Thursday, June 26, 2008

The Danger of Short-Term Predictions

A couple of weeks ago I wrote a post entitled "So Many Words, So Little To Say" expressing some frustration with an article written by Tony Crescenzi of TheStreet.Com. In his article, Tony started off by stating, "There is a scenario that has a low but reasonable chance of occurring next week that could result in a very large rebound in share prices and risk assets next week and the week after, say 500 points or so in the Dow." I took issue with that and a few other comments that he made.

So, it's been a couple of weeks now. Let's see how Tony's call panned out. Tony wrote his article in the afternoon on June 10th. The close that day for the DJIA was 12,289. Since he said the rebound could come within two weeks, let's check in two weeks later on June 24th. The close that day for the DJIA was 11,807. Ooops. That's actually pretty amazing since it is a 482 point DECLINE! So net-net, Tony was only off by 982 points! Now that is impressive. That would be hard to do even if you were trying.

As I wrote in my first critique of Tony's article:

I know that it isn't easy writing in a public forum and opening yourself up to criticism, but idle speculation about possible big moves in the market that might or might not happen over a ridiculously short time period if certain other things do or don't occur really doesn't add a lot of value. This type of article could just as easily have been written about the possibility of a 500 point drop in the market if the things Tony discusses don't come to fruition.
Looks like Tony should have written about the possibility of that 500 point decline instead. What are the lessons we can take from this?
  • The majority of the investment opinion articles out there are basically useless and do more to confuse people than enlighten them. Of course, none of us think our own articles are garbage!
  • Nobody knows where the market is going in the very short-term. If they did, they ought to be placing huge bets in the futures market and unblinkingly staring at their quote monitors -- not writing articles about it for Cramer.
  • Don't be fooled by someone's credentials. Some of the worst investors that I know have terrific credentials.
  • Be careful what you write. Someone might be reading it (my wife/co-editor reminds me of this with each of my posts).
Finally, as I wrote in the earlier post:
Although calling for a 500 point move isn't terribly bold in the current environment, Tony will get a ton of credit (and perhaps press) if it happens. If it doesn't happen, who will remember?
Well, I will.

The author is short sensationalism, silly short-term predictions, and poor short-term memories.

Tuesday, June 24, 2008

When The "Expert" Needs An Expert

How comfortable would you feel with your plumber if he had to call another plumber to fix his own running toilet? How about a CPA who hired another accountant to do her taxes? What if your pediatrician didn't feel competent enough to examine his own child?

These are the questions that immediately came to mind today when I read that Wachovia has just hired Goldman Sachs to "perform analytics on our loans to evaluate various alternatives." I think Saturday Night Live's Seth and Amy can probably sum it up best. "Really?! Wachovia. Really?"

I wonder how the good folks at Wachovia are responding today to customers walking into their branches around the country.

"You'd like to open a savings account? Um, can you hold on a minute while I call the teller over at Bank of America to find out what our rates are?"

"Yes, we can offer auto loans, but would you mind running over to Vinnie's Used Cars and Bait Emporium to see what size loan we can offer you?"

"A personal loan? Well, let me see if I can get in touch with the CEO who I think plays golf with one of the senior bankers over at Morgan. I'm pretty sure that guy has a gardener who knows a personal trainer who thinks he heard some rumor about whether we're still offering those."

"A mortgage? No, we don't do those anymore."

This is just sad. I'm embarrassed for Wachovia and its employees. If you're a large bank with a large securities and investment banking division and you don't feel qualified to evaluate your own balance sheet or market your own portfolio, isn't it pretty much time to just hang it up and go into the dog grooming business? No offense to dog groomers.

The only thing cushioning my pain is that I've been short Wachovia these past few months. I was thinking it might be time to cover. Now I'm not so sure.

The author is short Wachovia and long dog groomers and emporiums.

Wednesday, June 18, 2008

Energy, Inflation, and Speeding Tickets

By now, it's probably safe to assume that everyone knows that oil and gasoline prices have been rising sharply and are near record levels. Even the recently discovered uncontacted tribe in Peru can be seen in this photo trying to shoot down a plane for its fuel.


One of the surprises in the current cycle has been that rising energy prices haven't yet shown up in broader measures of inflation. The most recent Consumer Price Index (CPI) figure registered a year-over-year increase of 4.2%, but core CPI (excluding food and energy) came in at a relatively modest 2.3% increase. The bulls highlight this discrepancy and claim that it points to an overblown fear of inflation. They also point to the lack of flow through from the rising Producer Price Index (PPI) to the CPI as evidence that rising energy prices, in particular, are not impacting the price of goods and services more broadly.

According to the Bureau of Labor Statistics website, food makes up about 13.8% of the CPI, and energy accounts for 9.7%, for a total of 23.5%. In making the case for core inflation, economists point to the volatility of food and energy prices. Everyone can agree that food and energy prices are more volatile than many other goods and services, but I'm rather sympathetic to those who claim that we shouldn't ignore them. First off, they account for nearly one quarter of overall CPI. Second, we're talking about food and energy! Along with housing, these things are not exactly discretionary.

Now, let's look at the 9.7% weighting of energy in the CPI. We're definitely not as energy dependent as we were during the last energy crisis, which is certainly a positive. However, oil is used in a huge variety of ways and can be found in everything from plastic, lipstick, and disposable diapers to Captain Kirk's hair, tires, panty hose, lotion, Vaseline, and artificial limbs. And, of course, the manufacture of most products requires the use of energy, most of which is derived by the burning of fossil fuels. So although energy itself may only account for 9.7% of the goods and services measured by the CPI, the importance and impact of energy is certainly greater.

So, will we ultimately see these higher prices flow through to other goods and services? It seems likely. Plenty of transportation business are levying fuel surcharges, which is the obvious place to expect it first. Other service providers who rely on transportation seem to be jumping on board. Anecdotally, my wife just raised her rates for her interior design business in part due to higher gasoline costs. Her handyman just did the same. And, according to today's USA Today:
The surging price of gasoline has come to this: a "fuel surcharge" on your next speeding ticket.

Drivers caught speeding in this north Atlanta suburb soon will have to pay an extra $12 — to cover $4-a-gallon gas costs for the police officers who stop them.

The City Council passed the fee hike, effective July 1, to offset fuel prices that have eaten up nearly 60% of the police department's 2008 fuel budget, Police Chief Ken Ball says.

He expects the fee increase, which applies to all moving violations and can be rescinded if gas prices fall below $3 a gallon, to generate $19,500 to $26,000 a year for the town of 7,700.

Ball says he was seeking ways to maintain patrols despite record high gas prices. "I was hearing that Delta (Air Lines), pizza deliverers, florists were adding fuel charges to their services, and I thought, why not police departments?" he says.

By my math, a $12 surcharge on $4/gallon gasoline works out to 3 gallons of gas per speeder. If we assume 20 mpg (highway), it seems each speeder should be entitled to a 60 mile chase.

Whether higher energy prices flow through may not even matter as far as equity returns are concerned. To the degree that sellers don't pass along their higher costs, their margins, earnings, and valuation will suffer. If they do pass them along in this current environment, we run the risk of seeing a sharper decline in consumption as an over-stretched consumer is forced to retrench even further. Neither case bodes particularly well for equities.

As for strategy, I still believe that we are in the middle innings of this commodity bull market and plan to continue holding a core position while exploiting significant short-term moves. I remain overweight commodities and energy, but I wouldn't be at all surprised to see a pullback near-term given the rhetoric over new Saudi production, "crack downs" on oil speculators, and near-term reduced oil demand -- at least from the industrialized world. (For the record, I do not believe that this new oil from the Saudis or restrictions on speculators will solve the problem of high oil prices.) Retrenchments are part of a healthy bull market. Should such a pullback occur, I will be a buyer yet again.

The author is long artificial limbs and uncontacted Peruvian tribes and short Pollyannas.

Tuesday, June 10, 2008

So Many Words, So Little To Say

Like many portfolio managers, I spend a good part of each day just keeping up with the news flow on the companies that I own, the stocks on my watch list, the markets, the latest Bollywood gossip, and the global economy. Most of the "news" out there is nothing more than noise, and sifting through the garbage can be time consuming.

One of the "news" outlets that I gave up on years ago is CNBC. When I saw how they turned from somewhat serious reporting to out-and-out stock pumping during the tech bubble, I lost my lunch. When they started to rewrite history during the market collapse and claim that they had done a terrific job of being balanced, I lost my wife's lunch. It was a nice reminder that there really isn't much worth watching on TV. My wife and I canceled our cable.

I'm also not a big fan of TV Jim Cramer and although I do enjoy the writing of contributor Doug Kass. I'll save a more detailed review of Jim and TheStreet for another time, but let's just say that I've done fairly well fading (doing the opposite of) a number of his recommendations. One of my main complaints about Cramer is very similar to one of my major complaints about Wall Street analysts, strategists, and economists -- there is an ever-present pressure to have a strong opinion about a stock, the market, or the economy, but no one can know everything about everything (unless she's married to me). It's great for generating commissions but not so great for investment performance.

With that out of the way, let's turn to an article just highlighted on The article is written by Tony Crescenzi and is entitled "Big Rally Possible." Normally, a junk title like that would be enough to keep me away, but it's a slow news day. Now, I don't know anything about Mr. Crescenzi, so I checked out his bio. He's a chief bond strategist, so that's one knock against him. He did write a couple of books I'm not familiar with, but so did Madonna, so...I'm not really sure what to make of that. Most importantly, Tony Crescenzi is a name straight out of "The Sopranos", so I'm going to change my locks and avoid making direct eye contact with anyone for a few days. Let's look at what he wrote:

There is a scenario that has a low but reasonable chance of occurring next week that could result in a very large rebound in share prices and risk assets next week and the week after, say 500 points or so in the Dow.

If the G-8 delivers a communiqué strong enough to reinforce the recent message on the dollar, and if OPEC's meeting with consumers results in more oil production, the combination could boost the value of the dollar, jolt the commodities markets, and thus bring a huge sigh of relief to investors. U.S. Treasury Secretary Paulson has resisted opportunities like this before, particularly following the April 11 G-7 meeting, which produced a communiqué that French Finance Minister Lagarde said was on par in importance with the 1985 Plaza Accord. Any effort to boost the dollar would be welcome worldwide, given the recent surge in commodity prices. Massive intervention would cap it off.

Ok. Trying to be tactful. Let's start with the first sentence. "There is a scenario that has a low but reasonable chance of occurring next week that..." What doesn't have a low but reasonable chance of occurring next week?! Oil could hit $150, we could attack Iran, gold might retake $1,000, the Pillsbury Doughboy could go on the Atkins Diet, Lehman could collapse, the Fed might raise interest rates (just kidding), I could be killed in a tragic dirigible accident. The list is endless.

So what specifically might happen according to Tony? The Dow could rally "500 points or so." Well...sure. First of all, that would be about a 4% increase. Given the recent volatility in the markets, I don't know that anyone would be shocked by a 4% move either way "next week and the week after." The market fell by 400 points this past Friday alone. It's not like calling for another Black Monday when the Dow lost 22.6% of its value in one day.

What's going to cause this big rally? Apparently, IF the U.S. and G-8 get super serious about the dollar with strong words and massive intervention and IF OPEC starts pumping a lot more oil, then commodity prices would get whacked and money would flow into the U.S. market.

Could it happen? Sure. But the very opposite is at least as likely to happen. Paulson and Bernanke are already starting to talk tough about the dollar, but I have a hard time believing that they're going to raise interest rates or intervene in the currency market to support the dollar given the weakness in our economy and financial markets. Raising rates certainly won't help the economy recover, and the Fed has shown this to be of primary importance. A higher dollar would also harm U.S. exports, which have been one of the few GDP bright spots. So, until proven otherwise, this is just talk. Words are their only weapon since they don't have the cojones to raise rates. Once the market figures this out, I would expect the dollar decline to resume.

As for OPEC suddenly pumping more oil, I've addressed this in prior posts. Does anyone seriously think that there is one OPEC country sitting on idle production with oil prices this high and climbing? No way. First of all, these guys remember $10 oil in the mid '90s. They're going to make hay with current prices. Second, high oil prices are ultimately bad for OPEC as they encourage lower demand and the development of alternatives, and OPEC is well aware of this. If OPEC had the power to drive oil prices lower, they would -- not to $20, but back towards $100 seems reasonable. The only way they could do this is by further opening the spigots. I think the fact that oil prices continue to climb well beyond a level that OPEC is comfortable with points to the likelihood that the spigots are already open. OPEC is fairly powerless right now to combat rising oil prices (how ironic) and is not likely sitting on idle capacity. In fact, it's possible that some countries are producing at rates that are too high for the long-term well-being of their oil fields.

Of course, anything can happen in the short-term. So, should the market rally in the next week or so because of a dollar-led commodity price collapse, I'll be more than happy to take the opposite side of both of those trades and further short the dollar and add to commodities.

As for Tony's article and for others like it, they just don't serve a useful purpose. I know that it isn't easy writing in a public forum and opening yourself up to criticism, but idle speculation about possible big moves in the market that might or might not happen over a ridiculously short time period if certain other things do or don't occur really doesn't add a lot of value. This type of article could just as easily have been written about the possibility of a 500 point drop in the market if the things Tony discusses don't come to fruition.

Before I go, let's consider Tony's employer. Tony works for Miller Tabak + Co., LLC, which according to their website, is "a twenty-four year old institutional trading firm specializing in the discrete handling of stock purchases and sales, portfolio rebalancings and listed options." He works for a trading firm, and he's out with an article that (at least implicitly) encourages short-term trades. Coincidence? Perhaps. Either way, there appears to be a strong negative correlation between the number of articles/posts someone writes and the quality of opinions expressed in said posts (present author excluded, of course). Tony appears to be a prolific writer.

Finally, people seem to be more disposed towards remembering correct predictions/recommendations than the predictions that don't work out. The fact that Joe Battipaglia still has a career as a Chief Investment Officer following his disastrous pronouncements during the tech bubble and collapse is testament to this. Although calling for a 500 point move isn't terribly bold in the current environment, Tony will get a ton of credit (and perhaps press) if it happens. If it doesn't happen, who will remember? There is no downside. From an "investment" perspective, his minor investment in a few paragraphs of words has tremendous upside and no downside. Tony may be wrong, but he ain't stupid.

The author is short the G-8, Battipaglia, and the dollar and long OPEC, Bollywood, lunch, and cojones.

Friday, June 6, 2008

Employment Report Disaster

A loss of 49,000 jobs. If only it were so benign. Today, we add to the heaping pile of rotting economic indicators the latest monthly employment report from the Bureau of (lack of) Labor Statistics. At least this time the headlines don't appear to be shading the report, but they're not fully capturing just how ugly it is.

Let's start with the nonfarm payroll numbers. This showed a loss of 49,000 jobs in the month. Nothing too surprising in the breakdown -- construction and manufacturing down, service-providing up modestly, professional and business services down, education and health services continued their strong steady climb, and our "less is more" Republican-led government continues to grow. The only somewhat surprising number was that leisure and hospitality employment continued to grow despite an obviously stressful time for the consumer.

Now let's turn to the unemployment rate, which is the number we'll be hearing about in the news today. Its one month increase of .5% is the highest monthly jump in over 20 years! In layman's terms, that's bad. How did this happen? Double-whammy. The number of employed persons fell by 285,000 last month while the number of unemployed rose by 861,000! There are now 8.5 million people counted as unemployed, a level 30% higher than a year ago. And, yet, we're not in a recession?

What's also interesting is that the increase in the unemployment rate hit everyone. Men, women, teens, hermaphrodites, loan originators, and people of every color. Teens in particular took a hard hit with their rate climbing from 15.4% to 18.7%. Good luck getting your teens out of the house this summer. Even the professions that they're overqualified for (like investment banker, mortgage broker, home appraiser) aren't hiring.

Well, if you've made it this far you're in for a real treat -- the birth/death model. If you're not familiar with this, go back and read my post on April's employment report. Incredibly, this latest employment report includes an assumed 217,000 jobs created! If you back that out, then this month's nonfarm payroll figure would be registering a loss of 266,000 jobs! This birth/death model is assuming that 42,000 CONSTRUCTION jobs were added last month. That's just insane. Foreclosures are skyrocketing, builders are struggling, home sales are plummeting, prices are collapsing, but 42,000 construction jobs were added. I hope the folks at the BLS are at least a little embarrassed about putting out such a number. Just as ridiculous, the model assumes that 77,000 new leisure and hospitality jobs were created. Apparently, the 2 million additional unemployed people we have this year are all spending their last dimes at the beach resort getting cucumber mud facials in the spa. Come on. Even Starbucks is retrenching, and people are addicted to coffee.

So what does all of this mean for investors? Bernanke and other Fed member have been recently trying to talk up the dollar and have been hinting that the rate cuts are behind us. Given the data we've seen of late and the continued weakness in the economy, I can't imagine the Fed is suddenly going to develop a spine and actually start fighting inflation and the falling dollar by raising rates any time soon. They wouldn't have cut rates so far and so fast if this was their real concern (If you want to see a real Central Bank, check out the ECB). Bernanke always appears calm and collected in public, as he should, but I've got to believe he's spending a lot of time in his office mumbling to himself, violently brushing nonexistent bugs off of his pants, and dreaming of the day he can charge ridiculously high speaking fees to tell everyone that it wasn't his fault.

This report should put a nice headwind in front of the recent dollar mini-rally which also might provide a further boost for gold and commodities. It certainly isn't stock market positive as even further interest rate cuts would have limited, if any, positive impact, but it is clearly supportive of bonds. (The markets just opened, and not surprisingly, this is the initial reaction.). Of course, this all holds true only until the next bit of bogus manipulated data comes out and the traders and spinners tee it up all over again.

In the meantime, it will be interesting to see how the bulls try and spin this one. I imagine it will go something like this:

Well, the loss of jobs wasn't as bad as expected so that's outstanding and super bullish. Besides, that's old data. The month of May was over, like a whole week ago. The market looks forward, and I'm sure June will look even better. Heck, I just replaced two of my overpaid cabana boys with 4 illegals. That's a doubling of employment! The fact that the unemployment rate climbed a touch is simply testament to the fact that we Americans are a hard-working lot, and more of us are eager to get back into the labor force and do our part for the economy. As for the birth/death model you mention, I've never heard of that, but I can assure you it's bullish for tech stocks.
Disclosure: The author is short perma-bulls, the birth/death model, and cabana boys.