Archive for July, 2011

An Update on the Debt Ceiling Crisis

Thursday, July 28th, 2011

We thought it would be both prudent and timely to give a short update on what we see happening in the markets given the ongoing debates in Washington. As most, if not all of you are aware, the debt ceiling will, in theory, need to be raised by August 2nd to avoid a default of the government’s obligations. While there are numerous commentaries on this issue floating around all types of media sources, we wanted to give you ours. All three of the contributors to this blog, Mark, John, and Charlie, have conferred over the past couple of days and have come to a consensus viewpoint. We still think there is a pretty strong likelihood that some type of deal gets done in Congress over the next couple of days. If there is no deal by the self-imposed deadline, we believe the following will happen.

The United States WILL NOT default on its treasury obligations. These obligations would include EE, I, and any other type of savings bond issue, TIPS, and fixed duration Treasures from zero to 30 or more years. Long before any of its obligations are at risk, the government would likely take other measures like temporarily suspending foreign aid payments, slowing down Highway expenditures, possibly closing down National Parks for a couple weeks, closing non-essential government offices and, possibly, delaying Medicare payments to states. All of these things would be temporary stopgap measures until a deal gets done in Congress, but they would allow the government to negotiate the tough patch until a deal gets made. For those getting Social Security money, it would continue without interruption.

With concern to stock prices, there is obviously some chance that the overall market could see some type of drop in the near term as some investors sell in anticipation of some problem ahead. It is our opinion that any near term drop will be short lived as, ultimately, stock prices reflect their underlying earnings, which have been pretty good overall.

As regular followers of this blog will most likely know, we tend to follow the TED spread pretty closely to get a feel for the underlying risk of a major shock to the markets. If the TED spread is rising rapidly, it would most likely imply some type of underlying risk. When it is low and falling, it indicates that the risk of a major shock is pretty small. The current TED spread chart is below:

ted-spread1

As you can see, the spread has actually been dropping of late, implying to us that there is actually less risk out there than most currently seem to believe.

The other key number we would look at to get a feel for the likelihood of a default is the 10 year Treasury bond rate. If there was a fairly high risk of some type of default, the rate should be rising pretty rapidly. However, as of today, the U.S. 10 year yield continues to be quite low, at 2.95%. For point of reference, if we look at Greek 10 year yields, they are in the range of 14.5%, implying a much higher risk of some type of default.

It is our view, given the information above, that the United States will not default in any way on its obligations. We will keep you updated as either circumstances or our views change.

More merger insight…

Monday, July 25th, 2011

I hope you all enjoyed the weekend. Here’s to hoping this Monday gives us a reprieve (however short lived it might be) from the sauna of July in Central Illinois. As John mentioned last week, I will be adding some comments on our current investment management while Mark is out of town. This is my first posting to the blog, so please bear with me.

In several of the postings from late May to mid-June, we discussed that we were adding back a good percentage of the cash we had raised. As the graph of the overall market posted on Friday shows, this has worked out pretty well to this point. The market has generally trended up over this time period, with the general theme being one or two pretty good up days in the market, followed by a day or two of profit taking by market participants.

We have recently started to accumulate some cash. Fortunately, this has been caused by a few recent mergers involving some of our holdings. John touched on these Friday, but I thought I would go a little more in depth on the Petrohawk/BHP Billiton merger.

Petrohawk’s (HK) merger agreement with BHP Billiton (another holding of ours) is somewhat bittersweet. We have held HK for almost exactly one year (our first purchase was 7/20/2010). We originally bought HK as part of a small basket of natural gas exploration and development companies (the other main holding being Range Resources (RRC)) with the idea being that over the medium to long term, U.S. based natural gas would begin to replace some of the imported oil we currently use. The problem for most natural gas companies is that this shift occurs over the long term and there is a good chance that several of the companies in the industry will not survive until this happens, enter HK and RRC.

We focused quite a bit on HK for three reasons, which ultimately worked out very well for our clients. (See the one year chart below).

hk

One, HK had (has) one of the lower production costs in the industry, as well as a huge holding of long-term leases on very productive land. We found this very important because, in the commodity extraction business, low production cost is one of the best advantages a company can have. If a company has low production costs and a large area to reinvest the profits, even better.

The second attraction to HK was the history of the CEO. Floyd Wilson (CEO) has built and sold several energy companies in his career, and our research on HK gave us the feeling that it was being built to sell also. (This obviously turned out to be the case).

The final piece of the puzzle for our investment in HK was its size. You may have noticed through reading parts of this blog from time to time that we tend to favor mid-cap companies. HK was small enough to be acquired by a big company (BHP has an equity value of roughly $250 Billion) and large enough to make a difference for a company the size of BHP.

I hope the review of HK gives you some insight into the research we do on our holdings. It is a pretty good example because it fits a couple of our favored investment criteria; a good industry, a medium size company, and a good and growing company managed by great leaders.

Our current feelings are that there will probably continue to be quite a few acquisitions in the next six to twelve months due to the very cheap borrowing costs for large, stable companies. If interest rates stay low, our smaller and mid-cap companies should continue to be beneficiaries of the merger activity.

For now, we will look for places to redeploy the recent cash inflows and see how earnings season plays out. So far, earnings for our companies have generally been pretty good.

We will keep you updated as things progress.

Charlie

Greek Adventures

Friday, July 22nd, 2011

It is that time of the year again for me to take over the blog in Mark’s absence and live vicariously through Mark and his travels. In case you did not know, one week ago today Mark turned 50. In celebration of those 50 (mostly) glorious years, Mark flashed the bat signal, causing the assembly of a veritable wrecking crew from Champaign, Switzerland and parts in between and took off for Greece, Corfu, Albania, Montenegro and Croatia.

While the rest of us plunder along in unbearable temperatures, Mark, always one step ahead, set out for the greener pastures of a much needed and well earned vacation. Well…perhaps bluer waters would have been a better description. By my calculations, today Mark arrived in Santorini. As such, this is his current view.

santorini

Its no Daytona Beach Spring Break ’95 (it was legendary), but it ain’t bad digs.

I couldn’t help but chuckle reading the Journal this morning and seeing a headline indicating positive movement in the Greek debt crisis. I almost didn’t even want to read the article. I’d rather believe it was either Mark and the gang busting heads, talking some sense into the European powers that be or the economy being spiked by a sudden increase in the consumption of Mythos and Ouzo.

Back in the real world, we have had a good week. Charlie Osborne, our Assistant Vice President and Investment Officer (and overall brilliant mind) and I are keeping a close watch on everything that is going on. He and I will update the blog periodically in Mark’s absence. Charlie will provide his insight into the investment world and I’ll touch on some pertinent financial planning topics.

This past week has seen a nice pop back in the overall market after last week’s malaise, as indicated by the chart below.

sc

Additionally, we had positions in three separate companies that announced that they were merging/being acquired in the past week or so, allowing us to capture big gains for our customers. Two of our prevailing themes (as written about numerous times on the blog) have been natural gas and water. A week ago, mid cap natural gas company Petrohawk Energy Corporation (HK) announced it was being acquired by BHP Billiton in an all cash deal worth $38.75 per share, more than a 60% premium to HK’s closing price on the previous day.

On Wednesday, Naperville based water treatment company Nalco Holding Co. (NLC) announced that it signed a merger agreement with Ecolab and closed over 20% higher than the previous day.

Lastly, yesterday, Medco Health Solutions (MHS) closed 14% higher upon announcing an intention to be acquired by Express Scripts.

As such, its been a good week. Again, Charlie and I will try an uphold the, ahem, good name of Mark’s blog by providing you with market and financial planning information in his absence. Thanks for reading and, as always, if you should have any questions, please don’t hesitate to contact Charlie or me.

Best, and have a great weekend,

John

Wearing the Rally Cap

Tuesday, July 5th, 2011

equity-put-call-ratio

Back on June 20th [ here is the link: \"You\'re Gonna Need a Bigger Boat\" ], I showed you the above graph and told you that the market would likely be rallying based upon what the graph was telling us. I thought you might like to see what has happened to the market since this indicator flashed a “buy” signal to us so I’ve added the S&P500 Index in pink to this graph so you can see that it bottomed pretty much on schedule with the signal from the indicator.

We went to work and started putting the cash we had generated back into the market with a pretty good success rate. Below is a list of some of the Winners, So/So Performers, and Losers from our work based upon that buy signal (keep in mind that the S&P was +5% during this time):

WINNERS
Eaton: +7.6%
Potash Corp: +7.75%
iShares Timber: +7.2%
Kubota” +6.53%
Trinity: +10.14%
Manitowoc: +11.74%
Monsanto: +13.06%
Magna Int’l: +6.96%
EZ Chip: +7.35%
Emerson: +6.41%
Cummins: +7.82%

So/So
3M: +4.42%
XL: +2.23%
Stryker: 2.11%
Goldcorp: +2.55%
ITT: +2.37%
Komatsu: +3.36%

Losers
Procter & Gambel: -0.95%
Taiwan Semiconductor: -3.79%
ResMed: -0.13%
Boston Beer: -0.11%
Agnico Eagle: -1.31%
Altria: -1.08%

As I review this list, I see some things that are instructive: (1) the more cyclical the company, the bigger the gain, (2) the more defensive the company, the more likely is was to lose money, and (3) the companies that had fallen the hardest during the 7-week pullback in the market rose the most in the rally.

Looking at the graph above, though, you can see that we are clearly in no-mans land. We are neither over-sold nor over-bought on this indicator, so its time to put it to bed and look elsewhere for guidance.

Given that we are heading into earnings season, the fundamentals are likely to take over. What investors will want to see now is that the cyclicals are showing earnings gains during the second quarter – but even more important they will want to see that companies are not cutting expectations for full year earnings based upon a forecast slowdown for the second half of the year.

On Thursday of last week the Chicago Purchasing Managers Index report and on Friday the ISM Manufacturing Index report were released showing that the US is in a slow growth recovery. However, reports from Japan showing strong post-earthquake/tsunami growth and reports from China where the Premier has declared victory over inflation show that international economic growth is likely in the beginning stages. These two things to me mean that US companies that have a strong export business will continue to have growing earnings and that the cyclical stocks have more upside to them (albeit not in a straight line).

With the action in the defensive stocks being so poor during this rally, if we get further upside moves in the cyclicals based upon earnings, look for the Consumer Staples and the Health Care stocks to be used as sources of cash for buyers looking for earnings growth.

For now? We plan to continue to be fully invested at least for the first few weeks of earnings season. If earnings start to come in poorly or companies are providing tepid outlooks, we will book some of the gains above and wait to reinvest them prior to the next rally.


Click Here to Watch today\'s video on You Tube

Mark