Wednesday, December 31, 2008

The Haiku of Finance for 12/31/08

More TARP foolishness
Let's bail out suppliers too
Head to the junkyard

TARP Covers Car Parts Too!

Throwing a TARP over GMAC wasn't enough. Even auto suppliers are now going to be bailed out:

The U.S. Treasury drafted broad guidelines for aid to the auto industry that would let officials provide funds to any company they deem important to making or financing cars.

Taking this to its logical conclusion, the TARP will need to cover the beginning of the auto aupply chain: steel mills, rubber processors, mining companies, etc.

The TARP will need to get as big as a circus tent to cover all of these bailed out companies. Next I expect junkyards (like the one depicted in the photo) to become eligible for bailouts. Gotta save those non-running clunkers (not)!

Nota bene: Anthony J. Alfidi does not hold a position in any automotive parts supplier.

Tuesday, December 30, 2008

The Haiku of Finance for 12/30/08

Consumer index
Drops to record low levels
Who wants to spend now?

Worser and Worser

The Conference Board has found that consumers are more parsimonious then ever:

The Consumer Confidence Index measured by the Conference Board, a private research group, fell to 38 in December from a revised 44.7 in November. That is its lowest point since the group began compiling the index in 1967, and below the previous low of 38.8 in October. Economists surveyed by Thomson Reuters had expected the index to rise incrementally to 45.

This is no surprise when you consider how home prices keep dropping:

Home prices posted another record decline in October, falling 18% compared with a year earlier, according to a closely watched report released Tuesday.

The 20-city S&P Case-Shiller index has posted losses for a staggering 27 months in a row. In October, 14 of the 20 cities set fresh price decline records.

The U.S. economy is getting worser and worser.

My wild guess that the S&P 500 will drop to 500 sometime in 2009 is looking better and better. Today's jump of 2.4% means nothing to me. I'm staying short SPY.

Nota bene: Anthony J. Alfidi holds uncovered short calls on SPY.

Monday, December 29, 2008

The Haiku of Finance for 12/29/08

Wachovia sold
Wells Fargo's wagon drove off
Left me my options

Special Situation Updates on CEG, ROH, and RSG

Constellation Energy is in the doldrums thanks to its breakup fee to Berkshire Hathaway's MidAmerican Energy:

EDF estimated that terminating the agreement with MidAmerican would end up costing $2.4 billion in liquidity -- a figure that implies more than a 100% return on Buffett's initial investment over a 16-month holding period. That's a very profitable failed bid, particularly if one considers that Buffett puts together deals very quickly, without resorting to outside advisors.

My uncovered CEG short calls at 35 are thankfully far out of the money. Rohm and Haas sank today because Dow Chemical's ability to pull off its buyout unassisted is now in doubt:

The Kuwaiti decision deprived the U.S. group of about $9 billion in planned financing which it would have used for the Rohm deal, but unidentified people close to the situation told the FT that Dow could still tap a $13 billion bridge loan to pay for the takeover.

The sources also said Dow was likely to try to renegotiate the price of the deal to reflect the recent drop in Rohm's share price, the newspaper said, adding that both Dow and Rohm declined to comment.

I predicted in my post yesterday that Dow's share price would drop today, so it's nice to be vindicated. Rohm and Haas fell without the certainty of the deal to prop its share price, so my uncovered calls are much safer. I just wish Republic Services would drop some more:

The deal combined Republic, the nation's No. 3 solid waste hauler, with No. 2 Allied to form a mightier No. 2. The newly formed Republic Services boasts a roughly 17% share of the U.S. solid waste management market vs. 24% for top player Waste Management WMI, figures Standard & Poor's analyst Stewart Scharf.

I had sold short some calls on Allied Waste after its acquisition by Republic Services had been announced. One wrinkle that I hadn't anticipated was that, in a stock merger, the options of the target company (AW) would convert to those of the acquirer (RSG) at the same strike price. D'oh! Right now I'm hanging onto some very long-dated short options of RSG in the hopes that the share price will drop, and these options are very much in the money. Wost-case scenario: I'll have to buy them back later in 2009 after their premiums have decayed.

I may soon face a similar scenario with my uncovered short calls on Wachovia (WB) if they convert to Wells Fargo (WFC). Double d'oh! From now on, I'll probably stick to all cash buyouts in my special situations plays to avoid these option conversion problems. It also wouldn't kill me to consider short calls on the acquirer from time to time.

Nota bene: Anthony J. Alfidi is short calls on CEG, ROH, RSG, and WB at the time this commentary was published. He has no positions in DOW or WFC at this time.

Sunday, December 28, 2008

The Limerick of Finance for 12/28/08

Persons wise in financial matters
Whose records are now left in tatters
Formerly they were keen
It remains to be seen
If they are mere fools and mad hatters

The Haiku of Finance for 12/28/08

Acquisition debt
Use too much, it sinks the deal
Try cash flow instead

Kuwaiti Sheiks Jeopardize Dow's Rohm and Haas Buyout

The Emirate of Kuwait has decided that a business deal to make plastic is too rich for its blood:

Kuwait scrapped a deal to buy a 50 percent stake in Dow Chemical Co.’s plastics-making unit, depriving Dow of $9 billion it planned to put toward the acquisition of Rohm & Haas Co.

Dow still gets a $2B breakup fee from Kuwait's Petrochemical Industries Co., but it now has to seek nearly the full value of the $13B bridge loan to buy Rohm & Haas (ROH). That is a very questionable proposition given the credit market's logjam.

A few months ago I sold short April 09 calls on Rohm & Haas at 80 based on the proposed acquisition price of 78. This latest announcement makes my bet very safe, as it will take some heavy lifting from Dow to make good on that price now. Dow's stock should open down tomorrow since it still appears committed to this transaction by taking on a huge debt load. If Dow abandons this deal at some point, its share price should pop as shareholders breathe a sigh of relief.

Nota bene: Anthony J. Alfidi is short uncovered calls of ROH at the time this commentary was published.

Saturday, December 27, 2008

The Haiku of Finance for 12/27/08

Bond market repo
Burst bubble means bond fire sale
Buy bonds for a song

Discounted Repurchases: Coming Soon to a Bond Market Near You

Sovereign debt defaults do happen, especially in economies south of the border that elect not to pursue quantitative easing:

Ecuadorean President Rafael Correa wants debt negotiations triggered by the South American country’s second bond default in a decade to proceed in January.

“We will make a proposal to rebuy these bonds, many of which have already given great yields to these speculators,” Correa said. “It’s likely that those who hold the bonds now didn’t buy them at 100 -- rather at 20, 30, or 40 -- so it’s not like these people are being hurt.”

IMHO it's safe to say that the U.S. Treasury is watching this process with interest. When the bond bubble in U.S. Treasuries finally bursts, Uncle Sam will be faced with the very attractive opportunity to retire a good portion of his debt by buying back bonds that have fallen in value. The Fed has already demonstrated its willingness to finance Treasury bond purchases by TALF-ing new money into existence.

The beauty of repurchasing debt at a discount is that it sidesteps any need to raise interest rates to attract new buyers to government debt. Bondholders will be crying for someone to take bonds off of their hands even at a loss.

Debt retirement at rock-bottom prices. Voila! Problem solved? Not quite. One of my finance professors in graduate school used to say, "There are no solutions, only changed problems." The next problem will be figuring out how to grow the economy after fixed-income investors have seen the lion's share of their bond holdings wiped out.

Friday, December 26, 2008

The Haiku of Finance for 12/26/08

Treasury bubble
Bound to pop any day now
Always good for gold

Go Gold!

Gold did okay this week:

Gold futures for February delivery climbed $23.20, or 2.7 percent, to $871.20 an ounce on the Comex division of the New York Mercantile Exchange, the biggest gain for a most-active contract since Dec. 17. The metal is up 6.4 percent this month.

The article cites military tensions as the impetus for gold's rise, which is probably baloney. At any given time there's plenty of military action in the world, and gold doesn't always respond to that. What does make it jump is the kind of inflationary quant easing we've seen from the Fed this year. Gold will look even better when retail investors start to get spooked by any sign that the bubble in Treasuries is collapsing, like this one:

Treasuries posted their first weekly loss in almost two months as the U.S. sold record amounts of two- and five-year notes during a holiday week marked by lighter trading than usual.

The only thing standing between me and economic annihilation is my pile of gold. Gold, gold, gold. I love gold. It's the greatest thing since sliced bread.

Nota bene: Anthony J. Alfidi is long IAU and GDX.

Thursday, December 25, 2008

Wednesday, December 24, 2008

Sustaining the Market's Unrealistic Expectations

One axiom of financial market analysis is that securities prices are forward-looking; that is, today's stock prices reflect the expected value of tomorrow's earnings. This indicates that broad market indexes should be tanking if corporate earnings are expected to decline further:

Earnings for Standard and Poor's 500 .SPX companies are now forecast to decline in the final three months of 2008 by 0.6 percent from a year earlier, according to Wednesday's Thomson Reuters Director's Report, a daily analysis of earnings trends for the companies comprising the benchmark U.S. equity index.

The earnings estimates keep getting revised downward, yet the S&P stubbornly refuses to close below 8000 (except briefly on Nov. 20). What is sustaining this market's optimism if poor earnings are not fully reflected in securities prices? Let's consider some possible factors.

Hedge fund withdrawal suspensions. Hedge funds and their fund-of-fund gatekeepers continue to prevent their constituent investors from withdrawing money. This reduces pressure on the funds to sell their equity holdings to meet cash redemption demands.

Fiscal stimulus plans. The potential for massive Federal infrastructure spending in 2009 gives hope to equity investors. Unfortunately, federal contract awards have long lead times; government agencies have to plan projects and publicize RFPs, contractors have to submit bids, etc. The spending itself may not lift corporate earnings until Q409 or later given these lags.

Fed quantitative easing. Here's where things get interesting. The Fed has accepted assets of questionable quality onto its balance sheet as collateral for loans to banks under the Term Asset-Backed Securities Loan Facility (TALF) and other programs. These loans have temporarily revitalized the credit markets and given a reprieve to banks' stressed balance sheets. Without Chairman Bernanke's helicopters in the air dropping TALF money, many businesses would be starved for short-term credit.

Remove any one of these props and the market loses valuation support. The financial class is hoping for a long, slow unwind that leads to a soft landing for equities in 2009. This outcome retains public confidence in our governing institutions and minimizes social disruption. We can only hope.

Nota bene: Anthony J. Alfidi is short uncovered calls on SPY at the time this commentary was published.

The Haiku of Finance for 12/24/08

Converting GMAC
Car loans now funded by TARP
Drive out of business

GMAC Says You Can Take This to the Bank

Christmas came on time for Cerberus Capital! They got their wish as the Fed magically turned GMAC from a failed investment into a bank:

The Federal Reserve approved GMAC Financial Services' request to become a bank holding company, allowing it to apply for a portion of the $700 billion bailout fund and get emergency loans directly from the Fed.

TARP is just about empty now that its last $15B or so has been given to automakers, so the next Treasury secretary will have the ignominious duty of asking for the next $350B appropriation.

Never underestimate the power of private equity investors to get what they want even when they're on the ropes. They are the new Masters of the Universe.

Tuesday, December 23, 2008

The Haiku of Finance for 12/23/08

Grim data coming
More lost jobs, spending slows down
Just don't slit your wrists

Grim Data, Grim Reaper

Several reports due Wednesday are expected to provide more evidence that consumers are cutting back on spending and companies are eliminating jobs in the face of a deepening recession.

Job, spending, and GDP data are supposedly going to be worse than expected. This means that the picture for those of us who are shorting the markets will get brighter! Yay! What a wonderful Christmas present for me after last month's option misfires. Too bad this French guy didn't wait around to hear the news:

He was a distinguished investor who traced his lineage to the French aristocracy, hobnobbed with members of European high society and sailed around the world on fancy yachts.

But after losing more than $1 billion of his clients' money to Bernard Madoff, Rene-Thierry Magon de la Villehuchet had enough. He locked the door of his Madison Avenue office and apparently swallowed sleeping pills and slashed his wrists with a box cutter, police said.

He would have had a lot less to worry about if he'd been short. Conspiracists will doubtless scour the story for any Masonic imagery appearing at the crime scene. Even people who come from very old money have lost mountains of it in this market.

Monday, December 22, 2008

The Haiku of Finance for 12/22/08

Bankrupt real estate
Landlords going down the tubes
Less rent means defaults

Commercial Real Estate's Rotting Foundations

Here we go again! Yet another industry wants the government to guarantee its viability:

A group of trade associations representing the U.S. commercial real estate industry is lobbying to be included in the Federal Reserve's $200 billion asset-backed bailout plan in order to head off a wave of foreclosures over the next few years.

We can expect the hue and cry from commercial real estate companies to grow louder in Q109 as their rental income declines:

U.S. commercial properties at risk of default could triple if rental income on apartments, offices and retail buildings drops even five percent, according to New York-based real estate analysts at Reis Inc.

Is it worth it to play this by shorting insurers and REITs with commercial loan exposure? For me that answer is no, only because real estate isn't a specialty of mine. Investors with experience in evaluating commercial properties might find some worthwhile short candidates.

Sunday, December 21, 2008

The Haiku of Finance for 12/21/08

Private jet bailout
Need planes for a quick escape
Fly away with cash

Your TARP Money Stolen and Wasted

Executives at bailed-out financial firms still collected monstrously large compensation for doing a poor job:

Benefits included cash bonuses, stock options, personal use of company jets and chauffeurs, home security, country club memberships and professional money management, the AP review of federal securities documents found.

In other words, these self-made captains of industry need their every whim indulged in order to function at a minimal level of effectiveness. Meanwhile, yours truly, also a CEO mind you, makes do with none of the above. There may be a correlation between the size of a bank's balance sheet and the size of its aircraft fleet:

Six financial firms that received billions in bailout dollars still own and operate fleets of jets to carry executives to company events and sometimes personal trips, according to an Associated Press review.

In other words, the banks with the most toxic assets need the most jets to move all that garbage around. I don't need a private jet because I don't own any garbage mortgage pools that I need to airdrop into the TARP's gaping maw.

No way should TARP get another penny.

Saturday, December 20, 2008

Friday, December 19, 2008

The Haiku of Finance for 12/19/08

Smiling, lying guy
Trusted by rich investors
"Made off" with their cash

(inspired by Bernard Madoff)

China Still a Good Bet?

In a month when several of my option trades garnered me a small loss, it's perfectly appropriate to reassess the Alpha-D portfolio's allocation. My loyal readers know that I've been bullish on China. Skeptics of China's continued growth are weighing in with analysis:

China should cut taxes, do more to boost incomes, and follow Japan and Taiwan in handing out shopping coupons, economists at Merrill Lynch, China International Capital Corp. and Barclays Capital said. Announcing a package of measures could help to revive confidence as a slowdown deepens in the world's fourth- biggest economy.

It's always okay to look for countertrends that question a strategy. I'm still bullish on China, so its potential weakness in the near term won't bother me much. If anything it will give me a chance to add to my stake in FXI if I choose, unless ETFs for the U.S. markets hit rock-bottom prices.

Nota bene: Anthony J. Alfidi will remain long FXI (with covered calls) for the foreseeable future.

Thursday, December 18, 2008

The Haiku of Finance for 12/18/08

Closing out short calls
Cash went to money heaven
Be careful next time

Closing Out More Dec. 08 Shorts at Losses

I enjoy playing with fire, so I expect to get burned once in a while. Today I noticed that the market price of IWM exceeded the strike price of the short call I had sold at 48, so I decided to buy it back at a loss. I also bought back a short EFA call, although its market price hasn't quite reached the strike price of 46. I'm still holding my short call on SPY at 94 in the expectation that it will expire worthless tomorrow.

Here's a thought. IWM (U.S. small caps) and VWO (emerging markets) are clearly more volatile than their big cap friends EFA and SPY. In the future I'll try restricting my uncovered options on IWM and VWO to those that are at least 20% out of the money. I had only been going out to 15% up to this month, and in a market this volatile that was probably going to get me in trouble.

This was not a good month for most of the Alpha-D portfolio's uncovered calls.

Wednesday, December 17, 2008

The Haiku of Finance for 12/17/08

Oil down for the count
Pumping cut fails to pump price
Peak Oil is delayed

Oil Going Down the Tubes, Along With World's Economy

Earlier this month I had mused about whether an OPEC production cut would be a worthwhile investment play. Cut they have, and play it is not:

Oil fell below $40 a barrel for the first time in more than four years as OPEC failed to convince traders that the glut in crude will diminish and the U.S. government said supplies climbed for the 11th time in 12 weeks.

Previous production cuts have ususally led to predictable jumps in the price of oil. The failure of prices to climb this time suggests something deeper is amiss. I posted my typical pithy commentary on Clusterstock today:

If a cut of this magnitude can't provide support to oil prices, then demand destruction must be extremely severe. OPEC tried to shift the supply curve to the left by inducing a supply shock. The problem is that the aggregate demand curve has also shifted leftward.

These two big curves slamming to the left don't necessarily mean the equilibirum price in the market today will be supported. If the demand curve is shifting faster than the supply curve, the market price will keep falling even at much lower levels of available global supply. If oil is going a lot farther south because of Great Depression 2.0, then no way am I prepared to guess at a floor price. I'll take a second look in about six months.

Tuesday, December 16, 2008

The Haiku of Finance for 12/16/08

More Fed quant easing
Shifts demand rightward for bonds
Leaves my gold shiny

Fed Announces ZIRP, Gold Responds

The Federal Reserve has finally launched the first of its inflationary weapons of mass destruction:

The Federal Reserve cut the main U.S. interest rate to as low as zero for the first time and shifted its focus to the amount and type of debt it buys, seeking to revive credit and end the longest slump in a quarter-century.

Meanwhile, equity markets went insane by rallying. Investors in the DJIA, S+P 500, and emerging markets all went nuts with greed (and yes, unwinding my uncovered calls on VWO cost me more than I anticipated). The only rational response was from the price of gold, which rallied in response to the Fed's slow-motion dollar devaluation.

Treasuries are about to enter an economic Twilight Zone. When interest rates go to zero, bond prices shouldn't go any higher. That's mathematically impossible based on the fundamentals of duration, but remains financially possible because the fearfulness of bond investors shifts the aggregate demand curve for T-bonds rightward. This implies that the Fed's quant easing strategy can now support a much higher volume of Treasury issuance, and the market clearing price for these T-bonds will be unnaturally high. A debt default by the U.S. government now looks much less likely. What's more likely is the social dislocation provoked by ahistorically high inflation.

Nota bene: Anthony J. Alfidi is long IAU and GDX with the expectation that the Fed will pursue further currency inflation to destroy dollar-denominated debts.

Monday, December 15, 2008

The Haiku of Finance for 12/15/08

Unwinding short calls
May be a bit premature
Can't risk exercise

Unwinding VWO Shorts for Dec.

I noted in a previous post that emerging markets may be "decoupling" from the rest of the world. Maybe the market is starting to agree. VWO has climbed a bit since I last refreshed my short calls on November 24. I had sold Dec calls at 25, and now VWO is trading perilously close to that price. I'm buying them back to close out the position, as I don't want to risk the price closing above expiration when the options expire this weekend. It looks like I'll take a slight loss, but I won't know until the transaction confirms come in tomorrow.

It's a good thing my other shorts are working out fine. Diversification is still a good thing, especially in an age of decoupling.

Nota bene: Anthony J. Alfidi is still short calls on SPY, IWM, and EFA at this time.

Sunday, December 14, 2008

Saturday, December 13, 2008

The Haiku of Finance for 12/13/08

Bondholders want yield
And guarantees of safety
You can't have it all

Would You Like Fries With Your Bond Default?

America has pioneered instant gratification. We want everything now: wealth (dot-com stocks), sexual satisfaction (male enhancement pills), weight loss (diet milkshakes), you name it. Bond investors have taken this to its logical conclusion by demanding instant safety of principal in the money markets, and the American spirit of innovation has responded with massive Fed lending backstops. Now they're about get something else instantly: bond defaults on a huge scale.

Let's start with corporate bonds. American companies are having a hard time convincing bondholders that their cash flow is reliable:

The lowest yields on Treasuries are providing no solace to U.S. companies paying the highest borrowing costs on record.

While rates on everything from four-week Treasury bills to 30-year bonds fall to all-time lows, companies are paying an average 10.8 percent on their debt, up from 6.53 percent in January, according to Merrill Lynch & Co.’s U.S. Corporate & High Yield Master Index.

The Fed's liquidity-enhancing moves are now crowding out other debt issuers, forcing the yield curve for everything but Treasuries to steepen. That Treasury steepening isn't too far off given the record low yields we've been seeing lately:

Treasuries rose, pushing two-year note yields to a record low, after the U.S. auctioned $16 billion of 10-year securities at the lowest yield ever.

The $5.3 trillion market for U.S. government debt may be a bubble waiting to burst, according to analysts and investors.

Treasuries have “absolutely” entered a bubble, said David Brownlee, who oversees $15 billion as head of fixed income at Sentinel Asset Management in Montpelier, Vermont. “There is very little rationality in my mind to bills trading at zero.”

Note that the contra-opinion bubble quote was left for the end of the article. Financial publishers often do that to say that they left themselves a way out in a news item that marks the continuation of a broad trend. As the yield curve steepens, Uncle Sam's interest payments on the national debt similarly steepen. Inevitably we will see an all-American version of the Ecuadorean solution:

Ecuadorean President Rafael Correa said he wants bondholders to accept a “very big” discount in debt renegotiations triggered by the South American country’s second default in a decade.

Ecuador's president is an American-educated PhD economist, according to that article. You don't need a PhD to see the potential for massive bond defaults here in the good old U.S. of A. once the yield curve gets out of control. Perhaps bond issuers can entice their debtors to accept bond haircuts with a quintessentially American sales pitch: "You want fries with that?"

Friday, December 12, 2008

The Haiku of Finance for 12/12/08

Rip off your clients
And you will learn the hard way
Do hard time, jailbird

Holy Canole, Who Can You Trust?

I normally stick pretty close to discussing topics that directly touch my portfolio - gold, China, U.S. Treasury actions, etc. Let's digress for a moment and examine another money manager of note, one Bernard Madoff of New York City:

Investors scrambled to assess potential losses from an alleged $50 billion fraud by Bernard Madoff, a day after the arrest of the prominent Wall Street trader.

Federal agents arrested Madoff at his apartment on Thursday after prosecutors said he told senior employees that his money management operations were "all just one big lie" and "basically, a giant Ponzi scheme."

Wow. I though I'd seen it all after Enron. The alleged perp was a longtime Wall Street titan, a market-maker - someone exchange officials trust to regulate trades in key stocks and provide liquidity backstops in extreme trading sessions. The alleged victims are all well-heeled, savvy, ridiculously prominent people. And they were taken for a ride all the way to the poorhouse:

Those investors were scrambling Friday to learn whether they had been wiped out by what prosecutors described as a multibillion-dollar Ponzi scheme. The assets of Madoff's investment company were frozen Friday in a deal with federal regulators and a receiver was appointed to manage the firm's financial affairs.

These two articles provide some clues to the potential moral of this story. Madoff's trades were untraceable, his record unauditable, and his investment strategy indecipherable. All of these things should be red flags, but sometimes friendship overpowers good judgment.

The tragedy in this story, if it plays out to its denouement, is that a lot of prominent families in Palm Beach and NYC will no longer be prominent. No more opera box seats, legacy admittees to the Seven Sisters, or mentions in society columns can be a tough road to hoe.

Thursday, December 11, 2008

The Haiku of Finance for 12/11/08

Business cycle dates
It's an economist's job
Measure recessions

All Your Bailouts Are Belong To Us

Past bailouts notwithstanding, this article describes why the housing market is due for further destruction beginning in 2009:

Now, as the housing recession deepens, a coming wave of payment shocks threatens to bring another surge in defaults and foreclosures as these mortgages “recast” to higher monthly payments over the next two years.

Heavy losses from investments backed by pay option ARMs were a major cause of the demise of Wachovia and Washington Mutual, one of the largest originators of option ARMs during the height of the lending bubble.

These pay-option mortgages represent a huge portion of the illiquid bank assets that the bailout was supposed to support. They have only just begun to decline in value. When defaults on option ARMs force further bank writedowns, banks will once again face insolvency; they will cease lending and the credit markets will freeze up again in 2009.

Does that mean there will be a TARP II in 2Q09? Anything is possible in this climate. With China getting skeptical of any further U.S. bailout investments, only the Fed's quantitative easing will keep bailout money flowing. Instead of buying a wheelbarrow to carry stacks of worthless dollars around to buy groceries, I'll just hang onto my gold ETFs until a new U.S. currency is issued.

Brace yourself for the second phase of a multi-year credit crunch starting after 1Q09. Any analyst who claims that a federal spending stimulus or automaker bailout will bring GDP growth back in 2009 is unbelievably stupid. No way am I going long any homebuilder, bank, or REIT for the foreseeable future. NBER dated the beginning of this recession to December 2007, but I expect future economists to label it the beginning of a Depression.

The stock market is nowhere near a bottom. Fair value of the S&P 500 is nowhere near 1000. THIS IS GOING TO GET WORSE!!

Wednesday, December 10, 2008

The Haiku of Finance for 12/10/08

Pick useful ratios
Apply to stocks you know well
Don't overdo it

Tobin's Q for the S&P 500: More Questions than Answers

Tobin's Q is a financial measure of the replacement costs of a firm's assets. At first glance, both the Investopedia definition and the Wikipedia definition state that a low Q indicates an undervalued stock, so a value investor might take that as a buy signal. Well, we here at Alfidi Capital don't stop at some breezy pop-culture investment waystation. I didn't get my MBA for nothing, so let's consider what academicians have to say about using Tobin's Q:

This measure of performance is not used as often as either rates of return or price-cost margins. If a firm is worth more than its value based on what it would cost to rebuild it, then excess profits are being earned. These profits are above and beyond the level that is necessary to keep the firm in the industry.

The advantage of using Tobin's q is that the difficult problem of estimating either rates of return or marginal costs is avoided. On the other hand, for q to be meaningful, one needs accurate measures of both the market value and replacement cost of a firm's assets.

See that line I bolded? A firm earning excess profits may very well have a durable competitive advantage, which Buffett-style value investors like. A high Tobin's Q would therefore be a very good buy indicator for a stock. So what to do? Here's a thought: Use Tobin's Q in conjunction with other traditional value style metrics, like earnings growth and low debt. A high Q may very well be a good sign of a stock Uncle Warren likes. You'll see me try to apply this approach in future research on the Alfidi Capital main site.

An interesting news item prompted me to bring up this topic:

A global stock slump may have further to go, according to Tobin’s Q ratio, which compares the market value of companies to the cost of their constituent parts, CLSA Ltd. strategist Russell Napier said.

Long story short, the article contends that Tobin's Q for the S+P 500 will drop further in the tradition of past recessions, which saw the ratio plunge below its historical average. The article also quotes other money managers and strategists who have varying opinions on Tobin's Q, mostly because they also look to other indicators to confirm their analysis. Nothing wrong with healthy debate.

I'll confine my use of Tobin's Q to discussions of individual stocks and avoid the macro perspective. I don't have access to the high-powered data sources most economists use for such things (because I'm too cheap to pay), and even if I had the data I'd be mindful of the limitations of aggregating economy-wide estimates of intangibles like intellectual capital. Calculating a single stock's Tobin's Q can be as easy as looking at a balance sheet if you truly understand a company's history and operating environment.

Tuesday, December 09, 2008

The Haiku of Finance for 12/09/08

Emerging no more
New markets' assets on sale
Submerging some more

Emerging Markets Soon to be Even Cheaper

I recently wrote about my excitement that emerging markets have fallen far from their all-time highs. There's more to come if you're a bargain hunter like me:

The international financial crisis is set to sharply slow growth in emerging and developing economies next year, ending a five-year global commodity price boom, the World Bank said on Tuesday.

"Export opportunities for developing countries will fade rapidly because of the recession in high-income countries and because export credits are drying up and export insurance has become more expensive," the report said.

I always wonder why some business journalists paint developing economies as commodity exporters and little else. South Korea is one of the world's leading makers of cargo ships and computer chips (and their economy is sinking, BTW, which is why they've announced their own huge fiscal stimulus).

Emerging markets (which to me means VWO) may very well be the next thing I go long, but not just yet.

Nota bene: Anthony J. Alfidi is hanging on to his short calls on VWO for the forseeable future.

Monday, December 08, 2008

The Haiku of Finance for 12/08/08

OPEC wants to cut
Less oil means higher prices
More pain at the pump

Oil, Oil, Everywhere, Nor any Drop to Pump

Samuel Taylor Coleridge's "Rhyme of the Ancient Mariner" is famous for its signature line: "Water, water, everywhere, nor any drop to drink." The Mariner's sailors lamented their thirst in the midst of plentiful water. In a cute segue (thank me later), China thirsts for oil in a world still awash in recoverable black gold. Brazil discovered lots of oil very far underwater, and China wants to help pump it out:

China wants to loan Brazil's state oil company $10 billion to help develop massive new oil fields in deep water off the coast of Rio de Janeiro, Brazil's top energy official said in comments published Monday.

Investment implies partial control. China needs above all else to maintain some healthy level of economic growth to forestall internal unrest. Securing access to non-OPEC oil is one way to do that. OPEC is going to make its oil harder to come by anyway, if they can pull off this near-term cut in production:

Oil prices rebounded from four-year lows and shot above $43 a barrel Monday as OPEC floated the possibility of a "severe" production cut and several countries announced new measures to boost their economies.

Why make a threat if you can't make it stick? OPEC members that used to cheat by abandoning production cuts after OPEC announces them now have less leeway to do so as their own producing fields reach geological plateaus. Most producers would go along with a cut either out of inertia or as a way to boost their currency reserves with income from higher oil prices.

Can I make money from this possible oil action? China's move won't have an impact on supply for years, so the OPEC announcement is something I'll wait to hear. Short puts on USO are looking much safer now if production cuts drive up the price of oil. Furthermore, higher oil prices are usually also bullish for gold in the short term. The proposed cut will be announced on Dec. 17, and short duration options expire Dec. 19, so if I sell a put option on USO it will have to be one dated Jan 09. Watch this space.

Sunday, December 07, 2008

Treasury + Bailout = Zero

Everybody loves Treasuries these days, because all of the alternatives look so bad:

The panic in global financial markets has sparked an unprecedented rush into safe US Treasury securities, driving yields on short-term government notes down to almost zero.

Analysts say the fear factor has pushed up demand for Treasuries, since investors are virtually certain the US government will not default.

A bursting of this bubble could mean a rush out of Treasuries, forcing the government to pay higher rates on an unprecedented amount of debt.

My regular readers know by now that I only highlight the most important points of an article that catches my eye. To make a long story short, the financial panic has yielded a short-term window of opportunity for Uncle Sam to issue ginormous amounts of short-term debt at virtually no cost. This is very enticing to debt-addicted Keynesian policymakers, who continue to seek deficit financing for bailout goodies aplenty.

Stories like this prompt idle speculation about a potential U.S. Government default. I believe a sovereign default is a very remote possibility as long as the Federal Reserve is chaired by an academic whose life's research has been a search for tools to prevent just such an outcome. I think we'll be hearing a lot more about "quantitative easing" in 2009 . . . more than we would ever want to hear.

I do not waste my money on investments that pay nothing. I do not hold Treasuries at this time. I would love to hold Treasuries at some future date when the U.S. government is forced to pay through the nose for the privilege of crowding out private sector investment.

The Haiku of Finance for 12/07/08

Grow your capital
Found a startup, hit it big
Then do it again

Saturday, December 06, 2008

The Haiku of Finance for 12/06/08

Uncle Sam will buy
New roads and electric stuff
Contractors get rich

Getting Ready to Crank Up Fiscal Stimulus

Uncle Sam is getting ready to swipe his ginormous credit card all across this great land of ours:

President-elect Barack Obama promised to make the “single largest new investment,” in America’s roads, require public buildings to be more energy-efficient, and to modernize health care with electronic medical records.

In addition to investing in infrastructure, requiring energy standards on public buildings and updating health-care practices, Obama said that he will launch a “sweeping effort to modernize and upgrade school buildings,” and will boost broadband deployment across America.

I'm disappointed that the plan's transportation component addresses motor traffic (roads and bridges) rather than mass transit (bus stations, train tracks, ferry berths). Emphasizing the latter would be the greener solution, but perhaps that's coming later. Perhaps an elevated train trestle can be considered a "bridge" for spending purposes. I'm also worried about the "use it or lose it " provision for state governments. The housing crash has left many communities with unsustainable suburban sprawl. Rebuilding motorways that feed out to vacant subdivisions would be a repeat of Japan's wasteful infrastructure spending! Do you trust your state highway department not to waste money repaving a highway to a ghost town? That's what they'll do if they don't get advice from good urban planners.

Is there an investment play in this spending plan? Can I make money off of this? Let's think about it. All of this federal spending will be a gravy train of income for contractors who can deliver the desired services. Among the top corporate contributors to the victorious 2008 campaign were Microsoft, Google, and IBM. The broadband spending will certainly help their bottom lines, and they would not have contributed if they didn't expect some kind of payback. The pertinent question: Will there be lead contractors to manage each of the programs' components? For example, some big IT firm (IBM?) will have to do systems integration if the proposed networks for broadband and medical records will be built to universal standards. That's where the real money is always made in federal procurement.

If this plan plays out into mass transit or railroad spending, I may have some investing to do.

Nota bene: Anthony J. Alfidi does not hold positions in any of the companies mentioned at the time of this posting.

Thursday, December 04, 2008

The Haiku of Finance for 12/04/08

Your portfolio
Always hedge market action
Diversify it

Treasury to Perform CPR on Dead Body

The U.S. Treasury Department leaked its latest idea to test the taxpayers' patience:

The Treasury, which already has a program to buy mortgage-backed securities issued by Fannie Mae and Freddie Mac, could step up those purchases to drive down interest rates on some loans to 4.5 percent, the official said on condition of anonymity. The plan is preliminary and could change.

Exactly how MBS purchases will drive down home loan rates isn't obvious. Are MBS holders supposed to call the issuing banks and force them to renegotiate loans, one homeowner at a time? Using MBS pools' leverage over banks as a transmission mechanism for forcing loan workouts isn't nearly as efficient as good old fashioned foreclosures. The Treasury folks wisely left themselves an out in case they don't get the ginormous amounts of money they'll need to continue these buyouts:

Senate Banking Committee Chairman Christopher Dodd said he opposes giving the Bush administration the second half of the $700 billion financial rescue plan, joining Republicans upset with how it is being managed.

Is it the lack of auditable transparency that could hold back the money? Or is it that the TARP purchases of bank equity haven't spurred short-term corporate lending? Or that TARP purchases of some MBSs haven't been effective in reflating housing prices? Or that automakers are now competing for TARP-related cash? Congressional anger over lack of foreclosure relief (mentioned in second article) may have prompted the trial balloon in the first article.

TARP is about as effective at reviving the housing market as a paramedic performing CPR on a deceased patient. This is all kabuki theatre by now.

Wednesday, December 03, 2008

The Haiku of Finance for 12/03/08

China sure is mad
Bad investments turn them off
To Paulson's sales pitch

China Getting Choosier About Investing

Foreign investors with deep pockets are getting skittish about providing further support to the U.S.'s ailing financial sector:

“I don’t dare to invest in financial institutions now,” Lou Jiwei, chairman of China Investment Corp., said today at a conference in Hong Kong. “The policies of the developed nations on these institutions are not clear. Until they are clear, I don’t dare to invest in them. What if they go bust? I will lose everything.”

I figured this out before CIC's officials did, so I'm probably qualified to run that firm. The balance sheets of U.S. financial firms are loaded with too many junk assets to make their stocks palatable as investments. This candor from China's sovereign wealth fund further supports a point I have belabored here before. SWFs are now too focused on supporting their home economies and too dismayed with previous investments to support further U.S. bailout efforts.

The CIC's skepticism will make it a lot harder for Secretary Paulson to ask China to strengthen its currency:

The fifth round of the Strategic Economic Dialogue between China and U.S. is a swansong for Paulson, who initiated the talks and will exit with the Bush administration. The currency appreciation that he’s applauded -- a 20 percent gain since the end of a peg to the dollar -- may be wound back as President Hu Jintao seeks to protect exporters from the global recession.

What incentive can the U.S. give to China to strengthen the yuan? Specially priced sales of U.S. nonfinancial companies that go bust? China is in the catbird's seat in so many ways.

Nota bene: Anthony J. Alfidi is long FXI (with covered calls).

Tuesday, December 02, 2008

The Haiku of Finance for 12/02/08

Grab your begging bowl
Line up for more bailout cash
We all want some more

Automakers' Adaptation of "Oliver Twist" Now Playing in D.C.

The title character in one of Charles Dickens' classic novels, Oliver Twist, is famous for extending his dinner bowl to his masters. In a modern twist (pun intended), multibilliondollar beggars have arrived on Capitol Hill in a caravan of impoverished autos:

Humbled and fighting for survival, Detroit's once-mighty automakers appealed to Congress with a retooled case for a bailout as large as $34 billion Tuesday, pledging to slash workers, car lines and executive pay in return for a federal lifeline. GM and Chrysler said they needed an immediate cash infusion to last 'til New Year's, and warned they could drag the entire industry down if they fail.

Hold your iron horses there, fellas. Less than a month ago you said you needed a collective $25B to ensure survival, and now you've upped the request to $34B? An increase of 36% in a month? If their needs continue at that rate, the automakers will require a sum total bailout of exactly $1 trillion by this time next year. That's a ginormous extrapolation on my part, but it perfectly illustrates the stupidity of throwing more taxpayer money at failed business models.

If this $34B is approved, what assurance do we have that it will be used productively? The record so far with Washington's bank bailout is very discouraging:

The Treasury Department has no mechanism in place to track how institutions are using $150 billion in taxpayer money that the government injected into the banking system as of last month, the Government Accountability Office concluded in its report to Congress.

If recent history is any guide, the automaker bailout will proceed as requested. Too bad for us all. In a few months the same executives from Detroit will be back in D.C. mouthing Dickens' familiar line:

"Please, sir, I want some more."

Monday, December 01, 2008

The Haiku of Finance for 12/01/08

Bear market rally
Sucks in the suckers' money
Spits out some losses

The Bears Are Here to Stay

People who should know better (on CNBC, in equity research departments, etc.) got really excited after last week's surge in U.S. market indexes. I was pretty sure the rally wouldn't last long, and today's action confirmed it:

The stock market suffered one of its worst days since the financial meltdown Monday, slicing 680 points off the Dow Jones industrial average as Wall Street snapped out of its daydream of a rally and once again faced the harsh reality of a recession.

Erasing any lingering doubts, there was also finally an officially declared recession -- in progress in the United States since December 2007, according to the National Bureau of Economic Research, the nonprofit group of economists that classifies business cycles.

We're in a recession? Really? (Sarcasm filter off now.) Maybe the excitement of the non-smart Wall Street preppies has died down now that the recession is official. There's nothing surprising about an occasional rally in a secular bear market. Hope springs eternal, and some money managers live quarter to quarter instead of decade to decade. I wonder which active money managers tried to pick a bottom and buy what they thought were cheap stocks to dress up the next quarter's performance. Wall Street pros just can't shake the herd mentality, no matter how much they tout their "independent thinking" in sales literature.

I tell ya, my bear plays look better and better each month. I'm sticking with them (although I'm still thinking about going long VWO at some point in 2009).

Nota bene: Anthony J. Alfidi holds uncovered calls on SPY, IWM, EFA, and VWO at the time this commentary was published.