Wednesday, August 29, 2007

mid week update

Interesting week isn't it? Nothing like a little volatility to make life more interesting. Down 2.3% then up 2.2%? we are still down overall but only marginally.

Some stock thoughts:

DFR -- Trying to guess the dividend going forward. in Q2 they earned about 13.4% on investment and paid a 42 cent dividend. Book value was around $13. assuming book value has taken around a 25% hit, lets call the book value around $10 now. Using some back of the envelope math, I come up with an annual dividend guess around $1.1 to $1.25 but that's just a guess and it assumes liquidity is not an issue.

Why do I think book value has dropped so much? because prices on mortgages -- even agency and AAA rated -- have dropped. If the assets drop in value and the debt doesn't, the book value gets squeezed -- that's where the comment that leverage works both ways comes from. A 2% decline in the value of the mortgages is enough to drop book value 25% when you have the amount of leverage that DFR has. If DFR didn't have such high quality assets, they would have been long gone by now.

Am I being overly cautious on DFR? could be but given how many mortgage related firms are struggling to survive, being cautious doesn't sound like such a crazy idea. They paid the dividend and that means they managed to get this week's repo refunding done and that should give them another few weeks of breathing room. UBS' note from the 17th says management told them that they have the money for the deal lined up, they are just negotiating the convenants (fine print) -- that's a good sign.

But keep in mind they used up a lot of their cushion when repo margin requirements doubled a few weeks ago -- you may have read about TMA's delayed dividend and decision to "sell" 1/3 of its mortgage portfolio in response. Its scary right now but the more refundings we make it through the better the chances of survival and recovery.
So Far So Good.

UEPS -- they reported and it looked to be in line. their guidance also was roughly in line with estimates -- maybe some will raise marginally. Conference call is Thursday -- we will learn more then. Personally I don't understand why they wait so long to come out with the Q4 numbers -- they also published their 10k today -- what company waits to release Q4 numbers until they have published their annual report?

MDT -- read through the conference call transcript and didn't really learn much more than I commented on a few weeks ago -- they have cool stuff in the works but overall they are a slower grower than they have been in the past. probably a 8-10% revenue grower. That will look great as the economy struggles. I also like the fact that their international revenues are picking up as a % of the total -- those socialists around the world are spending a bit more on new technologies. Plus at 19X next 4 quarters EPS, the valuation is fairly reasonable for their growth and strong profitability. (mid teens return on assets, almost 30% operating margins, plenty of free cash flow.)

GGG -- stock was up 4% today thanks to the market's belief in Fed cuts. I am hopeful as ever that their international, industrial and commercial construction areas have enough strength to offset continued weakness in US residential construction because its going to continue to be weak for quite awhile.

I mentioned recently reading about Praxair -- PX -- and since then, I hit the comparison link both on yahoo finance and on factset's company explorer. I discovered Balchem (BCPC) and after reading a lot about them, I also rediscovered Neogen (NEOG), which is a microcap stock that does food and animal safety and that eventually led me to ECL -- Ecolab, which is my latest reading topic. These are all great companies -- I last looked at NEOG a year ago and now the stock is 50% higher -- missed that one. There were a few others in between but my memory is fading already.

ECL is a very consistent business both in terms of growth (8-10% revenues and higher on EPS) and profitability (Free cash flow above earnings, Return on Assets at least 10%, etc) and I think that is interesting in this market. They sell safety and sanitation products/services to restaurants, hotels and other institutions. Interesting part about the clean up at restaurants -- as soon as you are done it starts getting dirty again. Plus the cost of the chemicals that ECL sells are only 5% of the total cost of keeping the place clean -- labor, water, energy, etc. are the other 95%. ECL's customer support reminds me of Factset's -- they help you get your work done and in so doing they infiltrate your work so much that you can't get rid of them. Factset also visits us every month just like ECL sales people visit their accounts every month.

About half of ECL sales are international and that is great for this environment of faster growth overseas, but 2/3 of it is in Europe and its slow growing and lower margin. ECL has to be one of the only companies whose international sales are growing slower than its US sales. (US sales got a boost this year from a competitor retreating from the business.) We are 5% of the world's population and around 25% of the world's GDP (give or take 5-10%) yet ECL derives 50% of its revenues from the US? We have the income to eat out more than some of the emerging economies but that will change in time. There is no reason why this couldn't become 80% international in the future -- the potential is huge. Even in the US they only have about 20% market share -- very fragmented market. Reputational risk is one thing on ECL's side -- they sell peace of mind that the restaurant isn't going to be on the front page for an e coli outbreak or some other issue (rats in the kitchen, etc.)

Valuation is not cheap -- 22X next 4 quarters earnings estimates but given their PE has averaged closer to 26X, their future potential and their great consistency, the valuation is looking attractive. I haven't bought yet but seriously considering it. only have limited cash now so need to do some selling.

good luck

Sunday, August 26, 2007

Weekend reading and the week ahead

Spent part of my weekend reading about Praxair -- interesting company. They sell industrial gases including hydrogen for oil refiners; oxygen for medical use; helium for fiber optic lines; carbon dioxide to preserve your orange juice; a bunch of gases for use in making semiconductors; oxygen for increasing energy efficiency; and I think oxygen for lowering the cost of steel production. Bottom line is that they benefit from 2 forces -- economic growth and their ability to innovate or find new applications for industrial gases.

The management is very focused on return on capital and free cash flow -- they do ok on the numbers. No where near as good as Graco or Factset but pretty good relative to most chemical companies or most other manufacturers. Their growth is helped by growth in energy, emerging markets and environmental needs (hydrogen in refining removes sulfer). To me this is a play on the growth of manufacturing and a classic Philip Fisher play on innovation. Its kind of on the expensive side now but that depends on what future earnings will really be -- if they are able to keep beating estimates then the stock is cheap. plan on doing some more thinking on this one -- could be an interesting addition but it might be just one to watch and wait on.

This is a big week -- UEPS will finally report June earnings -- key is what they say about nigeria, wage payments and any update on the welfare distribution RFP of the South African government. Those are the 3 biggest issues but obviously I'm assuming they didn't miss numbers.

DFR has its actual dividend payment and its first repo refunding since the end of July. If they make the dividend payment, then they believe they will make the repo refunding -- why would you pay the dividend if you expected trouble? If they make the repo refunding that gives them some breathing room for the next few weeks and is a good sign. TMA was not able to do their refunding -- that's why they "sold" $20 bill worth of mortgages. As I joked with someone this weekend, if the stock makes it to $13 then most likely the liquidity crunch is over for them and the story will shift back to whether they can meet estimates or what the dividends will be in the future. So anyone that is saying if it just gets back to $13, then I'll sell is missing the point.

If it makes it back to that point then the reason to sell -- concerns about liquidity and survival -- will no longer be an issue and therefore you might as well hold. But if the stock stays below $10, then most likely the liquidity issues persist.

Its very easy to assume there are no problems since the stock has moved up but that is not true -- all the same issues are there in the mortgage market, its just the sellers were exhausted temporarily.

Thursday, August 23, 2007

Risk Management -- trimmed DFR

This topic deserves a careful analysis and a thorough discussion but its going to have to be over time because there is way too much to cover on this topic for one night.

I use several methods of risk management but I should have more -- over time I will keep refining the process. First method is diversification -- trying to keep positions to a reasonable size so that if any one of them drops sharply, it doesn't ruin the whole portfolio. Today I decided to exercise this part of risk control by trimming my position in DFR by 20%. It was just too big a position size given the risks involved -- I don't believe the mortgage market has suddenly healed itself nor is credit any more available then it was a couple of weeks ago. Investors seem to be worried about how much future dividends will be and whether the merger will still take place or be renegotiated and not very focused on liquidity concerns despite what happened to TMA, H&R block, CFC etc. I have had too big a position and the rebound off the bottom gave me a chance to sell some but I was probably too early -- if the UBS report came out post close, we could see another increase tomorrow based on that analysts bullish remarks (I plan on trying to get a copy of the report tomorrow).

I also try to diversify by type of stock as well as secular theme. My current list of themes:

1. Asia -- their economies are strong and yet their share of the world's value is low -- this will change over time. (matthews asian funds)

2. Asset management -- great way to piggy back on the market's gains with fund flows an outperformance kicker. (AB as well as indirectly with FDS, CME and potentially DFR).

3. DNA/biotech/genomics/etc. -- understanding DNA will have a huge impact on the practice of medicine in the future and there are many ways of playing that (ILMN, LH, GNVC, TECH and sort of MDT)

4. Internet -- we are all spending more time using it and gaining more value from it -- its a huge change in the economy. (GOOG, indirectly MSFT)

5. Energy -- they aren't making more of it; thermodynamic laws make alternatives very unlikely; finding and development costs are rising and that provides floor to pricing not to mention strong worldwide GDP growth. (VGENX, ERF, EPD, MMP)

6. Various smaller themes:
a. miniaturization of technology; growth in digital consumer products -- TSRA.
b. Smart cards -- use of smart card to replace cash in 3rd world economies as the low cost solution (UEPS).
c. GPS -- location based services will be much more valuable over time as applications are built and wireless access improves and the technology becomes more ubiquitous. (NVT).

I am actively looking for additional themes -- my interest in MSM, IHS, etc. is because they look like great companies, but on the other hand, I'm not sure they are beneficiaries of a secular theme I can point to other than energy in the case of IHS.

By type of stock I mean how it is generally characterized -- growth, momentum, value, high beta, low beta, high dividend yield, etc. Not every stock in the portfolio is a rocket like NVT and ILMN. Some are lower beta or pay dividends. Point is that this way if the market is spooked by high PE stocks, my portfolio will experience pain but there will be parts that will benefit too.

Besides diversification I use selection as a risk management tool -- trying to find stocks that are likely to outperform expectations (less likely to decline) that sell for reasonable valuations relative to what I believe they will earn in the future. Yes I am worried about NVT and ILMN's valuations but they are a small part of the total and they have strong fundamental momentum. I think UEPS is very undervalued. Stocks like GGG, LH, MSFT, MDT and AB seem very reasonably priced to me.

I have not taken advantage of volatility as well as I should have -- when stocks go up, I should be more interested in trimming them and also more willing to buy more when they dip. Using selection as a risk control can have merits but its not the best method -- what if I'm wrong about the future? every investor is wrong at least some of the time -- the future is uncertain so there is no way anyone can be right all the time. We can only try to improve the odds of being right. Using selection, you must be quick to sell when the risks outweigh the rewards -- when the upside is limited and the downside is great. This requires diligence -- you have to always be reviewing positions and asking where this stock is on the risk reward spectrum.

By trying to stick with what you know, what you have an edge in, that is how you can improve the odds and practice good risk management. The problem most people -- myself included -- is that we actually know a lot less than we think.

I don't focus on what academics call risk management -- volatility. its not true risk but rather a mathematical approximation. I think the recent past has demonstrated the impact of putting too much counsel in mathematics for risk control.

read the WSJ

Great editorial in Tuesday's paper from Wesbury about the Fed's job. He does some interesting math suggesting that subprime in a worst case scenario is worth around $73, which would hurt anyone that owned those bonds on leverage but shouldn't impact the overall economy. I see 3 main problems right now:

1. too many houses and too much capacity to build new homes, to sell new homes (realtor's) and to mortgage them (mortgage brokers). This makes the home builders troublesome.

2. too much origination capacity in mortgages -- figure 40% of origination volumes will drop over the next couple of years as the industry adjusts to new realities. That essentially means no more sub prime, alt-A and or jumbo mortgages.

3. too much leverage on the part of investors buying mortgage pools and other exotic, illiquid, hard to value/trade debt instruments. The problem is not in the securities but who owns them and what condition their balance sheet is in. Too many investors used leverage at the wrong time -- the peak instead of the bottom. at the peak leverage means wipe out. at the bottom leverage magnifies the gains.

So the editorial goes over an extreme example where by 50% of subprime loans default and recovery rates (forced sale of homes) amounts to only 50% of the loan values. That works out to a 73 value for the bonds yet most of these securities are no longer trading -- even if a buyer could be found that would accept that "emergency" price, the hedge funds and other leveraged participants couldn't sell at that price because that would wipe out their equity thanks to the leverage amounts.

none of the 3 reasons above is really impacted by the credit worthiness of the borrowers -- its more the creditworthiness of the lenders that has mattered.

Great article on Tuesday at the site (pay part of cramer's world) written by Howard Simons. He points out that any time we have had problem markets in the last couple of years (may 06, feb 07, jul 07) you can usually point to the BOJ doing something stupid -- this time is no exception. The bank of japan has been reducing global liquidity by way of allowing investors to unwind the carry trade of borrowing cheap yen to buy other higher yielding currencies. The Chinese are working to offset this folly so that we can continue to buy their exports. its a fascinating article that basically says who cares what the fed does its the BOJ that matters.

Wednesday, August 22, 2007

latest news (DFR and others)

Sorry about the delay in posts -- still having computer troubles with the Internet access. One of these days I'll get around to trying to fix them.

DFR - certainly nice to see the stock run up to the $8.70 area. Good and bad news this week -- first TMA sells down a bunch of their portfolio -- sounds like they couldn't do a repo rollover and decided to sell instead -- that shrank the portfolio by $20 bill and the book value by over 1/3 since the end of June. That would equate to some where around $9 for DFR so we are near 1X book value which is where the stock generally traded except for the couple of times it spiked to $17. Why assume DFR's book value has dropped too? because the value of all mortgage securities have dropped even those of the highest quality. Leverage that DFR is using magnifies the drop in assets.

H&R Block had trouble with their funding and had to use their line of credit. another sign that liquidity is not there.

On the good news front -- BAC buys a big stake in countrywide financial through a convertible preferred stock which they got on great terms -- they earn 7.3% yield and they get to convert at a price that was a discount to where the stock was trading (most converts are done at a premium to the current stock price). That provides them with $2 bill in new capital and gives a vote of confidence in their survival.

There is always the chance that DFR could do a similar deal -- raise equity from the Dart family or some other big investor that provides liquidity at a steep price. If DFR was smart, they sold some of their AAA non-agency mortgages and reinvested in agency mortgages but I doubt they did. collateral requirements are lower on agency so that would give them breathing room. But they would have to be able to sell their non-agency mortgages at a price that is not too big of a discount from their previous value otherwise DFR would struggle to pay off the repo's used to finance the purchases. all speculation at this point. Got 6 days to go before the dividend is actually paid -- wish us luck.

I still have no idea what the next dividend will be -- depends on liquidity, how much the portfolio has dropped in value and changes in the interest margin they are earning. we know that short rates are dropping and that mortgage rates are rising -- means their spread should be widening unless their repo's are costing them more due to the liquidity issues in the market.

I am still digesting the MDT quarter so I'll comment on that in the next couple of days.

AB -- only concern is where the hedge funds they manage now stand on year to date performance -- are they still eligible for a big incentive fee or not? quant funds have taken a hit so its possible they won't see the almost $2 in earnings in Q4 that is part of guidance. worst case is that the quarter is $1 instead of $2 so when the stock is near the low $70's its full discounted -- near the mid $80's and not so much.

CME -- first we get concerns about growth in derivatives but now its concerns about buying the NY merc. certainly possible. the company has a pretty good track record of doing what is best for the business. CME is already clearing the electronic trades for NY Merc so they have pretty good knowledge of the situation.

I used factset recently to do Greenblatt's screen based on the little book that beat's the market that was published a few yeas ago. He looks at valuation (price to cash flow) and return on capital. I saw several of my stocks on that list -- LH, TSRA, GGG, UEPS, which was pretty cool.

UEPS -- another week before results come out for the June quarter plus any day we can hear what happened in the welfare tender in south africa. I believe pricing will hold up at least in line with expectations and they will earn new business that no one is really expecting now. if the tender turns out favorably and the quarter goes well, this could be a low 30's stock -- easily.

EPD and MMP. MLP's that have been hurt by recent hedge fund trading (need for liquidity) more than any concerns specific to the companies.

ILMN -- should take some profits given the stock is up 50% since purchase but I still think the product cycles have a long way to go in terms of driving upside to results. translation -- I have decided to stand pat so far, which based on history is generally the wrong call. ABI is going to have a competing product in another few months so its possible ILMN's growth will be impacted then and that makes it harder to blow out epxectations.

Monday, August 20, 2007

Stocks: FDS, IHS, CME, etc.

Factset -- this is a wonderful business -- one of the best ever -- they have had sequential (as in quarter over quarter) revenue growth for some ridiculous number of quarters in a row -- say 100 or more. That is a record of consistency unmatched by I suspect any other company out there. FDS also has very high free cash flow margins, very high return on assets and big barriers to entry. I have been an extremely loyal user for most of my 12 years in the business (only exception was when my firm was too small to afford a Factset subscription).

Factset has expanded from providing analytical tools and access to data to evaluate individual stocks to tools to evaluate portfolios; to evaluate potential M&A deals; to help companies perform investor relations functions; and many many other functions.

But I don't know the odds of them maintaining their revenue growth record in this coming environment -- too many investment bankers, too many hedge funds, etc. only good news is that they don't have much exposure to fixed income so that could be a new growth area. I don't want to panic given their track record but as the firm grows it gets harder to maintain growth patterns.

IHS -- is this the Factset of the energy and defense and aerospace industries? similar subscription based model offering access to critical info but I just don't know how critical the info is -- as a user of Factset as well as some of Factset's competitors, its very easy for me to know where Factset fits in and how they compare to their competition. FDS is the gold standard by which all customer service/support should be judged. They are expensive though so not everyone can or is willing to pay up for it. cheaper solutions that are not as robust exist -- those cheaper solutions probably meet the needs of many users but for some its not enough -- they need the power and flexibility that FDS offers.

The neat thing about IHS is that they are exposed to other areas than finance -- energy and aerospace and defense. They also have much higher percent of revenues from International clients -- 47% vs. 28% for FDS. They also have lower margins than FDS as well as several other similar business models. IHS's profitability has been improving, which boosts earnings growth above that of revenues. stock is not cheap however. will be doing some more work on this one.

CME -- some are arguing that volumes will drop based on the idea that the cost of using derivatives has increased and that anything with a rising price ends up with less demand. Its quite possible but I'm skeptical that the growth rate of derivatives will slow -- just too flexible and too many advantages to using them. I still like this one.

Others I have done some reading on this weekend include: ACM, MSM and MIC. So far I have been less interested with them for various reasons. Will continue to keep reading and reporting. hope you are making money this year.

Sunday, August 19, 2007

Friday and the coming week

Well that was a nice surprise! Nice to be able to say you owned the strongest performing stock on the NYSE -- DFR -- of course still down quite a bit for the year. What effect will the Fed have on DFR and the markets in general?

At the margin, more firms will make it with the fed cutting than if they don't cut so that definitely improves the odds for DFR. That said, the Fed can't do anything to fix the balance sheet problems of so many players in the debt markets. They are overleveraged already -- that is the problem -- so reducing the cost of more leverage can't really help them.

Think back to 2000-2002 when the Fed was cutting rates from 2001 on and at first many tech and telecom stocks rallied hard but over time everyone realized there was no fixing what was broke without a massive decline in value and a large reduction in capacity -- my thought is 40% decline in mortgage origination between peak levels and the trough. think about how many brokers both mortgage and realtor will be unemployed in the shakeout. People like Countrywide or IndyMAC that keep talking about taking market share and growing are missing the big change.

Within that world is there room for a conservatively managed mortgage portfolio that can still allow the firm to operate as a REIT that also owns a management company and some alternative assets? I think so and that's why I still own it -- the biggest issues are with investors owning the wrong securities (credit risk or overly leveraged) and with origination volumes, which don't impact DFR.

Dividend on DFR -- some one on the message boards (yahoo) was making the buy case based on 42 cents for 2 more dividends this year -- its possible I guess but I wouldn't hold my breath. I have no idea what the dividend will be but it seems like a crazy question to ask when faced with survival as the primary goal.

I expect the rally will last a bit longer but I don't know where DFR will end up. longer term, if they survive, this is a big opportunity but that's a big IF right now.

Friday, August 17, 2007

dfr not able to get financing

not a good sign of their liquidity position. Maybe some will be happy that the deal may get canceled and bid the stock up. In that case I might sell half to recognize my losses and protect some capital.

when it rains it pours has never been more true -- so far at every turn the last month or so every thing has gone against them.

Interesting day in the market to say the least. I think we are near a short term bottom -- talk on real money today was about whether the right analogy is 1931. Also had lots of bears gloating about how they saw this coming and have warned about it forever and they see much more pain ahead. at the same time I could not access my schwab account for most of the trading day -- temporarily unavailable -- I presume due to heavy volume of trading. Also heard some high net worth managers talk about panic calls from clients worried about their money market assets and other stuff.

As far as stocks go, financials certainly got a bid (except for DFR of course) but a lot of other stocks were down even after the afternoon bounce.

I would urge you to go through your stocks and ask the following types of questions:

how strong is the balance sheet -- do they have any debt that may need to be refinanced? can they easily cover the interest expense?

are they a beneficiary of the growth in debt the last several years? this includes everyone from brokers to rating agencies to private equity related stocks to mortgage brokers, lenders, homebuilders, etc. -- the list could be long but anything on it could struggle to grow earnings in the future as the mortgage and housing industries shrink 40% or more vs. volumes from last year.

are they a supplier to anyone on the above list? I would include potentially FDS on the list because they sell to investment bankers and to hedge funds and those markets will struggle.

is their valuation reasonable using reasonable earnings assumptions?

do they have a growth strategy or is growth just cost cutting?

its late again -- will have to think of other options tomorrow.

Thursday, August 16, 2007

What do Mortgages/housing have in common with Telecom from 2000?

1. Special financing terms used to expand demand to those who can't afford it otherwise -- ie. if I don't ask for payment would you be willing to buy one? (Nortel Networks from the telecom equipment side, mortgage brokers/home builders from the housing side)

2. highly leveraged buyers that couldn't borrow another buck to buy any more -- (CLECs vs. home buyers especially sub-prime)

3. Huge over capacity from too much building on spec -- (16 national fiber optic networks vs. investment homes, beach front homes, downtown condos, etc.)

4. The fed will cut but it won't help the mortgage industry just like it didn't help the telecom industry in 2001. A brief rally and then a return to the steady decline.

5. there are more but its late....

So what does this mean -- expect the mortgage market to drop 40-50% similar to how telecom shrunk post 2000. Lots of companies will go out of business -- I assume Countrywide is a goner (absolutely no knowledge of their actual liquidity situation) -- why? because they don't get it.

They are still in growth mode hiring more loan officers from american home mortgage when they should be completely focused on survival. They don't realize the future is a much smaller industry. Back in 2000 half of all high yield bonds issued were for telecom -- now? no where close to that share.

Now comes the important question? Who cares besides those in the mortgage industry and investors to own mortgage related investments? Well, there is the chance that all this liquidity stuff impacts the rest of the economy. I've been saying for awhile that it wouldn't and then I thought of the analogy to 2000 and realized we got a recession then why not now? Interest rates were a lot higher then although much less of a liquidity crunch occurred. Markets require access to capital -- especially debt capital to grow -- no capital, no growth. Credit is the lifeblood -- the oxygen that the system lives on. Simple as that. Previous credit crunches -- 1998, 1990, 1981 and a couple of times in the late 60's and early 70's.

I'm still not convinced yet of pending doom and gloom but I probably believe more now than before.


CME -- volumes are huge but worries about liquidity in their customers holding it back. I still like this one because the earnings will beat by a lot.

FDS -- had the chance to sell some in the low $60's last couple of days after the sharp bounce form the dive to $52 and didn't sell. Realized now that with fewer deals they could get pressured with service cancellations within the investment banking areas. Plus the death rate on hedge funds must be pretty high and that could mean fewer customers. Post bubble burst they were able to replace shrinking long only customers with hedge funds and investment banking -- what will they do now? Hard to bet against a company that has never had a down quarter in revenues sequentially across 25 years of operations. That said, nothing wrong with taking a little off the table either.

NVT, ILMN -- still have strong momentum in their business but valuations are high so some are probably selling to lock in profits. On a rally, which we should have starting a week or so from now, I will trim unless they go up sooner.

AB -- their model is heavily influenced by quant models so I suspect their performance could be impacted by the recent troubles. The only issue that matters for the stock though, is what is going on with the hedge fund area's performance -- the incentive fees expected as of a month ago would equate to $2 in earnings in Q4 but what happens if they have lost that money and will no longer earn incentive fees? yep lower estimates and lower price. For me, this is a keeper because they are in all the right spots for the future -- I have weathered many a bump in the past with this one so I'm not about to skip town now but as the market goes, so goes this stock.

being that it is almost 3am -- that's enough for now.

DFR -- no margin for error

David confirmed today that margin requirements in the repo market have doubled -- that removes the cushion from DFR in terms of that unencumbered cash they talked about on the last call.

They do not have a repo refunding to do until the end of August and it will only be on a portion of their repo base but that is the next risk point -- will be interesting to see if they decide not to pay the dividend to conserve cash and increase their cushion of unencumbered cash. Assuming the deal for the management company closes, that might provide another source of liquidity -- or even a value even if the REIT portfolio becomes insolvent.

One interesting aspect, in addition to the potential for the management company to help, is that if the mortgages get wiped out in a margin call (see below on the math), then what happens to the alternatives portfolio? does that disappear too or does that survive. must admit to not knowing.

If DFR does go under, it will be a shame that they didn't react quick enough or didn't take survival seriously enough. Its always best to know the right question to ask -- they said it on the call and I am hoping they meant it -- they are focused on liquidity and will do yield optimization in the future. Right now I am standing pat -- hard to say what the right call is here.

Best way to think about it is would I buy it now if I didn't own it? no way too risky. Why not sell? I like David's comment on real money today -- there are stocks left for dead -- best to ignore those and focus on the walking wounded. To me DFR is in that situation. I won't commit new capital to it but rather than sell it, I will take the chance that they make it because the rewards will be great.

How does this work? If before they borrowed $985 mill to buy $1 bill in agency mortgages, now they can only borrow $970 mill to buy agencies. For AAA prime mortgages the borrowed levels would be $950 mill and now $900 mill. So to own the same level of mortgages going forward that they did at the end of July, they will need an extra $ 50 mill in capital for each $1 bill in AAA mortgages (they owned about $2.3 bill at that time) and an extra $15 mill in capital for each $1 bill in agency (they had around $5.5 bill end July). So as you can see that $229 mill they had then will be encumbered as the repos get refunded over the next couple of months. Will they pay the dividend -- can't know for sure until the money is in the account. if they are able to line up the next repo without any more issues, then yes I think they will.

A smaller cushion means almost any decline in the value of the mortgages and they will have trouble meeting margin calls.

I must admit fixed income trading is not my specialty so I'm somewhat flying blind.

I will lay out some thoughts on the market in the next note.

Tuesday, August 14, 2007

CME -- bull and bear case

Today I bought some more CME -- just a small increase -- left some powder dry for later. The stock was hurt today because of the Sentinel fund issue -- people are concerned about CME's clearing house operations where they serve as the counterparty for each side in a trade. So rather than 2 investors trading with eachother, they trade with CME in the middle because that way neither investor has to worry about whether the other is going to meet its obligations in the trade (deliver cash, etc.)

CME then needs to get the money from the investors or they suffer the loss. They claimed today there are no issues with people maintaining the appropriate margin or performance bonds (money set aside to cover the margin required to trade futures). So this is one issue -- that CME could face lots of losses from hedge funds or other parties backing out of trades and forcing CME to cover for them. I don't have an edge here but I go with history -- not been a problem before despite volatile markets with lots of losses. They mark to market customers twice a day too so they can wipe someone out pretty quick if necessary.

Second bear issue is that much of the problems in the credit markets are driven by losses on derivatives like those traded at CME's exchanges. So there could be either regulatory or investor concern about using these instruments in the future since they turned out to be too dangerous. But the OTC market for interest rate swaps and foreign currency trades is much much larger than what gets traded at CME's exchange. The problem then is not the standardized stuff that is traded in the open on the CME. The problem is the esoteric stuff that is traded behind the scenes in the over the counter market (OTC).

One answer could be to convince investors to convert their risky behind the scenes trades into more standardized stuff that trades in the open on CME's exchange. That is one way to continue to see big upsides in volume growth. July was up 40% but August is up closer to 100% at least in terms of certain contracts -- keep in mind that August of 2006 was probably a slow month given all the people out on vacation.

I think the estimates are too low given the volume and I am confident the higher volume is sustainable and they will not suffer counterparty issues. The stock could very well be $650 or more in a few months.

good luck.

DFR update

Another DFR update - I know you are probably sick of reading notes about DFR but this will capture some thoughts about the market too.

DFR dropped 11% today, which doesn't look so bad relative to the 60+% decline of Thornburg (TMA) mortgage. They announced after the close that they were delaying their dividend payment to a point when their liquidity would be better -- not a good sign really especially when you try to convince people that your book value is near $14 and your stock is around $8 (if your book value is so good, why are you having liquidity issues). TMA does jumbo loans -- those that are larger than Fannie and Freddie are legally able to buy/securitize.

You would think jumbo loans would be fine given that these are for wealthy people -- you would be wrong. These jumbos are also facing liquidity risks just like other parts of the mortgage market. These are loans that right now are having a tough time finding investors -- basically anything that isn't guaranteed by Fannie, Freddie and Ginnie is struggling. So what is the difference between TMA and DFR? One major difference is that TMA originated its own loans -- they have offices and loan officers that convince buyers to use them for their mortgages. DFR is just an investment pool -- they buy mortgage backed securities that are based on mortgages originated by someone else. The difference is in terms of what liquidity requirements there are. Originators are being attacked more. I don't know for sure that origination is the problem for TMA but it makes sense given that has been the problem for many others in the mortgage market.

TMA's book value was down to $14 from $19 at the start of the quarter -- quite a drop in such short time frame. I would not be suprised if DFR's book value has also been hurt this quarter -- life isn't just roses for them I assume otherwise the stock wouldn't be $7. I still think they have the liquidity to make it but one never knows -- diversification matters. David Merkel raised the issue of increased margin even for agency and AAA prime quality mortgages today -- if that is true it puts DFR in more pressure. TMA, just like LUM, said they were fine until the last week -- that's how a liquidity crisis works -- it sneaks up on you when you get complacent and takes you out before you know what hit you. If it happened slowly, people would be able to react and save themselves.

the saga will continue....

UEPS -- updated info

I wrote about UEPS last about a month ago after Baird had upgraded the stock. His model showed that wage payment would not be a big application for them -- maybe 25 cents of earnings 5 years from now, while Nigeria could be more like $1.50 of incremental earnings.

I just listened to the Morgan Stanley conference call that is available on their website ( and during the call they mentioned wage payment customers would generate 2-3X as much profits as their current welfare customers due to the higher wages that are paid to workers vs. welfare distribution. Since it took them quite a long time to get access to a banking license to make wage payments, they already have a lot of customers lined up to use this service soon after they get the infrastructure ready. They have 3.5-4 mill cards now used by welfare recipients. In the next few years I could easily see them earning close to $1 in earnings from this area similar to the last few quarters earnings in the welfare business.

The call also covered Nigeria. The CEO explained that they expect 200-300k customers to be signed up within the first 6-7 months and for that country to be breakeven within 12 months. Those initial customers will come mostly from the 8-9 million community bank customers that do not have access to national payment networks, which UEPS can give them. They are also bidding on a national ID tender that could give them access to 65 million cards -- that would be a huge jackpot.

The company also explained their latest technology which has integrated cell phones with existing credit and debit card networks and with the UEPS system to allow what they call virtual payments. It is complicated to explain and this note is long enough already but basically this technology integrates the 3rd world with the 1st world by allowing anyone with a cellphone to buy something using a virtual visa number that accesses their UEPS account. They are trying to get this up and running in Indonesia and Africa. It sounds pretty interesting to me (they talked about using this technology in the money transfer business from the US to the developing world -- Western Union's current domain).

Between continued growth in South African welfare, wage payments in SA, Nigeria, new cell phone technologies, plus other countries and other new services (prepaid electric and water), the growth opportunities for this company are huge. In fact this business sounds so good I continually wonder what I am missing -- it shouldn't be this good. Assuming it is, we should make several times our money in this stock. I am thinking about buying more.

Monday, August 13, 2007

Stocks you are interested in?

If you are interested in a stock, see if I have commented on it before by using the Google Search feature on the left and clicking on the search the blog option. If I haven't commented or you would like a fresh comment, try posting your question in the comments or send me an email at

I keep up with quite a few stocks/industries so I may have thoughts on it even if I haven't written about it.

Right now I am continuing my search for stocks with secular growth where something has caused the market to question just how good the future will be for the company. Perfect examples were Navteq and Illumina -- both great growth stories but many investors doubted the future only 2 months ago. Now everyone is fully convinced and the stocks are up a lot. Often times I don't wait for their to be a pullback in the stock -- CME is a recent example where I thought the prospects were good enough to jump in -- it did pull back after I bought but I was too slow to buy more.

would appreciate any comments. Thanks

Sunday, August 12, 2007

market plus couple of other names

Lot of moving parts the last couple of days. I buy into the idea that some quant funds are having troubles and unwinding their trades within smaller cap stocks. Each day for the last week or so I have had several stocks move up and down at least 3-5% often in a direction opposite of how the market was moving. There doesn't seem to be any fundamental news behind the stock price changes -- TECH had great earnings and moved up $4 one day only to lose $4 the next day. Will be interesting to see how long this lasts -- check out the article in the WSJ about Lehman's top quant who issued a letter to the "quant community" last week urging calm.

I was shocked to see the main headline of my local newspaper blaring out the news that the Fed injected liquidity into the market -- huh? They acted to keep the fed funds rate at 5.25%, which is what you would expect them to do. Isn't that what targeting a fed funds rate requires? adding or removing liquidity to maintain that rate? Why the rate was rising above the targeted rate is an interesting question -- obviously some bank that was part of the Fed system needed extra liquidity (demand) more than what was available (supply) at the 5.25% rate. The news headlines likely jumping the gun -- this action isn't news, but it has likely opened pandora's box -- a fed funds cut is probably in the cards over the next several months. That will provide nice juice to technology stocks and perhaps a few financials.

But don't get carried away on the financials -- not much the fed can do to repair the balance sheet woes of many hedge funds or other leveraged players. Just like when the fed cut in 2001, everything took off at first but then all the tech stocks kept dropping -- the business kept declining despite the fed cuts and the stocks were all overvalued too. There are financials that are overvalued relative to the future -- imagine a mortgage industry that is 40% smaller than 2006 and you can get an idea what I mean about future earnings power being under pressure.

I stopped reading about Mastercard -- I think they do a horrible job of telling their story. I just have a hard time understanding them and I don't really want to work at it to figure them out. My bet is that there is more opportunity in Net 1 (UEPS, use the search line on the left to search within the blog for comments on UEPS) then in MA.

I read something on Friday that suggested IGT -- International Game Technology. They sell slot machines and other equipment and services to casino's and other gambling establishments. Its a pretty good business with good profitability, good cash flow and what has been pretty good growth during industry up cycles. The stock has pulled back as growth is under pressure (US is replacement only and there is no reason to upgrade now. Valuation wise its ok -- not super cheap but not really expensive either. I think this could be a great stock going forward but I'm not sure its secular value investor material -- if the US is 80% of revenues and its almost all replacements how is that secular growth? its more like a cyclical story once the new server based gaming systems are available.

Another story I heard about is more speculative -- Angio-Dynamics (ANGO) which makes equipment for use in treating cancer as well as helping interventional procedures. The good news is that they get 90% of revenues from disposables -- generally higher margin products. The bad news is they are very small in size.

I plan on continuing to do some reading on these two plus -- I will let you know what I think.

Friday, August 10, 2007


Unfortunately I don't have the time to cover Thursday's swoon but I think the stories about a hedge fund blowing up and being forced to sell make a lot of sense -- how else do you explain Factset (FDS)'s 12% decline? I expect it will bounce back soon.

Overall the portfolio outperformed slightly thanks to better Asia, a strong bounce from DFR and a few others not falling as much (GOOG for one).

Thursday, August 9, 2007

DFR earnings

DFR finally reported Q2 results and explained their liquidity position (very strong) and the level of credit risk they have in their mortgage portfolio (its high quality) so that was reassuring. They refused to provide any guidance about the future both in terms of their dividend or the earnings potential of the management company they are buying in the next week, which was not reassuring.

It would take a lot of problems for DFR to become insolvent given the level of liquidity they have now (slightly less than 75% of mortgage portfolio is agency while the other 25% is in AAA rated mortgages that have various provisions to reduce credit risk but most important their funding sources do not have the ability to make margin calls most of the time -- only when they are repricing one of their repurchase aggreements (every 30 to 90 days). They also have an extra 10% of their AAA mortgage balance available to use as extra collateral if needed. The only squishy part is that they are assuming nothing goes wrong in the agency side but since those mortgages are guaranteed by either Fannie Mae, Freddie Mac or Ginnie Mae, there is an extra layer of protection for those assets.

I am not sure what the dividend will be going forward. This is a hard one to figure out. Their portfolio yield should be steady but one would expect they are suffering some losses in the credit portions of the portfolio -- even if its just market price declines on the fear of future defaults. The deal with DCM could actually be the biggest drag on the dividend since they are handing out almost 10 million new shares and taking out $145 million in new debt to fund the deal. Being a fixed income manager of CDOs and hedge funds dealing in higher credit risk products, DCM's revenues are probably under pressure. The extra shares mean an extra $4 mill per quarter in dividend payments at the current rate. The debt expense is probably an extra few million per quarter. so if DCM isn't able to provide an extra $7 mill or so in income or cash flow to DFR per quarter, that means a dividend cut.

Pre-crisis, I expected the dividend to reach $2.30 to $2.70 over the next couple of years -- perhaps its now going to take longer to get there. I still think its possible they reach that goal in a reasonable time though -- maybe its 4-5 years instead of 1-3.

I expect the stock to continue to be volatile depending on how other financial stocks are performing.

With any luck DFR will participate in a conference later this quarter and provide some more info on their current operations -- maybe even give some range for the dividend. I'm hoping that by September the credit markets will have settled a bit.


Merrill came out with a report this week that reiterated their view that the rest of the world is "decoupling" from the US -- meaning the US is no longer the growth engine of the world economy. Merrill believes that US economic growth will be less than consensus but that the rest of the world including Asia will be faster than consensus. They also argue that valuations in Asia do not reflect this -- investors in Asia appear to assume growth will slow as growth in the US slows.

Since my portfolio is 24% Asia, I view this report favorably. My Asian manager -- Matthews Asian funds is specifically targeting companies that benefit from the growth in the domestic economy and from intra-Asia trade rather than the traditional exporters to the US. They have a great long term track record built mostly by not going down when the markets falter. They get close enough on the upside and make up for it by huge outperformance when the markets are falling.

Techne (TECH)

Techne is a small cap stock that very few have ever heard of but it’s a wonderful business. They sell purified proteins and other biotech material for research labs both academic and biotech/pharmaceutical based. This is completely a consumable business so there is no expensive equipment to sell and therefore no capital budget concerns.

Given the importance of quality materials in multi-million dollar studies, quality is more important than price in this business. The other wonderful part of this business is that once Techne develops a product – and they have over 10,000 products – they can keep selling it for years to come. The business has high operating leverage – meaning high fixed costs so that incremental revenues do not require proportionate increases in costs. That’s how you get high 50’s operating margins. They have little need for capital expenditures either so the free cash flow is strong and their management of capital is exceptional – that leads to high returns on assets despite not using any debt.

The business grows in the 8-12% range consistently – even during the bubble burst of 2000-2002 when pharma stopped spending on most life sciences equipment, they still spent more each year with Techne. The one drawback is the valuation – its not cheap but you get quality for your money. This is one of my plays on the growth in biotech or the growth in genomics – DNA type stuff. Its also a consistent grower for me – a lower beta name that serves as a port in the storm when the market is falling.

They reported this week and the numbers were strong -- revenues up 12% and EPS up 18%. strong cash flow too. stock popped a few dollars on the news. check out the website -- -- not very flashy but functional. The management team is focused, disciplined and outstanding.

I view this one similar to GGG -- its a wonderful business that over the long term can make you wealthy but over shorter time frames might not move much.

Monday, August 6, 2007

Diversification -- how you are doing in the decline depends on it

At the low this morning was your portfolio down more than the 8% the S&P was down from its high? Then most likely you own some portion of financial stocks -- banks, brokers or mortgage REITs, high yield bonds or some other vehicle that is high yield oriented (business development companies, MLPs, etc.) or small cap stocks.

These are the worst performing areas so the more exposed you are to them the more you think the decline has been bad. If you own a lot of health care stocks or consumer staples like PEP, then your portfolio has done very well and you can't understand what all the fuss is about.

TECH, LH, MDT, ILMN, NVT, CME, etc. these are all up or flat since the market peaked. AB is another one that is only a couple of dollars from where it was in mid July.

If all of my portfolio was in DFR or BSC or something similar, then this decline would be much worse than it has been for me. Having a heavy exposure to smaller cap stocks has not helped -- especially with one that had a rough reaction to earnings (TSRA) but the list of stocks above that are up or flat during the decline is an offsetting factor. Diversification is key and its not just about owning different sectors as it is owning stocks with different drivers -- i.e. don't have all your money in stocks driven by the private equity boom or the mortgage boom or the debt boom, etc.

When I wrote a several posts ago about losing permanent capital, what did I mean? If you owned shares of SUNW, JDSU, EMC, NT, etc. during 2000 and did not sell until sometime later then you lost permanent capital. Some of those stocks are STILL down 90% from their highs several years later. They aren't coming back. American Home Mortgage is not coming back -- neither is Novastar or many other financials -- perhaps even BSC or even my own DFR. Yet during 2000 there were plenty of stocks that were bottoming and actually took off over the next several years -- they were non-tech stocks and include everything from MO at $20 to Exelon at $20 to many others. They have outperformed the market dramatically over the last 7 years.

There are financial stocks today that will lead to loss of permanent capital and there are non-financial stocks that will be big winners in the future. The key is finding those stocks where the future prospects of the business are materially better -- not just a little but a huge gap -- from what is embedded in their current prices. This is what I will continue to try to do.

BTW, the bond market is working the same way -- the problems are in sub prime, Alt-A and the debt that is private equity related or is part of a package of loans that is called a collateralized debt obligation. The CDO's aren't very liquid in the best of times but now its obviously worse. The more exposure to those areas and the more leveraged you are, the harder this market is for you.


Navteq had a great quarter and the stock has taken off too -- from the $38 I paid for it just a couple of months ago, to the $65 level of now. The valuation has expanded but its not too egregious -- especially if further upside is likely. If you haven't taken some profits yet, I would suggest it. The owners have changed to some extent -- more momentum oriented -- that will sell at the first sign of a slowdown.

I think GPS/location based services have a great growth potential but its hard to predict any individual quarterly numbers. Navteq is one step removed from the customer -- they sell to portable device OEMs like Garmin or to in dash suppliers like BMW so its even harder for them to predict demand -- they are not in touch with end users. The business is changing -- adding features like traffic, points of interest, etc. while also adding platforms -- started in dash in autos then portable devices and now smartphones too. Managing all this change is not easy -- lots of moving parts that Navteq has only limited control over.

Navteq mentioned various growth drivers on the call and said 2008 is when they will be ready or have a more material impact. That is what concerns me -- can they maintain the momentum when a lot of their future growth drivers are 2008 events. Luckily we are heading into the seasonally strong period for consumer technology products. They also mentioned that retailers are planning on adding shelf space to GPS models -- that should help unit growth maintain its momentum.

Longer term the growth drivers are there -- can't believe that location based content won't continue to become more valuable especially as we move to the iPhone paradigm of carrying around full functioning Internet enabled computers in our pockets. That doesn't mean the ride is straight up -- look at all the notes on now about NVT -- where were all these people 2 months ago when the stock was a bargain and growth was a question mark? all that changed was the momentum -- do you think it can't change back? Just advising to take advantage of the volatility -- if you trim now, then you can buy more on a pullback because they only grew portable units 100% instead of 200% or whatever the excuse is for slowing mo.

If the stock keeps rising before the next EPS report, I will be more inclined to reduce the position some -- momentum investors are wonderful on the way up but not as much fun on the way down!

1998? 1990? 1987? 1929? What is the right analogy

1998: financial stocks drop by more than half during the summer/fall of 1998 thanks to panic about the solvency of various brokers due to Long Term Capital Management's high leverage bets combined with Russian debt defaults and the Asian crisis. The Fed cut rates 3 times and stocks rebounded to record levels within a few months. If this is the right analogy, then you would expect a sharp snapback rally in the financials.

1990: Tax reform in 1986 took away certain real estate provisions that hurt the value of real estate as an investment. Falling values hurts collateral and when combined with poor savings and loan investments in high yield bonds, a lot of banks got wiped out -- Bank of New England being the most prominent at the time. Much of our banking system was technically insolvent just like the Japanese banks would become (or just like much of the hedge funds and other investment partnerships including potentially mortgage REITs are today) but we realized our losses and moved on unlike the Japanese who ignored them for years. Losses are a healthy part of the system -- they cleanse markets of investors who take too much risk or speculate too much. Lots of talk aboout Bear Stearns given their conference call on Friday -- if its 1990, then expect this firm to either go under or come close. Surviving firms will be great investments but there is lots of pain to get to the levels reached in 1990.

1987: Bond yields were rising all year at the same time that stock prices were rising too. By August the market peaked at 2728 (or thereabouts) or 22X earnings, while bond yields were near 10%. Why take the risk of the market, when risk free Treasuries are offering 10% guaranteed. Rates are near 5% and falling now on the flight to quality. Stock valuations are much better too. Unlikely.

1929: This period has been studied quite a bit but there are lots of myths or misunderstandings about what happened. Various factors conspired to create a debt financed boom that ended and was made worse by various policy mistakes. The Fed cut rates in the early 20's because Britain wanted to maintain the Pound at a 5 dollars/pound rate -- same as pre=WWI but that didn't make any sense given how much stronger we were post war then Britain. In addition, Mellon (Treasury Secretary) and Coolidge (Pres) engineered tax cuts that boosted after-tax incomes. New technologies such as mass manufacturing techniques plus electricity, radio, appliances, etc. created a huge productivity boom. Stocks were bought on margin -- there was no 50/50 rule like today -- people would margin their stocks up to 90%. The artificially low interest rates led to big growth in debt -- financing purchases of capital equipment, appliances and stocks.

Once the market crashed, the money supply began to shrink, Hoover raised taxes in a futile attempt to reduce the budget deficit, Hoover enacted the smoot-hawley tariffs that started a global trade war -- protectionism rose in most every country reducing the markets for our goods and making foreign goods more expensive. Falling incomes due to rising taxes, reduced trade and reduced liquidity combined with high levels of debt to create a death spiral for too many individuals and businesses. 2001-2003 the President engineered lower tax rates. 2001-2003 Greenspan kept rates lower than ever before -- down to 1% on the Fed Funds. Debt levels in the country have doubled since 2001. We have had a booming economy -- on a global basis and our markets reached new record levels thanks to booming corporate profits (increased productivity thanks to new technologies.) Concerns about our trade deficit have led some to call for protectionism against China. Democrats constantly talk about raising taxes. Don't know for sure but would expect liquidity measures to show declines.

There are the choices -- 1987 seems the most obvious to ignore. I believe we are in a 1998 scenario -- lots of liquidity driven panic but markets will rebound quickly once it passes. 1990 is next and I don't really believe a 1929 scenario is likely simply because there are too many safety nets around now vs. then.

If that is right and 1998 is the right analogy, then the fed will likely provide liquidity at some point to stem the panic and financial stocks will soar back to levels prior to the panic. Of course the question is where are we on the decline -- 2/3 done? 3/4 done or barely half way done with our decline? if we are early in the decline then stocks have a lot further to fall before the fed would take action.

Friday, August 3, 2007

DFR and the market

The last several days the fixed income market has experienced what can basically be described as an old fashioned run on the bank except in this case its hedge funds, REITs and other financial companies and those screaming for their money back are not individuals but large institutions that have provided the leverage to the system.

Imagine a game of musical chairs where all kinds of fixed income investment portfolios are looking for a seat -- meaning looking for cash or liquidity to satisfy their lenders. Only so much cash to go around right now and meanwhile the collateral -- the so called assets -- the mortgages and other securities are dropping in value due partly to increased credit losses but mostly due to forced selling -- no liquidity. It all starts because some securities have rising credit risks (subprime for one) and that leads to price declines. Many holders of these securities are highly leveraged and as those securities drop in price, the lenders call and ask for more cash -- a margin call. Some have no additional cash to give and they then lose out -- you may have read about American Home Mortgage or the Sowood hedge fund or the Bear Stearns hedge funds.

The risk to Deerfield is that they operate at 12X equity leverage levels -- similar to most banks -- so all it takes is a small drop in the value of assets and they are technically insolvent. Plus they are supposed to be buying their management company in a deal that requires deerfield to borrow $145 million in cash and pay shares of stock once worth $145 million (now worth $100 mill?) I think the stock has dropped because of liquidity fears -- would they be the next total loss -- and because as it drops the risk the deal falls through goes up.

I think the deal goes through because deerfield's manager is under just as much stress in terms of valuation. I think the liquidity issue blows over eventually -- wouldn't surprise me to see another sharp drop -- we are in the eye of the storm now. The reason is that the mortgage portfolio is fairly conservative and the higher yield portions of the portfolio have borrowed money from long term sources that can't do margin calls. I have relied heavily on David Merkel's analysis over at the Aleph Blog (see link on side) -- he does a far better job than I do of explaining their situation.

The liquidity issues for the market will end sometime soon -- its a snowball and eventually it can't get any bigger without one of two things happening -- the Fed cuts rates or injects liquidity or all the vulnerable companies go under and you are left with the strong that can't be taken down. The question is what impact will there be on either other financial stocks (can you say brokers or money managers!) or on the rest of the economy.

My take would be that the impact will not be as great as many now fear -- why? Some have the idea that private equity has been critical to the bull market and that is simply not true -- it hasn't hurt but rising earnings and low interest rates have played a huge part too. Again, the key to my strategy is to focus on company or industry fundamentals and not worry about macro concerns like the so called debt bubble or even worse the trade deficit.

TSRA's earnings or UEPS' earnings or any number of my holdings are impacted indirectly at most by issues in private equity. That statement makes more sense if you view it in the context of outperformance rather than absolute gains. I am not very good at timing the market -- to me there are always great stories to own that can make you wealthy. The key is selection. In the case of DFR, as I said in a previous note, I focused too much on the rewards and not on the potential risks.

My strategy is usually to identify stocks that are running downhill -- ones that have the wind at their back -- that are benefiting from secular trends while avoiding those that are fighting their way uphill. Now cyclical issues are different -- my ownership in AB suffered some hard times in 2001 -2003 but my cost is $35 and the stock even post pull back is still in the low to mid $80's. Not a bad deal. So there is nothing wrong with waiting out the cyclical issues in a stock that is a great business on a secular basis. I'm still optimistic that DFR will work out; but I wish my position size had been smaller to account for the risks when the credit cycle peaks and liquidity evaporates.

update on various issues

I apologize for the lack of posts since last Sunday -- totally driven by the wonderful service I receive from Time Warner cable -- NOT! briefly had access last night and just as I hit the publish button I learn that my access had ended again -- and oh by the way my note was lost!!! UGH!!!

What a week to lose access though!!! The portfolio has had a rough week thanks to the decline in DFR, my Asian funds taking a hit and some of my lower beta holdings getting hurt after doing well for the beginning of the decline (energy related mostly). About 100bps hit so year to date I'm back to only 200bps ahead (roughly up 7% through Thursday).

I will address DFR and the markets in general in a separate note. I also plan to cover TSRA in a separate note. Here I will cover some earnings and thoughts on other stocks.

NVT -- wow. I haven't had the chance to read the transcript from the call yet but obviously it was a good quarter. I did not end up selling any more shares as I had hinted I might on Sunday -- I did some thinking after CIBC upgraded the stock and realized there was more upside than I had thought when I wrote my comments on Sunday -- turned out to be correct. I will offer more comments post my reading of the call -- probably over the weekend.

CME -- volumes up 40% for July is not bad. They also have a tender offer on the table for 11% of outstanding shares for $560 -- the stock should not move too much from that level for this month -- nice support. I am thinking about adding to my position here -- probably trim some asian exposure -- let's face it, does it really matter whether I have 22% or 24% in Asia? either way its a BIG number.

MA -- I'm keeping an eye on Mastercard -- another stock that has gone up a lot but that has what could be a good business -- need to do a lot more reading and thinking but thought I would mention that it is one that I am reading about.

Apple -- got to see an iPhone Wednesday night while at dinner with friends. The owner pulled up this blog while I watched -- very cool. Key thing to think about is that right now its an expensive phone but over time as WiFi service improves, as they add 3G (need better battery life to do so) then you could see people viewing it as a cheap computer rather than a pricey phone. Right now that is a prediction -- high probability that one day it will be reality. Once that happens then look for someone to worry about cannibalization of $1000 MAC laptops for $500-$600 iPhones. Right now I am hoping that GOOG will serve as my play on that trend rather than Apple (Google's stock doesn't seem nearly as risky). One of these days when I'm low on things to write about I will pontificate some on Google -- most people in the media don't get them. To say that Google has problems because they are "just" a search company is to say that Microsoft had problems "just" being an operating system company until the early to mid 90's (say 20 YEARS after they started) when office took off.