Tuesday, October 28, 2008

Housing And The Candidates

"Homeowners are the innocent bystanders in a drive-by shooting by Wall Street and Washington." John McCain

"What we need is a floor in the housing market, a, a stop to the decline in housing values."
Barack Obama

One of these two men will be our next President. Neither of these two men have shown any understanding of basic economic principles or economic reality. There seems to be a collective re-writing of history underway that passes nearly all of the blame for the mortgage debacle on to Wall Street and Washington and absolves the home buyer from any guilt. That may make it easier for Congress to pass its ill-conceived bailouts, but it doesn't square with the facts.

Let's start with McCain's quote. Homeowners are the innocent bystanders? I can only hope that this comment is driven more by political expediency and pandering than actual belief. This type of comment makes me wish he'd focus less on the economy and more on Palin's wardrobe and make-up.

The fact, however, is that many homeowners over the last few years knowingly took a gamble on housing. Some gambled that interest rates would always remain low. Some gambled that they'd always be able to refinance their mortgage at a low teaser rate. Some gambled that they would be able to sell their home to a greater fool at the time of their choosing. Some gambled that their eccentric rich old Aunt Eunice would kick off and leave them a mint. Some gambled that they would get a raise that would offset any mortgage payment increase. Some gambled that they would be able to flip their negative cash flow investment properties for a nice profit to another investor who was even less concerned with cash flow.

Yes, there was some fraud that occurred. Those folks/firms should be prosecuted to the full extent of the law. However, when financial institutions agree to lend money to a homeowner with some combination of low credit score, low earnings, low down payment, and little savings, that's not fraud. It's just bad business. The bank was foolish for making such a loan, but that doesn't mean that the homeowner who willingly accepted that loan should bear no responsibility. Do you think these same homeowners would be complaining about their mortgages today if the real estate market and economy hadn't soured? Of course not. It seems to only be a problem for them because their gamble didn't pay off.

If you sign a document, you're acknowledging that you understand and agree to its terms. If you don't understand the terms, you have no business signing the document. Any homeowner could have hired their own lawyer for a few hundred dollars to explain the terms. Anyone could have Googled "mortgage" to help get up to speed. Instead, people were willing to spend more time researching the purchase of a new plasma TV than the details of their mortgage terms.

What about Obama's quote about needing a floor in the housing market? This ridiculous statement shows Obama's complete lack of awareness of the disastrous history of price fixing. This reminds me of
Pakistan's stock exchange. The Pakistanis grew tired of falling stock prices in their country this summer so they instituted a floor under stocks on August 28th. Until further notice, stock prices would be allowed to fluctuate within a 5% range, but they wouldn't be allowed to fall any further.

What has happened since? Volume has dried up and the market has barely budged. Who in their right mind would want to step in and buy with such a lack of transparency in this environment? If price fixing and floors really worked why don't we put a floor under incomes at $1 million? We could all be rich! In addition, let's pass some legislation mandating that everyone is entitled to a minimum level of attractiveness. We'll just have the "government" pay for all of the "necessary" implants, botox, and liposuctions.

Trying to put a floor under housing will lead to buyers stepping away from the market, which is the last thing we need. There is only one real ultimate solution to the housing crisis and that's for new supply to fall and for home prices to decrease to levels at which buyers (new homeowners and investors) will be able and willing to absorb the existing excess inventory. Artificially inflating prices by putting a floor under them would have the adverse effect of decreasing price transparency and discouraging buyers from making offers.

There is also the issue of fairness. Most U.S. taxpayers either rent a home or can still comfortably handle their mortgage. Why should this majority of Americans bear the cost of bailing out those who gambled and lost? It's truly absurd from the perspective of renters (future homeowners) as any government intervention that serves to artificially support home prices doubly bites this group. They incur their share of the cost of the bailout while artificially inflated home prices keep them from fully benefiting from the housing price correction.

Talk is now building for another round of bailouts, this time focused on directly helping homeowners who are under water. McCain has proposed buying mortgages from banks at face value and then replacing it with a new 30-year fixed government mortgage at an interest rate of just over 5%. He basically wants to reward the financial institutions who made these ridiculous mortgages by paying them full value. Then he'll give the homeowner a new smaller mortgage that's in-line with the current value of the house. What happens to the difference between the size of the old and new mortgage? Well, that loss will be borne by you and I, the U.S. taxpayer. You have to love the absurdity of the plan. Reward the banks for making bad loans and then turn around and reward the homeowner (who likely gambled) with a lower mortgage at an interest rate better than a new borrower with an 800 FICO score and 40% down would receive!

We don't need the government to get involved with loan negotiations. Banks will negotiate with homeowners when it makes economic sense to them. If the present value of a new mortgage at new terms exceeds the amount the bank projects that it would receive from foreclosing, a bank is going to take a hard look at negotiating with the homeowner. Otherwise, the property should be foreclosed upon. The homeowner will get out from under the mortgage and become a renter again with a rental expense that is likely much below their previous house payment. The homeowner may have to endure the stigma of foreclosure for some time, but with so many people facing foreclosure, I'm not sure much of a stigma will be attached. The bank will take the hit it deserves for making a loan it should have rejected. The property will be put back on the market and will eventually be sold to a new homeowner who will be able to meet the more stringent mortgage qualification requirements demanded by banks. No government (taxpayer) money needs to be wasted in this process.

Neither Obama nor McCain nor Congress will or can solve the mortgage "problem." The problem was the bubble. The correction is the solution, not the problem. I recently read that 6% of the U.S. workforce are lawyers but 45% of the members of Congress are lawyers (another 45% couldn't get into law school). The real problem is that it's impossible for a room full of lawyers not to meddle.

Congress, along with either Obama or McCain, will continue to pass ever-larger bailouts and stimulus packages in an effort to encourage increased lending in an economy that is imploding because of too much debt. Somehow, they (and many economists) don't see the irony of trying to fix the problem of too much debt by encouraging increased lending.

Disclosure: The Rubbernecker is short bailouts, pandering, and botox, and he's longing for the end to this election season.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Thursday, October 23, 2008

Ridiculous Analysis of Amazon - Honestly

If you've been following my writing you know that I had been short Amazon.com for a while but covered the position on October 8th. The thesis was simple. We're in a recession, the company is highly leveraged to the highly leveraged consumer, and the stock was trading at a very rich earnings multiple.

I, therefore, didn't find the company's earnings report last night terribly surprising. Earnings came in a little better than expected and sales were pretty much in-line. The more relevant issue is that the company guided fourth quarter revenue expectations to a range of $6.0-7.0 billion. Analysts had been expecting $7.0 billion. Not surprisingly, the stock is down today. Despite falling 13-14% pre-market, AMZN has been down in the mid-single digit percentage range for most of the day (thus far). Expensive stock + company guiding lower = lower stock price. Nothing too shocking there.

Or so I thought. Then I stumbled upon an article written today by Glenn Hall of TheStreet.com. Glenn seems a bit perplexed that the shares are down at all today. In his piece entitled "Today's Outrage: Amazon Honesty Has Price," Hall states, "OK, so Amazon's range was a little wider than usual. And CEO Jeff Bezos didn't inspire much confidence when he explained that 'all companies have limited visibility now.' I guess that merits a sell-off. Such honesty is outrageous!"

So, if I understand Mr. Hall correctly, Amazon's stock should be rising today because the CEO was honest about how lousy business is likely to be. Interesting analysis. They should be rewarded for being honest about bad news. Isn't that like saying your wife should love you even more if you're honest with her about how unfaithful you've been? Or promoting an employee who admits to embezzling from you?

What about the fact that the mid-point of the revenue guidance is a whopping $500 million below estimates? I guess we just ignore that. Why worry about silly things like revenue and earnings when it's honesty that drives security prices. True, Amazon's price/earnings multiple may be rich, but on a price/integrity basis, the stock is clearly a buy! When we couple Bezos's honesty with the fact that he didn't kill anyone this past quarter (to the best of our knowledge), Hall must be amazed that AMZN isn't the leading percentage gainer today.

This is the type of person and analysis that I always hope is on the opposite side of my trades.

Disclosure: The Rubbernecker has not killed anyone this past quarter either and is looking forward to shorting AMZN again.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Monday, October 20, 2008

Buffett versus Cramer

Two of the most widely-followed investment personalities were out with some fairly interesting articles late last week. The title probably gave away that I'm talking about Warren Buffett (the richest man in the world) and Jim Cramer (the whiniest man in the world). Buffett came out with a bullish long-term call on U.S. equities, and Cramer came out with an article that sounded a bit defensive and critical of Buffett's piece.

Before delving into the two articles, let's step back and consider which of these two professional investors is more worthy of our attention. I've applied my many years of objective security analysis to this question. The following is a summary of my conclusions:

  • Cramer has a goatee. I don't trust goatees. Lenin had a goatee. Alleged steroid user Mark McGuire had a goatee. Stoners Danny Bonaduce and Shaggy (of Scooby Doo fame) have goatees. Pee Wee Herman has a goatee. Colonel Sanders has a goatee (I'm a vegetarian). Count Von Count of Sesame Street has a goatee (pure evil).
  • One of them is intelligent, witty, and relevant. The other one is Jim Cramer.
  • Warren Buffett is the Warren Buffett of his time. Jim Cramer is the Jerry Springer of his.
  • If I were stranded on a desert island and had to take Buffett or Cramer with me, I'd pick Cramer. He'd be more likely to help me get over my aversion to cannibalism.
So, it's a tight race, but in the end I'm going to have to go with Buffett.

Buffett wrote an op-ed piece for the New York Times on October 16th that laid out the case for buying equities. In it, Buffett wrote the following:
THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.


A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors.

...Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

...Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
So, we have Buffett saying that stocks look attractive for the long-term, and he's moving his money from Treasuries to equities at these levels. Importantly, he's emphasizing that he has no idea where stocks are headed in the short-term. Notice that he considers even one year to be a short time period, as do I. I have a hard time arguing with him since I turned positive (for the first time in years) on the market back on October 10th as the market was dipping below 8300. I'm sure Buffett is comforted by that.

In response to Buffett's op-ed, Cramer put out a piece entitled "Sure, Buffett Can Afford To Buy Here." Here are a few snippets from that article:

Great to see Warren Buffett buying here. Fabulous. He has a lot of firepower. He is right to buy American. And I want to go with him, except, he's been buying for awhile, and, more important, he can be down 20% to 30% and it doesn't matter.

Buffett emphasizes over and over again that he can't time the market. Over and over again, he makes the point that he is in it for the long term.

...So, let's do the math. Let's say he is as wrong in these new buys as he was in his General Electric buy a few weeks ago. If you use, for the sake of argument, the allegedly controversial call I made when the Dow was at 10,000 that you need to take as much money out of the market as you may need for a big purchase in the next five years, you will need to gain 37% in your stocks to get back to even. Thirty-seven percent.

Do you think that you will be able to make that back? Maybe if you are the house, like Buffett, maybe if you have a long-term time frame.

But that was never my point. My point was that, if you need that money in the short term, it is better not to have it in the market.

...These buys are of absolutely no consequence to him whatsoever. He may very well make fortunes on his buys. And he has waited until stocks are down.

But are you Warren Buffett? Are you as rich as he is that you don't need to worry about those big purchases? If you are, I say bombs away. Go with him.

If you are not, consider that, if you followed him with GE and then followed him today with this New York Times picks and those prices fell as much as GE did, you would be in a real jam.

So, Jim is basically saying a few things. First of all, don't buy stocks if they're going to fall. Ok...right. That's too ridiculous to even comment on.

Second, apparently Buffett is clearly an idiot for investing in GE too early. I'm a little confused by this. Buffett invested $3 billion in GE PREFERRED stock that will earn him 10% a year in this low-return, high-risk environment. GE can buy the preferred back from him after 3 years, but at a 10% premium. Buffett is also getting warrants to buy GE common stock at $22.25 at any time during the next 5 years. GE's stock is currently at $19.63, not terribly out-of-the-money. There is a very good chance that GE stock will be above $22.25 in the next 5 years. Even if it isn't, barring the unthinkable, Buffett is guaranteed at least a low-risk 10% return on this investment, yet Cramer is criticizing his timing on the GE investment? Amazing. You don't get those kind of terms from GE when everything is wonderful and their stock is rising, Jim.

Cramer states that if "you followed him [Buffett] with GE and then followed him today with this New York Times picks and those prices fell as much as GE did, you would be in a real jam." That is an apples to oranges comparison. Cramer is assuming you bought GE common when Buffett announced that he had bought GE preferred. Cramer should know better. These are two very different investments, and Joe Mainstreet never had the chance to invest in Buffett's GE preferred. You never were able to "follow" Buffett on this one. Had Buffett bought the common, then Cramer would have a more valid point. I discussed this issue more fully in my article, "My Take On Buffett's Take Of GE Stake".

Third, Cramer tells us not to put money in the stock market that we may need in the next 5 years. Buffett clearly isn't telling you to do otherwise. In fact, he repeatedly emphasizes that this is a long-term call, and with Buffett long-term probably means his next two reincarnations. Besides, am I the only one shocked that Cramer EVER thought it was a great idea to put money you really needed in the next 5 years into equities?!

Fourth, Cramer seems to be saying that we should discount Buffett's opinion because Buffett is wealthy and can therefore afford to be wrong. But doesn't Cramer often remind us how filthy stinking rich he himself is? So, if we shouldn't listen to Buffett because he's rich, doesn't it follow that we shouldn't listen to Cramer either since he's also rich? Or maybe he's saying we should pay more attention to the filthy rich rather than the fabulously rich. To follow that logic through, my stock market opinions are far more valuable than either of theirs, and the homeless guy who lives in the woods behind my gym must be an investment genius.

In all seriousness, I don't know one professional investor who pays any attention to Cramer. I know many who listen when Buffett speaks. If I'm interested in an intelligent and clear-headed investment opinion, I'll listen to Buffett. When I want to feel better about myself, I'll listen to Cramer.

Disclosure: The Rubbernecker is long Midwestern oracles and short self-promoters (unless they're writing a blog).

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Friday, October 17, 2008

Housing: Good News! The Cliff-Diving Continues!

The latest housing data was released today, and not surprisingly, the big bad wolf once again blew over our pile of straw. The Census Bureau reported that housing starts fell to a seasonally adjusted annual pace of 817,000, which is 6% lower than last month and 31% lower than last September.

Building permit data was equally impressive with total permits falling 8% from the prior month and 38% from the prior year. Both are at near 50-year lows and are certain to break that record in the months ahead.

Plenty of the reports out today on this news are decrying the horrific state of housing, and plenty of pundits are further lengthening their estimate of how long and severe the housing downturn will last. I think we may have finally reached the point where even the hardiest housing bull has had to admit defeat, give up his Realtor license, hand the keys to his Miami condo back to the bank, and start planning his run for Congress.

I have to admit that I don't know how long the downturn will last. There are so many variables at play with housing, the economy, and the financial markets that any guess would be simply that -- a guess. What I can say is that I smile every time another "bad" housing report is issued.

The fact is that this is the type of data we will need to see for some time before housing bottoms. A massive amount of housing was built during the bubble, and that surplus needs to be eliminated before prices level off. We need to see fewer housing units built and increased absorption/destruction of the existing supply. It's really that simple. We should welcome this type of data.

What we should not welcome is any effort on the part of our legislators to interfere with the market adjustment currently underway. Any effort to support housing prices will only serve to muddy price transparency and prolong the length of the downturn. One key factor needed to help absorb the excess supply is demand from new first-time buyers. These folks are already "disadvantaged" by the tighter lending standards of the banks and grimmer job prospects. Any program/bailout/Ponzi scheme that keeps home prices above their natural market-clearing level will only further disadvantage and discourage these individuals and families from buying a home. Lower home prices are actually a good thing for a while.

I've remained out of housing stocks during this down cycle, and I still see no reason to jump in. Just as with the financials, there will be impressive short-term pops, but trying to time these is just gambling. The fundamentals of the homebuilders still look lousy, and I expect to see more failures before all is said and done. Even then, I don't expect home building to come roaring back. After bottoming, these shares are likely to remain rather unexciting as home prices once again tether themselves to incomes (unexciting) and rents (also unexciting). At least we'll all be a little less piggish, and we'll be rebuilding with "brick", rather than "straw."

Disclosure: This little Rubbernecker went to the market, and this little Rubbernecker had none.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Thursday, October 16, 2008

Google - Time To Buy?

I have done fairly well betting against widely-held, high growth, overvalued stocks that everyone loves. Google has been one such candidate. I've been on the short side of Google a few times, and each time it has paid off. I last wrote about Google following their second quarter earnings release. That piece can be reviewed here. With revenue and click growth slowing, a rich valuation, excessive bullishness on the stock, and a slowing economy, my earlier shorts were relatively easy calls.

It's important, however, not to put the blinders on and end up "married" to a position or viewpoint. In keeping with that, the situation with Google is now very different than when I last shorted it. For starters, valuation looks much more reasonable. IF the estimate for 2009 proves accurate, then Google is trading at a 14 P/E. That's down from 20 at the end of last quarter and north of 30 at the beginning of the year. We no longer need ridiculous growth estimates to support Google's earnings multiple.

Also different are investor expectations heading into earnings season. For the first time ever, management admitted last quarter that they were feeling some impact from the economy. It's probably safe to assume that the company has been further impacted by the economy, and it should also be safe to assume that investors are expecting some further negative impact. It shouldn't come as a surprise to anyone. In other words, the rose-colored glasses should have come off following last quarter's conference call. We can see that earnings estimates have come down since then, and analysts are now looking for a flat quarter sequentially. With the stock off 55% from its highs and 37% since mid-year, some healthy degree of headwind is already baked into the stock.

Google will be reporting last quarter's numbers after the close today, and all eyes will be on a few key areas. Click growth, of course, is critical as is cost containment. In the past, management has shown little concern for its stock price or near-term earnings as they've ramped spending regardless of results. It'll be interesting to see if the slowing economy has encouraged management to ease up on spending. Also, the company has been trying to improve the quality of its search results and hopes to earn more from this improvement. We'll get more color on all of this and more at 4:30 p.m. today.

The bottom line is that Google is an interesting buy candidate at these levels. Valuation is reasonable, growth is likely to remain decent, cash flow generation is strong, the excessive optimism in the stock is gone, and they still don't face a serious competitive threat. The market's reaction to Google's earnings will hinge in part on which side of the bed traders got up on this morning, and any large move in the market will almost certainly carry GOOG along with it in the near-term. Regardless, GOOG is finally once again looking intriguing to own.

Disclosure: The Rubbernecker is now long Google stock (for the moment) but short Google's foray into energy and world domination.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Monday, October 13, 2008

Nearly A 1000-Point Rally. Whaddya Know!?

When I wrote in last Friday's post that "Just a decrease in the amount or severity of the bad news (second derivative) could propel a near-term 1000-point Dow rally (not necessarily all in one day)," I have to admit that I wasn't expecting it would all come the very next trading day. Although I like to think that my expertise lies in long-term investing, my shorter-term calls of late haven't been too shabby. Our SSO and QLD positions are up 36% on average after 1 1/2 trading days. Since patting oneself on the back in this business is a sure kiss of death, I'll leave the self-congratulations at that and move on. Luck, intelligence or intelligent luck, we'll take it.

As I also wrote in the Friday post, "If we do get the rally, I won't be shy about closing out these positions as this is not some grand market bottom call. In fact, the more powerful the rally, the more likely I'll be to rebuild the short side of the portfolio." With today's 11.5% rally in the S&P 500, let's just say that I'm now 100 S&P points less bullish than I was just yesterday. The earnings outlook hasn't changed in my view since last night, so valuation, which was finally getting interesting, is now 11.5% less compelling than last night.

With that in mind, I'm certainly impressed that the market rallied strongly into the close and closed right near its high. Inve
stors have regained their confidence (at least for the moment) that the entire global monetary system isn't about to implode. Just as they rushed out of the market in fear as it was collapsing, they are now rushing back in -- this time in fear of missing the rebound.

Whether we've seen the lows of this cycle remains to be seen. Let's not forget that just as bull markets are marked by retrenchments, bear markets are marked by the occasional rally. These rallies are called "sucker rallies" for a reason, and they can be powerful. Following the October crash of 1929, the stock market experienced a nearly 50% rally over a 5 month period before continuing its crushing descent.

Will this rally be short-lived, or will it continue into year-end? There's no way of knowing, but I have no intention of overstaying my welcome. I suspect this move may well have more legs to it, but I also suspect that our recent QQQ and S&P positions will have a fairly short shelf-life in our portfolios. At a minimum, we'll begin scaling out of them very soon should the markets move higher still. Should the rally continue significantly higher, I fully anticipate once again ratcheting up some short positions.

One area that I'm very upbeat on that was left behind by today's rally is gold-related equities. The global flight-out-of-safety that we saw today left gold with a nearly $18 loss on the day. Governments around the globe are publicly announcing that they will print whatever amount of money is necessary to prevent the global financial system from imploding, yet gold is nearly 17% off its high, and gold mining stocks (particularly the junior miners) have been a complete disaster of late.

Events in recent weeks have served to remind the world of gold's value. Mints around the world are unable to keep up with demand for gold coins, and central banks are likely to cherish what gold they have left. On the supply side, exploration is becoming tougher and more expensive, and production is far from robust.

Gold prices and stocks are sure to be volatile, but both look very attractive at the moment, and I'll very likely be putting recent gains and some cash to work in this area imminently. My preference is to have exposure directly to the price of gold as well as to gold mining stocks, but new money will most likely be going into the mining equities given their recent drubbing. I believe that many of these stocks (particularly the juniors) will be triple-digit percentage winners from these levels.

Disclosure: The Rubbernecker is long gift horses and short all of the bottom-calling pundits.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Friday, October 10, 2008

Buckle Up: Turning More Bullish Near-Term

It sure feels like we're due for either a circuit-breaker triggering meltdown in the market or an incredibly powerful bear market rally. How's that for input? The market may go down a lot or up a lot.

My sense is that we'll see the latter, and in keeping with that, virtually all remaining short positions were covered at the close of the market yesterday. Furthermore, with the Dow down another 400 points today, I added two new market long positions to the portfolio, a double long S&P 500 ETF (SSO) and a double long QQQ ETF (QLD). I anticipate building these long positions on further sell-offs near-term if I prove to be a little early on this call.

This move is significant to me because many years have passed since I've made any type of overall bullish call on the U.S. stock market. Although this isn't a market bottom call per se, it feels good to finally be getting more constructive on the U.S. market, even if my bullishness is likely to be short-lived.

Of course, these types of shorter-term calls can be challenging and humbling. I imagine a number of people made a similar bet last Friday with the Dow at 10,325. They would have lost 18% in only five trading days.

Why the change and why now? For one, the market has just fallen nearly 20% in a mere week. To the best of my knowledge this ranks as the second worst week ever for the U.S. stock market. Keep in mind that a 20% decline is often the threshold for bear markets, and we've fallen almost that far in just the last five trading days. I've been looking for some sign of capitulation, and the second worst week in history seems like a pretty good candidate.

In addition, sentiment is simply atrocious. The VIX index spiked from 45 to 70 this past week (30 has often been viewed as an oversold level), and the VXN index has also experienced a huge spike in the last couple of weeks. Both of these indices are measures of volatility, both are illustrating the pervasive sense of fear in the market, and both have proven effective contrary indicators in the past. (Of course, if you went long when the VIX first crossed 30 this time, you'd be sitting on a sizable short-term loss.) These two indices could always climb higher, but with both at or near record levels (since they've been tracked), I believe fear and capitulation are likely to be close to a near-term peak.

Also, anecdotally, it seems as though everything I'm reading is focused on the potential for another Great Depression and a complete financial system meltdown. It's all over the newspapers, the television, the internet, and the Presidential debates. Few experts/pundits are pounding the table to buy stocks right now. Being bearish is popular. The focus seems to be more on how much further this market may fall rather than whether we're due for a bounce. This strikes me as yet another good contrary signal.

What gives me further comfort with this call is that market valuation is now far more reasonable. I've remarked to clients and peers on a number of occasions in the past few months how surprised I was that the market was holding up as well as it was given the fundamentals and the deteriorating earnings outlook. This recent rapid sell-off has helped to catch valuation up with the fundamentals. Although the market typically overshoots averages during manias and undershoots during bear markets, we're now at a very reasonable normalized market P/E multiple (in the low to mid-teens range depending on the earnings measure and time frame used).

This near-term bullish call is predicated on the assumption that the global financial market, though very strained, is not going to completely implode. If that holds true, there could be any number of catalysts to ignite a rally. The beauty, however, is that we don't even necessarily need good news to get a powerful rally given how negative sentiment is. Just a decrease in the amount or severity of the bad news (second derivative) could propel a near-term 1000-point Dow rally (not necessarily all in one day).

The strategy, therefore, is to build this position further if I'm early, barring any significant further deterioration in the fundamentals. If we do get the rally, I won't be shy about closing out these positions as this is not some grand market bottom call. In fact, the more powerful the rally, the more likely I'll be to rebuild the short side of the portfolio.

Oftentimes, investors should be doing that which is least comfortable. The least comfortable action right now is putting money into the market. Hence, that's exactly what we're doing. Buckle up.Disclosure:
The Rubbernecker is long the overall market finally and short on sentiment.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

All We Have To Fear Is...Another Bush Rose Garden Speech

Today, President Bush gave yet another Rose Garden speech on the financial crisis. He began the speech as follows:

Good morning. Over the past few days, we have witnessed a startling drop in the stock market - much of it driven by uncertainty and fear. This has been a deeply unsettling period for the American people.
I pulled the following from Bush's September 24th address to the nation on the financial crisis:

The government's top economic experts warn that, without immediate action by Congress, America could slip into a financial panic and a distressing scenario would unfold.

More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. Foreclosures would rise dramatically.

And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs.

Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And, ultimately, our country could experience a long and painful recession.

Interesting strategy. Scare the Jiminy Cricket out of everybody and then come back and blame the problem on everyone being so darn fearful! He would have been better off blaming the whole mess on Iran...or the Democrats...or Jiminy Cricket.

Disclosure: The Market Rubbernecker is long Disney characters and short "reassuring" statements from the least popular President ever.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Wednesday, October 8, 2008

Q&A: What To Buy?

Jerry e-mailed to ask: "What stocks would you recommend buying during this downturn? XOM, COP, GE?"

This gives me a good opportunity to write a little about what I've been up to lately and what I'm thinking today. Of course, what I'm thinking today could differ significantly from what I'll be thinking tomorrow in this market.

As a quick reminder, I am not a day trader. Most of the positions I take are for the long-term though some are shorter-term opportunistic trades. In addition, I pursue a long/short strategy with most client portfolios. Part of the portfolio is long, and part is short. Where that split falls depends on the number of compelling short ideas I find as well as market and sector valuation (and the degree to which the government prevents me from shorting).

Obviously, the short portion of the portfolio has done well. I'd love to attribute that to my genius, but there isn't much you could have shorted recently and not done...it's because of my genius. Of course, a true genius would have held an even larger short position.

The long portfolio has been a mixed bag. It was designed to be defensive, and it had been up until this latest "baby and bath water" stage in which any semi-liquid security has been tossed overboard. The only things rising these days seem to be Treasury securities, gold, pessimism, some currencies, and the number of political ads on TV. The portion of our long portfolio that has done well is the exposure to cash, gold, the Japanese yen, and the Chinese yuan (renminbi). These positions have fortunately been the largest holdings in most portfolios. I wish they'd been larger still for they haven't offset the losses from the other long holdings.

With the decline in the market of the past 2 weeks, I've been gradually covering my short positions (SRS, QID, TWM). I have a few remaining (MS, BWLD, COF, AMZN, and HOG). I also still have some put options in some accounts on the QQQs. I anticipate closing most of these positions out in the near-term if the market doesn't spike higher (which would not be surprising). I'll probably keep the BWLD short a little longer as it hasn't come off its high too much, the valuation is still rich, cost (margin) pressures are building, and restaurant spending is a discretionary expenditure that is easy to rein in when times are tough. Buffalo wings are tasty, but I can put tabasco sauce on my tofu dogs and watch the game at home.

On the long side, I think the best long-term buys today are in some of the emerging markets and in the commodity space. Again, these should not be bought if you're looking to make a quick buck or if you're the obsessive type who monitors his investments every few minutes. They could easily fall significantly from here before finding a bottom, but if you are a true long-term investor, these are the areas I would focus on. Many of my long positions are in these two areas, and as I've indicated, I've been very gradually adding to them as they've come in, and I plan to roll the gains from the short positions into these areas.

As for emerging markets, I like China and Russia right now. You want exposure to China over the next couple of decades (probably longer) given their growth prospects and rising incomes, and you can get it today at a very reasonable price given the tremendous decline in their stock markets. There are some good, non-speculative, individual Chinese stocks to own, but most people would be better off with an ETF/fund (FXI, PGJ, GCH, CAF).

I also think Russia is looking interesting. That market has been blown apart from the "war" with Georgia and the decline of commodity prices on which Russia is highly dependent. Some degree of continuing conflict with its neighbors has already been discounted, and I believe the long-term outlook for many commodities is quite bullish. Russia is in a much better position than it was during its 1998 financial crisis. The Russians should have enough reserves to make it through the downturn as they are far less dependent on external financing than they were in 1998. Russian stocks are currently trading at some of the lowest multiples in the world right now - typically a good time to buy. One of the easiest ways to gain exposure to Russia is with RSX.

On the commodity front, I like many commodities long-term, but the supply-demand balance and time frame differs for each. In general, commodities are being knocked down of late due to declining demand from a contracting global economy as well as the general de-leveraging underway that is hitting all risky assets. These factors are currently overpowering the supply side of the equation. Longer-term, however, we need to watch what's going on with supply as well. Heading into this downturn, supply of many commodities was struggling to keep up with demand.

Currently, due to lower commodity prices, inability to access funding, declining demand, and higher costs, there is a steady flow of news detailing mine/project closures and postponements. In many cases, it's too expensive to start a new project even if you're able to scrape together the funding to do so. This will eventually lead to even lower supply. Once the global economy settles out and starts to grow again (and it will some day), I suspect it won't take long for investors to realize how serious the under-supply situation is. Some of the commodity names I'd recommend taking a look at include POT, MOS, DBA, DBB, SLV, GLD, NEM, GDX, TCK, RIO, BHP, AEM, PAAS, SSRI, NGD, and COW, but there are plenty of others interesting names as well these days.

The market cycles between financial assets and hard assets, although neither have been working over the past few months. I believe that commodities are still in a long-term bull trend and that the bull market will reassert itself at some point and run quite a bit further. My preference is to have "direct" exposure through ETFs as well as owning stocks that operate in the commodity space. I had hoped that the commodity-related stocks would have held up better, but in the current environment, everything liquid is being sold regardless of long-term prospects. The good news is that these stocks are offering amazing entry levels for the long-term investor, assuming we're not going back to living in caves and chasing our meals with clubs.

Let me turn to gold. I've been a big fan of gold for about 5 years now, and I think it makes sense for just about everyone to have some exposure here. Gold has performed well of late, and it's our largest single holding in most portfolios. I'm actually a little surprised that it hasn't done even better given the global financial stresses. The recent relative strength of the dollar is likely the key factor keeping gold from exploding, but the explosion in the money supply that's underway, the declining level of (already low) interest rates, the terrible shape of the U.S. government balance sheet, and the implosion of the financial system should be supportive, to put it mildly. At some point, I think there's a good chance of a gold mania.

As for gold vs. gold stocks, I own both. Currently, despite the price of gold hanging in there, gold stocks have been beaten up, and many are trading near their 52-week lows. If you have a longer-term horizon, you have a wonderful opportunity to put a basket of these stocks together and tuck it away. You could also buy GDX which would give you exposure to a basket of mining companies. In addition, owning actual gold coins somewhere offshore wouldn't be a terrible idea either.

As for XOM, COP, and GE specifically, my feeling is that there are better opportunities available. These names aren't likely to outperform the market when things eventually turn, and they haven't really provided much of a hiding place thus far. If you have a longer term time horizon I would focus more on companies that will be more leveraged to the upturn. If you like energy (I do long-term), take a look at PBR, CHK, APC, and XTO. Also take a look at the drillers, especially the offshore deepwater plays. It's probably a little early here still, but these will be strong winners again.

As for GE, anything with significant financial exposure is still off limits for the time being. I've had a net short position in financials (wish it had been bigger) during the decline. The problem has been that no one really knows what any financial company's balance sheet really looks like. If you don't know the quality of the balance sheet and you buy still buy the stock, you're simply gambling. I save my gambling for the poker table. And buying the larger banks because you think the government won't let them fail is a flawed strategy. True, Wells Fargo and Bank of America won't be allowed to fail, but as we've seen, you shouldn't expect the common shareholders to be bailed out.

One final note if you're picking individual stocks. Equity investors never worry much about the balance sheet or cash flow statement when times are good. Now that times are not so good, the balance sheet and cash flow statement are critical. If you're not going to look at 10-Qs and 10-Ks then you shouldn't be buying individual stocks. Companies with too much debt and/or too high a reliance on external financing are off limits. These are potential company killers. High debt with strong cash flow may be fine if the cash flow remains sufficient during the downturn.

UPDATE: I was a bit sidetracked from this post today due to the market. The market has now closed -- down another 675 points. Today's action isn't shocking given sentiment and the lifting of the short ban.

At this point, I have turned from bearish to neutral on the market overall. There is certainly more room for downside, but after a 40% decline in the market, normalized P/E is looking more reasonable, and I'm having a much easier time finding attractive long ideas. This market is either ready to implode or we're due for an explosive bear market rally.

At the end of the day, I closed out my short positions in MS, COF, HOG, and AMZN. Currently, the only short I have is BWLD. At these levels, I'll be putting some cash to work on the long side in some of the names mentioned earlier. Never a dull moment.

Disclosure: The Rubbernecker is long on long-term buying opportunities and short of shorts.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Tuesday, October 7, 2008

Death And Birth

For every yin, there's a yang. For every sunset, there's a sunrise. For every Abbott, there's a Costello. And, for every death, there's a birth.

'Tis the season of death for the over-leveraged economy, death for over-investment, death for poor risk management, and death for failed government meddling. As for birth...

It's been a little quiet posting-wise at the Market Rubbernecker for the past week but not very quiet on the home front. As I've mentioned from time to time, my wife and I have been expecting our first baby in early October. The waiting is finally over. After a marathon 63-hour labor (that's not a typo), we finally welcomed our baby daughter into the world. As a contrarian, I take extra pride in the fact that she was born during the worst financial debacle since the Great Depression. That can only portend great things for her future.

With about 8 hours sleep total over the last 8 days, we're all in the process of adjusting to our new schedules. With so little rest I've been wary of sleep-deprivation-induced hallucinogenic trading. I came close to selling all personal and client investments and pouring the proceeds into a self-cleaning diaper venture. Cooler heads prevailed.

With a good night's sleep I plan to be back at full-strength in no time. With our new addition, I can already feel an increase in my level of disgust and anger at the failed interventionist policies of our government and central bank. I already explained to my daughter what her share of the recent bailouts and the national debt is. Her eyes widened for a moment, and then she peed on me (also true). At 2 1/2 days old, she's already more intelligent than our politicians and bankers. If only Bernanke or Paulson had been holding her.

Disclosure: The Rubbernecker is long baby wipes and self-soothing and short sleep.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.

Thursday, October 2, 2008

My Take On Buffett's Take Of GE Stake

With the ink barely dry on Buffett's recent agreement to invest in Goldman preferred shares, the sage of Omaha is on the move again. This time he's taking a stake in General Electric. As I cautioned on the Goldman deal, you need to look beyond the headlines to understand what this signifies. The press has been pushing the idea that these investments are evidence of Buffett's confidence in America, its leadership, and the stock market. We can't get inside Warren's head, so we really don't know what he's thinking, but the structure of these deals are designed for one thing -- to protect (and reward) Buffett.

As with the Goldman deal, Buffett is buying perpetual preferred stock at a yield of 10%. That works out to an annual dividend payment of $300 million on his $3 billion investment. GE will have the right to buy back the preferred shares after 3 years, but at a 10% premium, or another $300 million. Buffett is also getting warrants to buy $3 billion of common stock at $22.25 within the next 5 years. GE stock was already at $23.50 when the deal was announced and rose further following the announcement, as all Buffett deals do. The stock closed yesterday at $24.50, for a paper profit of -- you guessed it -- another $300 million for Buffett.

Buffett does wonderfully with this investment if GE just stays in business. He'll get his 10% from a highly-rated company in an environment of low-returns. If the stock goes up, his return will go up due to the warrants. Notice, again like the Goldman deal, GE also announced that it would raise a bundle of cash ($12 billion) in a common share offering in conjunction with the Buffett investment. I'm sure this was a precondition of Buffett's for his investment. This extra $15 billion of cash for GE should certainly ensure that GE stays in business and is able to pay Buffett his 10%.

It should be clear that this is yet another fantastic deal for Buffett. This type of deal isn't available to the average investor. We can buy the common shares of GE and incur all of the risk that comes with the common (including the $300 million less in annual cash flow due to the payment to Buffett), but Buffett is able to secure an almost riskless 10% yield with a free call option on the common shares.

How can this possibly be interpreted as a vote of confidence in America or the stock market? To the contrary, this deal is designed to provide incredible protection to Buffett in light of the risk in our economy and market. If Buffett wanted to signal any optimism concerning the stock market, he would have invested in the common shares of GE at a price very close to the current share price.

Disclosure: The Rubbernecker is long guaranteed 10% returns but short roughly $3 billion.

The Market Rubbernecker is affiliated with Aspera Financial, LLC, a registered investment advisor. Please read the disclaimer on the home page of the Market Rubbernecker site.