Wednesday, January 30, 2008

China and India's Economies

Interesting edotorial from the London Guardian a buddy sent me from the Taipei Times (thanks Andrew)

Couple of interesting excerpts

Things are a bit different in India, which does need to import capital -- unlike China it runs a deficit, but it too has an investment boom, and so far its companies have been finding it easier to raise capital since the credit dramas began last August, as investors desert the loss-making markets of the West.

I have thought and stated that the majority of this cheap cheap money the FED is creating is going to flow to emerging markets creating a bubble in these areas.

Rising prices for food, energy and other commodities, partly caused by strong Asian demand, lie behind the high interest rates and inflation worries that were spooking the Bank of England, the European Central Bank and, until its big interest cut last week, the US Federal Reserve. They are also a big worry for India and, even more so, China.


Then, in 1971, Japan was forced by then US president Richard Nixon to revalue the yen, and in 1973 the global oil shock brought inflation. The result? Not in fact a disaster for Japan, but a wrenching change.

The debtor nations are always much better off in the wrenching change than those nations who owe tons of money. i.e. During the Great Depression. England and especially Germany was much worse off than the U.S.

Economies of China and India are not invulnerable (Thanks Andrew)

Tuesday, January 29, 2008

Financials Worse Nightmare

Many of you probably have seen this over at but I was so incredulous I had to post on it in case someone missed it. is a sign of the times. Financials have had a huge rally of the past couple of weeks and they may rally for the next week or two depending on what the FED does but this has the potential to add yet another round of pain. This was never thought possible by the Wall St penguins. It is amazing how logical and rational it is for people to be walking away now when they didn't put in any equity down in the first place.

Daily Inflation News

Companies screaming about input prices and promising (if not all ready passing on) price increases continued today.

Pilgrims Pride ($700 million more in feed costs than last year), GM, Dow Chemical, and U.S. Steel all griping about input costs today.

Monday, January 28, 2008

Mary Whitman and MBIA

Man I am just pouring on the posts today. I keep finding things I find really interesting. This is famed valued invesotr Marty Whitman's lastest letter. He has a large positions in MBIA and Radian. I have bet strongly against MBIA and so have been very curious at his bullish thoughts on the company. This really doesn't shed much light into that but it is interesting. Basically he just think there cheap compared to book. I still disagree with his assessment of MBIA and think book isn't worth his $.40 on the dollar.

Everything below is from the letter
THE RESIDENTIAL MORTGAGE MELTDOWN AND HOUSING COLLAPSETAVF is investing heavily in the common stocks of companies suffering through the current housing crisis. These companies include financial institutions, a homebuilder, a building supplier, land banks and investment builders. The Fund’s reasons for this investment program provide a good case study as to how Third Avenue’s “safe and cheap*” approach works in practice:First, the bad side of these investments:
1) The stock market pricing for these equity issues is chaotic. There is no way Fund management is able to pick a bottom for securities prices, or a near bottom.
2) Fund management has no good idea of how deep the crisis will become, or how long it will last. Our best guess is two to four years.

Second, the good side of these investments:
1) In each instance, TAVF is acquiring common stocks at meaningful discounts from readily ascertainable NAVs. In the case of certain financial institutioncommon stocks – MGIC Common, MBIA Common and Radian Common, the prices the Fundis paying are no more that 40% of book value, or adjusted book value. For each of these companies, a normalized Return on Equity (equity equals bookvalue) (“ROE”) ranges from 8% to 14%. Assuming a 10% ROE sometime in the future, and no further dramatic deterioration in book value during the interim, probably a realistic assumption; and current pricing at 40% of book value, Third Avenue wouldbe paying only four times future normalized earning power. There seems to be a reasonable probability, too, that TAVF is really paying less than four timesnormalized earnings, even assuming that future normalized earnings are fully taxed and even assuming some modest dilution of the common stocks.
2) Each common stock acquired, is acquired in a company which enjoys a strong financial position. While there can be no guarantees, the probabilitiesare that each of these companies will survive as solvent going concerns either without requiringmajor access to capital markets for new funding, or by obtaining new funding from others on terms that are only modestly dilutive for TAVF. On December10th, MBIA announced that it is obtaining $500 million of equity financing from Warburg Pincus; and another $500 million from a rights offering which Warburg Pincus will backstop, i.e.,underwrite. Assuming that Third Avenue participatesin the rights offering and also takes advantage of any oversubscription privileges, the capital infusion should be, at worst, only modestly dilutive for TAVF.
3) Each company seems very well managed.
4) It is possible that the crisis will become increasingly deep, and prolonged; or rating agencies will start to place great weight on soft, qualitative considerations. In those events, the companies might need capital infusions toremain going concerns. TAVF has proposed to MBIA, Radian and USG managements that such infusions be in the form of equity, and that existing stockholders provide the equity via pre-emptive rights offerings. MBIA proposes to raise $500 million via a rights offering. If this were to occur, and if other portfolio companies were to follow the MBIA path, the capital infusions would be, for Third Avenue, mostly nondilutive, or anti–dilutive (if there are oversubscriptionprivileges). In the case of MBIA and Radian, it is crucial if they are to remain going concerns, that the national rating agencies continue to assign AAA and AA ratings, respectively, to each company’s bond insurance subsidiaries. As an aside, given current prices, TAVF would probably not lose money if Radian or MBIA were to go into run-off rather than remain going concerns. Run-off, i.e., liquidation, simply is not a likely outcome, however

A Classic Quote from Warren Buffett

In the December CNBC interview, Buffett was asked whether a recent bout of trouble for banking stocks might be the last shoe to drop. His response might well apply to the fresh round of write-downs we saw last week. "No, no," responded Buffett. "When people start dropping shoes, you really don't know whether they're a one-legged guy or a centipede."

A Great Article on One of the Best...Walter Schloss

A couple of points from this article. Information for information sake is worthless.

Schloss doesn't profess to understand a company's operations intimately and almost never talks to management. He doesn't think much about timing--am I buying at the low? selling at the high?--or momentum. He doesn't think about the economy. Typical work hours when he was running his fund: 9:30 a.m. to 4:30 p.m., only a half hour after the New York Stock Exchange's closing bell.

He is not all that bullish even after the market's fall.

The S&P now is off 15% from its peak, yet Schloss says he still doesn't see many bargains. He's 30% in cash. A recession, if it comes, may not change much. "There're too many people with money running around who have read Graham," he says.

Like most great value investors he refuses to overpay for anything.

He has a Depression-era thriftiness that benefited clients well. His wife, Anna, jokes that he trails her around their home turning off lights to save money. If prodded, he'll detail for visitors his technique for removing uncanceled stamps from envelopes. Those beloved Value Line sheets are from his son, 58, who has a subscription. "Why should I pay?" Schloss says.

The article also mentions five stocks he is looking at.

George Soros on the Coming Economic Doom

There was also a very interesting interview with him last week on

When George Soros says that the world is facing its worst financial crisis since the second world war, businessmen, politicians and the public pay attention. This, after all, is the man who famously made $1 billion betting against the pound in 1992.

“The current crisis is not only the bust that follows the housing boom,” he said. “It’s basically the end of a 60-year period of continuing credit expansion.”

Soros is just one more opinion out of thousands out there but I usually take notice when he speaks up. Anyone who has had as much success as he has had with the historical longevity that he has under his belt should be listened to.

Since I am on Inflation Again

Toll Inflation

Big toll hikes are planned for most of the nation's signature toll roads, bridges and tunnels. The increases would add dollars, not cents, to the cost of passing through many toll booths.

For example, in March, the toll for cars driving on the George Washington Bridge linking New York and New Jersey — the nation's busiest toll bridge — jumps to $8 from $5 during peak hours. Truckers will pay $35, up from $25.

Phone Inflation

AT&T and Verizon are raising prices for caller ID and other popular phone services by as much as 300%, even as they continue to push regulators to loosen up because of increased competition

Split Among the Three Big Central Banks

Not everyday I post something from Scotland but found this article interesting. Excerpts below point to the very different views between the central banks in looking at rate cuts and inflation. I do not know how Europe's inflation can be that much worse than the United States. It seems that Europe is getting it while the pressures of election year and Bernanke's love for higher stock prices is causing him to all but ignore half his mandate (to control inflation). Today again inflation signs were everywhere. Tyson complained bitterly in their earnings about inflation and said major price increases were coming. Hershey's basic chocolate bar has price increases coming of 13%. My family's company (manufacturing) just found out their will be across the board double digit steal price increases. Recession or not for the most part it is still an U.S. phenomenon and the demand on the margin (i.e. India and China) is going to cause huge problems going forward. I hope Bernanke doesn't bring us back to the 70s.

From the article

A truly dramatic week, with some of the worst falls seen since the 9/11 terror attacks in America, saw the three most powerful banks in the Western hemisphere respond in three starkly opposing ways. The reaction of the US Federal Reserve was swift and dramatic. That of the Bank of England was more cautious and measured. And the European Central Bank responded to pressure to follow the US with a determined 'Non', or, more accurately, 'Nein'.

Can all three be right? And might this evident lack of co-ordination and joined-up thinking cause the markets to be even more worried than they are?

Government officials and policy advisers at the World Economic Forum at Davos have been unnerved by the absence of a co-ordinated response. Calls for a global approach have now started to come thick and fast. Financial market veterans frequently note that one of the catalysts for the 1987 stock market crash was very public disagreements between the United States and Europe over the appropriate monetary and fiscal policy actions needed. And for them the events of the past week will have been especially scary.


On many measures, inflation expectations are the highest since BoE (Bank of England) independence.


ECB executive board member Jurgen Stark set the uncompromising tone with a statement that the bank was "very worried and alarmed" about inflation.


So which response is right – the dramatic slashing of rates by the US Fed, the highly guarded response of the Bank of England governor, or the 'No Surrender' stance of the ECB?

All involve cultural reactions to the crisis at hand, which seems to have acted to bring out fundamental regional differences in philosophy and outlook. US central bank policy, certainly since the mid-1980s under Alan Greenspan, has always seemed especially sensitive to adverse stock market reaction, the memory of 1929-30 being hard-wired into the American financial mind. The UK has always tended to prefer a pragmatic, muddle through approach. And the ECB's reaction reflects the continuing huge influence of Germany's deep-seated fear of hyper-inflation and its many consequences.

Saturday, January 26, 2008

Are Money Market Funds Safe?;_ylt=AsExbMm7k5ZPWyOvPPCLNfn2ULEF
Uncertainty over the fate of the embattled bond insurance industry has in recent months caused some sleepless nights for US money market fund managers.

For decades, money market funds have bought municipal bonds and, more recently, structured finance securities that have been insured by companies such as MBIA, Ambac, FGIC and SCA.

"The potential problem of the money market funds is what is really scaring people now," said one senior investment banker on Thursday.

One senior regulator said on Thursday: "In the old days, what we had to worry about was the idea of runs on banks in terms of retail deposits. But there is a prospect that we could see a run centred around the money market funds of the type we have not seen before - this is generating a lot of concern."

If there were widespread losses in money market funds, policymakers fear the political heat will ratchet up as retail investors start screaming and, worse, it could precipitate a widespread withdrawal of cash from money market funds, which could cripple the entire short-term funding market.

The wave of selling from Mr Shachat and other such investors has already pushed prices for insured securities much lower than those for comparable uninsured securities. Mr Shachat says this has created a "two-tiered market" in which yields for insured securities are up to 350 basis points higher than those for uninsured securities - in a dramatic reversal of conventional pricing.

As this last paragraph points out spreads have already widened trading as if these things are unwrapped but more downgrades / bad news for the monolines could cause panicky selling among the money market fund managers causing the spread to become much wider and break the buck on many market funds causing even more selling. The panic this could cause, which this news story alludes to, could have a catastrophic domino impact on our financial system.

In early December I moved all of personal and funds cash out of high yielding money market funds into low yield short term treasury funds. Better safe than sorry.

Friday, January 25, 2008

Burlington Northern

I have not touched BNI on my blog because there are many blogs who are following this story but I thought this article (really the table within the article) was interesting enough I decided to put it on here. For full disclosure I do not own BNI, though I came very close to buying it around $78 last week. Buffett now owns 18% of the company. It is his biggest purchase in dollar value ever in one year in one company on the NYSE. He has been buying it by the bucket loads.

The replacement value (what it would cost if you rebuilt the rail lines from scractch today) has been estimated north of $70 billion dollars.

More MBIA / Ambac News

America's biggest mortgage bond insurers collectively need a $200 billion (£101 billion) capital injection if they are to maintain their key AAA credit ratings, a figure that dwarfs a plan by New York regulators to put together a capital infusion of up to $15 billion, a leading ratings expert said yesterday.

Sean Egan of Egan-Jones Ratings Co. talks about the $200 billion number in the video above.

This news combined with the thought the Fed may not cut as much after they were duped and the fact that we had a 6% monstrous rally in the S&P from bottom to top is sending the markets lower.

Like I said, I still don't see how equity holders in these companies get anything back.

Thursday, January 24, 2008

Was the FED Duped - This could be big (currently this article does not require a subscription)

Massive fraud by a rogue trader at Societe Generale SA has led to a €4.9 billion ($7.16 billion) write-down and is roiling markets as far away as Asia and further shaking investor confidence in Europe's biggest banks.

Though Societe Generale says it first learned of what it termed "massive fraudulent directional positions" on Jan. 19, it waited until it could close out those trades before going public with the problem. Winding down the trades, the bank said, resulted in a €4.9 billion write-down, making it potentially the largest loss ever from an alleged rogue trader.

So maybe the global sell off had nothing to do with market panic or economic woes or coming doomsday but instead, unwinding massive positions because of fraud at a bank. Why is this so big. It could mean the FED was duped into cutting rates. It could validate what everyone has been saying that the FED is the markets punching bag. The FED said they cut rates because of tightening lending standards at regional banks. Lets hope they were seeing something else other than just responding to the world sell off. That would be a misstep of magnificent proportions. Today the jobless claims number came out. It was very strong. So the market is expecting a 50 bip rate cut next week. So you have a very good job reports number, revelation that the FED made have blinked as a result of fraud..... Can the FED really lower interest rates 1.25% in less than 2 weeks? HMMMMMM

Wednesday, January 23, 2008


If you have not been following this both bond insures MBIA and ABK are up about 100% in the last two days. A post I did back in December said everything revolved around these guys. I think I am being proven right in that statement as losses accelerated last week after these guys look they were done and huge market gains today after regulators met with their counterparties potentially infusing $5 billion to $15 billion in capital in what amounts to a governement orchestrated bailout.

Couple of thoughts.

1) When in history has a government bailout amounted to anything substantial for equity owners? The 1998 liquidity crises centered around LTCM. That hedge fund blew up and the governement had to come in to lead a bailout (Wall St banks ultimately bailed them out). The point is the owners of LTCM got next to nothing. Same with the S&L crises. The governement came in and huge bailouts. Equity owners got next to nothing. 1930s JP Morgan led huge bailouts, equity owners got next to nothing. Why is this time any different? The market is acting like it is and you shouldn't ignore that information feed. I am just not totally following why.

2) If this is resolved with a bailout we may have reached a bottom in financials. Not screaming from the mountain tops but it is possible. You still have problems with housing, increasing credit card defaults, commericial real estate turning sour, and auto loan problems but what could take the whole finacial system down (the derivative issue) would have a major repair job done.

One more bonus thought just for you.
3) It seems like we went through this about 5 months ago. Remember the SIV bailout with the super SIV fund that went the way of the dodo bird? Well this has all kinds of problems with it. All we know is that they met and options were discussed. I don't know how bad it really is but it could be bad enough that unlike in 1998 this will truly be a governement bailout with still large losses for various financials.

Well Well

We finally got it. A massive rally on the long end. How massive? Try 625 points+. We went from negative 200 to about break even and then to negative 300 + before going up 600 points to finish up 298. This is the Dow only but the other indexes tell similar stories.

Who knows, I didn't trade any today besides adding back my 1/3 of SRS. It fell 17% today and I think I might have been the last trade before the bell closed. It may go lower but the fall of commericial real estate I think is still intact. I thought I would be adding that back on in a few weeks not 24 hours.

Who knows what happens but I would not be surprised for the market to test 13,000 over the next few weeks. Either way stick to fundamentals and it will not matter.

Let the Good Times Roll

So I woke up this morning and do what I always do. Reach over for my blackberry and check the futures before I do anything else. I think I let out an audible groan as it looked like the market was going to open down again another 100 points or so. That feeling of nausea caught my attention. I figured compared to most investors I have weathered this downturn better than most and am still very well positioned going forward with quite a bit of cash and here I am groaning at another drubbing in the markets. Two more thoughts flooded my mind. What are most investors thinking who are not nearly as well positioned as I am? Also is that not an irrational thought? I mean as the market goes down this increases the future returns of stock. Companies, great companies, are getting even cheaper to buy so if you have any cash at all you should be looking forward (not groaning) at the prospect of a better buying opportunity. I realized how my thoughts were not matching rational thought (a very severe problem for investors). Anyway, I started trying to change my thinking pattern and decided LET THE GOOD TIMES ROLL.

On another note SRS (the inverse of IYR the REIT index) has performed exceptionally weak the last couple of days (meaning REITs have performed exceptionally strong). I took 1/3 of my exposure off the table yesterday and it is down 2% today when the market is down 2% also. I don't think the commercial REIT downturn story is over and I will probably add back my 1/3 position at some point. Worth watching.

Tuesday, January 22, 2008

Random Thoughts

Alot has happened. Feel like writing down a few thoughts so either enjoy or ignore.

Overall I was rather disappointed with the market today. It didn't seem to do much of anything. You have this huge open down after the Fed did a monstrous "surprise" rate cut (the market kind of yawned at the Fed) and then you have this monstrous rally only to kind of fall apart at the end and you finish down in no man's land down around 130 on the DOW. There didn't seem to be any major panic or major capitulation. I was a buyer today but was tepid. Took some short exposure off and went long another stock I have been following but considering the cash I have it really was not much of anything. I was hoping for a potential washout or some dramatic reversal so I could put some money to work. I hold stocks for a long time (typically and unless it is shorts which I tend to trade more) but at the same time the point of purchase and being aware the market psychological aspects involved can be huge in entry points. I really think we are headed for some kind of fairly decent bounce (5 to 10%) and I sometimes trade short exposure around that but I was thinking that last Wednesday and it did not come (market got slaughtered instead). Maybe it does not come this time either. However, you can not be a seller though on day the market opens down 450 points.

Another thing, looking at my holdings I felt like the market was up 300 points. Retailers (which I have been long) were up huge and banks (which I have been short) were also up huge. Did not seem like the markets overseas dropped 10% plus, or that the market opened down 400+ points, or we had an historic rate cut, or that the world was any less than perfect.

Friday, January 18, 2008

MBIA and ABK Plan

I am tired of putting Cramer on here because we are at the opposite end of the spectrum on so many things and usually when he speaks on the tv I turn the channel but he is right for a second day in a row. He overly simplifies a little bit and over exaggerates a little bit on the upside potential of the market if his plan is put into place but this is the first plan for MBIA and ABK that I have heard that actually makes sense.

Thursday, January 17, 2008

Cramer Rant
He is at it again. This one is close to on par to his rant back in August. In this one though I agree with most of what he said. I think he is right.

Agriculture Stocks....Interesting?

Today soft commodities are moving up again. Soybeans, corn, wheat, and rice are all up across the board. Once again the soft commodity stocks are getting slaughtered, Deere down 10% (down near 20% in the past 3 days), Mosaic down near 10% (down near 30% the past week) and Potash down near 12% (down near 20% of the past few days). I own known of these (except through MOO). Finally got the break where maybe they look interesting now, especially Deere. Mosaic I thought had upside at 100 on fundamental basis but wasn't willing to touch it, at 80 seems interesting. If you are buying these though you are betting on the 2009 and 2010 planting season. 2008 is done and prices will be high and these guys will make a killing but what about 2008 and 2009? Will anything fundamentally change that corn will not be at $5 bucks a bushel anymore? That is what you have to determine. I am a broken record but we produced more corn in the U.S. since 1944, most of the country had superb planting conditions to get very high yields, and we still didn't produce enough corn to replenish stock piles. The risk at this point is regulatory I think. The idiots in Washington who came up with the ethanol push take away the incentives to produce ethanol.

Totally Awesome

For investors who want to do their own research and look at the stuff that is most likely to be mis-priced this is the website for you. My theme has been defense, defense, defense and that appears like it is not going to change anytime soon. So if your not a bear fund and short ideas are becoming few and far in between the next artistic paint brush swipe may be into preferreds, exchange traded debt securities, royalty trusts, convertible securities, and all the other stuff everyone ignores. Honestly I am ignorant on most of this stuff and will be spending some time learning. Obviously this website is only for those who have the time and the desire but it could be the safe haven. A preferred share places you ahead of shareholders so if your seeking yield as you wait out what looks like will become a bear market this can be a good way to do it. As Buffett has said, it is not how much money you make in the good times it is how much money you lose in the bad.

Anyway yesterday in the WSJ page C2 it talked about Citigroups (C) new $2 billion IPO of its convertible preferred securities it will bring to the market. This will allow investors like you and me to get the same deal that the Singapore, Korea and all the other big investors got. Essentially you get 7% dividend (you are ahead of shareholders of common stock so if they pay the dividend of any kind you will get your full 7%) that is structured in a way that you only pay the 15% tax rate on it and you have the option to convert to common stock at any point that the common stock moves 20% higher than the current price of the issuance of the preferred. I am not recommending this when it comes out but it does sound very intriguing.

Anyway this site has all those type of listings.

Wednesday, January 16, 2008


Commodities are getting the snot beat out of them today. Doesn't matter what it is, the nail is going deep. I just want to punch something. I looked like a genius for all of 24 hrs in covering my copper short. I did not stick with that theme long enough. Grant it I didn't lose money but FCX is down 10% today. That hurts. MOO, an index!, is down 8% today. I sold puts to put me into position to buy more of MOO if it continues to go down or collect a healthy premium if it rebounds. It finally appears that investors are capitulating that the world will be affected by a U.S. slowdown (duh!) though it is punishing everything along the way. (Is Mosaic really going to sell less seeds or lose pricing power because the U.S. enters into a recesion or because China grows at 2% instead of 10%?)

By the way, if it wasn't the prospects of an early rate cut in the next week or two by the Fed I think the market would be down another 300 points today. With "in-line" inflation numbers the door is opened for the Fed to act like they are the big man on campus.

Monday, January 14, 2008

Crazy Bullish Scenario

Not advocating this, not saying it is going to happen, not saying I think will happen. Just a thought.

Bernanke last week sounded as gloomy as I have ever heard him and made it clear that they would be cutting interest rates. Rumors are flying that there will be an early meeting (nothing new) and the market is now saying it is a toss up whether it will be a 50 bip cut or 75 bip cut. WOW. Anyway, tomorrow and Wednesday are huge inflation number days. What if the inflation numbers come at or below expectation (wouldn't be surprised to see continued behind the scenes massaging by the government) followed by a rate cut of 50 bips Thursday or Friday by the Fed (an early meeting) pointing to the weak inflation numbers saying they could do it. The DOW would be up at least 500 to 700 points by next Monday.

Like I said, just a thought.

Couple Thoughts on a Couple Agriculture Names

John Deere a year ago traded about at 16X forward earnings. The stock price has doubled and it still trades at about 16X forwards earnings. Little to no earnings multiple expansion there. If your looking at a price to sales number that is a different story. You have gone from 1x sales to 2x sales. Shows the amount of operating leverage that is in the business. Though I rarely look at stocks that have the type of stock graph that Deere has it isn't crazy to think it could double again.

Another agriculture name that I have an interesting tidbit on is Mosaic. They sell seeds to farmers. I heard that a farmer in the midwest paid last year something like 250 per acre for seeds (I don't know the denomination seeds are sold in and if the lingo is correct) . Anyway Mosiac set the price at 400 this year. He apparently complained and Mosiac said if you don't want them, fine, we can ship it overseas tomorrow. Now that is pricing power.

I do not own either of these directly though both are represented in MOO. I am taking a close look at Deere trying to see if there is any margin of safety to the story. I am betting alot (have already made alot) that soft commodity prices will continue to go up over the next 12 months. Assuming that is right, what is the risk that Deere stock price goes down because of misses on the business front or major drought. etc Mosiac is interesting of course to but it is more expensive than Deere fundamentally, less diversified, and something I will only own through MOO.

Barron's Roundtable Quote

"Let me stress that weak currencies don't produce inflation. Inflation in the system produces a weak currency." - Marc Faber

Commodity Update

Corn's front month contracts are currently locked having limited up. Soybeans later contracts have also limited up for a second day in a row. Gold is flying and copper is moving higher. The really one that is interesting there is copper. A report today that China imports of copper was at an 8 month high as the raging demand in that country is offsetting the slowdown in the rest of the world. I covered my copper short today for a slight (really breakeven) profit. That theme may be slower to play out than I previously thought.

Sunday, January 13, 2008

Inflation and Food for Thought

I have been saying it for almost a year now, China's next great export is inflation. The British media picked up on it 3 to 6 months ago and now the U.S. media is slowly picking up on it.

For most of this decade, outsourcing to ultra-low-cost China has been a magic trick, enabling higher productivity and greater profits and consumption. This strategy has avoided the textbook downside of extended growth cycles -- an inflationary hangover followed by a recession.

While it is widely recognized that China has been behind rising prices of oil and other commodities, by supplying the world with mountains of ever cheaper toys, electronics and clothing the country has been a source of deflation.

But this could now be changing. Concern that China is now emerging as a source of higher, not lower, prices is emerging. The Times of London last week cited new figures showing that at the end of last year the cost of China's imports to the U.S. started rising sharply. The U.K. may soon follow.

And if China accedes to pressure to revalue the yuan substantially upward, the chances that those rising prices will be sharply felt increase as well.

The current looming recession will slow it down briefly but I think anything short of a depression won't change the end outcome. We are still in the batters circle taking practice swings before the game. The next big cycle I think is upon us.

Food for thought. Could a return to inflation actually be good for Japan? Think about it, they have been stuck in a deflationary funk for almost 17 years now. Inflation is running above 2.5% (above 4% if you don't just look at core) in most of the world. If Japan got caught up in it and inflation went to 2% from 0% could that be a good thing? Japanese stocks are cheap cheap cheap. I wonder if investors in Japan are seeing what is going on in the United States bringing back memories of 1990 and selling because of that memory. This is a United States problem not a Japan problem. It is the United States whose real estate and the collateral that will be in decline for years, not Japan. I have been spending some time on Japanese securities. No purchases yet but I have a feeling Japan's markets will greatly outperform the U.S. markets over the next 5 years. You have a tailwind with the currency. Like I said food for thought.

Friday, January 11, 2008

Inflation or Deflation

Today at least inflation is winning, big time (unless your talking about stock prices). After the agriculture news this just released which mirrors FedEx move a couple of weeks ago. Basically anything that is shipped not under contract by UPS just got 5.4% more expensive to ship starting Feb 5th. That covers alot of items.

United Parcel Service Inc.'s Freight unit will raise its rate for non-contractual shipments in the U.S. and Canada by an average of 5.4%, effective Feb. 4. The Atlanta package shipping company aid the rate hike applies to minimum charge, less-than-truckload and truckload rates.

Few Soft Commodity Statistics

The Numbers

The USDA said that 46.61 million acres of winter wheat are expected to be planted in 2008, up 3.6% from a year ago, but much less than expected. July wheat is up its 30-cent maximum daily limit.

The USDA's 2007-2008 U.S. ending stocks estimate for: Corn was reduced from 1.797 to 1.438 billion bushels, much less than expected. Soybeans was reduced from 185 to 175 million bushels, a little more than expected. Wheat was increased from 280 to 292 million bushels, more than expected. Sugar was reduced from 2.050 to 2.006 million tons.Cotton was increased from 7.70 to 7.90 million bales.

The USDA's 2007-2008 world ending stocks estimate for: Corn was reduced from 109 to 101 million tons. Soybeans was reduced from 47.3 to 46.2 million tons. Wheat was increased from 110 to 111 million tons. Cotton was reduced from 55.3 to 54.75 million tons.

The USDA's estimate of Argentina's soybean crop was unchanged at 47 million tons, but the estimate of Brazil's soybean crop was reduced from 62 to 60.5 million tons. March soybeans are trading higher.

The USDA said today that 296,000 tons of U.S. corn were sold to South Korea and 120,000 tons were sold to unknown destinations. March corn is trading higher.

The BIG News Today

The big news today is not the Countrywide merger with BAC. It isn't American Express or even Merrill's rumored write down of $15 billion. Oh no. The big news today in my opinion looking long term is what is going on in the trading pits at the Chicago Board of Trade. WOW.

The USDA released much anticipated agriculture report this morning. All that can be said again is WOW. Basically there isn't enough corn worldwide to meet world demands and even really domestic consumption. So corn has limited up today and there is chatter that it will limit up on Monday. Winter wheat acres projected planted is also very disappointing. Wheat is up. 6 month contracts and out on Soybeans has limited up also.

Why is this more important than Countrywide or American Express. INFLATION. If these food commodities move up another 50 to 100% the consequences for inflation are huge. The government will ignore them but they will make there way into other areas of the economy and be one more very large limiting factor on consumer spending.

Wednesday, January 9, 2008

Example of Money Velocity Deterioration

Countrywide made $6 million in subprime loans in December, down from $3.7 billion a year earlier .....................WOW!!!

Big Picture Overview

Unfortunately I can't add an attachment but I recently received a quarterly review from Hoisington Management (Thanks Nathan). I am not an economist and it focuses a little more on economics than I typically do but it touches on some big themes that I thought made it very interesting. If someone wants it, feel free to email me. Here are some highlights.

The beginning of what will surely be considered the greatest credit event since the 1930s emerged in 2007 with the discovery that derivatives multiply bad credit. The "seizing up" of credit markets resulted in a worldwide reduction of credit issuance from $2.5 trillion in the 2nd quarter to $1.3 trillion in the 4th quarter...... A supply shrinkage of over $1trillion is enough to shift the supply curve to the left, resulting in a bond price increase and lower yields in high quality fixed income securities. This more than offset an increase in inflationary expectations, and was most likely the proximate cause of the sharp reduction in Treasury interest rates in the latter half of 2007.

I have mentioned a couple of times that I am starting to think that because of the credit crises that the bond market is not telling the whole story. The story it is telling is tainted because of capital preservation concerns. The paragraph above said the same thing in an economist language, "a supply curve shift." They think this will continue, not because inflation concerns will go away or even slow but because their will be a decreasing supply of high quality options as demand increases.

In this environment, short-term interest rates will continue to move downward, reinforced by several reductions in the administered Federal funds rate. The long end of the Treasury market will benefit from two factors. First, investor desire for risk-free assets will increase at a time when default rates will be soaring on other fixed income securities. Second, the overall reduction in credit market instruments will mean fewer alternatives for those desiring a fixed rate of return. By the end of 2008 we would expect new record low yields in Treasuries for this cycle.

One very interesting point from this newsletter I have only partly thought of is the falling money velocity. The thing I found really interesting is that compared to historical standards, according to Hoisington, is it has much further to fall.

Under the right conditions, private sector activities can mitigate, and possibly overwhelm, actions taken by the Federal Reserve. Historically, swings in velocity have neutralized changes in the money stock many times, and currently appear to be having a profound affect on nominal GDP. During the past six quarters velocity has declined from 1.930 to an estimated 1.902 in the final quarter of 2007. At the same time, the annualized six quarter growth rate of M2 has accelerated to 5.9% from 4.3%. The interaction of these two forces has slowed the nominal growth rate to 4.9%, or 1.7% lower than the six quarter annualized growth rate prior to the peak in velocity a year and a half ago.

Velocity is functionally related to the rate of increase in financial innovation, rising when innovations are occurring rapidly. Due to innovations in mortgage finance that made mortgages available to households previously deemed not credit worthy, as well as the spread of collateralized debt obligations (CDOs) and structured investment vehicles (SIVs), velocity increased from 1.82 in 2003 to its peak of 1.92 in mid 2006. With these innovations dramatically reversed, velocity is likely to continue to fall significantly.

Over the very long run, the level of velocity tends to revert to its average. In spite of the recent modest declines in velocity, the latest level is far above the post 1959 average of 1.80. Even with further declines at a conceivable 2% annual rate, velocity would not return to its post 1959 average until the first quarter of 2010, providing a meaningful offset to money growth. Indeed, at a 4 ½% growth rate in M2, a rise of 2 ½% in nominal GDP could be expected—a pace that would not cover inflation. Real GDP would turn negative and cement recessionary conditions. The downturn in velocity and the persistent inverted yield curve suggest that the Fed remains behind the cumulating economic weakness.

I don't care what the numbers are or care whether something comes in at 4.2% or 4.5%. What you have above is a bunch of details or economic issues that alone are really not worth that much but the big picture it can give as you go look for individual ideas is huge. Focus on the themes. Value guys do not do this near enough in my opinion. I think the mispricing of bonds compared to equities will last alot longer than most people think because of what was touched on above. This also greatly bolsters my theory that there is really nothing different from the Tech Bubble in 2000 and the Financing Bubble in 2007. Both saw the initial cracking in the Feb March time frame (coincidence), 9 to 18 months after the initial cracking is when the biggest depreciation will occur in prices (we are currently in that period), both will take 3 years or so to work out with 18 months to 36 months entering into a buying opportunity of a lifetime. It will be different of course but it seems to be rhyming nicely. This bubble is scarier with fewer prices to hide though because of how it affects everything else. The tech bubble didn't really touch something like trash collection or toothpaste. The current unwinding bubble does because it makes capital more expensive for fringe borrowers (a trash company needing another trash processing facility) and because of the dramatic decrease in available credit and overall economic spending power by consumers and businesses alike.

Tuesday, January 8, 2008

More on Inflation
I have been on this theme for almost six months now and I am finally starting to see it mentioned here an there in the press. China's next big export will be inflation. This is from an England publication but it applies to America. It is why I have held the thought that the stock market is telling the better story than the bond market. Time will tell.

From the article

Growing numbers of economists are sounding warnings that rising cost pressures and wages in China mean that it may be starting to export inflation. Analysts fear that the era when Britain and other big Western economies could depend on steadily falling prices for Chinese imports to keep a lid on inflation and allowing their economies to grow faster without sparking price pressures, is ending.


The threat of a new wave of China-fuelled inflationary pressures has been thrust on to the agenda by official US figures, not previously available, which show that after years of steep falls, the cost of Chinese exports to America began to rise very sharply last year.


The very steep gains in America’s Chinese import bill were fuelled as sharp falls in the dollar cut US buying power abroad. But City economists are now increasingly concerned over signs that the same price pressures from dearer Chinese imports are emerging on this side of the Atlantic.

These cycles, like commodity cycles tend to be very long 10 year plus cycles. We may have a temporary inflation slowdown due to US recession but the wave I think is coming big time.

Monday, January 7, 2008

Bargaining Stage

Many of you have probably seen this but I thought it was worth posting. I agree.

Sunday, January 6, 2008

An Argument Against Inflation

This is a thought provoking presentation by Century Management. It is over 2 hours long (I only watched 2 hrs) (it is nice to work for yourself, don't think I could have done that at my previous job) but Wayne Angel gives his argument on why he thinks inflation is not a problem and we are entering a time period of ultra low inflation causing equities to be a screaming buy. Because that is very counter to my own thinking I wanted to hear what he had to say.

There is also interesting discussion about the consumer balance sheet which they argue is very strong and argued that we are in an oil bubble (which I disagree with).

Anyway Century Management has a very good long term track record and so it is worth listening to if you have the time.

Thanks goes to Pete for bringing this to my attention.

Bond Yields Compared to Equity Yields

From the article.

Stocks fell to the lowest last month relative to bonds since the 1970s according to the so-called Fed model, which was cited by former Federal Reserve Chairman Alan Greenspan a decade ago. Equities yield 4.17 percentage points more in projected earnings than 10-year government bonds paid in interest at the end of 2007, according to an analysis of 29 countries by New York-based Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm by market value.


The gap is now the widest since September 1974, when adjusted for volatility, the data show. The last time the spread was wider, equities outperformed debt by 24 percentage points in the next 12 months, according to Lehman.

This is the biggest bullish argument I think right now. The spread between bonds and equities is what keeps me up at night. Along with inflation I have pondered that point more than any other point. I don't have a great answer. If I was a macro guy and was running a large asset allocation portfolio and could choose only between stocks and bonds I would be 100% stocks and 0% bonds. There is no question in my mind bonds will underperform stocks but will it happen through bonds going down more than equities going down or bonds go down and equities go up?

My guess is we will see something similar to the 24% point outperformance by equities. The key to this whole thing though is inflation. If I am right in my thinking that inflation picks up speed, equities won't be going up much and bonds will go down alot more shrinking the yield difference. Right now everyone sees recession, a fear in the banking market, and a corresponding flight to safety pushing down treasury yields. If people stop worrying about the banking system then all of a sudden you may see a reverse as people worry more about the eroding of the value of their money (through inflation) rather than losing all of it (through banking insolvency). Because of banking fears we may be at one of those rare points in history where equities are telling the better (or I should say more true) story rather than government bonds.

If the bond market is telling the better story than we are at the buying opportunity of a lifetime.

Friday, January 4, 2008

Shower Me with Agriculture

What went up today? Rice, corn, later dated contracts for soybeans, other soft commodities.

What went down? Everything else.

Agriculture is still the only asset class on an absolute basis that I am jumping up and down about. Yes there are individual companies I like but as an entire asset class agriculture is to me the only no brainer though we are due for a 10% correction as it has been nothing but up for two solid months. I recently bought rice and am planning to buy more. The dollar looks like it has resumed its downfall which will only add to the tailwind. Unfortunately buying companies geared towards agriculture is much more difficult. My fund continues to hold MOO which seems like a lazy way of doing but it is up nearly 20% in the last month and I think will go higher (probably considerably). I am looking at companies within the indexes to try and find a better one but this is one of those rare situations where I am bullish on the sector in general but because of individual stock prices it appears you are taking on to much individual business risk. So hold the sector and if Potash or Monsanto stumbles because of a company specific problems you are not hurt to bad. The sector should continue to vastly outperform.

Thursday, January 3, 2008

Darwin Awards

This has nothing to do with finance but I always enjoy them.

There needs to be a Finance Darwin Awards. Seriously. You know how many stupid things people do with money or how many stupid comments are made in any given year.

Chuck Prince's comment about how they were still dancing would qualify. Seems he got left in the danc hall after everyone had cleaned up and lock the door. I think that story would definitely qualify for a Finance Darwin award.

Trillion Dollar Survey

Happy New Year everyone. Well not for the stock market though you wouldn't know it from the "trillion dollar survey." A survey of various powerful money managers. A recap was given here.

Good grief. In the survey 89% think the S&P will finish up for the year. 60% think it will finish up 8% or more. Only 2% think there is a greater than 50% chance for a recession!!!! 30% think the U.S. will be the number one performing market in the world!!! That is ahead of China which is 21%.

A couple of comments. There is no way the market can have a strong 20 to 25% run if that is the true level of pessimism (there is none). I coulnd't believe it. I can't believe I am saying this (again) but Cramer made a couple of comments (which I agreed with) on this and said he threw up his hands when he heard it.

Well so much for 2008....maybe 2009 will be better. (I am joking.....sort of)