of a bottomless pit (from which it may never emerge). I was right about continued competition, as evidenced by Nokia's announcement this week.

On the issue of continued margin expansion, I thought this was unlikely because Nokia was trying to sell more low-end phones in emerging markets. On the low end, competition only puts downward pressure on margins. Analysts often praise Nokia's scale and its "best of breed" status. Still, none of that can save it from vicious competitive pressures, especiall in Asia. there, ZTE, Huawei and other domestic producers are filling the market with low-cost phones.

Nokia also put out some two new high-end phones - the N85 that retails for $662, and the N79 which retails for $514. The problem? Nokia sells a lot more low-end phones, so a few high-end models won't make up for the decline on the low-end. Nokia learned this back in 2004 when I first invested. Guess what the reason was for missing numbers back then: Nokia had gotten so enthralled with making new, upscale phone models that they let the low-end competitors eat their lunch.

In recent years, Nokia had also tried to diversify its revenue base. The company offers internet services, music downloads and digital maps. Right now, these businesses are still nascent and don't add enough revenue to offset declines in the cellphone arena.

The conclusion: Nokia remains a cellphone company vulnerable to competitive pressures and weakness in consumer demand. I always find this interesting, because you tell people this, and they all seem to say, "Yes, that's obvious." But turn it into an investment decision, and its not so obvious.

Take for example, this question: should you buy Nokia now that it's down at these "ridiculously" low levels? If you've been watching Fast Money, as I do, the answer would seem to be yes. Several of the traders and some guests say its a value right now.

I think the answer is no, you do not buy Nokia now. The fact that Nokia is best of breed doesn't matter these days; the industry is highly competitive, and there's very little that Nokia can do to ward off the sharks. So competitors will continue to come up with new, cheaper models, and Nokia will either lose share or have to cut prices to keep up. As Buffett would say, Nokia has a narrow "moat".

The second reason you should stay away is that the demand won't come back anytime soon. World economies are pulling back, and consumers aren't going to be able to fix their problems this quarter, next quarter, or even the quarter after that. I think consumers around the world will be under pressure for a long time, and as a result the cellphone market will be too.

Now one other lesson in this exercise. I always have to ask, should I have know this was coming? And the answer is yes.

The first and simplest indicator was technical. After a run from the $20 range in February 2007 to the $40 range in December 2007, Nokia fell below it's 50- and 100-day moving average in December 2007 and January 2008. The stock came back, but crossed these lines again in February 2008. So here were two clear sell signals. After that, Nokia has been below these two indicators ever since.

Secondly, competitors have been signalling problems for months. Sony Ericsson barely broke even in Q2, pressured by falling average selling prices. The company has issued two profit warnings this year. Also, Vodafone, Europe's largest mobile operator, had poor results in July and a weak full-year outlook. At the time, Vodafone saw weak market conditions in Spain and Turkey, and rising costs as well. Finally, Samsung and Sony Ericsson cut prices in Asia in August, and Samsung is aggressively pursuing the European market.

The Great Unwind

2008-09-04T17:54:00.000-07:00

So I wrote my monthly investing article, this time entitled "The Great Unwind", for Asiance Magazine. You can read it at www.asiancemagazine.com/sep_2008/investing_the_great_unwind.

The Dow is down 345 points today. All the indices are down, almost every sector. Funny, the best that CNBC could do was say the market's in a bad mood.

I think its much more than that, I think it's the great unwind, continued. Truth be told, I had wanted to short commodities (or at least buy puts). I thought a couple weeks back, when I was thinking about it, that I had missed the opportunity to benefit from the downside.

It seems to me, there's a great liquidation going on right now. One indicator is the Ospraie Commodities Fund, which went under yesterday. The liquidation explains yesterday's weakness. I think today's weakness says, if Ospraie went under, anybody else holding commodities should sell. And as in previous periods earlier in the year when there was a lot of selling, EVERYTHING got sold because there was short covering, or people needed to take profits in other areas in order to cover losses in whatever was being liquidated. So the entire market gets hit. Another indicator is in the Swiss Franc vs Yen chart, which is going through a major downtrend (when borrowing yen and investing in Swiss Francs, the chart would be positive. When unwinding, that is, selling Swiss Francs and buying Yen, the chart is downward trending).

One lesson in all this is that the Great Unwinds (and I'm referring to major liquidations, like now) take a long time. So I could have bought puts in commodities last week and still be profiting. Oh well, next time.

The question is, how far does this go. Does it continue tomorrow? I can't really tell you, I don't have any way of estimating. Many charts are near the bottom of their short term trading ranges, but in this market, they could easily break support. I guess we'll find out over the next few weeks.

Meanwhile, the only thing going up is the dollar, which I'm looking to buy on a pullback. Problem, no pullback yet.

On tech, it's taken a beating lately. In addition to signs of worldwide weakness from Dell, Ciena announced a weakened outlook last week. Ciena provides network equipment to telecom companies, and they said that telecoms have become more cautious in spending and are upgrading networks more slowly. "While we've seen no project or order cancellations, sales cycles are lengthening and some deployments are slowing," said CEO Gary Smith. So more fuel for the thesis that tech is not immune to the worldwide slowdown. Only a couple weeks ago I wrote about the common belief, based on recent reports from various tech companies, that tech might weather all the problems in the world economy.

I have not yet decided where I come down on tech. I think it's going to be stock-dependent. As a whole, tech has to take a hit. But certain stocks, such as Apple, are likely to have a good year. And certain stocks, possibly Intel, might be oversold. It's hard to say today, because the tech stocks have yet to stabilize.

Financials in general took a hit too today. I have no doubt there will be another round of financial battering, or at least, announcements of losses and writedowns from the financial sector. It's likely that the market reaction will be a drubbing. But we will see soon.

Ming is long INTC, AAPL and several other tech stocks not mentioned in this post.

The Coming Problems in Commercial Real Estate

2008-08-22T09:50:00.000-07:00

Last week, the rent-regulated Riverton Apartments in Manhattan warned that it may not be able pay a $225 million mortgage payment due in September. If they can't pay, it would be New York's largest commercial default to date. Riverton's debt was packaged into a commercial mortgage-backed security (CMBS), split up and sold as bonds in the spring of 2007. The owners had also assumed that worse case, the low-rent apartments could be sold at the then-high real estate prices.

And thus comes the next stage in the credit crisis. According to the New York Times, Deutsche Bank (DB) held $25.1 billion of commercial mortgage backed securities, Morgan Stanley (MS) held $22.1 billion and Citigroup (C) had $19.1 billion at the end of the second quarter. Lehman Brothers (LEH) is trying to sell about $40 billion of commercial real estate assets, as well as its entire real estate business. Moody's REAL Commercial Property Price Index has dropped 12% since its high last October.

Over the next six months to a year, mortgages priced during the last throes of the real estate bubble should run into trouble. As these real estate owners try to refinance, costs should be higher, making the problem even worse. This will force writedowns at the banks mentioned above.

Position: Ming is long C and MS.

Is Tech the Next Trade?

2008-08-22T00:57:00.000-07:00

In recent weeks, things have been looking up for the tech sector:

- In an interview with Jim Goldman on CNBC, Intel's (INTC) CEO Craig Barrett said that the company was shielded from vagaries in the US economy because 75% of its business is from outside the US. Intel's customers have business models that have 60-80% of their sales outside the US. So as long as the emerging markets are strong, he argues, Intel will do well. (The interview was Tuesday, August 19, 2008 - see www.cnbc.com )

- IDC reported that PC shipments rose in the second quarter, growing 3.1% from the first quarter, and 16.1% from last year. Usually the second quarter is the slowest period for personal computer chip shipments, so this activity is very unusual. IDC analyst Shane Rau attributes this to strong demand for notebooks and Intel's "very aggressive push" in the PC chips market. Intel's processor shipments grew almost 4.3% in Q1 and 20.8% over last year, while AMD's processor shipments were flat. Intel is estimated to have 80% (up 1%) of the market for PC microprocessors, while AMD has about 20% (down 1.2%). IDC expects the PC processor market to grow 7.5% in 2008 to $32.8 billion (www.smartmoney.com, August 18, 2008)

- On August 24, 2008, Gartner reported that worldwide server sales rose 12.2%, year over year,to 2.3 million units in Q2. Meanwhile, revenue was up 5.7% to $13.8 billion. The major drivers were the replacement of x86 servers, expansion of data centers for websites, and growth in emerging markets. IBM had 31.2% of revenue, up 11.5% from 29.6%; HP was second with 27.6%, a drop from 28.4%; Dell held third with 13%, up 1%; Sun and Fujitsu share of revenue was down. In terms of units, HP's share dropped from 31% to 30% (although units rose 8.7%); Dell's share rose from 22.3% to 24.7% (unit growth grew 24%); and third-place IBM also lost unit share.

- Hewlett-Packard (HP) recently reported a 14% increase in quarterly profit driven by international sales and issued an optimistic outlook for the current quarter. HP's PC revenue was $10.25 billion, up 15% from the same quarter last year. This was largely driven by a 26% increase in laptop sales. Corporate purchases were strong. Enterprise servers and storage were up 5%, but sales of blade servers grew 66%. The services division increased revenue 14%. The company is estimating current quarter revenue of $30.2 billion to $30.3 billion and EPS of 95 cents to 97 cents (see wsj article, August 20, 2008)

- Cisco (CSCO) recently reported 10% revenue growth in the fiscal fourth quarter. While John Chambers, the CEO, expects slower revenue growth of 8% in fiscal Q1 (the next quarter) and 8.5% in fiscal Q2, he anticipates a recovery early next year in the beginning of 2009 (Chambers noted that his fiscal Q1 and Q2 growth figures could be +/- 1%). Overall, Chambers reiterated the company's annual growth forecasts of 12% to 17%. In the current quarter, enterprise IT spending did grow 13% over last year's figure, compared with only 6% last quarter (see wsj article, August 5, 2008). While all this may not seem extraordinary, analysts consider these pronouncements positive compared to statements from the past year in which Chambers reported significantly weakening spending. Keep in mind that it was Chambers' negative comments that started the decline in tech last fall.

- EMC reported on July 24, 2008, that second quarter net income rose 13% while revenue grew 18%. CEO Joseph Tucci called the environment "manageable" and said that customers were continuing to spend because they still need to manage an ever-increasing body of information. Sales in the US were weaker, growing only 10% over the same period a year earlier, but sales outside the US grew 27% year over year and accounted for 48% of total second quarter revenue (see WSJ, July 24, 2008).

All in all, these reports indicate that the tech market is not as soft as many analysts had feared. Following the credit crisis, many thought that weakening financials - usually one of the biggest buyers of tech - would severely damage the tech sector. As a result, tech pulled back over the last year. Now it seems that corporations have not pulled back as much as previously expected, and that overseas spending is continuing.

Positions: Ming is long INTC, EMC