Thursday, October 30, 2008

Economic models explained by...cows

I stole this from another blogger from my alumni site, Paula Lorenz (who knows where she read it):

The 2008 update

You have 2 cows.
You give one to your neighbour.

You have 2 cows.
The State takes both and gives you some milk.

You have 2 cows.
The State takes both and sells you some milk.

You have 2 cows.
The State takes both and shoots you.

You have 2 cows.
The State takes both, shoots one, milks the other, and then
throws the milk away...

You have two cows.
You sell one and buy a bull.
Your herd multiplies, and the economy grows.
You sell them and retire on the income.

You have two giraffes.
The government requires you to take harmonica lessons

You have two cows.
You sell one, and force the other to produce the milk of four cows.
Later, you hire a consultant to analyse why the cow has dropped dead.

You have two cows.
You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows.
The milk rights of the six cows are transferred via an intermediary to a Cayman Island
Company secretly owned by the majority shareholder who sells the rights to all seven cows back to your listed company. The annual report says the company owns eight cows, with an option on one more. You sell one cow to buy a new president of the United States ,leaving you with nine cows. No balance sheet provided with the release. The public then buys your bull.

You have two cows.
You go on strike, organize a riot, and block the roads, because you want three cows.

You have two cows.
You redesign them so they are one-tenth the size of an ordinary cow and produce twenty times the milk. You then create a clever cow cartoon image called 'Cowkimon' and market it worldwide.

You have two cows.
You re-engineer them so they live for 100 years, eat once a month, and milk themselves.

You have two cows, but you don't know where they are.
You decide to have lunch.

You have two cows.
You count them and learn you have five cows.
You count them again and learn you have 42 cows.
You count them again and learn you have 2 cows.
You stop counting cows and open another bottle of vodka.

You have 5000 cows. None of them belong to you.
You charge the owners for storing them.

You have two cows.
You have 300 people milking them.
You claim that you have full employment, and high bovine productivity.
You arrest the newsman who reported the real situation.

You have two cows.
You worship them.

You have two cows.
Both are mad.

Everyone thinks you have lots of cows.
You tell them that you have none.
No-one believes you, so they bomb you and invade your country.
You still have no cows, but at least now you are part of Democracy....

You have two cows.
Business seems pretty good.
You close the office and go for a few beers to celebrate.

You have two cows.
The one on the left looks very attractive.

And the bonus, recently added:

Your cows are really soy plants.
You claim the milk they produce tastes just as good but uses less energy to produce, and no one buys it. (No animals were harmed in writing this comment)

Monday, October 27, 2008

The other side of calls and puts...

Most speculators buy calls and puts, looking to earn exponential returns if they guess right on the movement of shares. Reading charts and using technical analysis, as well as exercising discipline and pricing models are pre-requisites in order to succeed. A great sense of timing--and luck help.

I normally don't like to do it, but selling covered calls is actually a conservative strategy to increase income and overall returns, so I've been known to utilize that strategy occasionally.

And I've never entertained selling puts--until now. Due to high volatility (as measured by the volatility index) and extreme uncertainty in the markets, options premiums have been astronomical. Hence, I sold a few puts on INTC, collecting the premiums, and lowering my entry point on Intel shares, should they dip below my strike price. If they don't hit, I still keep the premiums. Not a bad way to make money by doing nothing and standing pat.

And if the world were to end tomorrow, people will still go on-line, so Intel will be one of the strong brands that will be left standing. They have dominant market share, a strong cash position, no debt, and high margins. I like them at the present price, but I like 'em even more if the price falls further.

Bargain basement

Any bargain hunters who have ever been to Boston know of two names: Filene's Basement, and the No-Name restaurant. The former gets you designer rags for pennies on the dollar, especially factoring in the age of the apparel, as time erodes its price. The latter is a no-nonsense Maine lobster house, where prices are half of the more famous Legal Seafood chain and local favorite SkipJack's. There is no ambiance, but you get the true local flavor of what Boston is famous for: lobstah and chowdah. With both time-honored institutions, you get value, something you couldn't get from the nearby mutual fund industry--at least, not until now.

With the implosion of the stock market, due to hedge fund and mutual fund redemptions, it's time to nibble at this double-bottom (October 10 was a secular bottom, in my opinion). I picked up a couple natural gas plays, one a pipeline outfitter for both domestic oil and natural gas. With oil demand destruction driving crude prices lower, natural gas prices have fallen in tandem, as the markets brace for a long, crushing recession (some are predicting an outright depression).

But while oil is an indicator of economic activity, with the transportation and manufacturing industries being major consumers, natural gas is not as interconnected to the overall economy. Sure, we'll turn our thermostats lower this winter in the hopes of reducing our energy bill, but natural gas is more tied to consumer use than industrial use. My thesis is that natural gas use will decline, but not by 80%, as recent market prices suggest. We'll still use natural gas, and public transportation fleet vehicles are converting over to natural gas in increasing numbers, since they burn cleaner. Besides, if T. Boone Pickens is on that side of the bet, I want to be next to him.

But here is the kicker: the owners of these natural gas pipelines are like toll-booths--they just collect revenue for being gatekeepers--no drilling, no speculation, no unknowns. And with some share prices down over 80%, there is deep value, as some are kicking off 20% dividends! These are better than junk bond-like returns, yet these are solid, stable companies, with little debt. Even if I have to wait for a rebound, I don't mind collecting 20% on my money. And these aren't speculative startup plays with hockey stick growth trajectories. On the contrary, these are boring energy plays, with dividends over triple what they normally are.

Perhaps I'm older now, and I still get excited over discovering the next early-stage growth company, but for my serious cash, I really, really like dividend plays. Not earnings--dividends. Despite stricter accounting rules, earnings are still malleable (and manipulated quarter to quarter). Cash flow and dividends to shareholders are transparent. Companies either pay them, or they don't. And they are either increasing the dividend pay outs, or they aren't. Natural gas master limited partnerships (consult your tax advisor on the differences between common shares and MLP's, especially regarding qualified retirement plans) are not only paying out juicy dividends, but their revenue and earnings growth are accelerating.

Of course, all bets are off if the world were to come to an end, as some are predicting, but if you aren't one of those expecting Armageddon, you may want to consider natural gas pipelines. This will be one of the most painful recoveries, as we still have more de-leveraging ahead of us, but if your long-term horizon is beyond a nanosecond, these MLP's look awfully enticing. Consult your investment advisor, and proceed with caution.

Meanwhile, enjoy your lobstah and chowdah, and sleep better knowing you're pocketing 20% dividends at these levels.

Monday, October 20, 2008

Why Obama will win...

Obama is more media-friendly, specifically internet-savvy. He owns the youth vote (I've read up to 92% of young voters in urban centers), and one could argue he's younger and resonates with the youth better than McCain. I would drill down deeper and say he had better technical advisors, leveraging the internet to his benefit, while McCain ran a more traditional campaign. McCain is out of touch with America and especially the youth.

As a proponent of technology, I may be overstating its role in this election, but I could also make a very compelling argument that the US defeated the USSR in the cold war because of our smart investments in technology. Due to our capitalist system, we were able to launch smarter, more powerful weapons of destruction. How? The transistor, the precursor to today's high-intellectual content of semiconductors. Russia had a huge lead on us in Physics (they were first to launch humans into space, for instance), but our country fostered an environment conducive to innovation, as we allowed Moore's Law to produce smaller, faster, and most importantly, cheaper processing power. Hence, our bombs and missiles were more precise. We not only outspent the Russians, we were more precise in our investments. They had to inevitably declare "Uncle"--we tapped them out.

While they were playing around with glass tubes, Intel was busy producing CPU's cheap enough and powerful enough to house more processing power in one chip than in a whole Univac machine back in the day.

Much like the former Soviet Union, McCain never had a chance. The problem is whether we learn from our "win", because Russia and the rest of the eastern Europe certainly has learned from their "loss".

We need to keep developing the next great mousetraps, whether it's in nanotechnology, a cancer cure, genetic bio-indicators of disease, sustainable technology ("greening" our ecosystem), etc. We not only have to make things smaller, faster, and cheaper, but we also need to make them consume less power.

Who stands to benefit from this? Buy Intel. They've created a moat around their business, continually road-killing potential competitors. Their huge market capitalization makes them an unlikely 25% gainer per anum, but it's a play on America's future.

The market may tank more short- and mid-term, but when the dust is settled, Intel will be standing. No one else can power your laptop like Intel can. Of course, please consult your investment advisor, as any investment has risk. This is not a solicitation to purchase stock. This is just what I've done personally, as I hope to live another 40 years. As a non-real estate professional, certain areas seem pretty cheap long-term also. Not sure where the bottom is, but I would hope we're close to it. Although, hope is no strategy.

Tuesday, October 14, 2008

I'm out of MS for a tidy profit

Morgan Stanley shares were actually up over 80% at the end of the trading day yesterday, and were up big again today, as a certain Japanese bank thinks they're worth $25. I got the cue, hit my target, and sold for a 100% gain in less than a week. I am normally not a trader, but this one was too sweet to pass up.

I'll stick with my INTC position and scour for companies with dominant market share, plenty of cash, and a solid balance sheet. The market still has a lot of pain to endure over the next couple years, but there are bargains out there if you are looking for long-term value.

Good huntin'.

Monday, October 13, 2008

I guess I didn't screw up after all....

Morgan Stanley shares are up 50% today, so I'm treading water again. In hindsight, MS and INTC are cheap at these levels, so I'm glad I bought. I still like water stocks long-term.

I don't like the trading mentality I've been taking on recently, but at these levels and with the high volatility, it's hard not to do some bargain hunting.

Sunday, October 12, 2008

If you must...

If you must gamble (and yes, investing in stocks is a gamble, and something I don't recommend to clients since most are unfit investors) my next call is buying water stocks. Living without oil will be a struggle, but we will survive future oil crises. But living without water will lead to death. Not only do we need it to hydrate ourselves, but we also need water for our crops, and almost every product we consume. For instance, It takes thousands of gallons of water just to make one pair of jeans. It obviously takes a lot more water to manufacture autos, semiconductors, toasters, etc. I'm not at liberty to recommend specific stocks (for legal and other reasons), but you can do your own research on that. Just tread carefully, and only invest if you can afford to lose some or all of your investment. Hence, for most people whose net worth is under $5 million, I do recommend applying Missed Fortune strategies developed by Doug Andrew. It's a safe, conservative strategy to provide liquidity, safety of principle, and earn a competitive, tax-advantaged rate of return.

Friday, October 10, 2008

I screwed up...

I violated my rule of not trying to catch a falling knife, and nibbled at shares of Morgan Stanley--I'm down 25% in ONE day, and was actually down even further intraday. Of course, MS is already down over 90%, so at least I avoided the majority of the decline.

I also nibbled on INTC, and am down 10%--still manageable, as this will be a long-term play--INTC has plenty of cash, market share, and a competitive advantage in their manufacturing processes, which gives them pricing power. Hence, they are killing their only remaining viable competitor, AMD, which announced they are pursuing the fabless model. Going fabless frees up cash (a state of the art fab costs up to $4 billion these days), enables agility in fast-moving markets, but you lose control over your manufacturing process, and your variable costs can spiral out of control, especially during allocation (tight supply).

INTC will test their 52-week highs within a year. I really should have stuck to what I know--semiconductors, vs. credit default swaps (I'm not sure anyone understands how to value cds's--which is exactly why we're in the mess we're in).

Lesson learned.

Thursday, October 9, 2008

GM on the ropes

I've stated for months that General Motors will be insolvent within 18 months (now 12 months--see previous blogs), and now CNBC is splashing it all over the headlines today. Shorting it was the call. It may go down further, but if this trade was put in a while back, it's time to cover and take profits. I may miss out on further gains, but there's no need to be greedy.

The larger issue is the cascading of financial crises from one sector to another, and to the general economy overall. The capitulation is coming (despite several false proclamations already), and we want to see a definitive bottom forming before jumping back in. I will confess that I nibbled at quality yesterday on long-term plays, but it is still too early to catch the falling knife. Warren Buffett stepped up big with Goldman Sachs and GE, and in hindsight, could have bought better (and lower). Even the best of the best can be early. But let's face it--even he admits he is a lousy market timer--he is a long-term value buyer, being a Benjamin Graham disciple. His participation means we're closer to a bottom than a top, but the market and the economy still need to unwind some more before I feel confident we indeed have reached bottom. My rule (and one I don't always follow, to my detriment), is to sell early (to avoid the bulk of the carnage), and buy late (even if it means I don't catch the exact bottom). Specifically, I want to see confirmation, and right now, we're not anywhere near close to that.

As usual, I am not dispensing advice and please consult your investment advisor, but the call here is to play some more golf--you'll save money for now.

Tuesday, October 7, 2008

Unfortunately for some, I feel vindicated...

This is not a case of schadenfreude, as I don't relish in this, but I've had many naysayers, including friends and family, who did not agree with my recommendations of home equity planning, and the implementation of index-based annuities and index-based maximum-funded universal life contracts. Unfortunately, it's been "I told you so."

Fortunately, I helped a few other family members and friends escape the majority of the carnage, as the IUL's have a mininum floor guarantee of 1%. The best part is that when the market recovers, they'll be able to participate in the majority of run up as well--tax-free. But avoiding the carnage is huge, and they sleep at nite. Even better is that due to the resetting of the new starting point, the next year going forward should actually give them tremendous upside. So they are thriving even in this perfect storm of plummeting asset values, whether stocks or real estate.

AIG and Other Insurance Companies in this Bailout

I agree with Porter Stansberry's take on AIG's near-collapse, and its financial ramifications worldwide. Here is my take, with my own edits:

There's 3 things I learned that we need to understand before we figure out what we have to do going forward:

1) Without the government's actions, the collapse of AIG could have caused every major bank in the world to fail.

2) Without the credit default swap market, there's no way banks can report the true value of their assets - they'd all be in default. That's why the government will enact laws that require the suspension of mark-to-market accounting. Essentially, banks will be allowed to pretend they have far higher-quality loans than they actually do. AIG can't cover for them anymore. Our "recovery" plan includes false accounting.

3) Without the huge fraud perpetrated by AIG, the mortgage bubble could have never grown as large as it did. Yes, other factors contributed, like the role of Fannie and Freddie in particular. But the key to enabling the huge global growth in credit during the last decade can be tied directly to AIG's sale of credit default swaps without collateral. This went on for a decade, exacerbating the problem.

I agree with allocating at least 10% of assets toward gold. But a flight to quality means not only gold, but also to well-capitalized market share leaders who are being undeservedly punished. I have my targets, but every individual needs to find their own comfort level.

Wednesday, October 1, 2008

Bailout or Re-liquefication?

Well, it looks like Wachovia did fold like a deck of cards, altho technically, they didn't fall into insolvency. Tell their shareholders that, as they got "acquired" for $1 a share by Citigroup; they might as well be bankrupt, according to shareholders. The silver lining is that financial behemoths like Citigroup, JP Morgan, and Bank of America are grabbing market share, and should survivie and perhaps thrive going forward. Keep your money in these big money centers--Wells Fargo has managed to keep their high credit rating as well. Among investment bankers, Goldman Sachs is the gold standard, and could be an acquisition target itself. I wouldn't touch anything else among financial stocks.

Bailout or re-liquefication? It's the latter--we need liquidity to resuscitate the economy, much like a dehydrated patient needs liquids, even if it's done intravenously. Congress doesn't get it, and I'm afraid many of our citizens don't either. Anyone looking to get a loan will too, when the bank turns them down--or if the bank itself collapses.

This financial crisis was caused by risk mis-managment, poor due diligence, sloppy underwriting, and lack of oversight--not de-regulation. Go after the culprits, and certainly don't pay executives golden parachutes--but inject some liquidity. This world economy needs capital, for it to flow again. The alternative is a return to the stone age.

Speaking of draught, the last time I passed by the San Luis Reservoir between the 101 and I-5, it looked like a backyard pond--the water levels were almost depleted. With oil prices up ten-fold, with stock markets and real estate values plummeting, are we going to have a water crisis also?