Tuesday, April 24, 2007

The resilient U.S. equity market

Why is the U.S. equity market so strong and so resilient? Sure, corporate earnings continue to impress, below last year's pace but ahead of this year's expectations. And unemployment levels remain low in a moderately growing economy. P/E's are not at unreasonable levels if the party continues, and the U.S. remains as the great entrepreneurial haven in the world. So that's the answer. Everything's just fine.

That's, of course, not the full story. The U.S. as an economy has significant structural problems that are clear to everyone. First, while trade imbalances and budget deficits are not inherently a problem at reasonable levels, the U.S. positions are no longer reasonable and the market is taking it out on the dollar. That's a big macro deal. On the more immediate front the consumer in the aggregate seems to have the potential to run into a wall. There are many reasons for this but the simple explanation is that the paycheck to paycheck lifestyle that many Americans live is supported by credit, and this may not end well.

The stock market should be doing ok, no doubt about it. The question, however, is why is it doing so extraordinarily well. Here are a few stabs at an answer:
---Where is another attractive market? Bonds don't look like a bargain and the general bias is that medium and longer term rates must eventually climb and prices fall to support the budget deficit's funding by foreign buyers of U.S. securities. And if bonds by any chance rally, the stock market will as well. Cash is not bad with yields in money market funds at 5% but after tax the investor basically keeps even with inflation, no pain no gain. Real estate is an area where it looks today like the money has already been made and the upside today is for the serious risk taker to chase. The stock market has momentum and, practically speaking, it works. What is the alternative?
---The U.S. dollar has fallen roughly 33% against the Euro and the Pound over the last three years, a fact that would seem to augur against support for the U.S. equity market. There are at least three reasons why that is not necessarily the case. First with the multinational U.S. corporates' global exposure, overseas earnings translate into more dollars which translate into more EPS. Secondly, the investing world is global and a primary theme of global investing, and investing in general, is asset allocation. So if a fund has a U.S. equity market allocation of, for example, 30% and the value of their holding goes below that level due to the dollar decline, they buy more U.S. equities to keep at that 30%. Third, to those global investors who are discretionary and do old fashioned stock picking, today the price for a U.S. business can look cheap, just like Manhattan restaurants, hotels and shops are bargains to many foreign tourists. If they weren't in this market already, it's time to shop.
---The U.S. equity market is strong not necessarily because businesses are strong, but because the financial management of businesses is superb. A focus on reducing costs, inventory management, and returning capital to shareholders through stock buybacks and dividends(taxed at 15%) keeps underpinning earnings per share. Whether this is at the expense of reinvesting in the business(in research and development, in employee training and loyalty, in capital investments) is a longer term question, but financial management creates the results today.
---The amount of money chasing returns in the world today is huge, and private equity is always there, it seems, as either a windfall or a backstop. It can pay up for a performing company and bail out an underperforming one. There is the saying that the market in the short term is a voting machine but in the long term it's a scale. The voting machine is humming and the demand is underpinned by market liquidity. What the scale says, value or not, has yet to be determined.
---Since the market looks ahead and discounts future events, the fact that there are only 19 months left in the presidency of George W. Bush is likely another positive, without question from a global perspective but also one could guess in the financial centers of New York and Boston.

What is the outcome of all of this? If the music stops, who doesn't get a chair? The only thing for certain is that participation is mandatory. So what stocks look good for tomorrow.

Friday, April 13, 2007

Challenge the ordinary

When you call E-Trade Financial, the brokerage firm, the first thing you hear is a recording that says "Challenge the ordinary to help our clients be extraordinary". They have challenged the ordinary today.

In order to make my life more complicated I use multiple brokerage firms. Today(4pm on 4/13 by U.S. mail) I received a tax revision from E-Trade with a note attached that was entitled "What to do if you have already filed". I called but the well meaning but hapless rep had no answers.

No further comment needed really. This firm has obviously outgrown its infrastructure and is in for a nosedive in its stock price. If you own it sell it, and don't buy it.

The Spirit of the Day

The Duke lacrosse players have been vindicated, at least in the eyes of most. They have been through what must have been a nightmare. With a bizarre, but in this country not unusual, prosecutor and a pile on by the ever righteous in the media, they now have survived, can go on with their lives, and just deal with the fact that any google of their names for the rest of their lives will provide the media attacks for all to see.

The New York Times sports columnists were the leaders of the attack on the accused and the Duke lacrosse team in general. Multiple columnists at the paper of record attacked with pompous certainty over many months. By far the leader of this charge was Selena Roberts. Anyone who dares go back and look at her many columns focused on this issue may now be shocked. She was uniformly biased, often hostile and at times just plain cruel in her many written remarks. This was not a slip of the tongue but written content presumably passed by an editor.

While this is perhaps the most egregious example of her willingness to attack at any opportunity, she is in fact a serial offender. One could ask why she writes about sports at all when she seems to live to villify its participants at will. It's easy to see her delight when any young person who fits this profile(great athlete, minimally educated, given millions, in the spotlight) slips in some way. No need to think up an original column that day. Just attack the young person, the team, the agent, society in general, and feel superior once again.

With the Duke lacrosse case there is not a case of 20/20 hindsight for many observers. There was a clear concern within the first week of the event that the young men were being falsely accused, and within two weeks that this was a prosecutor off the rails. That did not deter Ms. Roberts. Her columns were relentless, biased and narcissistic tirades. In the spirit of the day, why does she have continued employment at the New York Times, and the same goes for her editor. Are young affluent white males open season for attack at the NYT with absolutely no standards of journalistic review. Of course she could not use street slang or profanity in the paper of record, but any review of what she wrote will show that she did not need that crutch. Her opinion pieces were at the time appalling, and today she should be held accountable. Any apology is unacceptable.

Wednesday, April 11, 2007

Recovery for homebuilder's stocks?

Homebuilder's stocks continue to decline precipitously. When do they hit their bottom and begin a recovery? Remember perhaps in the fall of 2002 when, in the midst of the Enron and Worldcom debacles and after the meltdown of private equity tech investments, JP Morgan Chase was trading below $20. Within a year the stock was in the high 20's and today it's around $50. It's easy in hindsight to see a bottom and, as with big banks at that time, it will come for the stronger homebuilders.

Trying to call this bottom is dangerous, actually impossible, but different points of view make a market. Today I bought a little KB Homes, last week some Centex, and yesterday added to Hovnanian. This may be foolhardy, and telling others about it may be just plain stupid. But anyway, a few facts on these three.

Each has been in business since the 1950's, has experienced management and staff that has been through the ups and downs of real estate for over 50 years, and have top ten shareholder lists that would be the envy of most firms in any industry(meaning people who have exceptional track records in investing are major shareholders in each of these firms). Centex is certainly a residential leader but it also has a significant business in construction of hospitals, educational buildings, airport facilities and office buildings. It's two year high is around 80 and now it's at 42. Hovnanian is a residential builder diversified across 48 states, of the three stocks has had the most conservative inventory build, and it's two year high was 73 and now it's trading below 23. KB Homes is residential but also has a commercial division and had a two year high of 85 and it now trades around 41. It was reported today that Fidelity Investments raised its stake in the company from 7.5% of shares to 15% in the last month or so.

Stocks of course can go to zero so why take comfort in these numbers. Real estate downturns can take years to unwind as in the residential stagnation that went on from 1990 until about 1994. More inventory write-downs may be probable for these firms as well. Good points by my alter-ego, but the other side of this coin is as follows. The leaders in businesses with experienced management teams tend to weather storms and come back even stronger over a period of time because weaker or less disciplined competition gets winnowed out. Like banks, housing is pretty much a necessary part of our economic infrastructure long term. Timing a bottom is not possible, so modest individual bets diversified among the best in the business is a reasonable way to play this, one could think.

Finally, as troubling as the mortgage market issues are and will continue to be for some time, they are being worked out as they should be. Bad lenders are folding, bad products are being removed from the market, portfolios are being sold at discounts, well-managed sub-prime lenders are able to get back up financing, inventories are being managed in related industries, major financials are relatively unscathed, and U.S. employment remains strong.

The market always discounts the future. There's a lot of really bad stuff already in the stock prices of CTX, HOV, and KBH. If things get worse, these stocks will likely go down but so will stocks in many other industries. If stocks are part of a portfolio, an allocation to names like these is now a reasonable option, PERHAPS?