Sunday, December 19, 2010

'Tis the season for top ten lists and financial prognostication

Year’s end is a time for publishing top ten lists covering topics such as the best movies, books, music, sports teams, weight-lose techniques, and New Year’s resolutions. In the world of investing, it is also the season for financial prognostication. Among the most frequently discussed predictions are those addressing how the S&P 500 index will perform in the coming year. For 2011, all major Wall Street strategists have a positive outlook for the S&P 500’s performance, with targets ranging from a low-end 1.2% increase to a high-end performance of 10%, based on this past Friday’s market close.

MY TAKE: Financial and economic forecasting remains a dismal science with little data supporting their accuracy. However, Wall Street strategists are not uniquely challenged in this regard. Projections from organizations such as the World Bank, the International Monetary Fund and the U.S. Department of Commerce’s Bureau of Economic Analysis suffer similar challenges. Bottom line - Most investors remain hopeful for the future, but are cognizant of the economic challenges facing many major economies. Similar to top ten lists, financial and economic predictions are always great topics for debate. The year ahead will provide us with much to consider.

Monday, December 13, 2010

Getting aboard, with High-Speed Rail

Earlier this month, the California High Speed Rail Authority Board voted to begin construction of the main phase of the system, a 520-mile span connecting Los Angeles and San Francisco, with construction costs estimated at $43 billion. At the same time, the Chinese government plans to spend $600 billion to expand its network of high-speed rail coverage. Additionally, its railway companies including CSR Corporation Limited and China Railway Group Ltd. are forming partnerships with industrial manufacturers Alstom, Bombardier Inc. and General Electric Corp. to develop new rail systems around the world.

MY TAKE:  While China expands its global high-speed rail presence, which includes high-speed links with Thailand and Laos and a passenger train that travels at a world record speed of 302 miles per hour, U.S. based projects remain controversial. Opponents suggest the projects are too expensive or wasteful, while supporters state that potential benefits include reductions in fossil fuel dependency, job creation and reduced transportation congestion. This past week, after governors in Ohio and Wisconsin decided not to move forward with somewhat questionable high-speed rail projects, the U.S. Department of Transportation announced it would redirect $1.2 billion of federal funding to projects in California, Oregon and Washington. Successful completion of these projects will likely require private sector investment and a less polarized political environment.

The following is a CNN Video on High Speed Rail in China (February 2010)

Sunday, December 12, 2010

Globally, a week with mixed market action

This past week, investors in U.S. equities benefited from news of an extension of the Bush tax cuts, increased U.S. consumer confidence, a narrowing of the U.S. – China trade gap, a continuation of jobless claim benefits, along with markets that were less concerned about European sovereign debt issues. On Saturday, the Chinese government said its consumer price index rose 5.1 percent in November. This is the largest increase in 28 months driven by sharp price increases in food, retail sales and property construction.

MY TAKE: As some markets have moved higher, there seems to be a sense of “Risk On” with analysts increasing their 2011 estimates. I would suggest a more cautious approach as we move toward the end of the year. While “decoupling” among major global markets may take place, this is generally not the case. If inflation in China persists, there are significant implications for investors globally.

Sunday, December 5, 2010

Foreclosure processing update

In my October 10 note, I highlighted the home foreclosure processing problems in the US and that while most participants wanted to minimize the financial impact to themselves and to the economy, there remained a challenge in balancing the desire for expediency with “rule of law” processes. On November 16, the US Congressional Oversight Panel released the report “Examining the Consequences of Mortgage Irregularities for Financial Stability and Foreclosure Mitigation” and stated the following: “Allegations of ‘robo-signing’ are deeply disturbing and have given rise to ongoing federal and state investigations. At this point, the ultimate implications remain unclear. It is possible, however, that “robo-signing” may have concealed much deeper problems in the mortgage market that could potentially threaten financial stability and undermine the government's efforts to mitigate the foreclosure crisis.”

MY TAKE: Foreclosure processing will likely proceed at a slow pace as judges, along with state and federal regulators, continue their reviews. The implications for large money center banks and their investors, as well as the financial system remain unclear.

Socially responsible, sustainable and hopefully profitable investing

Historically, socially responsible investing (SRI) has been associated with a strategy of avoiding companies involved in “vices” such as guns, gambling, alcohol and tobacco. A more modern view also focuses on ethics (perhaps avoiding firms that negatively affect the global economy) and sustainability (protecting the environment and managing the planet’s limited natural resources). As a result, today’s more expanded view includes investment opportunities in areas such as water treatment, energy conservation, agricultural production and pollution management.

MY TAKE: The broad array of SRI and sustainable investment opportunities include innovative emerging companies and industries (such as alternative energy) as well as the transformation of traditional industries (such as transportation and oil production). As investors, we must understand the risks. As with most investing activities, the SRI and sustainable themes do not guarantee profits. Issues to consider include 1) the negative impact of the credit and financial crises on project funding, 2) regulatory confusion, 3) the potential for pricing pressure and commoditization and 4) weak business models. I look forward to discussing this important topic with you in more detail as we move into the New Year.

Sunday, November 28, 2010

Is our world full of "black swan" events?

In his 2007 book “The Black Swan: The Impact of the Highly Improbable”, Nassim Taleb commented that the impact of hard-to-predict and rare events can shape society and that “Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability”. Since then, many events have reshaped the global economy into a less certain place.

MY TAKE: To the extent that uncertainty is now the norm, investors may begin to factor uncertainty into their processes. However, obtaining superior investment returns may require approaches that anticipate changes in asset price direction and are executed in a nimble and opportunistic fashion. If these strategies become more prevalent, market volatility will persist.

Black smoke rises over South Korea

On Tuesday, North Korea bombed South Korea’s Yeonpyeong Island, which is located in the Yellow Sea just off the west coast of North Korea. The assault resulted in the death of four people and the destruction of dozens of homes. As the week progressed, South Korea’s defense minister resigned because he was not prepared for the attack and tensions in the region increased.

MY TAKE: North Korea is considered a “rogue nation” on the international scene and this action coupled with increasing concerns about its highly enriched uranium program is very unsettling. While South Korea has yet to initiate a strong response to the attack, news reports suggest additional military action may take place. Such action would likely increase the volatility in most global markets.

Black Friday - is the U.S consumer coming back?

With consumer spending accounting for about 70% of the U.S, economy, “Black Friday”, the start of the holiday shopping season, is a significant event to evaluate. While the media focused on pre-dawn openings at stores such as Best Buy Co. Inc. (US: BBY), Target Corp. (US: TGT), Macys, Inc. (US: M) and Wal-Mart Stores, Inc. (US: WMT), analysts are also assessing the “Cyber Monday” effect, which incorporates the impact of on-line sales.

MY TAKE: The U.S. Commerce Department reported that third quarter consumer spending increased at a 2.8 percent annual rate, the strongest since 2006. As a result, positive holiday sales would likely be well received by investors. However, holiday sales are one among many factors that determine the short-term tone of the global investment landscape.

Sunday, November 21, 2010

Another wild week: markets zig down and then zig up

Last week, many markets moved down strongly on Tuesday, only to reverse in an equally strong positive direction on Thursday driven by a variety of positive and negative news. Investors, traders and speculators continue to react to 1) recent news headlines, such as European sovereign debt issues and concerns that economic growth in China may slow; 2) a broad array of economic statistics dealing with unemployment, consumer confidence, housing starts, foreclosures rates (some of which may be revised up or down at a later date) and 3) various technical indications: overbought, oversold, support, resistance, etc.

MY TAKE: Markets are likely to remain jittery with the economic news-flow driven by monetary and fiscal policy debates that include the assessment of austerity measures, entitlements cuts, and government bailouts; with an increasing focus on the future role of the U.S. Federal Reserve and central bankers. Expect volatility to persist.

On the Road with General Motors: An IPO Story

On Thursday, shares of General Motors (US: GM; Canada: GMM) began trading, after raising $23 billion in the largest initial public offering (IPO) in US history. With a history extending back to 1897, the timeline of this iconic American firm includes its high profile Tomorrow-land exhibit at the 1964 World Fair in New York, its critical treatment in Michael Moore’s 1989 film “Roger & Me” and its recent bailout by the US and Canadian governments which led some people to feel that GM stood for “Government Motors”. Viewed in a global context, GM is number two in vehicle sales in China (the world’s largest market for vehicles), behind Volkswagen and is number three in Brazil, behind Fiat and VW.

MY TAKE: During the two-week global road show for the IPO, there was great enthusiasm about this stock offering among investors. From an investment perspective, GM still has significant competitive threats from VW, Hyundai, Ford and other emerging players. Additionally, the firm must service substantial legacy pension obligations. For the U.S. government to recover its $50 billion investment, the U.S. Treasury Department has to sell its remaining 500 million shares at an average price of $53 (Friday’s close was $34.26). Please note: 98% of the shares purchased in the IPO were sold on the first day of trading – are there any long-term investors? The road ahead for GM could be tricky.

Sunday, November 14, 2010

Is the tone of the global markets changing?

Since August, when the U.S. Federal Reserve suggested that more monetary stimulus was coming, most markets have moved in an investor-friendly fashion. More recently, concerns have been creeping back into the markets. Dynamics on the investment dashboard include sovereign debt issues in Ireland, a rising U.S. dollar against major currencies, potential interest rate increases in China to curb inflation, a sharp correction in the U.S. Municipal Bond market and a major sell-off in network equipment maker Cisco Systems, Inc. (US: CSCO) who noted weakness in government sector demand among its short term challenges.

MY TAKE: While these dynamics may present a “buy on weakness” opportunity, my Risk Monitor (which incorporates equity volatility and credit data from the US and European markets) leaned a bit more toward caution. As a result, I increased my hedged position, which may be just a short-term trade. Regarding the impact of economic stimulus efforts, I continue to be concerned. I hope that the road ahead is not similar to that of the drug addict – the first fix feels good, the follow-up fixes only result in feeling less bad.

Gee-whiz G-20, how about some straight talk!

The Group of Twenty (G-20) provides a forum for global leaders to discuss international financial system issues. Its members are finance ministers and central bankers from Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, United Kingdom, United States, the European Union along with representation from the World Bank and the International Monetary Fund. This past week’s meeting was held in Seoul, South Korea. Among the messages from this session, the confusing text “These indicative guidelines composed of a range of indicators would serve as a mechanism to facilitate timely identification of large imbalances that require preventive and corrective actions to be taken.”

MY TAKE: G20 meetings provide 1) great opportunities for group photos of world leaders, 2) a nice economic infusion of tourism and hospitality trade for the host location and 3) expectations that may be met with mixed results. This meeting delivered on all three points.

Sunday, November 7, 2010

Go San Francisco, Go Barranquilla, Go Giants!

On Monday, the San Francisco Giants baseball team made history when they won their first World Series since moving to San Francisco in 1958. While the win took place at an away game against the Texas Ranges, our city instantly erupted into celebrations which continued through Wednesday when the team was welcome home to an amazing ticker tape parade.

MY TAKE: Here in San Francisco, it was an amazing week. Enhancing the moment was the ability to share it with our family and friends in Barranquilla Colombia where celebrations also occurred (this coastal city is the hometown of Edgar Renteria, the Giants Most Valuable Player for the series - his 3-run home run locked up the championship for the team). In addition, a World Series win is generally quite good for the local economy. Yahoo!

U.S Fed actions meet expectations, spark market rally and generate criticism

On Wednesday 3, the Federal Open Market Committee (FOMC) - a 12-member group of U.S. Federal Reserve members, announced that it would pump an addition $600 billion to the market to help improve the US economy. This action by the Fed had been anticipated since mid August. While many global markets rallied on this announcement, the news received mixed reviews internationally. Perhaps the harshest comments, presented in the Financial Times and Der Spiegel, come from Germany’s Finance Minister Wolfgang Schäuble who describes US policy as “clueless”, that its actions “increase the insecurity in the world economy” and “It is not consistent when the Americans accuse the Chinese of exchange rate manipulation and then steer the dollar exchange rate artificially lower with the help of their printing press”.

MY TAKE: Perhaps the more things change, the more they remain the same. In 1971, when responding to criticisms about US effort to devalue the dollar, then US Secretary of the Treasury John Connolly told global finance ministers “the dollar is our currency, but your problem”. If this view remains true today, conventional wisdom suggests that the Fed’s actions should continue to drive equity and commodity prices higher while driving the US dollar lower against most major currencies. However, these are not conventional times and global economic uncertainty remains. At a minimum, investors should assess how much of the “good news” has already been priced into the market since mid August, when markets started to move higher. Note: As G20 leaders meet in Seoul, South Korea this week, perhaps we will learn if Mr. Connolly’s comments remain applicable in today’s environment.

Sunday, October 31, 2010

Will the Fed meet expectations?

On November 2-3, the highly anticipated meeting of the Federal Open Market Committee (FOMC), a 12-member group of US Federal Reserve members that establishes credit and interest rate policies, will take place. Since mid-August, members of the Fed have been suggesting that significant action will be announced at this session to help improve the US economy. While the size and timing of such intervention is unclear, expectations range between $500 billion and $1 trillion dollars.

MY TAKE: Investors are a bit edgy as we approach this event. Equity markets have had a strong rally in anticipation of another round of quantitative easing (expectations of economic and financial engineering can have this type of effect on markets). However, while bailouts and printing money can help to stabilize an economy, such actions may be less effective in stimulating improved productivity and growth. Longer-term improvements will likely be more dependent on international trade dynamics and renewed consumer demand. Note that meetings by the European Central Bank, the Bank of England, the Bank of Japan and the Reserve Bank of Australia also take place this week. Bottom line – it is likely that market volatility will persist.

As election day approaches, a focus on Proposition B incerases

There is not enough space on this note to catalogue the media circus associated with this year’s mid-term election cycle in the United States. Therefore, I will focus a single topic close to home. In San Francisco, Proposition B is on Tuesday’s ballot. This proposition addresses Pension Reform and, if passed, would require city employees to increase their contribution to health care and pension costs. Similar to many cities, states and countries; when the economy was booming, investment returns addressed a large part of San Francisco's pension obligation. However, that is no longer the case. The city is now expected to contribute an increasing part of its operating budget to address pension costs, which reduces the funds available for other city services.

MY TAKE: Globally, addressing pension obligation issues will require many hard choices. The core debate focuses on how to preserve critical government services and protect jobs, while avoiding politically expedient “quick fixes”, or “kicking the can down the road”. The outcome of the vote in San Francisco may help to shape the larger pension fund debate. Taking a broader view of the US political landscape, Tuesday’s elections will likely provide several surprises for investors to factor into their market outlook.

Sunday, October 17, 2010

Bernanke's Fed wants some inflation to fight off deflation

On Friday, Chairman Ben Bernanke said the Federal Reserve "is prepared to take new action to boost the economy, because inflation has been too low of late and unemployment is poised to come down too slowly". He also noted, "there are clearly many challenges in communicating and conducting monetary policy in a low-inflation environment, including the uncertainties associated with the use of nonconventional policy tools".

MY TAKE: For many weeks, the market has been expecting the Fed to pursue another round of quantitative easing (printing more money). The expected outcome from such action should be a decline in long-term interest rates, an increased appetite for riskier assets such as equities and a weaker dollar that could help to increase exports. However, complicating the landscape are issues such as 1) many nations want to devalue their currency to address economic issues, 2) commercial banks may continue to increase their capital reserves to deal with non-performing loan portfolios instead of increasing lending and 3) terms such as "uncertainties" and "nonconventional" suggest that the Fed may be in a reactive mode as it navigates uncharted economic territory.

Saturday, October 16, 2010

Forclosure processing update - financial stocks take a hit

A week ago, I highlighted the issues related to potential home foreclosure processing problems in the US. Firms with potential exposure saw their stocks take a hit for the week: Bank of America Corp. (US: BAC) down 9.1%, Citigroup Inc. (US: C) down 5.7%, Goldman Sachs Group Inc. (US: GS) down 1.3%, J.P. Morgan Chase & Co. (US: JPM) down 5.5%, PNC Financial Services Group, Inc. (US: PNC) down 3.3%, and Wells Fargo & Co. (US: WFC) down 9.1%. It is being reported that the US Securities and Exchange Commission, the Department of Justice, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation are also joining the examination of the foreclosure issue.

MY TAKE: Most participants involved in this problem are hoping to both quickly resolve it and to minimize the financial impact to themselves and to the economy. The challenge is balancing the desire for expediency with “rule of law” processes. The concluding acts of the era of “no doc” mortgages and “no doc” foreclosures will likely involve modifying the terms of many mortgages and the settlement of many yet to be filed lawsuits. The price tag could be in the billions of dollars.

Sunday, October 10, 2010

Is cloud computing hitting an air pocket?

In late August, my comment "Is 3PAR frenzy" a 3-ring circus?" highlighted the high valuation of this "cloud computing" acquisition that resulted from a bidding war between Dell, Inc. (US: DELL) and Hewlett-Packard (US: HPQ). While cloud computing has been an interesting theme in the technology market for a while, investor enthusiasm for 1) a major technology transition, 2) an open ended market opportunity or 3) some price charts with strong upward moves was overdone. This past week Equinix, Inc. (US: EQIX), a firm associated with the cloud computing theme, announced a slight earning shortfall which resulted in a one day stock drop of over 30% and sent the stocks of other related names such as Citrix Systems Inc. (US: CTXS), Rackspace Hosting (US: RAX), VMware Inc. (US: VMW),, Inc. (US: CRM), and F5 Networks Inc. (US: FFIV) down 7% or more.

MY TAKE: This week's price action should be a reality check for cloud computing investors. While these companies have fundamental business propositions, cloud computing is not a spiritual experience. Investors should be cautious about 1) merger and acquisition frenzy, 2) momentum trading and 3) media cheerleading. Investing is never a simple process and understanding valuation is important. The stock valuations of this group were very extended.

Forclosure processing: a small problem, or is there something more going on?

In recent weeks, lawmakers and the attorney generals in many states in the US are focusing on the foreclosure of thousands of homes where processing may have taking place without the proper review of supporting documentation As a result, J.P. Morgan Chase & Co. (US: JPM), Bank of America Corp. (US: BAC), Ally Financial Inc. (previously known as GMAC), PNC Financial Services Group, Inc. (US: PNC) and Litton Loan Servicing LP - a unit of Goldman Sachs Group Inc. (US: GS) have temporarily halted foreclosures as they review their processes and legal exposures.

MY TAKE: Among the contributing factors leading to the housing bubble were poor lending practices by mortgage originators. Today, as the market seeks stability in US residential housing, it appears that similar sloppy processes are being applied to foreclosures. The foreclosure slowdown may be a temporary issue (estimates suggesting there may millions of pending and completed foreclosures requiring review). If substantive processing issues are revealed, confidence among potential home purchasers could be undermined, which may stall an already fragile housing market. If legal probes and actions expand, we will likely learn more about Reston, VA based Mortgage Electronic Registration Systems Inc. (MERS). MERS acted as an intermediary in processing mortgage. Its shareholders include several of the larger market participants and its motto is "process loans, not paperwork".

Sunday, October 3, 2010

More on Sam Zell in Latin America

Last week, I mentioned that Mr. Zell's Equity International (EI) unit was increasing its focus on Mexican and Colombian real-estate firms.

On Friday, EI reported that it had trimmed its holding in Brazilian homebuilder Gafisa S.A. (Brazil:GFSA3, US: GFA) and property manager BR Malls Participacoes S.A. (Brazil:BRML3). EI's chief executive officer Gary Garrabrant, said. "Today's transactions simply reflect the ongoing execution of EI's disciplined and proven monetization philosophy." In other words, it is time to take some profits.

Flash Crash: US regulators provide their report

During the days preceding May 6, 2010, concerns about European debt issues and a potential Greek default were placing stress on global markets. On that day, US equity markets began to trade down at an accelerating pace as many systematic traders exited the markets – a factor contributing to the “Flash Crash” where stocks moved wildly and the S&P 500 dropped by 8.5% at point during the day. This past Friday, the US Securities and Exchange Commission and the Commodity Futures Trading Commission released a joint report on this matter. Several news articles are highlighting that a large unnamed trader (likely to be Kansas based mutual fund Waddell & Reed) pursing an automated futures contract trading strategy increased the instability of the markets. The regulator’s report notes that our current trading environment remains complicated because 1) there are several sources of data feeding into the markets, 2) data communication methods vary, 3) the volume of quotes, orders, and trades are high and 4) the laws of physics create inherent time lags in how information is handled.

MY TAKE: High frequency trading (HFT), according to the Tabb Group, accounts for 56% of equity trades in the US and 38% in Europe. This sub-second trading arms race is less about assessing business and economic fundamentals, and more about leveraging a mix of quantitative algorithms, high performance supercomputers, finely tuned communication networks and a server’s proximity to exchanges. The exchanges like HFT because they generate significant trading revenue (note: there are plans for co-located data centers next to exchanges in Hong Kong, India, and Australia to support HFT). Yes- the US regulators have approved “circuit breakers” that should pause trading in moments of market instability. However, it seems they remain behind the curve on the effect HFT may have on increasingly interdependent markets where speculative trading volumes are increasing and transparency is low.

Sunday, September 26, 2010

Going Global: Thoughts on investing in Emerging Markets

Investors are increasingly aware of the opportunities in developing regions around the world. The focus on the BRIC countries - Brazil, Russia, India and China (the acronym was introduced by Goldman Sach's Jim O'Neill in a 2001 paper entitled "The World Needs Better Economic BRICs") addressed the shift in global economic power toward the developing world. Growth drivers include a large market opportunity, coupled with the growth of a large, youthful and increasing affluent population that needs improved physical infrastructure, better health services, and a broader array of consumer goods. In addition, these countries are significant players as both global importers and exporters of a broad array of products and services. A broader view of the developing market opportunity should be considered which includes Argentina, Chile, Colombia, Czech Republic, Egypt, Hong Kong, Hungary, Indonesia, Jordan, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Saudi Arabia, Singapore, South Africa, South Korea, Taiwan, Thailand and Turkey among others.

This past week, Bloomberg News noted that billionaire investor Sam Zell's Equity International unit is increasing its focus on Mexican and Colombian real-estate firms. At the same time, Financial Times columnist Martin Wolf highlighted the cautionary comments from Chinese premier Wen Jiabao who stated, "In the case of China, there is a lack of balance, co-ordination and sustainability in economic development." Wolf 's concern is that "The longer rebalancing is postponed, the more painful the adjustment will be. The Chinese economy of two decades from now will have to be vastly less investment-driven than the one of today. How smoothly and how soon will it get there? These are huge questions."

MY TAKE: While there is a mantra of "buy emerging markets", investors should not lose focus on the need to understand the business drivers, valuation and risks associated with potential investments. Understanding the maturing and stability of the investment environment in each region is also important. This week, as a brief primer, I am sharing several charts which compare the per capita gross domestic product (GDP), population and population density for the largest (by population) economic regions globally; along with the International Finance Corp's Investor Protection Index ratings which measures the strength of shareholder protection from asset misuse by directors. In the coming weeks, I look forward to expanding this discussion with you.

Sunday, September 19, 2010

Is dividend yield, an investment topic, long out of style, now back in fashion>

As structural changes are reshaping the global economy, significant changes are taking place among investors about their strategies as well. Driving these changes are 1) concerns about persistent equity market volatility 2) how lower economic growth may limit the potential for stock price appreciation, 3) the impact of declining interest rates on investment portfolios and 4) the potential for increase risk aversion as many investors move toward retirement. In an environment where investors are interested in "what CAN you do for me?" rather that "what MIGHT you do for me?"

investments that provide hard cash to shareholders in the form of dividend payouts has increased appeal. To provide additional context to the dividend yield topic, please consider the following: as of Friday's market close, 104 of S&P 500 stocks in the US provided a dividend yield of 3% or higher, and 9 companies provided a yield of 6% or higher. In Europe, 246 companies in the DJ STOXX 600 provided dividend yield above 3%, 54 were above 6% with the highest providing an annual yield of 15.5%. When reviewing a universe of publicly traded limited partnerships and real estate investment trusts (REITS) in the US, there are 140 with an annual dividend yield greater than 3%, 68 above 6% and the highest provided a yield of 18.9%.

MY TAKE: As treasury yields have dropped into record low territory, stocks with a dividend yield of 3% or higher, provide an interesting investment alternative. In addition, as cash has increased on many corporate balance sheets, some companies which have historically been reserved about providing a dividend, such as Cisco Systems (US: CSCO), are moving in this direction as well. It is important to understand that investments options are never without risk. While providing a dividend payout is generally a sign of a strong company, the investment should be assessed on both the potential future dividend yield and the safety of the principal (the price of the stock). When considering high dividend yield investment ideas, an understanding of both a company's financial health and its capacity to pay dividends over a long period of time are important. A track record of consistent or improving earnings and free cash flow growth should be helpful tools in assessing the quality and potential risks related to these investments.

Sunday, September 12, 2010

Trading ranges, trend breaks, the new normal and understanding valuation risk.

The long-term bull market that began in the early 1980s and concluded in 2007 provided a very “equities-friendly” environment for many investors. More recently, the market reversal toward the end of April and the “trading range” trap where asset prices swing up and down from week to week has been frustrating. Investors focusing on fundamental company analysis are challenged by the strong influence of macro-economic issues such as sovereign debt, unemployment, housing and slowing economic growth. Against this backdrop, some pundits suggest that stocks should be purchased at current levels because they are cheap.

MY TAKE: Over the long term, financial markets move through economic cycles that can have significantly different investment dynamics. It is important to understand how the risk profile can change when moving from a bullish to a bearish phase. Our current period, often referred to as "the New Normal" - a phrase popularized by Pimco’s CEO and co-chief investment Mohamed El-Erian, suggests an environment with lower investment returns, slower economic growth and higher than normal risk.

Over the past 100 years, three major “trend breaks” have occurred in the US: during the 1930s, the 1970s and the current period. Chart 1 (see page 2) presents the performance of the S&P 500 since 1960 and highlights the two “trend breaks” during this period. Historically, significant economic changes trigger trend breaks. These breaks can alter investor’s views on how asset prices are valued along with their appetite for investment risk. While no two economic cycles are similar, it is helpful to understand how asset valuations have been affected in the past. For example, the average price to earning (P/E) ratio for the S&P 500 from 1960 to the present is 16.6. The high, during 1999, was 29.8 and the low, during 1980, was 6.9. When a trend break occurred during the 1970s, the S&P 500 entered a twelve-year period during which the S&P 500 traded in a P/E range of between 7 and 13. At Friday’s close, the S&P 500 traded at a P/E of 14.6. Given the current level of economic uncertainty, bull market P/E ratios may not be a helpful guide. It is also likely that many of the investment tools and processes developed and used during positive (bullish) phases become less effective during negative (bearish) phases. My approach remains cautious and I continue to apply a process that focuses on managing risk and analyzes free cash flow yield dynamics.

Sunday, September 5, 2010

Westfield, New Jersey gets a debt rating downgrade

This past week,  the Town of Westfield, located about 25 miles southwest of New York City, had its debt rating reduced by Moody's Investors Service to Aa2. This community has about 30,000 residents and a median family income twice the national average. Notable residents have included Charles Addams (cartoonist for The New Yorker magazine, and creator of The Addams Family), Butch Woolfolk (National Football League running back), Jeff Torborg (Major League Baseball player and manager), Kevin Kelly (founder of Wired magazine) and Robert Greifeld (CEO of NASDAQ).
I grew up in this town during the 1960s and 1970s. It is an upper-middle class commuter town known for its good schools with good sports teams. Today, it faces challenges confronting many communities across the U.S. Its tax base has contracted. The State of New Jersey has placed limits on the town's ability to increase property-taxes. Now, as this suburan community struggles to meet its expense obligations, it has reduced municipal jobs. Bottom  Line: We may be near the economic bottom of the financial crisis, but we are not out of the woods.

Perhaps there will be no"V' shaped recovery or double-dip disater

Another week of cross-currents with 1) stronger economic data from China and Australia, 2) the Institute for Supply Management's index on U.S. manufacturing activity rose to 56.3 in August (expectations were for a decline to 53.2) and 3) while the US unemployment report on Friday was mixed, the results could be interpreted as "while not getting much better, it was not getting much worse". President Obama's comments on Friday presented his view of the situation in the US: "There's no quick fix for this recession. The hard truth is that it took years to create our current economic problems, and it will take more time than any of us would like to repair the damage."

MY TAKE: Investors have significantly debated the potential for deflation, inflation, a double-dip or a "V" shaped recovery as they position their portfolios. However, what happens if we just end up with a "muddling-along" economy? If this is the case, some investors and money managers, in an attempt to generate positive returns, may move beyond their traditional comfort zone and extend the reach of their processes. Such approaches can lead to costly mistakes. In this environment, job number one remains "risk management".

Sunday, August 29, 2010

Is "3PAR frenzy" a 3-ring circus?

On August 18, data storage firm 3PAR, Inc. (US: PAR) traded at $9.65 a share which valued the firm at about $600 million. On August 20, a bidding war started between Dell, Inc. (US: DELL) and Hewlett-Packard (US: HPQ). This process has driven the company's value up to $2 billion.

MY TAKE: The technology industry buzz is that personal computers are in decline and that "cloud computing" (is this a fancy term for "time sharing"?) is where the action is. Given that 3PAR's revenue for the past four quarters totals about $97 million, understanding the business leverage to be achieved from this transaction may be a challenge. In the short term, one of the big winners from this deal is 3PAR's advisor- Qatalyst Partners led by Frank Quattrone. Is the frenzy associated with this deal based on a brilliant strategy, a bubble or corporate "dumb and dumber" syndrome? - only time will tell.

Beyond bullish and bearish - just be pragmatic

The past week's news flow included 1) a decline of 27.6% in US home resales during July (a more modest 13.4% decline was expected), 2) US second quarter GDP, as reported by the US Commerce Department, grew at a 1.6% annual rate (a decrease from last months 2.4% estimate and 3) Intel Corp. (US: INTC) cut its third-quarter revenue forecast because of weak consumer demand for personal computers in mature markets. When U.S. Federal Reserve Chairmen Ben Bernanke addressed policy makers and economists in Jackson Hole, Wyoming; he said "the task of economic recovery and repair remains far from complete," and "in many countries, including the United States and most other advanced industrial nations, growth during the past year has been too slow, and joblessness remains too high".

MY TAKE: Bernanke's comment that the Fed "will do all that it can", along with a short-term trading view that "markets are oversold and ready for a bounce" helped support a rally in US equities on Friday. However, debates persist on how to deal with 1) the potential of deflation and/or inflation, 2) slowing economic growth and 3) continued unemployment. There are also concerns that the Fed's ability to address the economic challenges is in decline. Uncertainty is the enemy of investors and uncertainty remains high. Be pragmatic in your investment decisions and heed the words of Warren Buffett: "Rule No.1 is never lose money. Rule No.2 is never forget rule number one."

Sunday, August 22, 2010

Notes from "Clean Technology Investing: A Global Perspective"

With recent news of floods in Pakistan, fires in Russia, and glaciers cracking in Greenland, my 45-minute presentation in San Francisco last week seemed timely. The session notes below provide an overview on the topic.
The clean technology market is broad and diverse and includes solutions based on:
  • geothermal - deriving energy from within the earth,
  • wind - using mechanisms such as wind turbines,
  • bio-fuels - based on plants (sugar, corn, algae) and waste,
  • solar which converts the sun's rays to thermal or electrical energy,
  • portable storage such as lithium ion batteries, hydrogen fuel cells and ultra-capacitors,
  • water-driven hydroelectric power using dams, tidal waves, etc.,
  • carbon sequestration - which captures harmful CO2 emissions and
  •  nuclear fission based power.
To illustrate potential uses of clean technologies, I provided the following examples: 1) wind power use at the Nelson Mandela Bay Stadium during the World Cup in South Africa, 2) the 26-hour flight of Solar Impulse, a solar powered light carbon-fiber aircraft, over Switzerland this past July and 3) investigations by Pacific Gas & Electric (PG&E) in California to launch satellites capable of converting the sun's rays into radio waves and beam the energy to receiving stations on the ground. Public equity investment ideas for consideration included Power-One, Inc. (US: PWER) - a provider of power conversion systems; Cosan Limited (US: CZZ)a leading producer of sugar and ethanol, Quimica y Minera de Chile (Chile: SQM/A, US: SQM) a provider of lithium as well as potash and potassium nitrate based fertilizer products and General Cable Corp. (US: BGC) a provider of copper, aluminum and fiber optic wire and cable products.

Yes - addressing global economic instability is a high priority by policy makers, but the need to minimize environmental damage to the planet and reduce dependence on fossil fuels has not disappeared.
Challenges confronting this market include:
  • the impact of the financial crisis (this past week Vestas Wind Systems A/S (Denmark: VWS, US: VWSYF), a provider of wind turbines, said demand was negatively impacted by the credit crisis - the stock dropped 25% for the week),
  • regulatory confusion and
  • achieving grid parity - the point where alternative energy sources are equal to or cheaper than incumbent energy sources. While about 200 "clean tech" companies publicaly trade in the US, significant venture capital investment is supporting innovation in this market. Investors should seek companies with strong business models and the capacity for sustainable performance. The potential to generate free cash flow is a useful indicator in this analysis.

Sunday, August 15, 2010

Cisco Systems' John Chambers joins the “Unusual Uncertainty” choir.

Last week, Cisco Systems (US: CSCO), the world’s largest maker of networking equipment, reported quarterly results and its stock dropped 10 %. During the earning conference call with investors, CEO John Chambers reiterated a view recently presented by Federal Reserve chairman Ben Bernanke - he warned of “unusual uncertainty” in the economy.

My first meeting with Mr. Chambers was in 1994 – just three guys sitting in a small conference room at JP Morgan (Chambers had not yet assumed the role of CEO). Since then, I have listened to him on conference calls, attended his presentations at investor events, and spoke with him at a business function at the Dead Sea outside of Amman, Jordan in 2004. He is the leading “perma-bull“ in an industry populated with extreme optimists. While he may be signaling a momentary “speed bump”, he is also known for choosing his words very carefully. Cisco is more than a technology bellwether; it is a global leader in a significant industry. Investors should not take his comments lightly.

What lies ahead for Europeans as they return from summer holiday?

Several weeks ago, European banks published results of a banking system stress test. With only seven banks failing out of ninety-one tested, European central bankers celebrated its success. Last week, Germany reported strong GDP growth (2.2% from last quarter), France’s report was more moderate (0.6% growth from last quarter) while other countries reported weaker results.

MY TAKE: Recently Greek, Italian and Portuguese banks increased their borrowings from the ECB, a signal that the challenges facing the European banking system have not been resolved. Additionally, similar to the United States, the Eurozone is moving into the "post-stimulus" stage of its economic cycle. The true “stress test” for Eurozone members will be the level of resilience these economies can maintain in an environment of weak growth and decreased risk tolerance. To gauge the level of recovery or weakness in the Eurozone, it will be important to monitor borrowing trends from the ECB along with the performance of credit markets; which have been sending a cautionary message in recent days.

Sunday, August 8, 2010

More about the “risk on, risk off” monitor

Last week, I noted that shorter duration “risk-on” (bullish) and “risk-off” (bearish) investment phases will likely replace the persistent bull market (1980s through October 1997). While stock picking and asset selection remain critically important skills, it is equally important to understand the current market risk phase.

MY TAKE: As of Friday’s market close, the S&P 500 and FTSE 100 remained in “risk-off” (bearish) mode for medium to long term investors, while maintaining a “risk on” (bullish) status for short term traders. The risk monitor (which incorporates a broad set of market data) was helpful in identifying the most recent “risk off” phase that developed during April, along with several other significant turns in the market. As always, please be aware that market conditions are subject to change.

U.S. unemployment - the big "Ouch"!

On Friday, the U.S. employment report was disappointing. During July, 131,000 jobs were lost, with results impacted by the termination of temporary 2010 census staff. The private sector added 71,000 jobs, but expectations were for 90,000, and the unemployment rate remained at 9.5%. On this news, US equity markets initially fell about 1.5%, but moved to more moderate losses by the end of the day. The much larger and more influential bond market (consisting of corporate, consumer and government debt instruments) reacted in a less enthusiastic manner. Notably, the US 10-year Treasury yield dropped to 2.8% (the lowest since April 2009) and 2-year Treasuries dropped to 0.51% (an all-time low).

MY TAKE: While the recent equity rally received significant attention by the media and investors, bearish trends in the bond market, while volatile, should not be overlooked. Recent bond market moves suggest that concerns about slower economic growth and the potential for deflation persist. Additionally, economists have been cutting 2011 U.S. GDP growth estimates (the most recent cut from Goldman Sachs on Friday, reducing its estimate to 1.9% from 2.5%). Some economists believe an annual rate of 3.5% is required to stabilize the economy. Adding to investor confusion are recent positive corporate earnings and manufacturing data. Volatility will likely persist as investors seek answers to: 1) how much of the “good news” resulted from corporate cost cuts and government stimulus spending, 2) how will additional stimulus spending, if it is injected into the system, be interpreted by investors and 3) when will corporations start hiring/investing and stop hoarding cash?

Sunday, August 1, 2010

Navigating the “risk on, risk off” investment landscape.

From the early 1980s through October 1997, investors benefitted from a persistent “risk on” (bullish) market. In today’s environment, the timing and duration of “risk on” and “risk off” (bearish) periods will be difficult to predict. Understanding when they begin and end will be a critical component to investment and risk management strategies.

MY TAKE: Investors must be nimble and adaptive to the changing landscape. I have added a process to monitor “risk-on, risk-off” market changes to my investment toolbox (more details will be shared in the coming weeks). As of Friday’s market close, the S&P 500 and FTSE 100 were among the market indexes in “risk-off” mode, but that could change soon.

Continuing the uncertain journey

After three weeks of quarterly financial reports from S&P 500 companies, three hundred and nine firms collectively reported an 11% annual revenue growth rate. Additionally, on Friday, the U.S. Department of Commerce announced that second quarter GDP grew at a slightly lower than expected annual rate of 2.4%.

MY TAKE: As economic cross currents and confusion persist, equity markets swing wildly intraday as moves are dominated by 1) systematic and high frequency trading systems, 2) leveraged exchange traded fund (ETF) speculators and 3) portfolio managers playing the "trading range" game. Within this context, please consider the following thought from Warren Buffett: "Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."

Sunday, July 25, 2010

Volatility - Get use to it!

During the past two weeks, one hundred forty-eight of S&P 500 companies reported quarterly results. One hundred fifteen of these companies delivered positive results with total year over year revenue from this group increasing by approximately 9%. Additionally, on Friday, General Electric Company (US: GE) unexpectedly increased its quarterly dividend in a sign of confidence about its future.

MY TAKE: Given the rally off the July lows, recent stability in the price of copper and a potentially improving tone in Asia; if several US economic data releases scheduled for this week support an improving view, we may have hit bottom. Until then, both bulls and bears have plenty of data to support their market perspective.

For European banks – skepticism will continue

As expected, European banks published results of the banking stress test on Friday. Ninety-one banks were tested and seven failed.

MY TAKE: Prior to publishing the results, investors were skeptical of the testing process. Given that 1) only a small number of banks failed, 2) the tests identified a potential capital short fall of only 3.5 billion Euros, 3) some banks performed the tests on their own and 4) some banks did not release details of the impact of a potential sovereign debt default; investors will likely remain skeptical of this process.

The certainty of an “unusually uncertain” environment

During testimony to the U.S. Congress last week, Federal Reserve Chairman Ben Bernanke noted that the outlook for the economy is “unusually uncertain.” In Germany, the Ifo institute reported a significant increase in business confidence for June. In the UK, the Office for National Statistics said its preliminary estimate for gross domestic product was an increase of 1.1% for the second quarter. At the same time, a closely followed index (because of its “better than most” ability to identify potential US recessions) from the Economic Cycle Research Institute (ECRI) had its Weekly Leading Index (WLI) decline for the seventh consecutive week to -10.5.

MY TAKE: It is unlikely the number of crosscurrents confronting investors will decline in the near term. Consumer and business sentiment continue to be on a roller coaster ride as concerns about potential government spending cuts, tax increases and managing sovereign debt issues persist.

Wednesday, January 6, 2010

Seth Klarman (The Baupost Group) interview at the Ben Graham Centre for Value Investing.

While Warren Buffet remains the highest profile investor of our time, another investor worth becoming familiar with is Seth Klarman. His firm, The Baupost Group, focuses on value investing and has been notable for holding significant amounts of cash in its portfolios if suitable investment opportunities are not present.

In 1991, Klarman wrote "Margin of Safety, Risk Averse Investing Strategies for the Thoughtful Investor" which is an out-of-print value investing classic.

Click here to access his March 2009 interview at the Ben Graham Center for Value Investing. The video's duration is a little over one hour. It is time well spent.