Wednesday, January 30, 2008

Techne: another example of how I suck at trading

Thumb sucking again! what is this the 2nd or 3rd time I have whined about thumb sucking and missing a chance to add to TECH? ugh! Anyway, over the last week or so I have thought about adding to TECH because the stock had dropped a good 10% or so down to $60 and below. I was planning on swapping my MDT for it -- of course that one has dropped too but the difference is TECH's fundamentals are strong while MDT's are questionable -- could be improving but have consistently been worse for awhile.

I couldn't get past the idea that TECH's multiple was several points higher than MDT for what should be about the same level of growth. So what happens? Techne reports a stellar quarter -- just blows away the revenue and earnings estimates. So the stock pops over 7%. Meanwhile I reminded myself that the PE premium that TECH has is due to 2 reasons 1. much better profitability and 2. much higher confidence in that growth rate.

TECH is a better business and therefore deserves to trade at a premium to MDT. That said, MDT is a turnaround story -- one that could show improving fundamentals in which case it could turn out to be the better stock after all. TECH hasn't actually been the best of stocks -- I have owned it for about 18 months and my gain is about $10 a share or a high teens percentage. That's not bad -- its in line with what you would expect -- a slow consistent rise upward that after several years will look pretty cool but at any one time looks pedestrian. Not a bad idea to have a few of these lower beta (less volatile) stocks in the portfolio to balance out those gazelles.

Have to wait and see -- may get another chance to buy in and hopefully this time I won't miss it.

Monday, January 28, 2008


CME is now in talks to merge with NYMEX. They already have a clearing/operations deal with them for trading some energy contracts so the two companies are very familiar with eachother. I would expect some cost synergies but more importantly would be the ability to move the Nymex volume to Globex (CME's electronic trading platform), which would have a positive impact on volume and therefore earnings.

The stock was down to flat today despite the strong up move in the market. The stock is trading around 30x, which I think is not a bad price for the quality of the business and the growth potential of the company.

financials and consumer discretionary stocks definitely making a comeback over the last week or so. I remember making various comments about how financials had bottomed and would bounce but I admit my timing wasn't the greatest. Google is my current enigma -- I expect their earnings to be pretty good yet the stock has dropped like a stone. Granted, the stock's rise from $500 in the summer to $700 at the peak was a very steep rise and makes the decline seem bigger than it really is. What I mean is that Google is still up 10% or more from where it was in July -- it might be down 20% from September/October but its still up from July.

Should I have taken profits in Google while it was near $700 -- absolutely. Is the stock vulnerable to further declines from here? unlikely. Not unless fundamentals are weakening. VMWare's miss after the close could be a sign that tech demand is weaker than anticipated. Of course VMWare is up against MSFT so that might have more to do with it than a general slowdown in tech spending.

Google's main problem is the same as Apple's problem: Cramer. The mad man boosted their stocks for so long that now they are in a hangover -- the stocks became too over owned and too loved by too many funds and too many individual investors. Now those investors need to raise cash and that means selling Google and Apple regardless of what happens with the numbers. As this selling is completed the two stocks will be at very attractive levels but its hard to say how long that adjustment takes.

Thursday, January 24, 2008

nothing like a little volatility

The portfolio has lost about 200bps of relative performance to the S&P 500 the last 3 days -- that sucks. To some extent I'm giving back some of the great performance I got from being long asia, energy and not owning financials over the last few months. This week financials have been rallying while my stocks have been pulling back. In some ways its just the way corrections work -- the problems go down hard and fast but eventually bottom. The good stuff (hopefully in my case) goes down late and not as much but comes back too. Imagine a fund manager realizing all his financials are down 30-50% but his Google is still up huge since July -- why wouldn't he trim the winner while its still up. That gets the ball rolling and then the momentum types bail and then the oh my goodness chartists sell because they violated some rule.

I say all that but the reality is that corrections serve to change market leadership while everyone is distracted by losses. I am talking about leadership for the next few months not long term -- in the next few months I would expect consumer discretionary (retail, restaurants, etc) and financials to do better than the market while energy, tech and other areas may struggle. Its all hard to say for sure but it could happen. I would bet that after a bounce back the financials will roll over again to go back to their lows but that kind of depends on where we are in recognizing losses, where the fed cuts to and other stuff.

Interesting comments I have seen from others -- Fed is trying to prevent a repeat of the great depression but in doing so they are driving us towards the Japan scenario or a repeat of the 1970's depending on how successful the Fed is at reflating the economy. high energy prices, the promise from the dem's of higher taxes and a fed cutting aggressively look like the 1970's but all of our debt makes us look like Japan -- our low rates due too. such great choices we face. that's why asia may suck for a time due to things getting ahead of themselves but over longer time periods that's a great place to be.

By the way, 12:53pm wednesday and Cramer says here we are at the lows again and he says they hold and its time to buy. I bought some more CLB yesterday but just a nibble. What I realized afterward was that was the chance to buy some calls on the S&P 500 -- I checked out the feb 1325's and they traded between 18 and 47 yesterday closing at 47. Assuming the 18 was near the lows of the day -- that would have been one profitable trade. Buy 10 calls for less than 2000 and sell them for 4500+ all in a couple of hours work? good deal. everytime Cramer makes a call like that I think about it but usually don't or can't (work).

AB had reasonable numbers -- I think they are well positioned but it will take some time for the hedge fund performance fees to come back. in the meantime I would expect them to earn around $4 to $5 this year depending on where we end up in terms of the market. In my mind the stock is still cheap even at $4.

got to go to work

Wednesday, January 23, 2008

more fun

Well that was fun! My Asian funds got crushed! I did mention there was room to sell them a few days ago but I never managed to pull it off.

Bernanke -- tough position he is in -- wants to tough it out but politics getting in the way. It definitely looks like amateur hour over at the fed but its really not his fault. Greenspan's willingness to always hand out liquidity in times of need has caused our market to shift from one bubble to the next. Except that it could be tough to get another bubble started given all the losses in financials. Think about it though -- one moment its so close to the regular meeting why cut in between meetings. Then he cuts anyway? looks like its totally a response to the markets collapsing so it makes him look like he is reacting rather than being proactive.

Fascinating article today on real money by howard Simons -- he claims the dollar has already been in a dollar carry trade like position since the tech bubble burst -- basically acting very similar to the way the Japanese carry trade is used to borrow yen to buy other assets. So if you borrow dollars and then invest in euro denominated assets you have made money the last several years. He argues basically that saying we are like Japan isn't going too far out on a limb because we have been like Japan for the last several years. He argues that since either 99 or 00 the two worst markets in the world have been the US and the Japanese stock market -- the rest of the MSCI World index has beaten the pants off the US.

That's why I might be losing on my Asian funds today but over the next several years the international markets will win vs. the US. Asia should be a big winner from the fed cutting -- doesn't save the financials but it will help the emerging markets perform better.

AB reports wednesday night -- most interesting question is about 2008 guidance. Will they bother to make a guess or will they say its just too hard? What will they say about their hedge fund performance fees -- maybe or no chance? I expect 08 guidance to be around $4.25 to $4.75 but that could prove optimistic if the markets keep dropping.

not sure why TECH got hit so bad today. Could be the sharp decline in WAT stock -- another life sciences stock. I don't know the specific issues surrounding WAT's drop other than 08 guidance was less than expected. I thought about selling some MDT today to buy some more TECH but decided against it. Its several multiple points higher for similar growth. Then again, MDT has been seeing estimate cuts while TECH has been increasing numbers. probably best to wait for the 50's on TECH.

Friday, January 18, 2008

stimulus plans

Temporary plans are not helpful because they don't change behavior and they don't do what is truly necessary right now: support and increase incomes.

Asset bubbles like we have had (i.e. soaring asset values supported by rising levels of leverage) always end in a deflationary spiral (unless the fed chairman is Alan Greenspan, in which case they just engineer a new asset bubble and push the inevitable issues out further into the future).

So what does that mean -- deflationary spiral? It means that asset prices deflate or decline and as they do they pull everything else down with them. Businesses use asset values (whether we mean financial assets or manufacturing assets or human capital assets) to generate income, which they can use to pay dividends, buyback stock, make acquisitions, pay down debt, etc. Households provide labor for businesses and often own a large asset in the form of a home. Household income and the value of the house supports the mortgage used to purchase the home. As asset values drop -- businesses earn less income and that means layoffs, which means consumers will have lower incomes and have less to spend. Lower income makes debt service more difficult. Falling house prices makes it more likely the household can't service their debts -- either through income or through the value of the home. that increases foreclosures, which pressures asset prices even more. Bottom line is that the dramatic fall off in incomes is one of the main reasons the Great Depression was so bad.

Handing out $250 checks is nice -- and predictable in an election year -- but its a one time thing that has no impact on the economy's ability to generate incomes and service its huge leverage.

hopefully someone will come up with the brilliant idea to lower tax rates -- even more than the bush tax cuts. lower tax rates help sustain and increase incomes.

with the democrats assuming they are coming to power in a big way later this year, probably nothing happens on this front this year.


Quite the decline since October -- from 1550 to around 1330 or so with many many stocks down much further. I remember talking in the summer about the real risk is permanent loss of capital. Yes it would be nice to have gone to cash over the last few months and I know many smart folks that have done that -- one year I will do it too -- once I allow myself to follow my instincts rather than my emotional ties to greed. that can be one expensive deadly sin.

Have I lost any permanent capital in DFR? perhaps but I'm not giving up yet. They still seem to be a viable business to me and one that is very cheap. They are smart fellows and they have a good plan. I have far more faith in the value of their assets than in any of the banks or brokers because their track record is very impressive.

Have I lost permanent capital in any of the other holdings? definitely don't think so -- AB is a high beta stock that goes up AND down faster than the market. As long as they have positive cash flows over time and are able to maintain margins and the global equity markets increase longer term, that stock will outperform significantly. That has been my thesis since I first bought a money management stock in 1990 and its still the case today.

If its not permanent loss, then it can come back. What is permanent loss -- the bond insurers, many of the banks and brokers are either not coming back or they won't for so long it doesn't matter. If 5 years from now Citibank is still between 25 and 35 can you really say its come back? that is a very likely possibility.

I have losses in Asian funds but they are holding up better than some of my stocks -- still lots of money there and since they haven't declined as much there is still a chance to save some before they drop so that I could buy back in -- something I debated doing with the energy fund I have -- so close to raising some cash but just didn't do it.

CME -- that stock has definitely surprised me in terms of the violence of its decline. I think its about solvency -- they are the clearinghouse for their exchange so they take on counterparty risk and in a doomsday scenario that could be significant. There is also the thought that too many financial players will be wiped out and that will lower trading volumes for a long time -- bear markets equal lower volumes. Remember the oppositve of love isn't hate its apathy. Apathetic investors/traders don't trade a lot. To demonstrate just how expensive CME got (and I did mention that on this blog when it hit $700) the stock has dropped over 150 per share and yet the PE is STILL over 27x and that assumes upside to current estimates.

TSRA is beginning to reflec t a positive outcome on their litigation -- I think the move is early but that stock is up over the last few months, while the market is getting crushed. I figure many large investors think they have nothing to lose at this point -- in the last week the stock got to $36 yet post win earnings could be $3 -- not really paying much for that win yet so many probably figure the downside isn't too bad especially relative to other tech, which seems to be dropping like a rock and the upside is huge if they win. stock could easily be in the $50's post win.

scary thoughts -- look at a 10 year chart of the S&P 500 -- sure looks like a double top to me -- think we are headed back to retest the lows? That's around 770 on the index or quite a drop from here. Not many in 2002 thought we could get back to the old highs anytime soon -- most assumed it would take 10-15 years. Instead it took about 4-5 years. But the other analogy is to the 70's -- commodities, war, inflation, bad monetary policy (Greenspan), rising taxes, dollar dropping to dangerous levels, etc. Could we see the same results -- a move back to the lows over the next 2-3 years only to see the old highs again a few years after that? Back in 2000-2002 many said we were heading for 15+ years of flat markets -- so 7 years so far, add 2-3 for a downturn and 4-5 for the next upturn and you get pretty close to 15 years where the S&P 500 fluctuates between 800 and 1600. its possible but who knows -- I'm not betting that way and even if it does pan out there will be plenty of opportunities to make money.

Thursday, January 17, 2008


The stock had a great day wednesday despite the tough market. Not hard to understand why -- lots of financials rallied and given that the insiders (including management and the Dart family) own about 28% of the stock and about 20% is sold short (roughly because I'm not sure if my total share count is right given the merger), the stock can fly at any moment.

So after hours the company issues news and overall its fine but there are some issues. First some writeoffs but really these are just recognizing in the income statement what has mostly been reflected on the balance sheet already -- accounting crap but not a big deal. They sold the pinetree CDO, which is the one with their subprime exposure. Since they had completely written off their exposure to the CDO the sale has no impact -- except they may have been receiving management fees and if they sold that too that's a hit to income.

They sold $1.5 bill in RMBS to improve liquidity. hmmm.... Well let's give them the benefit of the doubt and assume they proactively sold them to boost liquidity (as in better safe than sorry) as opposed to the uglier version, which is that the dealers they are getting their repos from changed the terms and made the deal uneconomical. Near term more liquidity is a good thing, but it does hurt the amount of income the portfolio can generate. On the other hand they are constantly reinvesting cash flows (regular monthly payments of P and I plus pre-payments) and over the last few months the spread between what they pay and what they earn has widened -- i.e. more income per dollar of assets.

I'm hoping these two issues offset eachother to some extent -- I'm also assuming they will reinvest the equity from that RMBS sale at reasonable rates of return sometime soon. Leverage is great isn't it? helps on the upside but makes life a little tricky on the downside.

So dilution from the deal, less leverage, sold the pinetree, etc. -- raises the question of what the dividend will be for the next year. They will likely pay out a higher amount than they earn because they didn't pay everything they earned last year. so let's assume they pay out around $1.60 but only earn $1.40. Even on the earned amount that is still almost a 20% yield. With that high a yield plus a 30-40% discount to book value plus the potential to grow the dividend over time (alternative assets, higher money management fees, etc)? that's a great deal in my book.

Some probably wonder why the stock is so cheap -- simple -- too many investors doubt their ability to survive. To them the dividend yield is meaningless. How could that happen? Well for the month of August and September the concern was liquidity but since then everyone has learned the real issue: solvency. Who will remain solvent. Obviously Countrywide wasn't going to remain solvent for long -- that's why they sold out to B of A.

Deerfield uses a lot of leverage, which minimizes the amount of price declines the assets have to suffer before the collateral (equity) is used up. The part I am not sure about is all the different pieces of DFR -- I would think even in a worst case scenario some parts might come into trouble but other parts would survive or be able to bail out the rest. The management company to me is the main savior -- other than the sellers note there is no debt. I would argue that the management company accounts for a significant part of the value of the total company right now.

The key assumption is the accuracy of the asset values used to calculate the book value estimate of 11-12 dollars. how solid are those numbers? right now in fixed income, not much outside of US treasuries are truly solid. One other point DFR made was to say that starting Jan 1 2008 they will be doing fair market value pricing as part of their accounting -- not sure what that means but hopefully they have been doing something close to that already. I have a lot of faith in the deerfield people -- they have an amazing ability to analyze credit risks based on their results during the last credit cycle bust in the 2000-2002 time period. They have a good structure and a great plan. I believe they will get through these issues and thrive in the future.

Oh, if mortgages fall enough in price to endanger DFR, perhaps we should all be shorting all the banks and maybe FNM and FRE too.

Tuesday, January 15, 2008

market thoughts

Fun days in the market huh? ouch. Good news is that the portfolio outperformed today by about 40bps -- bad news is that I still lost over 2% of my money today.

People are looking for an intermeeting fed funds cut but does it really matter other than for confidence whether the cut comes today or at the regular meeting in 2 weeks? How can you argue it matters when fed rate cuts have an 18 month lag to their full impact? This is the problem the fed forgets -- the last rate increase is still impacting the economy, while the first few rate cuts have only had a minimal impact so far.

Remember the rule -- rate cuts can't save whatever part of the economy that is in trouble but it can help other parts. So what does that mean? financials are going to suck for some time and the lack of credit availability will likely impact consumer spending (see retail and restaurant results). But tech spending might hold up better than other areas -- say the need for network capacity or new consumer gadgets, etc. IBM has great results as an anecdote for this thought.

But Intel lowered Q1 guidance for revenues, which is not good and runs against this theory.

Flir won a $17 mill defense order -- this is a good time to have the US Government cover half your revenues.

A few days ago I discussed the whole depression question and argued folks were getting too bearish. Still think that even after today -- the issues are being dealt with. That's what the bears never count on -- they assume there is nothing positive that can occur and then B of A buys countrywide and Citi and Merrill raise billions in new equity from foreign investors. Did citi hold back on some of their losses? probably but its not like all the tech issues came out at once in 2000/2001 either. There are ripple effects -- in 2000 first the dot coms busted in march 2000 and then the telecom services companies couldn't borrow anymore money and then the telecom equipment stocks missed and then the storage stocks missed -- in mid 2001. Somewhere after that Enron collapsed. So earlier this year a hedge fund blows up and then the subprime moves to the rest of the mortgage market. First liquidity was the issue and now we realize its solvency is the real issue -- which financial institutions are solvent and which are technically insolvent or bankrupt.

I believe financial stocks have further to fall before the ultimate bottom but that doesn't mean we can't take a break for awhile. Nothing declines in a straight line. This is why I'm waiting on the Moody's -- figure there is a good chance I'll be able to buy some in the 20's later this year.

Monday, January 14, 2008


The portfolio got a boost from ILMN on Thursday but then gave it back on Friday with AB.

Illumina was being held back by litigation with Affymetrix over various patents that Affymetrix said Illumina violated. They were about to start phase II of their trial when last Thursday they settled all litigation for a lump sum payment of just $90 mill. EVERYONE had assumed Illumina was going to have to pay on going royalties of close to 10% of sales. This was a huge victory for ILMN and that is why the stock popped around 15% higher. They have strong positions in the 3 main areas of genetic analysis with the key being their market leading share of next generation sequencing. ILMN appears to be an expensive stock -- I would peg them as being around 35 to 40 times 08 estimated free cash flow. The growth rate is also big -- probably in the 25-30% range for the next several years. I would probably wait on a pullback before buying now -- my original shares were bought at $32 with more bought at $56.

AB lowered Q4 numbers by 30 cents after hours on Thursday. The biggest issue is that their hedge funds are no longer earning any performance fees for 2007. The unknown at this point is how bad their results are -- how high are the high watermarks for those funds vs. current values (have to regain the lost value to reach a new high watermark before eligible to earn performance fees again). If the high watermarks are much higher than current values, then we need to assume no performance fees for 2008 and maybe beyond. This is a minor negative -- can't assume they are going to outperform all the time. it does impact asset growth and performance fees but just on one part of the business. Stock has a high yield, great management, lots of resources and plenty of opportunities on the global front.

I haved owned AB since 2001 through a lot of bad times and good times -- no reason to sell now.

Wednesday, January 9, 2008

more on last night plus some thoughts on TSRA and CME

As I had some more time to think about my dinner last night -- you know the one where I learned the next depression is starting any moment -- I realized that as David Tice presented his case of doom and gloom, no one really challenged him. None of the questions really argued with his positions -- no push back. That either means the audience was just there for the free meal (Hello!) or they agreed enough with Tice not to argue with him. probably a mixture of both. Amazing that he could be that bearish and no one choose to argue with him.

sure seems like we are at a near term pause in the decline as investors have gotten too bearish.

Spoke to a friend tonight and they reminded me that the charts of all the financial stocks are not buyable yet -- downtrends galore. That would include my newly beloved Moody's but I am hopeful the eventual bottom isn't too far from here.

TSRA -- listened to a conference presentation and the Q&A session posted on the website. Fascinating stuff -- they are very confident they will win the trials coming up, which will have a huge positive impact on their royalties. A few key points:

65 of 70 licensees signed up to pay for the technology without TSRA having to litigate.

only litigated the same handful of patents because they were proven but they do a bundled deal for 1100 patents -- most sign 5-7 year deals including MU despite the fact that some of the patents used in the litigation will expire in a few years. They plan on expanding the patents they use to get more visibility towards ones that don't expire in the next couple of years to help investors realize their royalties won't end in a few years.

spent over 10 years and 100 mill developing their CSP packaging technology and then the last 7 years setting up licensing deals for it.

wireless and DRAM have the same revenue potential but their share of DRAM is 2X wireless. If they win all their trials in the next few months, likely to see wireless share more than double. Cowen estimates $3 in earnings power post win -- that is fully taxed I believe. If they win, expect the stock to pop -- it could very easily move towards $50. Since litigation is risky, many are waiting until post win to buy. Plus there is no telling what the economics will be -- can they get good pricing or will these companies string this process out by appealing decisions,etc. This could be wrapped up in a few months or appeals could drag it out for another year plus.

They also were very confident in their optics business reaching the $100 mill in 2010 revenues -- in fact they believe that estimate is low. TSRA also talked about adding another leg of growth -- looking for new tech areas that they can build into $100 mill revenue opportunities in the next 5-7 years. They consider themselves to be an infrastructure company similar to MSFT, CSCO, ORCL, QCOM, etc. Its a great opportunity in the sense of more predictable growth with great margins and cash flows.

CME -- why has the stock dropped over $100 in the last few weeks? because in the waning days of december 2007, the WSJ talked about a consortium of brokers starting a competing exchange. Everyone dismissed it until Credit Suisse put out a note saying that they had done a lot of due dilligence talking to futures traders at brokers and hedge funds and come away with the impression this is a more serious threat than many believe. All the other analysts who follow the stock have generally made theoretical arguments that the new competition won't be very successful but none of them actually talked to anyone involved. The CS report argues the partners in the new exchange represent as much as 40% of the volume in treasury futures -- that's a huge volume number that has the potential to provide reasonable liquidity.

Still despite CS's comments, I am skeptical that anything comes of this -- consortiums are impossible to keep together and building exchanges is very difficult especially against CME, which is generally regarded as having the most innovative management teams of all the exchanges.

Volume trends also remain good too. still like the stock -- chance to buy in much cheaper than expected. still figure on $20 in 08 earnings.

Wow -- there are some bearish people out there!

Can't help but think that sentiment is getting a little bearish right now -- anecdotes only so I could obviously be guilty of sampling error but here are some thoughts:

Have you read any of cramers thoughts lately? talking a lot about bankruptcies and not much else. only positive on a handful of stocks. Went to a dinner tonight with a few hundred colleagues that had a panel discussion including David Tice -- he runs the prudent bear funds (mostly short selling but also buying precious metals) and boy was he bearish. But I expected that -- the surprise was the rest of the panel was bearish and so were several audience members who I spoke with afterward.

One guy starts talking about how similar we are to Japan and that unlike them we don't have the manufacturing base because we outsourced it and then someone else pipes in that Japan also had savings so their debt was all owed to themselves whereas we owe foreigners. I compared this situation to 1990 (S & L crisis) where Citibank almost failed while Bank of New England and many others did fail and asked where are all the failures now -- have they just not happened yet or will this situation turn out better? Most said this was much worse and that we will see more losses and failures, etc.

Tice talked about the Austrian Credit Cycle -- every credit induced boom is followed by an equal sized bust -- since we have been booming from the early 90's (first tech stocks then housing) the bust could be pretty huge. he showed many pretty charts about the growth in debt and how unsustainable debt has become. As a percentage of GDP, debt is a huge number -- bigger than ever before including in 1929. His key point was that our economy has become addicted to debt to the point where there would be no economic growth without growth in debt. If we have a credit crunch where credit shrinks, we will have to have a recession.

Other issues mentioned include asset inflation meaning that the Fed has kept rates over the last decade or two lower than they should have been. They were able to do this because the CPI was tame and because the Fed didn't notice that their loose money was causing asset prices to soar. The problem comes when everyone borrows against those higher asset prices -- at some point the system reaches a peak in asset values and just won't support anymore debt. At that point the asset values drop and all of a sudden assets are worth less than the debt owed (housing/mortgages). That leads to massive losses as the asset holders are wiped out, while the lenders are left with huge loan losses because the collateral isn't able to cover the debt owed.

This leads to a deflationary spiral where homeowners/businesses are wiped out because their assets have declined and can no longer support their debt which causes their lender to foreclose and sell which pressures other home values which forces other homeowners to be under water which leads to more foreclosures and further pressure on home prices, etc.

The Austrians definitely are the best economists because they don't just look at GDP -- they care about balance sheet items -- quick question: which matters more the $12+ trillion in GDP or the $140+ trillion in assets in the US? obviously the assets matter more.

That said, I don't agree with all the bearishness. Cramer highlighted EAT today -- great company with a solid plan to raise returns on capital and free cash flow -- stock is down almost 50% in the last few months. Yet he won't tell you to buy it because he can't predict how much further it will drop (they were down 10% today on falling estimates). If you have confidence in the future cash flow and growth for EAT then now is the time to step up. I don't think I have any particular edge in this one. Also, YUM has been a much better stock -- it hasn't declined sharply though so its probably not as good going forward.

The analogy with Japan stops with we both have had asset inflation with strong growth in debt that has ended. Our economy is more flexible, more balanced and has more inherent strength than Japan.

I find Tice's use of debt as a percentage of GDP a little self serving -- I just said that assets matter more than GDP -- exactly what Austrians think and yet Tice uses this GDP based stat to help his case.

He argues that structured products are done -- no one trusts them and too many have lost too much to want to buy more of them. I think structured products will make a come back because the product makes too much sense -- there needs to be some adjustments but not an elimination.

I also wonder about this growth in debt issue in that it all started in the early 80's -- right about the time when Reagan was lowering taxes and deregulating (especially financial services). Lots of financial innovation since the early 80's so obviously not all the growth in debt has been bad.

Anyway. sold the last of my GGG today and bought some more MCO. Still a small position but it had dropped about 10% from my first buy so it was time to put some more money to work.

Tuesday, January 8, 2008

how bad is it going to get?

Are we headed for a depression? I assume not but we are dealing with asset deflation in the residential housing market -- very large numbers -- trillions at stake but several trillions are borrowed against that declining asset value and that is the potential problem. A deflationary spiral occurred in the 1930's thanks to the huge build up of capacity in the 1920's plus the big growth in debt -- with all the new toys that were being sold came new installment payment plans to help folks pay for them. Not to mention those that had borrowed to buy stocks or the businesses that had borrowed to buy other companies or build new capacity, etc.

The problem is debt service -- can you generate the income necessary to make your debt payments, when that debt is tied to a deflating asset? Why would you make the payments when your house is so far under water (debt worth more than house) that your hopes of having any equity are a huge long shot?

In the 1930's incomes dropped but the debt didn't -- that made it hard for folks to pay their debts -- once they can't they lose everything. the banks look to sell those assets but there's too much supply of basically the same things so they are worth a fraction of their peak value. The process works like a snowball getting bigger and bigger as more folks are brought under. Keys to surviving this environment -- no debt. Unfortunately, I have a mortgage and a home equity line of credit.

Last time I was worried about an asset deflation was in 2001 when the tech stock bubble was bursting. Lots of money lost then but housing has the potential to make the tech stock losses look puny. The Fed's aggressive rate cuts helped bail the economy out of that asset deflation by getting the housing market going pretty strong. that card has been played already -- not sure what is up the Fed's sleeve anymore but my hope has been that international strength plus good employment would be enough to keep the economy growing -- slowly but still growing. Part of the theory is that the housing problem would be a long term drag on the economy -- say several years but it might not be any worse of a drag that it currently is. its a theory. honestly don't know -- that's why I am focused on finding the right secular stories.

BTW, the WSJ has a good editorial monday about corporate tax rates -- the US has some of the highest tax rates -- Europe is being forced into cutting rates due to the strength of Ireland and eastern europe -- both low tax areas. Combined with the low taxes in Asia and our housing issues -- it means more risk to US underperformance. This year could be an outlier year due to current expectations but over time the US will underperform unless we start cutting taxes.

not likely.

160bps ahead already? is the year over yet?

Well just a few days into the new year and already the portfolio is about 160bps ahead of the S&P 500 -- of course since the index is down this just means I've lost less money than the index.

I had the chance to buy some MCO if I acted quickly this morning near $33 and change but I hesitated and the stock popped a dollar. Cramer's comments that everywhere he goes people ask him about bottom fishing in the financials got me scared. Lots of money has been lost by smart folks buying financial stocks too early -- warburg pincus with MBIA; Davis advisors with MBIA; B of A buying that Countrywide convert; some billionaire that has lost $250 mill buying 10% of BSC at over $100 per share; etc. Cramer himself argues not to buy financials until we see a lot more dividend cuts and bankruptcies.

On the other hand why I should have bought -- how many people do you see or hear talking about buying MCO or MHP? Many talk about the banks or the brokers or the bond insurers but how many talk about the rating agencies -- Barron's slammed them a couple of issues ago and talked about the conflicts of interest and how the business model needs to change, etc. David Merkel (see the links section for the Aleph blog) did a great response to the Barron's article on his blog if you are interested.

I was hopeful that I would get another chance at paying under $34 but I could be pushing it. If Cramer and many others are right that we are headed for recession then I shouldn't have any trouble paying under $30. Right now I'm still nibbling -- buying a little bit at a time and trying to buy only after its dropped since my last purchase. Keep in mind that they haven't reported since October -- fixed income has gotten worse since then (stock has dropped too) so the question is how much will estimates drop post report and how much of that is expected in the stock already.

Tony C., an economist who writes for, pointed out that bank lending is growing -- partly due to banks bringing SIV assets on their balance sheet skewing the reported numbers but he also said C&I loans were up 30+% real estate was up too -- probably banks taking back some share from the capital markets due to less securitization and bond issuance. That's the near term risk -- slower growth in rated debt. I think this is known -- its driven by investors choking on too many securities and the market's drive to take less risk. This should be a temporary issue -- next year or two at most (presuming we miss the coming depression) because investors are too greedy not to take risks again in fixed income securities.

As we head toward $30, risk in buying MCO should be dropping.

Thursday, January 3, 2008

2007 results and thinking about 2008

Should have mentioned this in my happy new year post but forgot -- for 2007, the secular value investor's portfolio was up approximately 14.6% or about 900bps ahead of the S&P 500 (not the most appropriate index given my large Asian holdings or my large weght in small cap stocks but its the main measure of the "market").

How did I do so well? Easy -- lots of Asia, lots of energy, lots of tech that went up. Can I repeat in 2008? possible -- and on the first day the portfolio outperformed by about 56 bps -- but the likelihood of another huge outperformance year is slim in my mind. I'm still worth listening to though because you might take my ideas and do even better.

Why slim? Asia is unlikely to outperform again in my mind for the 6th or 7th year in a row. Expectations in Asia are high but they are low in the US -- investors have moved their money accordingly and that sets many up for disappointment. I should take some profits there -- the question is one of timing and having the guts to do it. For me, Asia is a long term bet based on their relatively free market approach to the economy and huge populations that have lots of opportunity to increase productivity.

With Asia around 1/4 of my assets, how that region does is a big deal for this portfolio.

Energy in my mind will continue to do well although I wouldn't be surprised if we saw some "volatility" this year as investors sort through economic issues. Slowing economic growth will hurt the price of oil but how much of that is already factored in the stock prices is a hard question.

My stock picks -- who cares about the overall market and the overall economy -- if my companies do well then the stocks will too. That is the advantage of buying individual stocks -- the disadvantage is that if you are wrong you are very likely to lag the overall market by considerable amounts. This is why selection is so important. You need to really know the situations and have confidence that you are right -- that allows you to withstand the volatility and even take advantage of it.

Just a reminder, my philosophy is based on the precept that investors often underestimate secular growth stocks and that an investor can outperform by owning a portfolio of secular growers. The key is selecting the right trend to follow and picking the right stock to play the trend and getting in at a valuation that suggests investors haven't already fully discovered the story. The right trend is one that will afford above average growth for years to come. The right stock is one that has a very high probability of benefiting from the trend in an above average way from an economics standpoint. The best valuation is after the stock has taken a dip or a pause for reasons that are temporary. ILMN and NVT from this last year are quintessential examples. FLIR in mid 2006 would be another one. Is MCO one now? potentially although its early in that story.

FLIR -- I have the utmost confidence in the long term secular story as I have been saying over several notes but I have not been aggressive in buying the stock because of the valuation. I wouldn't be surprised if at some point investors become a little more concerned about the future story -- this could drive the valuation down to 20x instead of 30x now. At that point I will endeavor to pounce and really build up the position. It won't be easy to buy in the face of a decline like that but unless I see clues that suggest the companies franchise is in trouble, I will buy more.

hope you do well in 2008 and thanks so much for reading -- if you would like me to cover particular issues or stocks or make changes to the site -- please either email me or make a comment. If you enjoy the blog, please feel free to mention it to others.

thank you and good luck in 2008!

Tuesday, January 1, 2008

Happy New Year!

Thought I would take some time to talk about a secular trend that has strong growth but is difficult to find good stocks to play.

Carbon Fiber -- this is a new material that is stronger and lighter weight than steel or aluminum so it is taking over airplane frames and other uses throughout industry. The growth is very predictable and very long term but on the other hand -- not particularly profitable. Issues -- a. capital spending equal to 33-50% of sales -- wow. b. operating margins only around 10%, which are ok but not great. c. free cash flow isn't that great because of the huge cap ex requirements. d. one reason the margins aren't that great -- what is the barrier to entry? what is the competitive advantage for firms -- how do they differentiate themselves enough to get firms to pick them over other suppliers despite charging premium prices? e. too few customers -- there are only 2 buyers for airframes -- Boeing and Airbus -- so they can squeeze suppliers hard because they have pretty concentrated market share. ie. don't like the prices I want to pay? fine, sell to someone else. oh, there isn't anyone else? sorry.

The key is to see the difference between this situation and FLIR -- which has cap ex to sales of around 5-6% and operating margins in the mid 20's. FLIR also has revenue growth that is as fast or faster than the carbon fiber companies. FLIR also has a more diversified customer base -- 50% of carbon fiber is to aerospace. That diversified customer base allows FLIR to have some pricing power -- that and their ability to use brand name, technical specs and distribution to differentitate themselves.