The Big Picture | Valuation

Confessions of a Short Seller

Saturday, May 17, 2008 | 09:43 AM

in Psychology/Sentiment | Short Selling | Trading | Valuation

Nice Interview with my pal Doug Kass, the "anti-Cramer" in this week's Barron's, called "
Confessions of a Short Seller."

Doug runs a short only fund, Seabreeze Partners. He discusses a few key datapoints from the interview:

• As of April 30, flagship Seabreeze Partners Short fund was up 16.5% (vs 5.6% loss for the SPX)

• Since inception (January 2005) the fund is up 40.7%, versus a 15% gain for the S&P

• The amount of trading dollars that are in dedicated short pools are tiny: About $5.4 billion (Knowledge@Wharton). That's one-seventh the size of Fidelity's Magellan Fund.

• The $5.4B dedicated short hedge funds are a sliver of the nearly $2 trillion of hedge-fund assets.

• Over the past two decades, 58% of the issues on the New York Stock Exchange have advanced, while 42% have declined -- every year.

Here's an excerpt from the Interview:

What makes short selling so difficult to do effectively over a long period?

The objectives of a long buyer and a short seller are similar. Both want to produce uncommon returns by taking common risk -- typically by developing a variant view. Many believe short selling is a mug's game, but I don't, and thus far our results at Seabreeze have supported our opinion. But it is essential to maintain a disciplined short-selling strategy because, remember, risk and reward are asymmetric in selling stocks short. An investor can make only 100% if correct -- that is, if the stock sold short goes to zero. But you can lose an infinite amount if you're wrong as the stock keeps appreciating. And there is a gravitational pull of stocks higher over longer periods of time. So we use a very conservative approach to shorting.

Explain it, please.

First, we're diversified across company and industry lines. No individual security exceeds 2.5% of our partnership's assets and no industry sector exceeds 20% of the assets. We'll have 35 to 40 holdings at any given time. Second, "Wee Willie" Keeler, a .341 lifetime hitter who played in the early part of the 20th century, liked to say he "tried to hit 'em where they ain't." We try to do the same by being creative in our stock-selection process.

In what ways are you creative?

We strenuously avoid stocks whose short interest is high relative to the float, or companies whose shares have large short positions relative to their average daily trading volumes. Many short sellers have made the mistake of shorting valuation and have blown up during short squeezes. Avoiding them allows us to sleep at night and allows time for our negative fundamental catalysts to develop.

We also mitigate risk by avoiding leverage [borrowing to enhance the size of a position]. Historically, short sellers have taken concentrated positions, often in companies with small to medium capitalizations, and then used -- and abused -- leverage. That's a recipe for disaster, particularly when they select investments with too many shorts. The average market capitalization of our holdings is more than $10 billion. Shorting large-caps is another way to control risk.

Interesting stuff . . .

Source:
Confessions of a Short Seller
Interview With Douglas A. Kass, President, Seabreeze Partners Management
LAWRENCE C. STRAUSS
Barron's May 19, 2008
http://online.barrons.com/article/SB121097996687000019.html

Only 5% of Wall Street Recommendations Are "SELLS"

Friday, May 16, 2008 | 09:00 AM

in Investing | Psychology/Sentiment | Valuation

Here's a fascinating data point:

Only 5% of the fundamental research of the brokerage firms is a sell. That's up from 2% in the 1990s. Despite having paid $1.4 billion to settle the analyst/banking scandals of the 1990s and early 2000s, Wall Street is still disproportionately afraid of the word "Sell."

That's rather low, when you consider how many stocks underperform their respective indices each year.

There's a small sign of a potential change in this attitude: Merrill Lynch: "Starting in June, Merrill will require that its analysts assign “underperform” ratings to 1 out of every 5 stocks they cover. About 12 percent fall into that category now."

NYT excerpt:

"The bank [Merrill] analyzed stock performance over a decade and determined that from 1997 through 2007, on average, 37 percent of stocks in the MSCI world index and 40 percent of stocks in the Standard and Poor’s 500-stock index declined each year. The bank covers about 75 percent of the stocks in those indexes.

Under its new system, analysts cannot assign “buy” ratings to more than 70 percent of stocks they cover, “neutral” to more than 30 percent and “underperform” to less than 20 percent. (An underperform rating suggests the analyst believes the stock will either fall within 12 months or will rise less than competing companies with higher ratings.)

But some in the financial industry say it may be too late for research departments at Merrill or other investment banks to reclaim the credibility and prestige they lost after the technology stock bust. Hedge funds, which account for up to 75 percent of trading on some markets, conduct much of their own research and often pay twice the going rate on the Street for analysts. Many banks, by contrast, have cut research budgets." (emphasis added)

40% of the SPX? wow, that's higher than I would have guessed.

It would be a interesting to see a longer data run -- more than the 1997-2007 period, as it contained the bubble and crash period.

Also, I'd be curious to see how many stocks underperform, in terms of their marketcap as well as their trade weighted volume percentage on the NYSE and the Nasdaq.

Source:
Merrill Tries to Temper the Pollyannas in Its Ranks
JENNY ANDERSON and VIKAS BAJAJ
NYT, May 15, 2008
http://www.nytimes.com/2008/05/15/business/15place.html

Oil Bubble?

Friday, May 09, 2008 | 10:51 AM

My friend Paul points to this report by Factset, titled: An oil bubble to rival the internet boom.

The difficulty with the bubble moniker is determining exactly how much of the price is being driven by purely speculative factors. With Crude, a variety of forces are driving prices: A combination of both fundamentals (increasing demand, constrained supply, pipeline problems), technicals (Trend, money flow, etc.), along with the geopolitics of two Middle East wars -- as well as some speculation.

Additionally, we have seen the general perception of commodities shift, where they are now seen as a more legitimate asset class for portfolio managers, along with Equities, Fixed Income, REITs, cash, etc. than it has been previously.

Even If I disagree with the bubble thesis, I love any report festooned with lovely charts, and this one is no different:

Source:
An oil bubble to rival the internet boom (PDF)
FactSet, 3 May 2008
http://www.factset.com/websitefiles/PDFs/outlook/english/03-05-2008english.pdf

What Is Yahoo Actually Worth ?

Sunday, May 04, 2008 | 09:50 AM

in Corporate Management | M&A | Valuation

Here's a question worth pondering: What is Yahoo (YHOO) actually worth per share, both today and 3-5 years from now?

I expect Yahoo's stock will get nicely whacked tomorrow. Does this create an opportunity?

There are many ways to answer this question. The traditional balance sheet approach is so well covered, let me suggest something else. Its worth, at least from an M&A perspective, what someone else is willing to pay.

Microsoft (MSFT) believed Yahoo was worth $33, at least as a part of Microsoft. Wouldn't that imply the company has a value above the January 31 pre-bid price of $19 ?

Short answer: Maybe.

The key is whether there are any other bidders lurking put there.

Consider another high profile deal that failed to go through: GE's attempted takeover of Honewell (HON) back in 2001. You may recall that HON was in merger talks with United Technologies (UTX) when Jack Welch offered $55.39 a share, which topped the UTX' bid.

When the deal fell apart -- rejected by EC anti-trust rules -- the acquisition target dropped to the low $30s. By the market lows in fall 2002, it even kissed $20. Over the past 6 years, HON has gained better than 300%. I have been bullish on HON for quite some time, buying after the deal fell apart and holding on for many years; However, I recently sold out of a long held position in HON.

There are some similarities between GE/HON and MSFT/YHOO -- and one crucial difference: Another bidder. In the GE/HON deal, there was also another bidder -- United Technologies. I am less certain a friendly 3rd party bidder will show up to woo Yahoo!

>
Your thoughts?

Bear Markets Seduce Investors

Tuesday, April 29, 2008 | 07:22 AM

in Markets | Psychology/Sentiment | Technical Analysis | Valuation

One of the astute comments recently from Paul Desmond of Lowry's was that "Bear markets seduce investors to keep buying stocks."

Most investors do not study market history, but if they did, they would learn that the financial wreckage of the great crash of 1929 was not from that year, but rather, the bottom fishing in 1931 and 1932 ~~and 1933~~. Bottom fishing is the killer.

Consider this discussion of similar bottom fishing, only this time, in a specific sector: Financials:

The credit crunch, despite the strenuous exertions of Bernanke & Co, shows little sign of easing, much less ending. Yet, financial shares have risen from the grave and are enjoying a dandy whirl. As Stephanie Pomboy, the perspicacious proprietor of MacroMavens, points out, this pop amid dauntingly ugly corporate reports by the banks and the rest of the financial gang is something we've seen before, and often.

"Since the wheels first started falling off last summer," she relates, "the financials have posted no fewer than 12 rallies of 5% or more.... It bears note that none of these stints, separate or combined, have precluded the financial sector from shedding 28% over the stretch."

Maybe 13 will prove the lucky number. Stephanie, though, sounds more than a bit skeptical, and so are we. At some point, we suspect, investors are going to sober up and stop popping the cork to celebrate the latest lender to take a multibillion-dollar bath.

Amazing -- 12 rallies of 5%+, and the sector is down 28% from when the Fed began cutting.

S&P500 Financial Sector

Source:
Great Expectations
ALAN ABELSON
MONDAY, APRIL 28, 2008
UP AND DOWN WALL STREET
http://online.barrons.com/article/SB120916362804146087.html

Professional Money Managers Are Bullish

Monday, April 28, 2008 | 06:54 AM

in Economy | Markets | Psychology/Sentiment | Valuation

Barron's does a regular "Big Money poll" with domestic portfolio managers. Their most recent survey is the cover story for this week's mag.

What's the state of the professional fund manager's psyche? Bullish!

Consider these numbers:

50% consider themselves "Bullish (43%) or Very Bullish (7%)"
12% consider themselves "Bearish (12%) or Very Bearish (0%)"
38% consider themselves "Neutral"

Most pros are "looking over the valley" to an economic recovery: 74% believe the US is in a recession, but only 32% believe this will lead to a world wide recession.

As to the state of the stock market, according to the managers, it is cheap: 55% believe it is undervalued, while only 10% think it is overvalued (35% chose fairly valued).

The greatest risks to equities was surprising: It was not, according to the managers, disappointing earnings (10%) or higher interest rates (9%) or a recession (6%) or even hedge funds (6%) -- rather, it was continued credit market dysfunction (56%).

Lastly, 87% plan on being buyers of equities over the next 3 - 6 months; Only 13% said they expect to be sellers. Most are exposed to large cap (64%) versus midcaps (19%) and small caps (15%).

Here's a quick excerpt:

"JUST AS MOST MANAGERS are sanguine about stocks, they're optimistic about the U.S. economy's growth potential later this year.

Like legendary investor Warren Buffett, nearly three-fourths of our respondents think that we're already in a recession, even if the official numbers won't provide confirmation for months. Asked to predict the change in gross domestic product this year and next, the managers offered growth forecasts of 1.16% in 2008 and 2.11% in '09.

Nearly 68% of poll participants are quick to dismiss the notion that a U.S. recession would drag down the rest of the world. "Slowdown from a torrid pace? Yes. Recession? No," quipped one investment pro, while another noted that "the infrastructure build-out around the world should maintain a certain non-recessionary level of growth."

Others don't buy the notion of a neat "decoupling." "The U.S. economy is 27% of global GDP," wrote one manager. "It would be next to impossible for developing economies, which represent another 29% of global GDP, to overcome a slowdown in the U.S. and Europe."

The one thing that would make the survey much more valuable would be the history of the survey results. Plot that against the SPX for a few decades, and you might have a very useful tool for sentiment analysis.

~~~

One small caveat -- most survey respondents are liars: 74% claim to be beating the S&P500. An alternative explanation is that primarily the outperformers responded to the survey.

click for larger graphic

Table courtesy of Barron's

Source:
Back in the Pool
JACK WILLOUGHBY
BARRON'S, APRIL 28, 2008
http://online.barrons.com/article/SB120916344041346031.html

Schwab: We Don't Need Your Stinkin' Analysts

Monday, April 21, 2008 | 07:30 PM

in Earnings | Markets | Psychology/Sentiment | Valuation

Charles Schwab is raises an interesting issue regarding analysts:

"When Wall Street's almost 1,800 equity analysts figured U.S. earnings growth for the third quarter of 2007, they were 8.2 percentage points too high. Forecasts for the fourth quarter were wrong, too, overestimating profits by 33.5 percentage points, the biggest miss ever.

It's no wonder investors don't trust analysts, says Liz Ann Sonders, chief investment strategist at Charles Schwab Corp., which oversees $1.4 trillion for clients. Merrill Lynch & Co., Bank of America Corp. and the rest of the securities industry aren't losing credibility because of anything sinister. The problem is they didn't get their math right after credit markets froze nine months ago.

As Alcoa Inc. kicks off first-quarter earnings season [Monday], analysts say 2008 will be the best year ever for U.S. profits, data compiled by Bloomberg show. Earnings for companies in the Standard & Poor's 500 Index will rise 10.7 percent, even after Federal Reserve Chairman Ben S. Bernanke acknowledged that the economy may fall into a recession and banks reported $232 billion of writedowns and losses, the forecasts show. . .

The S&P 500 dropped almost 10 percent in the first quarter, the worst start to a year since 2001, as increasing unemployment, record mortgage delinquencies and a retreat in consumer confidence signaled that the economy is falling into a recession. Even with the decline, analysts' recommendations to "buy'' or "hold'' U.S. shares climbed to 94.5 percent, the highest rate in more than five years."

There's an old Wall Street expression about analysts: You don't need them in a bull market, and you don't want them in a Bear market. The latter half of that expression is usually because of the earnings downgrades adding to stock price action weakness.

Question: What will happen to equity prices if and when analyst downgrades start coming ?

~~~

What say ye?

Source:
Schwab Asks Who Needs Analysts After Biggest Flub
Michael Tsang and Eric Martin
Bloomberg, April 7 2008
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aafbjqdWG7pQ

Fortune 1000

Monday, April 21, 2008 | 11:15 AM

in Corporate Management | Valuation | Web/Tech

The full Fortune 1000 list is out, and as always, its rather interesting if just for the surprises:

Fortune 1000 Top 20

1. Wal-Mart Stores 378,799.0 12,731.0

2. Exxon Mobil 372,824.0 40,610.0

3. Chevron 210,783.0 18,688.0

4. General Motors 182,347.0 -38,732.0

5. ConocoPhillips 178,558.0 11,891.0

6. General Electric 176,656.0 22,208.0

7. Ford Motor 172,468.0 -2,723.0

8. Citigroup 159,229.0 3,617.0

9. Bank of America Corp. 119,190.0 14,982.0

10. AT&T 118,928.0 11,951.0

11.
Berkshire Hathaway 118,245.0 13,213.0

12. J.P. Morgan Chase
116,353.0 15,365.0

13. AIG 110,064.0 6,200.0

14. Hewlett-Packard 104,286.0 7,264.0

15. IBM 98,786.0 10,418.0

16. Valero Energy 96,758.0 5,234.0

17. Verizon Communications
93,775.0 5,521.0

18. McKesson 93,574.0 913.0

19. Cardinal Health 88,363.9 1,931.1

20. Goldman Sachs Group 87,968.0 11,599.

Some surprises on the list: I hadn't expected to see Ford come in at #7, or Berkshire Hathaway at 11, and Goldman Sachs at 20.

Fortune slices and dices the info in a variety of ways: Investment Returns by Industry; You can also see the 20 Most Profitable companies.

I also like the nice mashup of Google Maps and the list -- this views is "25 Most Profitable firms."

>

Source:
Fortune 500
http://money.cnn.com/magazines/fortune/fortune500/

Earnings Report Card

Monday, April 21, 2008 | 03:30 AM

in Earnings | Valuation

Very mixed results -- is the is glass half full or half empty?

What's Wrong With Billionaire Fund Managers?

Wednesday, April 16, 2008 | 07:00 PM

in Corporate Management | Valuation

An article on humongous hedge fund paydays in today's NYTimes was quite interesting:

"The richest hedge fund managers keep getting richer — fast. To make it into the top 25 of Alpha’s list, the industry standard for hedge fund pay, a manager needed to earn at least $360 million last year, more than 18 times the amount in 2002. The median American family, by contrast, earned $60,500 last year.

Combined, the top 50 hedge fund managers last year earned $29 billion. That figure represents the managers’ own pay and excludes the compensation of their employees. Five of the top 10, including Mr. Simons and Mr. Soros, were also at the top of the list for 2006. To compile its ranking, Alpha examined the funds’ returns and the fees that they charge investors, and then calculated the managers’ pay."

This is exactly the sort of thing that makes my liberal friends crazy. It shouldn't, but it does.

And, I make it even worse, by pointing out to them that if they thought it through, they should have no problem with the John Paulsons, (Paulson & Company), James H. Simons (Renaissance Technologies) and George Soros (Quantum Fund) of the world. These 3 earned a neat ~$3 billion apiece last year.

And by earned, I mean these guys earned it. They have figured out how to make money for their partners and clients. Their skill sets add value. There have always been people in the world who had vast amounts of wealth -- earning it legally through your own cleverness and hard work should not be a problem. Dictators, Robber Barrons Sultans, and Anti-Trust violators are a different story.

I believe it is misdirected energy to rail against that.

On the other hand, there are plenty of bad actors they should be truly upset about instead. Stan O'Neal of Merrill Lynch (MER), Chuck Prince of Citigroup (C), Robert Nardelli of Home Depot -- any many, many more undeserving cads -- are value destroyers. And they got paid an absurd amount of money to help destroy the very companies they were brought into run. If you have a retirement account (IRA, 401k, Pension plan) then they took money from you. That is unconscionable to me.

How did billions in shareholder money get transferred from S/H to departing schmucks?

The short answer is Crony capitalism. They have (had) do-nothing-boards who failed to watch out for the shareholders' interest. I sit on the Boards of 2 public companies, and I am very conscious of who my constituency is. Remember, Board of Director members are elected by, and work for the Shareholders -- not for insiders, not for management. Whenever a BoD cuts a deal with one of these they become diminishers of value, they are not only failing in their fiduciary duty to the shareholders, they are essentially converting corporate assets private ones for their buddies.

This used to be known as stealing . . .

UPDATE: April 17th, 2008 5:21am

I think people are overlooking something: These guys are the top 0.01% of their industry -- they ARE the Michael Jordan and Steve Jobs of their industries.

What they create are investment returns -- something that many hedge fund managers do not. In fact, about 25% of funds are dissolved each year due to poor performance and the unlikelihood of manager compensation (courtesy of the high watermark).

Source:
Wall Street Winners Get Billion-Dollar Paydays
JENNY ANDERSON
NYT April 16, 2008
http://www.nytimes.com/2008/04/16/business/16wall.html

Apple Now Bigger Than Citi

Wednesday, April 16, 2008 | 04:15 PM

in Psychology/Sentiment | Valuation

I had to pass this along, as it is so revealing about oh so many things: As of today's close, Apple (AAPL) is considerably larger than Citigroup.

Market Cap: 135 billion versus 115 billion.

>
Apple vs Citigroup, Two Year Weekly Chart

Related:
Citigroup's Market Value Drops Below Apple's Amid Credit Crisis
Connie Guglielmo and Bradley Keoun
Bloomberg, April 12 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=aYDmSu.TmOrU&

Surprise: Gee! No, G.E.

Friday, April 11, 2008 | 10:00 AM

in Earnings | Economy | Financial Press | Valuation

So much for the theory that because there weren't a lot of profit warnings, earnings will be hunky dory.

Just back from a morning meeting, having heard about GE earlier this morn.

Obviously, this does not change our main thesis at all: The slowdown in Consumer spending caused by a weak economic recovery, and then by the Housing collapse, combined with increasing cautiousness on the side of Business spending and hiring is taking its toll on revenues and earnings. Markets are not cheap, and are not priced for a full blown earnings recession.

The stock market may be entering a mine field as earnings start to flood the tape next week. We shall soon see if investors are getting real about earnings. GE proves that the economic slowdown is directly impacting corporate America.

Again, there's that word "Surprise!" We know that financial services contribute about 35% -- down from 40% Q1 07 -- of GE's operating profit. So who is it that is truly surprised that they missed? Quite bluntly, the bigger shock would have been if they hit their numbers.

~~~

How many CEO's get to miss their quarterly numbers, and then get such a kid glove treatment from a major business news channel? I can tell you, not many.

"Hi Jeff! Hi Joe!"
click thru for softball interview

A few highlights:

- GE CEO Jeff Immelt blames the financial shortfall to a large degree on Bear Stearns;
- Immelt takes responsibility for the earnings miss;
-Immelt also confirmed GE's triple AA rating (something that id din't know you could do yourself);
- If we are not in a recession now, we are very very close

One point that needs to be made: There is an obvious conflict of interest for any journalistic entity to interview their own CEO. Its an interview that most journalists would shy away from. Its impossibly conflicted.

My friend Herb notes that this is a thankless task, and "CNBC would get criticized for not covering their parent. If I were interviewing my boss on tv I'd probably be careful -- at least if I valued my job." Given all that, this interview was stunningly gentle -- the only thing missing was a group hug at the end. I don't know what sex acts Spitzer paid for, but I suspect the interview above was not dissimilar to them.

~~~

Here's an alternative to this sort of nuzzling interview: If I were GE's CEO, I would say to my reporting staff:

"I expect you to maintain our reputation as the pre-eminent business news channel, and if you are too soft on me, it costs the company its reputation.

Ask me tough questions. Raise difficult issues. Challenge me as if this were 60 Minutes.

Anyone who pulls their punches or throws me a softball question is fired."

But that's just me . . .

How Cheap Are Stocks ?

Wednesday, April 09, 2008 | 07:07 AM

in Earnings | Economy | Markets | Trading | Valuation

One of our intermediate concerns about equities involves valuations. While we recently made a short term buy call, that is merely a trade that could possibly run for a couple of weeks or months -- but not much longer. That call certainly wasn't made because stocks are such screaming bargains.

As to valuations: Its hard to really say that stocks are cheap here. At best, I believe we can argue that -- assuming that historically high earnings do not fade -- that stocks are not terribly expensive. But that is very different than saying they are cheap.

Have a look at this lovely table from Dow Jones Market Data Center:
>

Stocks Are Not Cheap

You can also see the Yields On Dow Stocks here (Thanks, Tim!)

These are not the sorts of valuations you find at the end of Bear markets. And, James Montier points out a factoid that makes the above even worse: Analysts lag reality. James adds the damning observation that "They only change their minds when there is irrefutable proof they were wrong, and then only change their minds very slowly."

Have a look at his chart below: It is a linear time trend out of operating earnings and the analyst forecasts of those earnings (so the chart simply plots deviations from trend in $ per share terms).

>

As the red line in the chart shows, the earnings recession is just now beginning. But as the black line reveals, analysts have yet to lower their earnings numbers. Montier notes that the downgrading of estimates has been highly constrained to the financials (and to a lesser extent the consumer sector in the US for 2007).

Roughly speaking US earnings ex financials have been revised down by 1.5% compared to nearer 4% for the market as a whole.

Thus, our contention that markets have only priced in a short, shallow recession . . .

Source:
Asleep at the wheel, or, How I learned to stop worrying and love the bomb
James Montier
Apr 07 2008, 02:52 PM
http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2008/04/07/asleep-at-the-wheel-or-how-i-learned-to-stop-worrying-and-love-the-bomb.aspx

Related:
Schwab Asks Who Needs Analysts After Biggest Flub
Michael Tsang and Eric Martin
Bloomberg, April 7 2008
http://www.bloomberg.com/apps/news?pid=20601109&sid=anstoKu002tE&

5 Reasons Why Bank Stocks Have Not Bottomed

Monday, April 07, 2008 | 12:00 PM

in Credit | Earnings | Employment | Valuation

Merrill Lynch says that they (ML) are through the worst of the credit crisis.

RBC Capital Markets believes that whether that is the case or not, Bank stocks remain attractive. Here are RBC's 5 reasons why bank stocks have not reached the bottom:

5 Reasons Why Bank Stocks Have Not Bottomed

1) Bank Stock Valuations Are Still Excessive:
• Current stock valuations of the Top 50 banks relative to historical valuations, remain expensive -- even with the recent poor performance.

• The Top 50 banks' forward 12-month P/E ratio stands at 13.2x, which is roughly one standard deviation above the mean (25-year avg of 10.9x).

• During the trough of the last two bank stock bear markets, 1990-91 and 2000-01, P/E ratios for the top 50 banks declined to 5.7x and 10.1x, respectively.

2) Recessionary Forces Will Lead To Bigger Credit Quality Problems:
• In prior recessionary periods, credit problems typically followed as a result of the weakening economy. We believe the U.S. economy is currently facing recessionary pressures that will only worsen extending into 2009.

3) Exposure to Riskiest Loan Areas Remains Extreme:
• Construction, Commercial Real Estate (CRE) and leveraged loans have provided steady growth over the past few years. Commercial loans outstanding for the US banking industry grew 64% from 2004 to 2007 due to demand from the syndicated loan market, in our opinion. As the economy weakens further in 2008, the underlying fundamental strength in commercial real estate and industrial America will soften leading to higher defaults in poorly underwritten CRE and leveraged loans.

4) Loan Loss Reserves Are Too Low:
• Bank management teams will often claim loan loss reserve adequacy only to boost reserves in subsequent quarters. We have adopted the Eyles Test (ET) for loan loss reserve strength. Banks should build and maintain reserves that will ensure survival during the down leg of the credit cycle.

5) Credit Problems Are Not Likely To Peak Until 2009:
• Given our belief that CRE, construction and leveraged loan portfolios have significant room to weaken in 2008, we believe credit problems will not reach their peak until sometime 2009.

Nice work . . .

Source:
Commercial Banks - Has The Hurricane Passed Or Are We In The Eye Of The Storm?
Gerard Cassidy, Jake Civiello
RBC Capital Markets, APRIL 3, 2008

Today's Rumor: Bear Goes Belly Up (Who's next?)

Thursday, March 13, 2008 | 09:30 PM

in Corporate Management | Finance | Investing | Valuation

A few years ago -- around 2001-02 -- I had strongly recommended Bear Stearns (BSC).

They had a great franchise, they had lagged the rest of the banking sector for no apparent reason, and overall, the quality of management under Ace Greenberg seemed to be terrific. The stock was $54-57.

Subsequently, Bear ran to $170+. I have long since been gone from the stock.

Today, we witnessed it complete the round trip as it careened through that $54-57 range. At one point, today, Bear was down $10, on a rumor that they were going to go belly up.

I have no opinion or special insight as to the truth of that . . . Hey, it could happen, it really wouldn't surprise me, but I don't know, and we have no position in BSC.

But that rumor raises a more interesting question: What companies could take the long dirt nap? Who out there is ripe to be absorbed, merged, taken over (hostile or not). There has to be a long list of mortally wounded firms out there that simply haven't keeled over yet. What CEOs are dead men walking? What stocks are waiting to be euthanasized?

~~~

What say ye?

(I want names and stock symbols!)

~~~

S&P500 Earnings for 2007: Down -4.2%

Friday, February 29, 2008 | 05:30 AM

in Earnings | Valuation

At the beginning of 2007, the S&P500 was over 1,400, the Dow was just under 12,500, and the Nasdaq was about 2,500. Stocks, according to consensus estimates, were "cheap," and profit growth expected to be 10%+.

With 90% of earnings reported by the S&P500 firms, we now have enough data to see how the full calendar year was for profits.

Here's the overview from S&P's Sam Stovall:

At the end of 2006, S&P equity analysts expected operating earnings per share (EPS) for the S&P Composite 1500 (comprised of the S&P 500, MidCap 400 and SmallCap 600 indexes) to advance 10% in 2007, a healthy follow-up to the 15% gain seen in 2006.

Yet with 2007's results nearly final, we now find that EPS for the S&P 1500 actually sank by almost 4% on a worse-than-expected fallout from the housing, subprime, and credit crises.

Within the S&P 1500, the S&P 500 index, which represents 88.5% of the market value of the 1500, likely registered a 4.2% year-over-year decline, while the S&P MidCap 400 (7.8% of the 1500) eked out a 0.1% gain, and the S&P SmallCap 600 (3.7% of the 1500) fell 5.6%.

The 1500's negative earnings results for the year were the result of deteriorating profit growth for the Consumer Discretionary and Financials sectors in particular, as these sectors posted declines of 17.8% and 33.3%, respectively, as of Feb. 19, 2008. The second half of last year was the toughest for the overall market, as it suffered through EPS declines of 9% in the third quarter and 22% in the fourth, a quarter that many dubbed the "kitchen-sink quarter" as companies wrote down everything—including the proverbial fixture. (emphasis added)

The relative performance of the mid-caps was likely due to the presence of many energy, commodity and agricultural stocks. Indeed, a few sectors have done rather well: The exporting industrials, anything Ag or energy related, consumer staples, utilities have all thrived. Financials, anything house related, many retailers, consumer discretionary all performed poorly. I was a little surprised by the full year number, thinking the good sectors and the first half numbers might partially offset the second half.

What does this say about the market itself as a forecaster?

Short answer: The easy, glib readings -- so favored by all too many ignorant media pundits -- are all too often, wrong. Accurately interpreting the body language of Mr. Market is far more difficult and nuanced than the usual nonsense you hear peddled.

Here's the amusing part: The same group of S&P equity analysts who foolishly were looking for a 10% advance in 2007, are now expecting a profits recovery in the second half of 2008. Their favorite sectors are (drum roll) Consumer Discretionary and Financials.

The thinking must be that the credit crunch will just go away, energy and food prices will drop, and the consumer will begin another wanton spending spree.

Hmmmm. I suspect this S&P profit forecast to be every bit as prescient as the previous one . . .

Source:
Earnings: A Clearer Picture Emerges
Sam Stovall
February 26, 2008, 7:44PM EST
http://www.businessweek.com/investor/content/feb2008/pi20080226_304457.htm

Barrons Review: Is the Magic back at Disney?

Monday, February 25, 2008 | 01:30 PM

We've held onto The Walt Disney Co. (DIS) for quite some time.

I've mentioned it in a positive vein repeatedly -- over a year ago on PBS with Paul Kangas, and then again here (Tribune Media), and even a year before that on the Pixar takeover.

Why? A few years back, our quant tool (an earlier version of the FusionIQ software) had Disney highly ranked (12/05/2006). Since then, the shares have performed rather well, especially as the US dollar weakened.

But back in 2005/06, analyst coverage was rather neutral. Well, it turns out that the fundie guys missed the boat, while the unbiased quant assessment turned out to be much better at stock picking.

Since last year, however, there has been a deterioration of the many factors that go into the quantitative ranking of Disney: The short and intermediate term trend was broken, money flow slowed down, and institutional ownership slipped. The quant ranking of DIS started to drop to bearish levels (below 70), prompting us to exit the positions in our managed accounts.

Fast forward to this weekend's edition of Barron's: They had a glowing cover story titled "The Magic is Back" about Walt Disney and its prospects for the future. Problem is, its a few years late to the party.

Rather than merely assume Barron's cover story is a contrary indicator, we decided to run Disney through the system to generate a new unbiased metric. As seen in the chart below, Disney's master quant ranking is now down to only a 58 out of a possible 100.

Maybe there is some magic left in the kingdom, but objectively speaking, its not showing up in our system. With only a 58 ranking, I cannot tell if the magic has come and gone, or if its already reflected in the share price.

If you want to invest in Disney shares, then perhaps your money would be better served waiting for the quantitative ranking to improve. We consider it bullish when its ranking score moves back over 70 again. (I will set up an email alert based on ranking change and post it here if and when that occurs).

>
Disney (DIS) daily
click for larger chart

Chart courtesy of FusionIQ

WTF Headline of the Day: "Dow 18,500? Believe It"

Wednesday, February 13, 2008 | 06:58 AM

I got a huge kick out of this headline last night:

Dow 18,500? Believe It
http://biz.yahoo.com/ms/080212/228434.html?.v=1

Morningstar based this number on the "fair value estimates" of the index's components. I have no idea how fair value is derived -- earnings? ROI? cash flow?

Regardless, this is Morningstar's forecast over the next 3 years; that translates to 14.8% annualized price return, excluding dividends. With divvies, returns are 17% per year.

And why I was so amused? Well, first off its precariously close to exactly half of the infamous Dow 36,000 book by Glassman & Hassett we all know and love so much. Could the timing of that book have been any better, published as it was on October 1, 1999?

Second, I find that high degree of certainty in the headline, well, cute. It ignores the basic reality of forecasts, that no one knows what the future will bring. And that is always amusing to me . . .

Source:
Dow 18,500? Believe It
Jeffrey Ptak, CFA, CPA
Morningstar, Tuesday February 12, 7:00 am ET
http://biz.yahoo.com/ms/080212/228434.html?.v=1

Previously:
Apprenticed Investor: The Folly of Forecasting
Barry Ritholtz
TheStreet.com, 06/07/05 - 01:05 PM EDT
http://www.thestreet.com/_tscana/comment/barryritholtz/10226887.html

AIG: Don't Try to Catch the Falling Knife

Tuesday, February 12, 2008 | 04:15 PM

in Derivatives | Quantitative | Technical Analysis | Valuation

Here's an excerpt of a report we put out on Monday:

AIG shares broke down through what had been solid support over the last three years on the second heaviest weekly volume on record going back to 1996. The breaking of support happened to coincide with news that outside auditors had found deficiencies in the way the company values some financial derivatives it has written based on collateralized debt obligations (CDOs).

Additionally with a FusionIQ Technical Rank of only 12 (out of a possible 100) forward returns for AIG do not look promising. The next downside target for AIG shares is $ 32.00 (green line) and this aligns nicely with the objective point and figure derived target of $ 33.00.

Analyst sentiment remains overly bullish with 14 BUYS and only 4 HOLDS, particularly given the recent breakdown in price. We would expect to see the analyst recommendation skew migrate from its more bullish posture over the next several weeks/months bringing additional downward pressure to shares.

From a tactical trading strategy rallies into strength can be sold into to either exit long positions or put on new shorts positions.

American International Group (AIG) -
Weekly Chart through Monday's close

chart courtesy of FusionIQ.com

Tuesday, February 12, 2008 | 04:15 PM | Permalink | Comments (23) | TrackBack (0)
de.li.cious add to

1.	Wal-Mart Stores	378,799.0	12,731.0
2.	Exxon Mobil	372,824.0	40,610.0
3.	Chevron	210,783.0	18,688.0
4.	General Motors	182,347.0	-38,732.0
5.	ConocoPhillips	178,558.0	11,891.0
6.	General Electric	176,656.0	22,208.0
7.	Ford Motor	172,468.0	-2,723.0
8.	Citigroup	159,229.0	3,617.0
9.	Bank of America Corp.	119,190.0	14,982.0
10.	AT&T	118,928.0	11,951.0
11.	Berkshire Hathaway	118,245.0	13,213.0
12.	J.P. Morgan Chase	116,353.0	15,365.0
13.	AIG	110,064.0	6,200.0
14.	Hewlett-Packard	104,286.0	7,264.0
15.	IBM	98,786.0	10,418.0
16.	Valero Energy	96,758.0	5,234.0
17.	Verizon Communications	93,775.0	5,521.0
18.	McKesson	93,574.0	913.0
19.	Cardinal Health	88,363.9	1,931.1
20.	Goldman Sachs Group	87,968.0	11,599.