Wednesday, August 29, 2007

Take out the eraser

It's now as if yesterday's market fall did not happen. Today was a mirror image and, if a portfolio was weighted toward technology and small caps, the image may even be a little more attractive. Market commentary suggests that opinion shifted. There is for the moment a renewed belief that the Fed will cut the discount rate in September and take it down further before the end of the year.

Is it possible that a rate cut or series of rate cuts could lead to higher long term interest rates, fuel inflation, and promote speculation? The short term benefit of this popular option may be offset by resulting negatives such as these within a year. A rate cutting agenda by the Fed is not a panacea and is by no means an absolute certainty.

Tuesday, August 28, 2007

Is this quicksand?

Looking for a bottom in this market is becoming increasingly difficult. In the early afternoon stocks were down meaningfully but not on high volume and with big hits more or less contained within the housing related and financial segments. It seemed like a normal down day of late. Looking ahead at that point, one could see a monthly close coming up on Friday and begin estimating when the bounce would begin, the last hour of trading today, Wednesday, the latest Thursday. It was time.

The last two hours did not cooperate. Volumes picked up and selling pressure intensified, across the board. Those earlier hopeful thoughts were erased. The last week in August, a holiday week, is not supposed to have gut wrenching moves. Predicting the next few days is not possible and dreaming about the bounce tonight, if it happens, might unfortunately just be a dream.

Don't give up on a Thursday rally just yet. Rally from what is the question.

Monday, August 27, 2007

Heading off the edge with Dell

If "The World is Flat", then Dell is heading off the edge.

It's too boring and tedious to detail, and it was already covered in a post in May 2006, but Dell's customer service is like a circuitous bad dream, a Kafkaesque nightmare, or maybe being stuck on a tarmac for six hours with no useful information from the flight crew.

Obviously working from scripted protocols, the customer service reps in Mumbai, Bangalore, or wherever are just amazingly frustrating to work with. "Working" with them is like being on the designated losing team in one of those professional wrestling matches: "just let me put you on hold for a few minutes" equals a thumb in the eye; "now we need to remove all cords from the computer and open it up. It's just like a suitcase" portends a period of time being bounced off the ropes repeatedly accompanied by occasional head-butts; "do you have all of the disks for the software that was preloaded at the factory" is a body slam; and "can I call you back later" is pretty much like being thrown out of the ring headfirst onto the scorer's table. The Dell team wins. You're exhausted and bloodied.

At least 80% of the service reps speak English in an accent that can be understood and roughly the same amount seem to understand what you're saying. Unfortunately they are not necessarily the same 80%. Perhaps it's a lack of training, maybe it's just that on average Dell products are lousy in the first place, or could it be some kind of cultural thing(following the protocols precisely and rigidly seems to be the goal, and no ingenuity, real problem solving, or understanding needs to be displayed). That's too much of a generalization of course as usually after about eight hours and at least four "technicians" someone intelligent somehow appears. Even that may mean a "we'll send you the software" solution(elbow to the head), which means the entire process gets to start again after DHL comes to your door a few days later.

Can yoga relieve the stress of dealing with Dell. Thinking back on the Indian call center scene in Albert Brook's "Looking for Comedy in the Muslim World" helps. Expressing any form of emotion is politely ignored and therefore more stressful. Enough on heading off the edge of the world with Dell. It's time for a cup of Kava before calling U.S. Air to book a commuter flight here in America with the service reps in, you guessed it.

Friday, August 24, 2007

What's in the cards?

More than a year and a half back, on 2/17/06, an Eyes Not Sold post on credit issues included the following: "In 2004 37%of all consumer mortgages were adjustable rate and of that 88% of the lower credit score was adjustable". The rate reset issue was raised and then it said, "Credit cycles always come around. It's been awhile. They always are the result of excess. It may be months and maybe a year year or more, but it's hard to see how significant consumer credit defaults in mortgages and credit cards are not in the cards..." You get the point. This raises a few questions:
---Why have the significant issues in the sub-prime mortgage business been such a shock to the regulators, media, politicians and even some investors? With publicly available information it was not hard to see that there was danger unless the economy roared ahead in an unprecedented way.
---What has happened to credit cards? Well, they're ok, with delinquencies and charge-offs stable and payment rates just fine. Credit card companies in general are doing well in this environment with high balances that are being serviced. Their main gripe may be that they're not getting enough late payment fees, as they have raised them so many times that consumers now are forced to pay attention.

The mortgage business and the credit card business had taken two different paths in recent years. Mortgage extended its product reach to a broader segment of credit scores, extended distribution of product to new sets of investors and with new structures, and developed products that effectively had very low barriers to entry. The credit card business is working on roughly the same model that it has had for at least 20 years. There have been a few new wrinkles, some new costs for the consumer, and incentives to use the card more often and more widely but, generally speaking, the business has just evolved, fine tuning its business model.

The changes in the mortgage business and the aggressive sales efforts that it engendered put the industry in a vulnerable position. Then interest rates rose from abnormally low levels and house prices stopped rising. It did not require a recession or higher unemployment to trigger the problems. The credit card business, despite the risks associated with the consumer's high debt levels, will likely begin to experience out of line losses only when and if the overall economy enters a recession. To some it has seemed counter-intuitive that people would pay their credit card bills and at the same time walk away from their homes. Given the mortgage product offerings to those with lower credit scores, however, it was a business on a hairtrigger. If an individual was behind on their mortgage payments on a house that was rapidly losing or had lost its equity but in good standing on their credit card, their source of liquidity, the right economic choice may be difficult but it's as clear as the nose on my face. Where we are now unfortunately makes sense and was pretty much foreseeable. What could not be predicted was the overall credit contagion that this would cause and that the bears have been reveling in.

Also unfortunately, though, it seems likely that the credit card business will eventually have its own set of problems. In recent months credit card balances have been rising as the mortgage refi market is shut down. With the stress in the financial system and the consumer's continuing decline in purchasing power by any global measure(meaning the dollar is not doing well at all), even a mild recession could begin the tilt toward a higher level of charge-offs. Add in the beginnings of a populist mentality among consumers as a result of the mortgage mess, political rhetoric and media finger pointing, and then consider that as a result of promotional efforts the consumer now puts their groceries, a cup of coffee, and a Big Mac on their card(totally different from just 10 years ago), and a troubling scenario could develop.

The overall picture is one in which the major changes in the mortgage business and the negative results of those changes and its ramifications could be leading us into at least a mild recession. If it does the credit card business will likely be challenged. This should surprise no one.

Thursday, August 23, 2007

Oh please dilute me and let me go, for I don't love you anymore

Countrywide Financial's investors are no doubt singing this ballad of loss today as they digest the news that Bank of America has made a $2 billion injection into CFC that has an $18 convert price.

In ordinary circumstances these terms would be viewed as terrible. Faced with the prospect of seeing their investment destroyed, however, it's great news for CFC's stockholders. Make believe after-market and overseas trading before the NYSE open had CFC trading above $26 as compared to yesterday's close of $21.82. In the real liquid trading now CFC is up less than a buck, around $22.80. While almost assured that a liquidity crisis won't take down the company, with an $18 a share partner that has a hypothetical 16% ownership of the company, many investors are likely happy to reduce their positions and move on for now, and cede ownership of CFC to deep value investors with patience.

Wednesday, August 22, 2007

Those early primaries

The way things are shaping up we'll know who the two main candidates for president are by the middle of February. While favorites have often been clear at that point, they have definitely not been certain. What does this mean?

First it will mean that the debates of Democratic and Republican hopefuls is over. That's really good news. They were entertaining at first, but when a hair spray loving fly is the biggest news in one of these sessions, it's gone too far. It also presumably means that debates between the nominees can be avoided until the candidates are officially nominated by their conventions. Second, it should mean that the candidates will not, as they say, jump from the frying pan into the fire. They will have the time, if they are so inclined, to more fully develop coherent policy positions and then have the time to try to rally their party around these policies, which get renamed platforms at the conventions. Third, however, and this is the real point of this comment, it will give a potential third party candidate the time to assess the situation and if it looks right, the chance for a meaningful challenge. Sounds implausible but this is new ground.

Mid February until election day in early November is almost ten months. So much can happen in that amount of time. Could one of the main candidates have a meltdown of some sort and put their party in disarray at their convention. Could polls clearly show that a candidate is simply out of it and drawing limited support. Could the economy slowly but surely slide into recession, with the effects growing month by month, leaving Republican candidates with little choice but to defend their party's policies. That scenerio could be like Jimmy Carter in 1980, when month after month, even week after week, he and his band of incompetents(remember Hamilton Jordan and Jody Powell) would regularly announce imminent success in negotiations or contemplated actions to free the hostages in Iran. Carter's credibility eroded steadily such that as a sitting president he lost to the actor Ronald Reagan. Could the Republican candidate follow this kind of downward spiral of communications to a hopeless situation. Maybe so.

Michael Bloomberg has the resources to take advantage of the right situation. He has a political record that is solidly independent and by most accounts successful, without any taint of corruption or overt pandering to special interests. He has a business record of accomplishment that is way beyond any candidate, including Romney, and for the most part it appears that in making his fortune he could have been operating under Google's mantra of "first do no evil". As for his "liberal" or more correctly libertarian views on social issues, if his main opponent is Clinton or Obama this red state negative is neutralized. This conjecture may be far fetched, but if not it could make for the most interesting presidential race since Kennedy/Nixon.

The likely result would be Bloomberg as the Bull Moose in 1912, with the Republican candidate playing Ross Perot's 1992 role. In other words, Democrats win unless their candidate totally collapses, but in any event a Bloomberg candidacy would likely break the mold on discussions of many important issues.

Tuesday, August 21, 2007

How much is a picture of words worth?

If you have opinions about presidential politics check out and today's article "Finding the Difference in R's and D's in a cloud of words".

Pushing the reset button

Regardless of whether the unwinding of credit issues is done or not, and it is probably not, this has been a market event that will have a lasting impact. Equity portfolios will be reshaped significantly in the coming months and regardless of what's happening in the overall averages there will be plenty of activity among the components. Here's what will drive the change in equity analysis:
---The balance sheet will be back in vogue. That boring old part of a financial statement is coming back like hats in winter. Investors will look at those mundane stats of debt to assets, long term debt to equity, and current assets to current liabilities. A new twist will be looking at fixed assets and seeking to determine their viable life first and, given the fact that the dollars five year collapse will likely continue, how valuable those fixed investments are on a world stage. The final ingredient of this balance sheet analysis will be the more intangible networking analysis of financial flexibility, meaning are the credit markets open to this industry and this company.
---After that and only after that comes the income statement and cash flow statement, and the growth that they imply. To use one of the few management buzz words that has meaning, that will lead to an analysis of "sustainable competitive advantage". Does the company have the products, brand, human capital, and financial capital to grow over a reasonable time frame, and as always let's put a number on that amount of time.
---Passing these tests will lead to an examination of the global nature of the firm, given the dollar's ongoing plight. Does it have exports---good, does it depend on overseas suppliers for components or products---maybe not so good, and does it have overseas production and sales operations---possibly good. If a company is primarily U.S. dependent on sales it is likely best that it is in, first, essential items like energy, food, war supplies, and infrastructure maintenance or, second, in luxury goods and services. Anything in the middle will be less profitable on any global measure.
---Only then will come a look at some of the market issues that have been most important in recent years, and remain worth looking at after the above tests. What is the P/E relative to others and historic market data, who owns the stock and why, and what is the market momentum of the company and its industry.

All of the above applies to commercial and industrial companies. Financial companies have their own reset button given that they are structurally more leveraged. They are facing increasing scrutiny on many fronts that could lead to regulation, some of which will inevitably be damaging to the companies and even the economy. They are the easy villians for political rhetoric. But most importantly they are solely dependent on financial capital and human capital. They don't have machines that make dollars and euros and yen, and so when accidents happen they can be devastating. Until the coast is clear on all of the recent credit panic, the whole sector will be discounted heavily and it will take time to recover.

On that cheery note, we start another day.

Wednesday, August 15, 2007

Incantation in prior post fails

Equities dog paddled around keeping their head above water for most of the day, but finally got tired and went under. The averages took another hit of consequence. Financials stayed under pressure and a slower economy as a result of this self-fulfilling decline in values began to get factored into other industries. At the moment I can think of only two possible positives:
---Looking at a sample of stocks that were under pressure and declined materially, many had volumes that were below their three month average(this does not apply to the obvious financials). That could mean that buyers are on hold and sellers are slowing down. Ready for a rally?
---Bill Poole, President of the St. Louis Fed, had a chatty interview on Bloomberg radio just a half hour ago. This is not a random happening. He was relaxed and informative to a degree. When a question was asked that went something like this, "Wouldn't it be a problem for the Fed to cut interest rates when just on last Tuesday you confirmed rates as they were and more or less continued to maintain a posture with a bias to raise, as inflation was the biggest concern?" and the answer was, "No that wouldn't be a problem. What we do is dictated by the data, and if the data supports any type of decision, acting on that data is not a problem."

So is the selling at least slowing and the Fed jawboning, and ready to move if this goes much further?

Tuesday, August 14, 2007

Today should not have happened

The market was due for a rebound, RIGHT. It was oversold. It was not time for another drastic sell-off, but that's what we got. Have we run out of time to rally?

After hours U.S. trading shows many oversold stocks getting nice bounces. That's on typical after hours light volumes but it looks promising. Too bad we can't hang our hat on it. This may be out of everyone's hands for a few days unless something dramatic happens, some watershed event that attracts enough attention to give the market a pause that refreshes.

Tomorrow will be a day of frightening news stories and sobering to downright apocalyptic comments from the people that allow themselves to be interviewed or quoted on CNBC, Bloomberg, and elsewhere. The real players will be at work, manning the trades, chewing their nails, picking at scabs, yelling at subordinates, and manically multi-tasking between screens while meaningless fringe participants in the market will talk and scare the living bejesus out of the investing public. If it gets bad enough perhaps some firms will let their smart people go on the air and try to cool things down. Let's hope so.

As this is being typed Asia is selling off big time. With Europe's late sell-off today, the slide will likely continue early this morning and the U.S. will need some real firepower to turn this around. But since today should not have happened, there's a hint of panic in the air. If the general public gets agitated into worrying about their money market funds, and acting on that concern, things could get terribly messy.

Settle down market, take a deep breath, and give us that oversold opportunity that we missed today. Soon. It will happen at some point. Bring on that wall of worry.

On the other side of the coin, so to speak, at least the dollar is rallying after a five year slump. Wrong reason though. Investors are selling other currencies to bring the money back home to deal with their dollar obligations.

Saying too much

It's hard to believe it. Companies just cannot get away from the supposed "protocol" of giving specific guidance about future earnings. It's pervasive and it's not smart.

Today Wal-Mart, as part of its second quarter earnings report, said that third quarter earnings would be "as much as 65 cents a share", less than the 68 cents estimated by analysts and that full year profit will be "from $3.05 to $3.13", less than the previously forecast $3.15 to $3.13. Home Depot, reporting as well, gave specific guidance a different way by saying that earnings per share from continuing operations "will decline 12 to 15 %". That just takes a couple of seconds on a calculator to turn into an EPS projection.

It seems that most companies these days think that this is what they need to do to communicate to investors. What they are doing under legal and regulatory guidelines is obligating themselves to ongoing disclosure anytime that their guidance falls outside of the projected range, and they are also setting themselves up to get asked to refine their guidance at any public meeting, conference call, or investor event. This raises a few questions:

---What is the role of securities analysts? Don't they look at trends, financial structure, market events, management, and comps to come up with their estimates, or are they now just there to opine on what management constantly gives them. This basically levels the playing field as the few capable analysts that actually add valuable insight and understand the dynamics of a business can barely show their stuff before the company hands over the goods to the entire insight challenged analyst community.

---Is management at all of the firms that give specific guidance, most firms, expected to have a crystal ball or a trusted psychic? For example, look at what's going on now. The interest rate environment is up in the air, consumer spending has some big questions around it, the dollars impact on export and import prices has some significant variability, and corporate investments of cash and securities(for rainy days, pension funding etc.) is faced with the same challenges as the overall equity and credit markets. Yet, these managements are projecting earnings six months out to with around a 2 to 3 % margin of error. Damn smart they are, I'd say. The fact is that they are giving "all things being equal, or as they are now" projections and that's generally not the way the world works.

---Is the focus on constant updating that this guidance practice requires productive for American companies? The lament once was that investors and analysts force companies to focus constantly on quarterly earnings and not on longer term investment, planning, and financial health. Now it's real time earnings that the companies have caved in to.

It doesn't need to be this way. No rule requires companies to give specific guidance on earnings. Google doesn't do it, not at all, because of all of the issues above. They have the power to ignore the requests of many analysts and investors. All companies can choose and there is no evidence that it has an impact on stock price to not play this game. Here's an example.

In 1990, as today, most companies played the game but without Reg FD it was done on an informal basis constantly and securities analysts were the conduit to investors. In the banking industry companies almost uniformly gave guidance to the penny on quarterly earnings and in tight ranges for the year. To my knowledge only four banks did not follow the practice---Manufacturers Hanover, Chemical, Citibank, and J.P. Morgan. ManHan and Chemical combined and the new Chemical continued the approach, and when Chemical bought Chase and became the new Chase the approach continued. From 1990 to 2000 this company, Chase as the combination of MHC, CHL, and CMB, had over a 600% gain from its legal entity stock basis of Chemical. J.P. Morgan's stock price was flat as a pancake until mid-'99 when the market began to price in the possibility that its excellent franchise but woeful financial performance would lead to a takeout(it did in August 2000). Citibank was up over 700% from its beleaguered position in 1990. The point is that choosing to not kowtow to the securities analysts had no discernable impact on stock price. Performance was the issue.

Why do companies give in:
---Everyone else does it so we have to as well(if a few more were brave others would follow)
---Our investment bankers say we need to(investment bankers are experts at making money--clients are their second priority and apart from that they have no interest in rocking the boat)
---The securities analysts say that they can't defend us without the updates(find another line of work if you can't do it)
---Our institutional investors want it(talk to the ones that matter and really move the market and find out the truth)

Open communication to and a dialogue with the investment community is a good practice and is healthy for both the companies and investors. That is generally and correctly presumed to be good for a company's share price over the short and long term. Handing over the keys to internal projections does not need to be a part of this and arguably leads to a lot of wasted time, misdirected priorities, and greater stock price volatility.

Sunday, August 12, 2007

Reminded of Jazzfest

This week reminded me of one of those special moments at Jazzfest in the 90's. Michelle Shocked and an electric folkie band were ripping into an Irish jig, an instrumental that went on and on, highs and lows, great music, and everyone in the crowd near the front of the stage was dancing wildly with people they'd never met before and would never meet again. The music was loud, intense. It stopped abruptly, silence, and then she and her band mates slowly and clearly sang out, "It don't hurt when you're fallin', it hurts when you hit the ground". Silence. Then the music suddenly hit its manic stride again, and the momentarily stunned crowd was still flatfooted.

It's highly unlikely that this traditional Irish lyric was referring to the financial markets, but as a warning this week why not. While the equity markets for the week were flat, it definitely did not feel right. Those equity markets were volatile to the extreme, the credit markets were in turmoil, and central banks were huddling to determine how bad things really are and what to do about it. There were widespread reports of the inability of the market to price asset backed securities, speculation about an emergency Fed rate cut, talk of risky asset-backs even embedded in money market funds, China's comments on their possible response to the protectionist rhetoric of Clinton and Obama, anticipated further dollar weakness, the troubling rise in credit card debt in recent months as the mortgage market is shut down, big losses at quant driven market "neutral" funds, and the constant questions about CDO's and CLO's of "who has this stuff" and in some cases "do they even know they have it".

That's what was happening last week, and in markets that are essentially based on trading paper and contracts backed by the imprimatur of governments, confidence, or maybe faith, is what holds it all together in the short term. While equilibrium will inevitably be reached, if it takes panic to get there it can be a destructive process. And now I hear in the background "the phenomenal" Ruthie Foster crooning "getting back up is harder than the fall".

Ok enough. I'll end this with a quote from Ben Stein's comment in the NYT today. He wrote, "...the market reactions are wildly out of proportion to the real problems that have been revealed...This economy is extremely strong. Profits are superb. The world economy is exploding with growth. To be sure, terrible problems lurk in the future: a slow-motion dollar crisis, huge Medicare deficits and energy shortages. But for now, the sell-off seems extreme, not to say nutty".

I'd prefer to sleep on that, and at least be rested for whatever tomorrow brings.

Wednesday, August 08, 2007

Traders show market fragility

Did you see what happened this afternoon? At around 2:30 the Dow was up 175 points. By 3:30 it was down 4 and it closed up 153 a half hour later. That doesn't look like pension funds, mutual funds, endowments or individual investors going haywire. One could therefore deduce that it's traders aggressively competing with each other, using rumor and aggressive positioning to pick off some meaningful profits if they win. Volumes were low in the afternoon and one can guess that the institutional investors had closed their books. Innocent bystanders could easily get hurt if they tried to play this game.

Why the title? An unattractive aspect of the limited number of hedge funds that are solely traders is that they pick on those in tough situations. In less volatile markets it's individual companies in myriad ways, but here's an example. Fragile Company X which has been going through a rough patch has scheduled a conference call with investors. Trading Hedge Fund M, and possibly funds N, O, P, and Q since these guys are thick as thieves, sets up or adds to a short position before the call. Fragile Company X gives its presention to listeners and opens the conference call to questions. After some questions that are constructive if perhaps not easy, a questioner from Trading Hedge Fund M asks "Could you comment on the rumor that... take your pick: you have taken a billion dollar loss on... ; you are under investigation by the SEC for... ; that your derivatives for hedging risk have blown up and the losses are... etc. Fragile Company X can basically say that they don't comment on rumors or stammer our some explanation saying that the rumor is completely untrue. The fact is that these hedge fund guys are smart enough to develop a rumor that, because of Fragile Company X's current challenges, is not beyond the realm of reason. You get it. The stock gets hammered if just for a short period.

In today's market the traders can pick on the entire market. It can simply be some program selling, a cascading of shorts and sells that reinforce each other, or an "intuitive" coordinated attack. Who knows. Buried in a Bloomberg report on the market day there was mention of a market rumor in the late afternoon, that rumor being that Goldman Sachs would be liquidated. Absurd rumor maybe but if it made the Bloomberg report it had some currency for a short period before it was put to rest. Who knows?

It does suggest that this market is still not on solid ground.

Wednesday, August 01, 2007

Out of the flow

This is one of those times when individual investors really have no idea what's going on. That's an exaggeration but it is, relatively speaking, correct.

In less volatile and stressed times an individual investor can do research and look at balance sheets, income statements, cash flows, headlines, charts etc. and make decisions based on, to some extent, the same information that the pros use. In those "normal" type times the individual investor also has one significant advantage over the big guys, and that's liquidity. Large investors always need to be aware of how much they move an investment going in and out. Generally speaking, unless they are extremely wealthy or in a miniscule small cap, an individual investor can buy or sell without worrying about getting the screen price. Buy, nobody knows, and sell, it's not going to be on Bloomberg.

That's not to say that the best institutional investors and traders don't always have the advantage of a network of information that is beyond what the individual has. They do.Their experience as investors and this network should give them an advantage versus the individual but there are no guarantees, and at times an individual can be more agile. In times like these, however, that network makes a huge difference.

So here's a real life example. Today I can look at a stock and see that it is getting walloped. Looking at all of the financial information and making a judgement about its industry, management etc. I can choose to buy that stock. In the totally stressed market that exists now I would big making a bet, taking a significant risk, as I would be assuming that the overall market is not going to collapse further and leave me with a good stock in a market that is getting revalued in the wrong direction. The pros who choose to buy now are making that same bet. There's a huge difference now however. The components of the shareholder base are critically important and I don't have a way to evaluate that. The pros and their network have valuable information that I don't have.

Let me explain further. There could be two stocks that have been clocked, seem to be good companies, and look like they're worth taking a flyer on. The two stocks look the same but what if one has a shareholder base with a number of investors who are leveraging their positions. What if those investors get into a position, with their overall portfolio, in which they must sell to stay viable regardless of a rational analysis of the company. And it doesn't need to be a leveraged situation. It could simply be a plain old mutual fund that is seeing significant redemptions and must do some across the board selling. The neural network of the best in the professional trading community will know in both of these situations. They will sell or short. That selling will drive a company's stock down further in the near term. One may say well so what---in an efficient market my investment will ultimately be valued appropriately. Well so what is that if I buy the stock with the weak hands and it goes down 20% more I would obviously have preferred to buy it at that level. The other stock does not have that problem. In most cases I don't have the information needed to make an intelligent or relatively safer choice between the two stocks.

CNBC'ers can talk about the opportunity that this market will eventually present but most individual investors in the market basically need to watch and let the momentum turn before pulling the trigger. We lose a few points of potential gain and that's just the way it is.