The Commerce Department reported on Durable Goods today while the markets were engaged in a powerful rally. For the Computers and Electronic Products category, new orders in October fell at a surprising rate, down more than 8%, from the level established in September.
Two of three sub-categories were considerably worse:
Computers and related products: -15.2%
Communications equipment: -22.6%
These declines were the largest of any sub-category in the entire report. The next closest was a 10.6% decline in Defense aircraft and parts. (The third sub-category under Computers and Electronic Products is Semiconductors. New orders data is not available for Semiconductors.)
What does this say about a recovery in tech stocks?
Moreover, given that tech as an industry has the largest over-seas sales exposure, what does that say about the concept of "decoupling"? At least some of this fall-off in orders has to be from foreign customers postponing purchases.
As noted above, the markets rallied strongly today. The Technology Select Sector SPDR ETF (XLK), which I use as a proxy for tech stocks, finished up nearly three percent. The Financial Select Sector SPDR ETF (XLF), which I use as a proxy for financial stocks, finished up nearly six percent. When the dust settled, tech ended up trailing the financials by almost three percentage points. Perhaps a few investors were cautious after all...
Sources: US Census Bureau - Manufacturer's Shipments, Inventories and Orders (M3)
Wednesday, November 28, 2007
The Commerce Department reported on Durable Goods today while the markets were engaged in a powerful rally. For the Computers and Electronic Products category, new orders in October fell at a surprising rate, down more than 8%, from the level established in September.
Tuesday, November 27, 2007
Today we heard about the "investment" in Citigroup by an entity controlled by the government of Abu Dhabi. Citi will receive a $7.5 billion cash injection by selling a stake in the firm to the Abu Dhabi Investment Authority, the sovereign wealth fund that acts as the investment arm of the Abu Dhabi government.
The Investment Authority will receive equity units that pay an 11 percent annual yield until they are converted into Citigroup common shares at a price of up to $37.24 a share between March 15, 2010, and Sept. 15, 2011.
I was reminded of a post I recently read at the Information Arbitrage blog. (Read the post here) It was titled "Looking Overseas for a U.S. Financial Sector Bail-Out: It'll Cost You."
The author, Roger Ehrenberg (who also quotes Thorold Barker, a writer for the Financial Times), points out that the sovereign funds have "lots of investable cash at a time when relative bargains might become available. And given the scarcity value of their liquidity and the rough shape of many U.S. financial firms, they will likely demand far more onerous terms than they've gotten previously."
At a coupon rate of 11 percent, Citi is paying junk bond prices for the cash it is receiving. These are indeed terms better than were offered previously. Ehrenberg and Barker seemed to have called the play quite accurately.
There have been a number of publications and blogs that have focused on that 11% rate, considering it expensive and an admission by Citi that they are in desperate shape. There has been one blogger who feels it is a good deal for Citi. Andrew Clavell has written on his blog, Financial Crookery, a post (read it here) that describes how Citi is actually receiving "funds for 4 years at a cost equivalent to another financing source of Libor+150." He refers to it as "smart business" on the part of Citi.
Be that as it may, it also seems to be smart business for the Abu Dhabi Investment Authority who will collect a nice premium to the current dividend.
Disclosure: author is long C
Monday, November 26, 2007
The agricultural equipment sector has been strong this year and appears to be one of the sectors that may provide some relief for stressed investors in this difficult market.
The John Deere Company (DE) recently reported strong earnings that gave the whole market a boost on the day the numbers were announced. Sales in agricultural equipment were very strong though construction equipment sales were somewhat under pressure. Deere provided solid forward guidance despite the risk of a falloff in the market for building construction equipment.
Everyone is familiar with Deere but a lesser known player is AGCO (AG).
AGCO company background --
Here are a few excerpts from the AGCO company profile at Yahoo Finance:
What is significant is that AGCO is more of a pure play on the agricultural equipment sector than Deere. Whereas Deere is somewhat dependent on its analysis that housing will hit bottom in 2008 and construction equipment sales will firm, AGCO has no exposure to this sector. AGCO is focused exclusively on agriculture where a commodities boom has been playing out and providing a solid underpinning for strong sales.
Looking at the chart below, it can be seen that in recent months AGCO has outperformed Deere, the industry bellwether.
Also evident in the chart above, it can be seen that the stock gapped upward at the end of October. This is when it reported Q3 EPS of 77 cents and revenues of $1.61 billion. Analysts had been expecting 47 cents and $1.36 billion. The CEO said that robust farm equipment markets drove strong sales growth and improved operating results. Management also guided FY07 EPS to $2.10-2.20, versus analyst consensus of $1.77 and versus AGCO own expectations back in July of $1.55 to $1.60 per share.
Can the stock go higher?
It would appear AGCO is hitting on all cylinders. Still, there are a few questionable aspects. AGCO is a complicated company, made up of numerous acquisitions. When looking at quarterly financial statements, there is a fair amount of inconsistency. You can see how in Q3 net income surged compared to Q2 yet operating income and revenues were lower in Q3 than in Q2. The quarter was saved by lower interest expense and lower taxes in the United Kingdom and Germany. Are we running into a problem with organic growth?
The other factor that worries me about AGCO is that its stock price is up so much more in percentage terms than the agricultural commodities indexes. Commodities have been in a strong bull market this year. Using either the PowerShares DB Agriculture ETF (DBA) or the PowerShares DB Commodity Index Tracking Fund ETF (DBC) as proxies, it appears commodities are up around 25% in 2007. On the other hand, AGCO is up close to 90% so far in 2007. At some point, it would make sense for a company that is so closely tied to the profitability of the agricultural markets to more closely track those agricultural markets.
Given the negative tone of the markets in general, the questions around organic growth and the strong possibility the stock has gotten ahead of itself and the agricultural markets, I think we may have seen the highs for AGCO.
Disclosure: author owns no shares of AG, DE, DBA or DBC
Saturday, November 24, 2007
The week started off poorly with a Goldman downgrade of Citigroup. Things went further downhill from there. Lowe's, Target and Freddie Mac added to negative tone. We got a little positive blip in October housing starts but the housing market remains far underwater. The Fed released the minutes from their last FOMC meeting and surprised investors by revealing the decision to lower rates was "close". They also provided an economic forecast for 2008 that predicted slower growth due to continued financial market turmoil.
All in all, this week was pretty much like the last few weeks: volatile and in the end, depressing for investors.
Against this backdrop, there has been a higher level of trading in the TradeRadar portfolio and the holdings have changed quite a bit. There were a number of disappointments delivered by TradeRadar stock picks, stops were hit and we have ended up with a more bearish set of investments. Let's look at what happened to these stocks, why we sold or bought and what has happened since. The following comments cover the last month or so of portfolio activity.
Stocks or ETFs we sold --
Starbucks (SBUX) - This was a pick based on a TradeRadar BUY signal. We hit our stop and sold with a 6% loss well before the latest earnings report drove the stock down even further. As Starbucks often does, they put up decent numbers in terms of same store sales and profitability but for the first time they announced that there were fewer transactions per store. Investors took this to mean growth in the US was maxed out and dumped the stock. The stock is no longer in the BUY zone. Thank goodness for the stop we set at $26.
Qualcomm (QCOM) - stopped out during a market downdraft back on October 19 for a loss of a few per cent. The stock had been on a losing streak in terms of of its legal woes. Since that time, QCOM has fallen sharply and rebounded sharply. It has had a few legal opinions go in its favor and recent earnings were robust with decent forward guidance provided by management. Still, as of this week, it is pretty much at the same level where we sold it.
Cisco Systems (CSCO) - Cisco delivered another excellent earnings report but indicated sales to US corporations were "lumpy." This comment precipitated a sell-off in tech stocks and initiated the first leg down of our current market downturn. We hit a stop and ended with a double-digit profit. Great company - hate to see it leave the portfolio. This is one to keep an eye on.
China Automotive (CAAS) - here is another stock pick based on the TradeRadar BUY signal. Here again, year-over-year earnings were great but looking at the sequential numbers, investors worried growth was slowing instead of picking up. Add to this the Chinese government's attempts to slow the economy and reduce lending and suddenly the Chinese automotive market doesn't look so hot. The stock hit a stop and we took a modest loss.
ProShares Ultra Technology ETF (ROM) - this ETF was a victim of the Cisco effect mentioned above. When tech stocks plunged, it fell through our stop and we only managed a small gain.
Big Band Networks (BBND) - with the stock apparently going nowhere and a big loss incurred, this is a good time for tax related selling. So it leaves the portfolio and provides a painful lesson on why stops are essential. We threw away a double-digit gain on this one.
Stocks or ETFs we bought --
PowerShares DB Oil Index ETF (DBO) - picked as a somewhat emotional reaction to high heating oil prices. Still, the trend has been up and looks to continue that way for a while. We have been keeping a tight stop on this one and indeed got stopped out once (with a profit) and decided to buy it again when it resumed its upward climb.
ProShares UltraShort Financial ETF (SKF) - at the time I bought this ETF the question was: will financials keep falling? So far the answer is yes.
SanDisk (SNDK) - Yes, I bought SanDisk again. There were no TradeRadar signals. Saw it had hit a low from which it has rebounded in the prior two years and read that the SIA expected sales of flash memory to grow 20% next year. The stock has not performed well thus far as there is lingering fear of pricing pressure in the NAND flash market.
ProShares UltraShort FTSE/Xinhua China 25 ETF (FXP) - this ETF was bought based on a TradeRadar SELL signal on another ETF, the iShares FTSE/Xinhua China 25 Index (FXI). On both the daily and weekly TradeRadar charts, FXI is a sell and FXP is a way to short the index.
Stocks or ETFs we have continued to hold --
ProShares UltraShort Real Estate ETF (SRS) - continues to perform strongly as REITs continue to weaken.
ProShares UltraShort QQQ (QID) - we bought this ETF quite a while ago, during a downturn back in the first half of 2007. This proved to be way too early. In any case, having previously reduced the position we have now added to the position and are holding it as a proxy for a falling tech sector. Recently, it has moved up nicely but is still under the price where we initially bought it. Averaging the two positions, we are at least getting closer to a break even point.
Generex Biotechnology (GNBT) - bought this a long time ago. As its products gain acceptance and government approval in various countries, the stock bounces up and then settles back. A small investment we are patiently waiting for. I like the pattern it is setting lately of higher highs and higher lows.
Disclosure: as of this writing author is long DBO, SKF, SNDK, FXP, SRS, QID, GNBT
Friday, November 23, 2007
We have seen a consolidation wave begin in the Business Intelligence space. IBM just bought Cognos and Oracle recently bought Hyperion. SAP just announced they are buying Business Objects after barely having time to digest their recent acquisition of Pilot Software.
There are three major database vendors at this time: IBM with their DB2 product, Oracle with their flagship Oracle database and Microsoft with their SQL Server database. IBM and Oracle now have premier, industrial-strength data analysis and reporting products in their product portfolios that complement their core database products. Microsoft has what, Excel?
Actually, Microsoft, like IBM and Oracle, has a suite of proprietary tools that do happen to integrate very well with Excel and SQL Server. Still, IT departments are not deploying the Microsoft tools for heavy-duty corporate use. Microsoft is unique among the big three by their lack of a premier reporting product. It seems safe to assume that Microsoft will be the next major player to buy one of the remaining independent companies in the BI space.
Candidates for acquisition
Informatica and SAS (privately held) have been mentioned as some of the few remaining large players in the sector. There are also a group of smaller players that might make excellent takeover targets for Microsoft. Let's take a look at some of the prime candidates.
Market Cap: $1.4B
Enterprise value/free cash flow: 34.6
Market Cap: $463M
Enterprise value/free cash flow: 21
Market Cap: $1.8B
Enterprise value/free cash flow: 31
Market Cap: $689.3M
Enterprise value/free cash flow: 11.86
Characteristics of the top candidates
Informatica has its strength in data: integration, migration, data warehousing and data synchronization. This is important in large corporations where disparate data sources need to be brought together to provide a complete picture of business performance. Informatica does not offer a strong reporting component.
Actuate is the cheapest in terms of market cap and provides the investor more cash flow for the price. Despite weak revenue growth, the company has shown good growth in net income over the last several quarters and a tight control on costs. The product suite is complementary to Microsoft with a built-in Excel integration capability. Besides strong reporting tools, they offer full cube-based OLAP analytics with multi-dimensional modeling. In addition, Actuate has been a pioneer in deploying true web-based reporting solutions, a feature that expands Microsoft's capability beyond the desktop.
Microstrategy is currently trading at a fairly high valuation, closing at $106 today. After a couple of bad quarters, it has posted a very good 3rd quarter and is almost back up to the level of profitability it last saw at the end of 2006. They offer functionality comparable to Actuate but have a reputation of being more scalable and able to support larger quantities of data and more users. Their product suite includes integration with SAP and strong data mining capabilities. Still this looks somewhat like a comeback story.
SPSS has had its share price crushed recently. For much of the past year, it has suffered from uninspiring revenue growth and uneven results. It's most recent quarter, however, showed improved income based on a jump in revenue and improved cost control. SPSS offers the usual BI tools, data mining, statistics and reporting. SPSS differentiates itself from competitors by emphasizing its Predictive Analysis capability that adds a rules/recommendation engine to the output of their analysis tools to help corporations to identify which initiatives will deliver optimal results and to enable better risk management.
So who might be the best fit for Microsoft?
I think Actuate might be the best fit for Microsoft. Microsoft has been building their SQL Server database into more of an enterprise-caliber product. Actuate, who concentrates on the reporting aspects of BI, can be more easily integrated with Microsoft's SQL Server business strategy. A strong reporting layer on top of a strong database layer would be a good story for Microsoft.
The other candidates may have stronger built-in data warehousing functionality built into their product suites but I am not sure Microsoft would value that kind of capability as they are well along in developing their own capabilities in that area. Informatica has much stronger data integration capabilities that Microsoft's DTS product and, as such, Informatica might make excellent sense as an acquisition from that point of view as opposed to the general category of Business Intelligence.
Financially, Actuate is currently in pretty good shape. Compared to some of its competitors, it has been more consistent lately at delivering solid numbers. With the smallest market cap, it could be the more cost effective alternative and there would be none of the debt associated with an acquisition of SPSS.
In conclusion, Actuate plugs a hole in Microsoft's product lineup, adding a well-known and accepted reporting and analysis solution to the SQL Server product line. It could be easily integrated into Microsoft's business strategy in the BI space and, at a modest market cap, would cause little impact to Microsoft's cash hoard. And I would go further and assert that Informatica would also be a good acquisition for Microsoft. This would yield an industrial-strength, top-to-bottom solution with reporting, data integration and database capabilities.
Disclosure: author owns no shares in any stocks discussed in this article
Tuesday, November 20, 2007
The focus was on the Fed today after they released minutes of the last FOMC meeting and provided their economic forecast for the next several years.
Their expectation for slowing growth has Wall Street holding its breath waiting for more rate cuts. Yet the minutes reveal that the decision to lower rates at the last meeting was a "close call".
It is worth considering what power the Fed has to resolve current market problems with rates alone.
As everyone knows, one the primary problems facing the economy is the "credit crunch." The term "credit crunch" appears in so many articles and blog posts that it sometimes seems to be in danger of losing its impact on investors. That is, until the next financial blow-up that is the result of credit not being easily available or loans or debt offerings being rebuffed. Just look at some of today's examples. It was reported that the $4 billion sale of loans stemming from Cerberus Capital Management's acquisition of Chrysler has been postponed indefinitely, leaving banks holding the bag, I mean, loans. And we also have the spectacle of Freddie Mac scrambling for cash and suggesting a dividend cut might be in order.
Can manipulation of rates alone solve a "credit crunch"? Merrill Lynch has put together some data that shows things aren't that simple.
Merrill periodically publishes their Research Investment Committee Report, known as the RIC Report. This week's report covers a lot of ground but one small part of it provides some thought provoking information related to credit and the Fed.
The following chart shows Merrill's Credit Availability Diffusion Indicator which tallies all of the Fed's loan officer surveys to determine if the banking system is being generous or stingy in its lending practices, and whether lending is getting more or less generous over time (higher scores reflect tighter standards).
To quote the report:
The chart removes any doubt about the severity of the "credit crunch" we are experiencing. Note that rates have been cut twice and the indicator hasn't even paused in its steep upward trajectory. This implies that, though the Fed might cut again at its next meeting, it could be a while before we see an easing in credit markets and a reduction in market volatility.
Credit flows when financial institutions make money available and the chart shows that these institutions are being especially cautious. Caution is not so much a function of rates but of risk aversion. Unfortunately, the Fed can't do much about the attitude of risk managers at financial institutions.
Not to forget one of the other sore spots in today's markets: housing. Tightened lending on the jumbo and sub-prime ends of the housing spectrum will contribute to lengthening the downturn in this industry and make it that much harder to absorb the excess inventory. This is not the kind of news homebuilders want to hear.
Fed futures are already pricing in a 92% chance that the Fed will cut again at their December meeting. Inflation and dollar weakness issues aside, don't be surprised if it doesn't do much to help resolve the "credit crunch."
Monday, November 19, 2007
China Automotive Systems (CAAS) reported 3rd quarter earnings on November 9 and the stock promptly sank.
I have written about the stock previously. The post was titled (with high expectations) "China Automotive -- looking for another good quarter." What went wrong?
Chart Breakdown --
CAAS had been caught in the general market downturn that began in the first few trading days of November. This derailed what was looking like a nice pattern forming that indicated the stock might be bouncing off support and getting ready to start running up again. The support didn't hold and the stock has been trading in a choppy manner before dropping further today. It now looks like the stock could take another leg down before bottoming.
The Numbers --
For the most part, it appears that 3rd quarter earnings were actually quite good. The day earnings were actually announced, the stock ran up nicely but fell back before the end of the day. Here is a rundown of the numbers:
-- Total net sales for the period increased to US$31.2 million, reflecting 39% year-over-year growth;
-- Net sales from steering components for passenger vehicles increased to US$20.2 million, reflecting 49% year-over-year growth;
-- Net sales from steering components for commercial vehicles increased to US$8.11 million, reflecting a 26% increase year-over-year;
-- Operating income increased to US$6.6 million, reflecting 95% year-over-year growth;
-- Net income rose to US$2.6 million, reflecting 68% year-over-year growth;
-- Diluted earnings per share were US$0.11, an increase of 57% year-over-year
Why didn't these numbers kick the stock into overdrive? First, note that all the results listed above are year-over-year numbers. Compared to the previous year, the results are indeed excellent. Looking at the numbers from a sequential point of view, however, not everything is so wonderful.
The first thing that jumps out is that sequential revenue is actually lower compared to the 2nd quarter. This has the downstream effect of causing a quarter-over-quarter decline in gross profit. Operating income was only 5% higher in the 3rd quarter than it was in the 2nd quarter.
A decrease in unit cost was partially offset by a decrease in selling prices which in the end resulted in the decrease in gross profit. Gross margin slipped a bit year-over-year which also contributed.
The company received an income tax refund of $801,059 for domestic equipment purchased during the 3rd quarter, which was reflected as a reduction of income tax expense in the company's consolidated statements of operations. Overall financial results would have been worse if this one-time tax benefit had not occurred.
Not everything is negative. The company did manage to keep a tight rein on costs.
With the agreement with Volkswagen in place, I had expected to see an accelerated improvement in China Automotive's numbers. Though management pointed to the 3rd quarter as historically a slow season in the Chinese automotive market, I had the expectation that it would be able to overcome the slowdown due to increases in manufacturing and partner agreements. That just didn't happen.
Still, the company claims to be growing faster than the market, specifically the Chinese market. On an annual basis, results should be clearly better than the previous year. Unfortunately, it appears that the Chinese government is trying to cool off the entire economy by putting limits on bank lending. This will not bode well for the automotive sector as the vast majority of vehicles are purchased via auto loans. As a result, CAAS will, for now, only merit a place on our watchlist.
Disclosure: author no longer holds shares in CAAS
Note to users of the TradeRadar software -- the FTSE/Xinhua China 25 Index ETF (FXI) generated a SELL signal about a week ago. Using a start date in early March of this year, you will see a clear signal with all green lights on the dashboard.
No one can be sure if this is the bursting of the Chinese stock bubble. If you are interested in a trading opportunity, however, there is now an inverse ETF that will allow you to take a bearish position. It is the ProShares UltraShort FTSE/Xinhua China 25 (FXP).
This TradeRadar SELL signal is based on daily data. Looking at a weekly chart, the SELL signal is not quite as strong as the daily signal but almost. As a result, this may not signal the big crash in Chinese stocks but it seems there is a good potential to see the intermediate term downturn continue for a while.
Knowing how volatile the underlying index is, caution is advised. Be sure to determine a stop before opening the position.
Disclosure: author is nibbling on a few shares of FXP
Saturday, November 17, 2007
It has been one whole year since I started writing this blog and trying to document both my opinions on the markets and my experiences using the TradeRadar software.
In terms of writing on topics of interest related to stocks, ETFs and the economy, I know I have gone in many directions but I hope that I have at least hit a few areas that have been of value to you, the readers. Many times I have tried to pull together information in such a way that a new point of view can be derived. Other times I have tried to be informative on a subject in which I myself wanted to know more. In any case, I want to thank everyone for visiting this site and taking time to read the posts and leave your comments. Feel free to leave suggestions on new topics you might like to see covered.
As for using the TradeRadar software and attempting to trade based on its signals, it has been an interesting journey. There are a couple of general points that I would like make.
One of the pieces of advice that many stock trading gurus provide is that investors should keep a journal of their trades. Why they elected to open the position, why they chose to close the position and what was the result. This is how investors can most effectively learn from their experiences. This blog has served as my journal, a very public journal.
What are some of the things I have learned? The first one is that I am better at buying stocks than I am at selling them. Over the past year I have watched a number of profitable positions go bad by not selling in time. Sometimes these were cases where the time between buying the stock and the optimal selling point was too short for the TradeRadar software to generate a clear signal in time. Other times I allowed my hope for a recovery to overcome my common sense. This is why I have adopted the practice of setting stops and communicating them in both this blog and on the TradeRadar Track Profit & Loss page. Where I am unclear about the future of a stock or ETF, you will see that I adjust the stop accordingly, tightening it up to ensure capital is preserved.
(For those of you who have downloaded the TradeRadar software, you can use the Portfolio feature to keep your trading journal for each stock that you may purchase. You may also join the TradeRadar Users group which allows you start your own blog that can be private or viewable by other members of the user group.)
Recently, I received a comment on my picking Starbucks as a Pick 'o the Month. The person took me to task for picking a loser and potentially costing my readers money. I sometimes pick stocks based on a positive trend's continuation (Cisco Systems, for example) but when using the TradeRadar software, stocks are picked because a trend appears to be broken. This means we look for stocks that have been viewed in a negative light, whose stock prices have been declining. The TradeRadar software attempts to identify when this kind of stock has hit bottom and has begun a reversal. There is risk to that approach. The stock could disappoint again and resume its downtrend. That is what happened with Starbucks, for example.
What all this means is that the TradeRadar software attempts to identify out-of-favor stocks that are beginning to show signs of a recovery. With Starbucks, we set a stop that prevented us from taking much of a loss. The fact that the stock eventually fell in spite of generating a BUY signal shows that there were a good number of buyers who also believed the reversal was imminent.
As users of the TradeRadar software, we need to understand what the signal is saying. It may be better to use weekly data rather than daily data to generate BUY/SELL signals in order to be more assured that a true reversal is taking place. I have typically used daily data and, as you can see, I have not always been right. Using weekly data, however, may cause the signal to be delayed and you may miss quick swings up or down that can cost you profit or capital. This can be an especially acute issue in today's volatile markets.
In any case, as I experiment with the TradeRadar software and attempt to improve its functionality and my trading techniques, I will keep you informed. Now that the User Group is in place, I encourage you to leave your opinions and experiences regarding your trading and your use of the software.
Once again, thanks to everyone for visiting this site. It has been an interesting year to be involved in the stock market and I have enjoyed sharing my thoughts with all of you. I look forward to continuing this blog and, in a crowded blogosphere, I hope I can continue to earn your attention.
Friday, November 16, 2007
Industrial Production numbers for October were released today by the Federal Reserve. It was a somewhat dismal report with decreases across all categories compared to the previous month.
I wanted to see how the numbers were trending so I plotted the Manufacturing sector (in red in the chart below) versus SPY, the SPDR S&P 500 ETF (in brown in the chart).
As can be seen, Manufacturing hit its peak in July of 2007 at a reading of 116.6; SPY, on the other hand, was at that time on its way down to the August lows. Since then stocks have recovered, made new highs and are currently in another downtrend.
To do a few comparisons, during the time period covered by the chart above, Manufacturing has gained 5.16% since November 2005. The S&P has gained 19.7% even after the decline shown in the last segment of the chart.
In 2005, manufacturing comprised 12.2% of GDP, roughly the same percentage contributed to the nation's output by the government. Interestingly, the real estate-rental-leasing sector also contributes a similar percentage. Finance and retail make up the next largest segments at about 7% to 8% each.
So, adding it up, we have about 40% of GDP made up of manufacturing, real estate, financial and retail. These are precisely the market sectors that are under the most pressure these days. With manufacturing prone to multi-year cycles, there is the potential that we are only in the beginning of a downtrend there. There is a good chance that with respect to real estate and financials the worst is still to come. Recent earnings warnings from retailers don't do much to bolster confidence in that sector either.
All that being said, it is quite possible to draw the conclusion that stocks will come down from here. Manufacturing is just one more point of confirmation.
Sources: FRB Industrial Production and Capacity Utilization
Thursday, November 15, 2007
In a recent post I wrote how Goldman Sachs and others could be facing deeper write-downs as the result of FASB Rule 157.
There has been news that the rule has been deferred for one year. In actuality, the FASB has only chosen a partial deferral. The rule takes effect today as scheduled for financial assets and liabilities of financial institutions. Accounting in compliance with the rule will be deferred for one year for non-financial assets and liabilities.
The FASB statement is brief and the full text of the announcement is below:
FASB Rejects Deferral of Statement 157 for Financial Assets and Liabilities
Partial Deferral Granted for Nonfinancial Assets and Nonfinancial Liabilities
Norwalk, CT, November 14, 2007-At its Board meeting today, the Financial Accounting Standards Board (FASB) reaffirmed its vote against a blanket deferral of Statement 157, Fair Value Measurements. For fiscal years beginning after November 15, 2007, companies will be required to implement the standard for financial assets and liabilities, as well as for any other assets and liabilities that are carried at fair value on a recurring basis in financial statements. As a result, Statement 157
becomes effective as originally scheduled in accounting for the financial assets and liabilities of financial institutions.
The Board did, however, provide a one year deferral for the implementation of Statement 157 for other nonfinancial assets and liabilities. An exposure draft will be issued for comment in the near future on this partial deferral. The audiocast of the November 14th meeting is currently available at www.fasb.org. More information about topics discussed and decisions reached at the meeting will also be posted on the FASB website in the coming days."
Unless SIVs, CDOs and MBSs are somehow considered "non-financial" it still looks like many financial stocks will get hit with the full force of reality in pricing their illiquid Level 3 assets. This could get very ugly.
Barry Ritholz has written a good post on this subject. You can read it here.
Disclosure: author owns no stocks mentioned on this article
Wednesday, November 14, 2007
As we head into the close today, SanDisk (SNDK) is trading well under $40 per share. It is in the vicinity of the lowest prices it has seen in the past two years. It was last at this level in July 2006 and then again in March 2007. It now has a forward PE of about 15 and a PEG ratio of 1.03. These indicators suggest that SanDisk is reasonably priced.
Recap: why the shares have been beaten down --
Earlier this week, market research firm iSuppli downgraded its rating on near-term conditions for suppliers of NAND and DRAM memory chips to "negative" based on expectations that the average selling price for 512 Mbit NAND will drop 24% in the fourth quarter, to 46 cents from 60 cents, after having seen price increases in the previous two quarters.
Last month, Needham and Oppenheimer both downgraded the stock when shares were up around $48. Their message was that supply from competitors looked to increase and pricing could weaken. There were also questions on how solid demand appeared to be going forward. Yet the downgrades came only two weeks after a report by EETimes magazine saying Toshiba's NAND supplies were sold out through December. Toshiba and SanDisk are joint-venture partners in a semiconductor fab in Japan.
Is there a catalyst that would prompt a buy signal?
Today, the Semiconductor Industry Association released their prediction of global semiconductor sales growth for this year and next year. By far and away, Flash memory sales growth is projected to be higher than any other category of semiconductor. Looking at the CAGR for 2010, Flash comes in at 20% while at the other end of the spectrum, DRAM comes in at 1.5%. The remaining categories are distributed in a range between 5.5% and 9.1%.
Also mentioned in the SIA report, is the fact that growth has been driven by strong world-wide demand in consumer devices. This is a market segment where Flash is an important component and where we are seeing high rates of NAND bit growth.
With SanDisk still the preeminent player in NAND Flash memory, the SIA prediction could help put a floor under the share price. It is my opinion that buying SanDisk at the current level presents good opportunity with modest risk. In the last two years, the two times SanDisk traded down to the upper $30's, a strong rally followed. With tech stocks currently under pressure, SanDisk could even get a bit cheaper for those interested in taking a position.
Sources: SIA Forecast: Global Chip Sales Will Surpass $321 Billion in 2010
Disclosure: author is long SNDK as of late Tuesday
Tuesday, November 13, 2007
Financial stocks rallied today. The Select Sector Financial SPDR (XLF) was up 4.69%. The KBW Bank ETF (KBE) was up 4.63%
What was behind the gains today? WalMart reported good earnings and provided decent forward guidance but I don't think that did much for the banks. Apple selling iPhones in China? Not likely. Many analysts attributed the rally to comments by Goldman Sachs (GS) CEO Lloyd Blankfein saying that Goldman doesn't expect to take any significant write downs and has a "pretty good grip" on asset valuations. Furthermore, it is said that Goldman has short positions in subprime mortgages.
All that is well and good; however, there is a good possibility that Blankfein is being a little too sanguine on the situation. Last week there were several blogs that wrote about FASB Rule 157.
The general thrust if Rule 157 is that assets and liabilities should be valued at market prices and take risk into account. It will make it harder for companies to avoid putting market prices on securities considered hardest to value, known as Level 3 assets.
The fair value hierarchy --
In the fair value hierarchy, Level 1 is simple mark-to-market, whereby an asset's value is based on an actual price. Level 2, known as mark-to-model and used when there aren't any quoted prices available, is an estimate based on observable inputs.
Level 3 consists of unobservable inputs, such as those that reflect the reporting entity's own assumptions about what market participants would use to price the asset or liability (including risk), developed using the best information available without undue cost and effort, according to FASB.
Impacts on Goldman --
In a recent report, Bob Janjuah, Royal Bank of Scotland's chief credit strategist, noted that according to Bloomberg, Goldman Sachs has a Level 3 to Equity ratio of 185%. This is based on an estimated Equity base of $39B and Level 3 assets of $72B. Compare these numbers to Merrill Lynch (MER). Merrill's Equity base is $42B, Level 3 assets are $16B and Level 3 to Equity ratio is 38%. Of the six big investment banks listed by Janjuan, the only company with a worse Level 3 to Equity ratio than Goldman is Morgan Stanley.
So is today's bank rally premature?
FASB 157 is effective for fiscal years that begin after November 15, 2007. This means, for the most part, we won't see the real hits to bank assets until after first quarter of 2008. Banks can party on for a few more months but I suspect there are some CEO's praying the credit market comes back to life and SIVs, CDOs and MBSs regain some value by the time FASB 157 begins to have an impact . Otherwise, they may well have to take another round of write downs that would put further downward pressure on the credit markets, wreak havoc on balance sheets and possibly put some other CEOs out of a job. Better hope for the best, Lloyd.
Disclosure: author has no positions in any stocks mentioned in this article
Sunday, November 11, 2007
The long run of outperformance tech stocks have enjoyed came to an end this week. Cisco and Qualcomm failed to provide forward guidance to Wall Street's liking and tech stocks were treated like tainted financials; ie, they sold off with a vengeance.
The technical outlook --
With financials already dragging the markets down, the collapse of tech has removed on of the major supports for the major averages. We now see both the Dow and the S&P 500 falling below their 200-day moving averages. We also see the 20-day moving averages just about crossing below the 50-day moving averages. This situation occurred in August and the markets recovered; unfortunately, there is no guarantee that history will repeat itself.
Especially ominous are the intra-day charts. It can often be seen these last few days that volume is heaviest on down moves. This can be observed looking at both financial and tech ETFs. This is not a good sign.
There some analysts who say the financial and economic situations are worse than in August so the market is probably heading down. There are value players saying stocks, especially financials, are getting cheap and that now might be the time to buy. As there are always two sides to every trade, there are always two ways to look at the markets. No matter which group is correct in their analysis, the charts are clearly signaling "caution."
The week coming up --
The week hasn't even started and the financial sector is raking in more bad news. Bank of America and JP Morgan Chase announced late Friday that their fourth quarters would be affected by issues surrounding exposure to CDO's. E*Trade announced an SEC investigation into its mortgage trading and that earnings would be hit by the deteriorating value of its mortgage portfolio. Rumors continue to dog Barclay's concerning their sub-prime holdings and HSBC is reported to be ready to announce another round of write-downs. Financials can't get out of their own way.
According to the New York Times, Bank of America, Citigroup and J.P. Morgan Chase have finally agreed on how to structure a fund to help stabilize the credit markets. Sounds good but will it help? To quote the Times:
Interestingly, their were no bombs dropped over the weekend concerning any tech stocks, only reports that short interest has spiked in Microsoft. Have we seen the beginning of a rotation out of tech or just another buying opportunity? Stay tuned...
As for potentially market moving economic reports, we will see the latest on producer prices and consumer prices reported on Wednesday and Thursday, respectively. October retail sales is due on Wednesday and October industrial production and capacity utilization on Friday. The September pending home sales index will be reported Tuesday. Anything that hints inflation is increasing or the economy is slowing down could potentially trigger another sell-off.
The TradeRadar Model Portfolio --
The gyrations in the markets this week caused us to hit stops in several of our holdings and encouraged us to pick up another inverse sector ETF. Details can be found on the TradeRadar Track Profit & Loss page and in the following posts: Financials tank but ultrashort ETF is up nicely and Overweight tech no longer. The titles say it all.
Citi (C) has spent the last five years pushing risk prevention and regulatory compliance deep into the corporate culture, right down to the lowest levels. Under the leadership of Chuck Prince, the lawyer picked to head one of the world's largest financial institutions, no process detail has been too small for Citi's internal auditors to obsess over.
It is therefore quite ironic to see Citi undone by the flagrant lack of risk management at the highest levels in their fixed income and investment bank segments. SIVs seem like an easy way to make money? Citi had to be the biggest player. Sub-prime mortgages kicking out high interest rates? Grab as many as you can. CDO's look like a good place to park some money? More is better.
Evaluate the risk in all of this? Why bother? The pressure is on to expand profits; after all, this is the "year of no excuses." And no one gets fat bonuses by being timid, right?
So with so much of the debt on Citi's books going from "mark-to-model" to "mark to who knows what?" the risk clouds that started to gather on Citi's horizon are sure to continue to swirl around the company for months to come. Add to that the weakening of the US economy and the attendant raising of loan loss reserves to cover bad credit card and consumer debt and Citi is clearly in for more pain.
To me this seems like a classic case of misplaced focus as Citi chose to sweat the small stuff while letting the big stuff get out of hand. Citi has been penny wise and pound foolish.
Disclosure: author owns shares of C in a retirement account
Thursday, November 8, 2007
It wasn't so long ago that I wrote a post titled "Why I'm Overweight Tech". After today's volatile day, I can no longer say that I'm overweight tech.
After Cisco's report of a very good quarter and good but not great guidance, tech stocks sold off heavily. As for the TradeRadar model porfolio, both Cisco (CSCO) and the ProShares Ultra Tech ETF (ROM) hit their stops and were sold. ROM ended up returning only a couple of percent during the short time we held it but gains on CSCO were about 18%.
It is telling that Cisco's guidance had such a lethal effect on the markets. Here is an example of investors suddenly looking at the glass as half empty rather than half full. As other bloggers have put it, today we realized we could no longer hide in tech while the rest of the market (financials, homebuilders, cosumer discretionary and recently retailers) showed signs of weakening.
A bear by default --
As a result of the stops that were hit today, the model portfolio has taken on a bit of a bearish tinge. We have held a little of the ProShares UltraShort QQQ ETF (QID) for some time now. We continue to hold the ProShares UltraShort Real Estate ETF (SRS) and we recently bought the ProShares UltraShort Financials ETF (SKF).
In other portfolio news, we were also stopped out of China Automotive Systems (CAAS). For the last several days the stock has rallied most of the day only to crumble going into the close. Today it just headed straight down to the point where it was sold.
What's next --
I have no clue if this is the beginning of a bear market or just another hiccup. The damage to the charts indicates to me that we will need to wait for a while to see what direction the trend will take from here. Certainly there is plenty of bad news fueling the bearish outlook.
What I do know, however, is that the long term story on Cisco remains strong and the company continues to dominate its competition. The same can be said for other tech companies like SanDisk (SNDK). I intend to watch and wait and hopefully find low risk, lower priced entry points for each.
Disclosure: author holds QID, SKF and SRS
Wednesday, November 7, 2007
Investors were greeted with a barrage of bad news this morning. GM reporting its worst quarter ever including a charge of $39B. Rumors of a $3B to $6B writedown at Morgan Stanley. Gold futures up, the dollar down. Estimates that the value of broken buy-out deals will total $200B this year. Ratings agencies downgrading $92B in corporate bonds. Reports of $5B of defaults in CDOs. Banks like Washington Mutual and Citi continued to garner bad press with conjectures of more writedowns, law suits, etc. Bloggers were starting to use phrases like "perfect storm". Stock futures indicated a big down day on the way.
In thinking about which sector would be hardest hit, it seemed that the financials were about to really take it on the chin. Looking at the Select Sector Financial SPDR (XLF), it is already down about 18% this year. Could it go lower?
I have written about avoiding chasing trends when using sector ETFs. In the case of the financials, the trend has been clearly down for a while now. But surveying the day's news I began to get a knot in my stomach. Yes, I felt, the financials could continue on their downtrend.
After the open, I bought some shares of the ProShares UltraShort Financial ETF (SKF) at $93.46. The ETF closed the day at $99.55 for a 6.5% gain and new 52-week high.
Disclosure: author owns SKF
Tuesday, November 6, 2007
Facebook made their formal announcement today of how their new ad platform will work. Founder Mark Zuckerberg made an enthusiastic presentation at ad:tech in New York, outlining several new sets of functionality.
Facebook Ads --
This is the primary advertising vehicle. As described in the press release:
Advertisers can design custom pages with information, content, and custom applications--"any application that was written for users on the Facebook Platform," Zuckerberg explained. Facebook users can sign up as "fans" of that brand, install branded applications (games, etc.), that will all show up in their profiles' "mini feeds" and on the "news feeds" that are broadcast to their friends lists. Once an advertiser has built a page, Facebook users can become a fan of a business and can share information about that business with their friends and act as a trusted referral. This is the viral and social aspect that Zuckerberg touted as one of the marketing breakthroughs of the new system.
Another quote from the press release that further emphasizes the social and viral aspect:
The third component is called Insights. This analytics functionality gives marketers metrics about their presence and promotion on Facebook, provides access to data on activity, fan demographics, ad performance and trends that better equip marketers to improve custom content on Facebook and adjust ad targeting. It is expected that this is where Facebook will let marketers see all the ways they can slice and dice user demographics, interests and activities.
Beacons allow users to share their actions on 44 participating sites with their friends on Facebook. The websites participating in Beacon can determine the most relevant and appropriate set of actions from their sites that users can distribute on Facebook. These actions can include posting an item for sale on eBay, completing a purchase, viewing of video, buying movie tickets on Fandango or buying airline tickets on Travelocity. When users who are logged into Facebook visit a participating site, they receive a prompt asking whether to they want to share those activities with their friends on Facebook. If they do, those friends can now view those actions through News Feeds or Mini-Feed stories. These actions were touted as brand endorsements by Zuckerberg.
Facebook also announced that 60 companies have immediately committed to using Facebook Ads. Partners joining Zuckerberg on the stage today included senior executives from Blockbuster, CBS, Chase, The Coca-Cola Company, Sony Pictures and Verizon.
What was not announced --
There was speculation in the blogosphere that Facebook would announce the creation of an ad network. No reference was made to anything that ambitious. For now, it seems clear that the Facebook site itself will be the focus of the initiatives announced today.
Time for the Facebook backlash?
Call me grumpy, but from my point of view the company has identified some great ways to annoy users with a constant barrage of ads and, in the process of so doing, create plenty of reasons for privacy advocates to begin targeting the site.
Zuckerberg is convinced that advertising messages can be spread virally. I am sure that some can, if they are humorous enough or otherwise entertaining. To me, though, it just seems like this is just a good line to attract advertisers to the site. After all, how often have you ever wanted to share an ad with your friends or been moved to endorse a brand in a communication to a friend?
The improvement in precise ad targeting based on the use of Facebook user data should initially increase click-through rates. I suspect advertisers will flock to Facebook to try to take advantage of it. Still, I would not be surprised to see Facebook users eventually begin to ignore these ads as energetically as they currently ignore ads on the site. When users begin to see the increase in number and types of ad material being presented it will reduce the overall impact of the ads.
As for the privacy issues, it appears that Facebook is lagging the financial industry, for example, in protecting users privacy. It has been discussed on ValleyWag and other blogs that Facebook developers have access to production data, ie, the personal profiles of all those users. The company is supposedly scrambling now to tighten its controls. Today's announcement indicates that all that data will now be presented to advertisers, supposedly scrubbed of personally identifiable information (PII), in an aggregated manner. Still, I find it hard to believe that every user will be comfortable allowing all their information to be shared with advertisers. This is an issue the Google OpenSocial initiative, and the various partners involved in it, will have to face, as well.
Sources: Press releases for Facebook Ads and Facebook Beacons
Monday, November 5, 2007
Back in October, Rogers Corp. (ROG) boosted its outlook for 3rd quarter earnings and its stock moved up nicely. At the time, they indicated they expected earnings, excluding items, of 44 cents to 48 cents a share for the third quarter, up from its prior view of 32 cents to 35 cents a share. The chart started looking pretty good and the TradeRadar software flashed a BUY signal (read the original post).
Actual earnings were reported late last week and the results exceeded raised expectations. So why did the stock take a dive? Management pointed to Durel.
So what is Durel? The Durel Division manufactures Electroluminescent (EL) backlighting systems for wireless telecommunications, portable electronics, automotive, signage and timepiece applications. One reason for this quarter's good earnings is an unexpected $3.6 million increase from forecasted sales of Durel products related to mature cell phone programs. This one time benefit of those Durel sales totaling $1.7 million in pre-tax profits, or $0.06 per diluted share, is not projected to repeat in the future. Therein lies the problem. But more on that later.
First, the numbers --
Third quarter 2007:
- Sales: $ 109,626
- Net Income: $ 8,950
- Net EPS: $ 0.51
Third quarter 2006:
- Sales: $ 121,588
- Net Income: $ 17,179
- Net EPS: $ 0.99
As can be seen, year-over-year numbers look pretty bad so let's look at income over the last five sequential quarters.
- 3Q06: $17.2M
- 4Q06: $12.7M
- 1Q07: $9.5M
- 2Q07: ($4.3M)
and then this quarter, 3Q07: $8.95M.
Sequentially, we see income declining until Rogers posts a loss in the second quarter of this year. The third quarter, just reported, represents a return to profitability and, according to the TradeRadar software, a confirmed reversal.
Forward guidance --
Robert D. Wachob, Rogers' President and CEO, provided the following comment:
So, even after removing the effects of the one time gains related to the Durel division, fourth quarter guidance represents a modest decrease over the third quarter. This was a disappointment to those investors who were hoping the Rogers turnaround would accelerate. Still, investors can take solace in the fact that the company seems to be firmly back in profitable territory. Let's hope the company can build on this somewhat improving picture.
Thursday, November 1, 2007
Having recently invested in the PowerShares DB Oil Index ETF(DBO), the following statement caught my interest today:
Clearly, the average investor would find it difficult to know with any accuracy what the inventory levels are for most commodities. Gorton and colleagues have determined that investors can infer inventory levels from futures- and spot-pricing data.
Here is the background as Gorton and his associates describe it:
Futures markets provide insurance against future price volatility. So, when low inventories heighten the risk of price volatility, the cost of this insurance can be expected to rise. That translates into bigger returns for the contract holders who take on these bigger risks."
To investigate the premise, they looked at three types of portfolios comprised of 31 commodities over the time period from 1969 through 2006. One portfolio was based on high-inventories, one was based on low inventories and one was a simple index composed of equal amounts of each commodity. The high-inventory portfolio returned 4.62%, the equal weight portfolio returned 8.98% and the low-inventory portfolio returned 13.34%.
So how identify those commodities with low inventory? Investors can look at the difference between the spot price today and futures prices. When inventories fall, the spot price rises because supply is low relative to demand. The futures price may rise as well but not so much, because traders believe inventories will gradually be replenished before the contracted delivery dates arrive. As a result, the gap between spot and futures prices widens. The wider the gap, the the higher the potential return
Gorton and his colleagues looked at holding a basket of the commodities with the best indicated returns based on the difference between spot and futures prices. What if we looked at one commodity, crude oil, example.
As of 11/1, the spot price of crude oil was $93.49. The December contract is the same. But starting with the January contract, the futures prices begin to decline. By April, it's under $90. Futures prices continue to decline for each month's contract by roughly $.60 per month.
So it appears we don't have a major gap between crude oil spot and futures prices but it appears there may be enough of a gap to support prices in the current vicinity. Heating oil and natural gas show very small gaps.
Looking at wheat and corn, the gap is in the opposite direction, indicating high inventories. Similarly, metals are not displaying futures prices that indicate inventories are tight.
Using this approach, it appears that oil is the place to be if you feel the need to invest in the commodity markets.
Sources: The Inventory Code: New Ways Investors Can Cash In on Volatile Commodities, futures prices courtesy of Barchart.com
Disclosure: author is long DBO
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