Chesapeake - Never Boring

At the beginning of 2008, Chesapeake had a market value of $23 billion. Four months ago this company had a market value of $43 billion. A few weeks ago, that market value had fallen to $7 billion, and today it stands at $12.7 billion. I'm getting a bout of vertigo just typing these numbers.


I know what you're thinking. "What's the big deal? All of the banks are getting killed these days." That's fine, but this isn't a bank. This is the largest independent producer of natural gas in the United States. They have a strong exploration and production track record and hold some large and interesting acreage positions.

$43 billion to $7 billion in a few months. That's a decline of over 80%. That works out to over a 300% annualized loss (it's the new math). Immediately, one's thoughts wander to Enron. These guys must have been cooking the books. They must have overstated the amount of natural gas reserves they own, right? Wrong. So what's going on here?

For starters, we have to put that 80% decline in context. The market overall hasn't been exactly kind to anyone since the end of July. From the time of CHK's peak to its bottom earlier last month, the S&P 500 fell about 30%. It didn't help that natural gas prices fell 53% over this same time period in sympathy with oil prices (down 43%) as the global economy continued to sputter. XOP, the SPDR S&P Oil & Gas Exploration & Production ETF, was down 62% over this period. Still, CHK has outdone itself by falling further than any of these.

There is an added wrinkle to the CHK story. Chesapeake's CEO, Aubrey McClendon, owned about 32 million shares of CHK on October 8th. A couple of days later, most of those shares were gone. Loss of confidence in the company? Not exactly. McClendon was hit with a margin call. Amazingly, this billionaire thought it wise to keep adding to his already sizable CHK stake by buying on margin as the stock started falling this summer. You have to admire his belief in the company while questioning his money management strategy.

It boggles the mind that a billionaire would risk his fortune by buying stock on margin and not diversifying his holdings, but that's what McClendon did. This is a massive failure in Financial Planning 101. Amazingly, he wasn't alone. We've been learning of executives at other firms (see BSX, CPE, DNR, LTM, PROV, PHM, and WSM) also experiencing margin calls, although of a lesser magnitude.

McClendon was forced to unload 31.5 million shares between October 8th and 10th at an average price of just over $18/share. He sold 1.8 million of those shares as low as $12.64 on the 10th. Ouch. With the stock now back at $22, that forced sale has "cost" McClendon another $125 million. Ouch. It doesn't help that this margin call occurred as the market was gapping down to a new low on the 10th.

You can see in the chart below that from the peak on the 9th to the low on the 10th, CHK lost about 50% of its value. With about half of McClendon's shares hitting the market on the 10th, it's pretty safe to assume that the extra 15 million share of selling pressure somewhat exacerbated the stock's decline. Not surprisingly, with that selling pressure now abated and with the market a bit higher, CHK has rebounded a tremendous 83% from its intra-day low on the 10th.


This is all water under the bridge at this point. The more pertinent issue is what to do with the stock now. Is the stock attractive at this level, or is this a value trap? As I've shared in the past, if I can't figure out that a company is inexpensive on the back of an envelope then it isn't worth my time or money. And, as always, I encourage everyone to do their own work.

With that said I'd like to share a couple of comments from last Friday's quarterly earnings conference call (10/31/08) that caught my attention. Chesapeake CEO, Aubrey McClendon, started off the call with an interesting statement:

First, we open the third quarter with a bang, in announcing a very innovative sale of 20% of Chesapeake's Haynesville acreage position in the Plains for $3.3 billion in cash and drilling carry. This was a great transaction for both parties and established a $13 billion value for our remaining 80% in the Haynesville, a value that today ironically exceeds our entire market cap. That does seem very unusual to me.

What makes this even more intriguing is that the Haynesville play accounts for only 20% of the company's total proved and risked unproved reserves. We can argue all day and night about the pros and cons of shale gas production, but this is an actual deal with a knowledgable buyer, so it's hard to dismiss it. To be fair, however, this deal was struck back when natural gas prices were near their peak, so I don't believe for a minute that the company would fetch $13 billion for its remaining 80% today. In defense of management, however, their timing on that sale was impeccable, or impeccably lucky.

McClendon continued,

Second, in early August, we completed another innovative JV transaction, this time in the Fayetteville Shale with British Petroleum to whom we sold 25% of our Fayetteville assets for $1.9 billion, leaving our remaining 75% position in the Fayetteville worth about $6 billion or roughly $10 per share which is about one half of our stock price today. For the record, only about 4% of our proved reserves are booked to the Fayetteville yet this transaction alone established a remaining Fayetteville value equal to 50% of our stock price; again, very unusual.

Again, natural gas prices have fallen since that time. Still, these transactions provide a bit of support and some margin of safety. The company has more of these deals in the works. It will be interesting to see what type of value they receive and its implications for the entire company's valuation.

As I always stress, I don't pretend to know what any stock or market will do in the short-term, but this is the type of situation I like. We have a real company with real assets that is currently out of favor due to a recession of questionable length and severity. If you believe that the recent flood of bad economic and financial news around the world is a sign that the rapture is near, then you'll probably want to pass on this stock (and every stock). Of course, if you believe the rapture is near, why are you wasting your time reading this? If you believe that the economy will eventually recover and you have a long-term horizon, then the following points are worth considering:

• As with many stocks, this sector is best bought when it's out of favor. Check.
  
• Current natural gas prices aren't too far from average industry all-in cost levels. This may provide some price support.
  
• Natural gas wells deplete fairly quickly, on average. This helps to balance supply when activity slows due to excess demand.
  
• Most everyone is expecting the rig count to continue falling in the coming months, further reducing expected natural gas supply.
  
• Natural gas is much cleaner than oil and much closer to home. Demand is likely to resume growing following this recession.
  
• CHK's balance sheet looks fine. They have no large near-term debt maturities, they have a nice chunk of cash, and they should generate significant excess cash in coming years.
• Valuation looks very attractive on a number of metrics.
  
• McClendon has to be angry given how much money he recently lost. He probably has a nice-sized chip on his shoulder right now. I wouldn't bet against him.
  

Importantly, natural gas is a self-correcting market. Lower prices result in less drilling which leads to less supply which leads to higher prices. The only real question relates to the length of time it takes for this to occur, and that depends on how far and fast natural gas prices decline, how quickly firms pull back on their drilling, how quickly wells deplete or are shut-in, and how severe the fall off in demand is. But make no mistake, the stage is again being set for a period of tight supply, higher natural gas prices, and higher equity valuations for this sector.

Disclosure: The Rubbernecker is long CHK and short the rapture.

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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.

American vs. Chinese Bankruptcy

Hat tip to my friends over at Calculated Risk for bringing the following LA Times article to my attention, "Some owners deserting factories in china."

First, Tao Shoulong burned his company's financial books. He then sold his private golf club memberships and disposed of his Mercedes S-600 sedan.

And then he was gone.

...As more factories in China shut down, stories of bosses running away have become familiar, multiplying the damage of China's worst manufacturing decline in at least a decade.

I don't want to condone disappearing bosses who run off with whatever cash remains and leave behind unpaid employees and suppliers, but there is a simple beauty and efficacy to this process. Capacity is immediately taken out of the market.

Entering this global downturn, it is clear that many industries are suffering from an excess of global production capacity given declining demand. One of the things needed for the global economy to find some support is for production capacity to adjust lower to meet the new lower demand. Basically, factories need to be shut down, and the sooner the better. The fact that Chinese capacity can disappear overnight is actually a good thing for rebalancing the global economy, especially since much of the excess capacity that was built in recent years was built in China.

When these Chinese bosses disappear and their factories are shut down, that production is gone. Contrast that with the typical U.S. corporate bankruptcy. In the U.S., a troubled company files for bankruptcy "protection" and continues to produce. Typically, the stockholders are wiped out, and the bondholders are given new equity in the company in exchange for their debt. Then, the company emerges from bankruptcy, often with a production footprint not terribly different from its pre-bankruptcy days.

So, not only is it likely that zero to modest capacity was taken out of the system, but now the remaining competitors in that industry are facing this "new" old competitor which has a clean balance sheet and can more aggressively compete on price. This puts added pressure on the "survivors" who may have been fairly conservative and done everything right, but nevertheless now face a stronger competitor that would have been liquidated in a true free market. There's probably no better example of this than the U.S. airline industry.

We can bad mouth the Chinese bosses who are leaving their employees and suppliers in a bind, but at least they've found a way to quickly address the excess capacity overhang.

Disclosure: The Rubbernecker is long disappearing Chinese bosses and short the U.S. bankruptcy code.

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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.

So That's Why Gold Prices Are Up Today

Those who've followed me for some time know I've been a fan of gold for over 5 years now. So I folllow the news on gold, gold prices, gold mining, gold teeth, gold mining stocks, gold pine cones, gold demand, gold supply, and alchemy pretty closely. Those who've followed me for some time also know how ridiculous I think it is when the press attempts to explain away why a particular market or asset class rose or fell in a given day. MarketWatch has obliged both of these interests of mine today with an article entitled "Gold Rises 1% On Speculation Prices Have Bottomed."

The article begins,

Gold futures rose Monday for the first time in three sessions, adding 1% on speculation that the precious metal's prices, after suffering their biggest monthly loss in October, may have bottomed. Gold for December delivery gained $7.30 to stand at $725.50 an ounce on the Comex division of the New York Mercantile Exchange. The contract had surged to $739.50 earlier.

Now, I'm glad that gold is up, but this type of commentary is ridiculous. First of all, in this market a 1% move in just about anything is little more than noise. There haven't been many days in the past few months when gold hasn't moved at least 1%. We even had a gain in gold of 11% back on September 17th. A 1% move may have been significant in prior years, but a move of only 1% makes for a fairly quiet day of late.


It's even more ridiculous that MarketWatch believes it can attribute a minor 1% move in gold to any particular factor or set of factors. In this case, MarketWatch attributes the rise to speculation that gold has bottomed. How can they know this? If there were only one buyer and one seller who both happened to be cousins of Moming Zhou (the author of the piece), then fine. But this is a market with many buyers and sellers. Some are trading to speculate while others are trading to hedge. There is no way to net out the effect of all of these trades and boil it down to only one factor.

Claiming that a price rise is due to speculation that prices have bottomed is also about as weak an explanation as can ever be given. It's akin to saying that prices are rising because people expect prices to go higher. No kidding?

Unfortunately, this claim and rationale could have been proffered (and probably was) for any 1%+ move in gold over the past few months, yet gold is trading only 8% above its 52-week low. So, even if the author truly believes that "speculation of a bottom" was the reason for this massive 1% rise in gold prices, perhaps he/she could have pointed out that prior bottom-fishing speculations have proven to be a false dawn over the past few months. Also, the gain on the day is much smaller than the fall from the intraday high. Why no explanation for the fall in gold prices from the intraday high of $739.50 to $725.50? This $14 fall seems at least as interesting as a $7.30 rise. Actually, it seems almost twice as interesting.

Don't get me wrong. I hope gold has bottomed. At some point it will. If the press keeps attributing any slight hiccup in the price to "speculation that prices have bottomed," one day they'll be right. Even a blind squirrel finds an acorn sometimes.

By the way, gold is now up only $3. It's down $17 from its intraday high.

Disclosure: The Rubbernecker is long dentistry and golden plant organs and short the press.

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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.

3Q08 Earnings Season and Valuation

What a week. We wrap up the worst month in the market since the 1987 crash by enjoying the best week in the market in 34 years. This neurotic bi-polar market continues to redefine everyone's view of volatility. It feels like we've had 3 years worth of action in just the past few weeks. The news flow has been incredible as well as the financial crisis continues to unfold at the same time as earnings season is in full swing.


Now that I've had a chance to catch my breath, there are a few thoughts about this earnings season that I thought I'd share as we enter the last heavy week of reporting. First of all, it isn't surprising that most of the news on the earnings front has been rather disappointing this quarter. It's looking like earnings for the quarter may end up falling 9-10%. Few firms in any industry are very upbeat about the near future although most firms claim to be very well-positioned for the long-term. This is just how things are done during a "slowdown." Mangements are typically of the optimistic sort, so when the near-term outlook is terrible, the conversation begins to focus more on the long-term, for which their enthusiasm knows no bounds. Of course, when the near-term starts to improve, we can expect the conversation to quickly shift back to their more typical, "long-term", three-month outlook.

Another point that I'd like to stress is that it gets a little more difficult during an economic downturn to assess the performance and prospects of a firm. Whatever the true reason for a slowdown in sales, a fall in margins, or a lower earnings forecast, virtually all companies will blame any shortfall on the economy. Thus, differentiating between company-specific and economy-specific reasons for a firm's poor performance gets a little tricky. No CEO really wants to say, "Hey. Not only does the economy stink, but we've been really making a mess of things around here ourselves." So, instead, blame gets shifted solely to the economy. For this reason, paying attention to a company's industry peers takes on even more importance during a recession (yes, this is a recession). If all of the companies in an industry are hurting fairly equally, it's probably the economy. The larger the differences in performance, the less likely it is that the economy is the only factor impacting the laggards.

Finally, let's take a look at earnings expectations for the fourth quarter and 2009. A report from Thomson Reuters Research came out in the middle of last week that showed that analysts were expecting earnings for the fourth quarter to increase by 32.2% and for 2009 to show growth of 15.7%. I suppose anything is possible, but these figures strike me as a touch absurd.

Let's look at earnings estimates a little closer, using Standard & Poor's data. For the fourth quarter of 2008, the estimate for S&P 500 earnings based on analyst projections (bottom-up) is calling for a 15.2% sequential increase over Q3 and a 36.8% increase year-over-year. These are operating earnings, which leave out all of the "one-time" items. Unfortunately, there isn't a comparable top-down operating number. The top-down estimates that we have come from strategists (as opposed to analysts) and are for reported earnings, which do include those "one-time" items. It's interesting to note the difference in these figures. The bottom-up (analyst) operating estimate for the fourth quarter stands at $20.82 while the top down (strategist) reported figure comes in at $12.12, 42% lower. For 2009 those numbers are $94.25 and $48.52, respectively. That's a huge difference of 48.5%. By way of comparison, the difference between the reported and operating numbers for 2007 and 2006 were 19.8% and 7.1%, respectively. The difference for 2008 is forecast to be 25% currently.

What does this mean for valuation? The S&P 500 index closed last week at 968.75. Put a 15 multiple (arbitrary) on the $94.25 figure for 2009, and you get a level for the S&P 500 of 1413, implying that the market is undervalued by 45% currently. Put that 15 P/E on the $48.52 figure, however, and we find fair value at 727, implying the market is overvalued still by 25%.

There are two points to this analysis. First of all, the bottom-up estimates from the analysts are almost always too optimistic, particularly during a downturn. The analysts are being spoon-fed by optimistic managements and are therefore very slow to bring their numbers down to better reflect reality.

The other point is that we have to be very careful when trying to value the market using P/E analysis. There are a number of different earnings measures and time frames that can be used. The use of a particular P/E multiple is also highly subjective. Care must be taken not to mix a forward (2009) earnings estimate with a P/E based on historical trailing earnings. Forward P/Es must be applied to forward earnings, and trailing P/Es must be applied to trailing earnings. Better yet, these inputs should be normalized for the business cycle. Unfortunately, rather than approach valuation objectively, many people tend to use the combination of earnings and multiple that best helps them justify the bullish or bearish view they already hold. This is called data mining, and it's a dangerous substitute for objective analysis.

Disclosure: The Rubbernecker is long mining, but not data mining.

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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.

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.

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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.

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.

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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.

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.

Why?

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).

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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.

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.

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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.

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.

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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.

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. Investors 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.

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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.