Archive for May, 2012

All That Glitters

Tuesday, May 29th, 2012


I’ve had some readers of the blog email me about Summer vacations in Paris, Italy, and Barcelona relative to the falling Euro. They are deservedly excited to be getting under $1.25 Euros to the Dollar (I paid over $1.35 in February when I was in Paris).

But that got me thinking that the current strength in the Dollar and the current weakness in Gold are following a historic pattern. If you look at the chart above, you can see that there is a decent correlation between the Dollar and Gold – since 2001, the Dollar has been falling and Gold has been rising. Yes, there isn’t a perfect correlation – nothing is ever perfectly correlated other than death and taxes (both arrive way too soon). However, a weak dollar generally means that gold will strengthen.

So the investment question is obvious: since we are in a period of Dollar strength due to the economic foibles in Europe, is there an opportunity to buy gold or gold stocks while the dollar is strong in comparison to the Euro? This clearly assumes that at some point, the dollar will weaken again.

To answer that, we need to look at what makes the dollar weaken. Since it is traded against other currencies, a strong dollar implies that the US is stronger than other widely traded currencies – that is true right now when you compare it to the Euro and the Yen (whose Japanese debt was recently downgraded by S&P). But, I don’t think you can say it is true when you compare it to the Chinese Yuan or the Brazilian Real – two countries with strong balance sheets (compared to our own laughable one), positive demographics, and an growing middle class.

My opinion is that the European situation will be difficult, but that the German Government will find a way to support the rest of Europe and the threat of financial doom will subside. That will equalize the unattractiveness of the Euro to that of the Dollar, and both will slide in relation to the much strong emerging economies – not to mention the commodity economies like Canada and Australia.

Gold will then continue on its upward path as the US, Europe, and Japan print more money to pay down their respective debt – and that debasing of their currencies will lead to higher gold prices.

Based upon this, we are adding to gold miners in client portfolios – particularly the junior miners whose stock prices have been crushed during the recent pullback in gold prices. We are viewing this as an opportunity for the long-term – it may not work out right away, but for those with a long-term view it should be very profitable.

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Congressional Budget Office Report

Wednesday, May 23rd, 2012

I’ve posted this link to a CBO Report that discusses why our politicians need to renew the Bush tax cuts and not decrease spending. Otherwise they predict we will see a recession in 2013.

(Just click anywhere in the article to be linked to the report)

There is a lot to this:

1. Do we really believe our politicians will do anything but bicker before the November election?

2. Will the people who believe the deficits were caused by the tax cuts agree to an extension?

3. Will the people who believe the tax cuts were only for the rich agree to an extension (the reality is that significant cuts were given to the lower end as well and those will expire, too)?

4. Will those that believe the trillion dollar deficits we’ve had the past few years will turn us into the next Greece agree to continue spending at current levels?

This is obviously a very complex issue with implications on the economy, employment, investment markets, and people’s everyday lives. So, I thought you should have an opportunity to read the report yourself.

As we move forward, we will obviously be keeping this thesis in mind during our portfolio management decisions. I don’t know if I buy into it completely, but our economic growth numbers are pretty fragile and any end to stimulus will certainly have an impact.

This is something that will dominate discussions for months to come.


Value Matters

Tuesday, May 22nd, 2012

Facebook Vs Apple, Microsoft, and Dell

I’ve gotten some emails from people asking about Facebook given its spectacular fall from the IPO price. How can that happen?

The answer is a bit puzzling from the standpoint of how could the principals involved price it for failure. If you look at it from a standpoint of valuation, there really isn’t much of a surprise at all.

Yesterday, I was chatting with Charlie and Karen and we were doing some back of the envelope analysis of Facebook’s numbers now that they are publicly available. I thought I’d put those into a bit more formal format for you and do some further comparisons so you can see what investors now see.

Below are some valuation ratios so you can see how Facebook compares to some other well know companies as well as the Internet Content Industry and the broader Information Technology Sector.

Price to Free Cash Flow Ratio
The higher this ratio, the more expensive this company is. What it represents is how many years an investor will have to wait for the company to generate free cash flow equal to the share price they pay for the stock.

Facebook: 98.46
Industry: 41.35
Sector: 38.76
Apple: 11.77
Microsoft: 11.62
Dell: 5.44

Price to Sales Ratio
This ratio represents the number of years an investor has to wait before the companies sales equal its stock price.

Facebook: 19.61
Industry: 22.83
Sector: 15.90
Apple: 3.69
Microsoft: 3.42
Dell: 0.42

Price to Book Value Ratio
This ratio tells us how many times the fair market value of the companies assets is an investor paying for the stock of the company. Again, lower is better.

Facebook: 15.62
Industry: 4.22
Sector: 3.39
Apple: 5.12
Microsoft: 3.64
Dell: 2.96

P/E Ratio
This is the most common valuation ratio and most people know that it represents the number of years an investor has to wait before the company earns its share price.

Facebook: 108.92
Industry: 18.47
Sector: 17.51
Apple: 13.68
Microsoft: 10.82
Dell: 7.96

Earnings Growth Rate
Unlike the previous ratios which represent valuation, this represents growth. A higher growth rate is better because an investor can justify paying a higher valuation for a company if they anticipate that the company’s earnings will grow more than its competitors.

Facebook: -10.45% (yes, their earnings shrank this quarter)
Industry: 27.21%
Sector: 88.02%
Apple: 92.28%
Microsoft: -2.23% (also a loss)
Dell: -11.07% (also a loss)

Sales Growth Rate
A company can have several things happen to its earnings, like reinvesting in its core business to promote future growth, so a savvy investor will want to see that their sales are growing despite what is happening to their earnings.

Facebook: 44.73%
Industry: 22.52%
Sector: 17.26%
Apple: 58.86%
Microsoft: 5.96%
Dell: 2.16%

It is clear that Facebook is priced for perfection in operations and definitely not a value proposition. Their sales growth numbers are admirable in spite of their earnings growth decline – but if you read about the company you know they are investing heavily in data centers and other server farms, all of which are extremely expensive and have a negative impact on net earnings.

On the chart above, I have a comparison of Facebook to Apple, Microsoft and Dell. You can see that the price path of the latter three has been up while Facebook has fallen significantly.

Now that Facebook is public and their numbers are available, investors can perform the comparative analysis above and decide where to put their money. Do they want to buy a company with great sales growth but whose price represents 108 years of future earnings? The vote so far has been a resounding “no.”

However, FB will find a valuation level that investors are willing to pay an above average P/E ratio for those earnings. And, if FB can find a way to monetize their business, increase their earnings, and show investors that it is a sustainable communication/lifestyle platform that people will use far into the future – and that they are not America Online redux which danced its way into the largest merger of all time with Time Warner before Time Warner spun it off as a $10 stock – it could prove to be a value at that point and go on to make investors a lot of money.

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Thursday, May 17th, 2012

Oversold S&P 500 Index

Sorry for the short post today but I wanted to make sure you saw this graph.

I haven’t annotated it so hopefully you can pick out the following:

1. Look at the big red bar in the main graph that is dropping below the blue price channel. This is an indication of a very oversold situation when prices move more than 2 standard deviations from the trend.

2. Look at how far below the 30 Line the graph has moved in the RSI box at the top. This says that the relative strength of the market is nearing a 10 reading, from which we should see a bounce in coming sessions.

3. Look at the two lines in the Full STO box, well below the 20 bottom boundary nearing zero – also indicative of an over-reaction to current events.

4. Why do I say overreaction? (a) Look at the Volume box and you can see that we are not experiencing a huge thrust higher in negative volume like we did in last August’s selloff; and (b) In the CMF box, you can see that the money flow in the market is definitely negative, but no in a huge way. These two things tell me that there is not a lot of conviction in the sales and that there are a number of bulls waiting to put money back into the market.

I have to run to a meeting, but I wanted to make sure that no one overreacted to May’s selling – at this point it looks like an orderly correction of the big move off last Fall’s lows to shake out the weak holders that may have just recently gotten into the market.

Have a great night!


Is Apple The Best Investment Ever?

Thursday, May 10th, 2012


I had an email from a client asking me if their Apple stock was the best investment ever. That got me thinking and I remembered a conversation I had with Charlie Osborne, one of my investment officers at the bank, a couple weeks ago and he mentioned at that time that he’d just looked at a chart of Terra Nitrogen compared to Apple (I’ve posted it above).

You can see that TNH has performed very good compared to AAPL over the past 20 years (not quite a 4000% increase but 2750% increase is nothing to sneeze at) – just look at that rocket shoot in AAPL (the red line) compared the less rocket shoot like line from TNH, but they are currently to companies with strong performance records that shareholders want to own.

So, why are some stocks performing like this and others like this (see Procter and Gamble – the flatish green line):


Sometimes its a catalyst internal to the company – like Apple’s innovative products – and sometimes its a catalyst outside the company – like Terra Nitrogen being the beneficiary of the shift in Ag demand from the third world’s move to more nutrient rich foods and Terra providing the nitrogen to grow more crops to satisfy that demand.

Companies like Procter and Gamble have relatively steady earnings since they produce products that consumers use everyday. They have no catalyst for explosive growth but they have a consistent level of demand which creates a fairly stable earnings stream. Which would you rather own?

Honestly, it depends upon your place in life. Sometimes you want to gamble on buying a company you anticipate to be innovative – Apple has always been innovative, but its just been the past 5 years that their performance began to beat PG. For 15 years, PG was ahead of the race. Sometimes you want a nice solid company that won’t ever hit a home run but that shouldn’t ever report performance so poor that it risks bankruptcy and driving your investment to zero.

Me, I’ve honestly never understood how to effectively buy the defensive stocks. My system is an earnings growth system – sometimes the market rewards earnings growth and sometimes it rewards earnings consistency. Ultimately, earnings growth wins out in the long-term – but as you can see from AAPL and TNH above, you sometimes have to have patience for the market to recognize the catalyst and reward the earnings growth.

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The Pain From Spain

Wednesday, May 9th, 2012

S&P 500 Index With 1370 Support Line

On Sunday, the Greek and French voters threw out the reform governments and elected governments that promise to return to the old deficit spending policies that put their economies far into debt. That caused the Asian markets to tumble overnight, but by the time the US markets closed on Monday, we were in positive territory on the S&P 500 Index. It looked as though US investors were taking the news in stride and basing their investment decisions on the much better than expected earnings season to date.

By Tuesday, news from Spain that their banks would likely need a capital infusion of 30 billion Euros sent US markets down, with follow-on downward pressure today so far.

The question for us is: is this a buying opportunity or is it the start of a longer deterioration in the market that will repeat what we saw last summer.

Looking at the fundamentals:

1. Corporate earnings have been good with the exception of companies that get a significant amount of their revenue from European sales (like McDonalds) or from natural gas (like Conoco Phillips).

2. News from China shows that they have likely engineered an economic soft-landing, with news that their manufacturing index expanded in the previous month.

3. Both short and long term interest rates are low. Bond yields, which had increased during the first quarter, have fallen. The 10-year treasury yield is now 1.80%, very close to the 1.71% low that dates back to the 1950’s. And the Fed continues to restate its position that it won’t be raising short term rates until 2014 at the earliest.

4. And, 30 billion Euros is a small amount of money compared to the near-$2 trillion that the various agencies have available to shore-up European banks and governments. The capital can be put into the Spanish banks from these funds held by the IMF, ECB, etc., and they will still have significant balances on hand for other problems.

If you look at the graph above, you can see that today is the second day where we are below our 1370 support level. If we close below it three days in a row, then we will have broken that support and it will take effort to move back above it – and we cannot expect a sustained advance higher if we do not sustain the support level.

I’ve circled two important short term indicators on the graph. Both show that the market is oversold near-term and due for a bounce higher – but there is no guarantee that it will happen in time to avoid a breaking of support or be strong enough to move the market back above the support line.

In general, I’d characterize the market as in a short-term pullback, but at this point not yet into a full correction.

We are sitting on a lot of cash, and are selectively buying certain companies that get punished by the market – the cyclical stocks (those tied to the economy) have gotten hammered recently so we are buying some selected ones with great fundamentals. However we are not committing significant funds until the market gives us a sign as to whether this short term pullback will resolve itself or turn into something greater. There seems to be enough positive tailwinds to push the market higher to the pre-crash levels around 1500 in the course of time – but rest assured it will be a struggle to get there.

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Europe Wags the Tail (again)

Sunday, May 6th, 2012

The news out of Europe that both the French and Greek voters are throwing out the governments that are imposing austerity measures in an effort to fix their debt and deficit laden economies had me worried, so I wanted to check on things this Sunday evening.

Unfortunately, the Japanese market is down 2.8% right now on the news in early Monday (Japan time) trading and the Euro (trading on Asian exchanges) appears to have fallen through support.

The US 10-year treasury is down to a 1.84% yield, which may be a record (I can’t recall a yield that low) showing a rush to safety.

We still have 13 hours before the US markets open, so things may calm down before then, but I will be back on the blog with thoughts on where things will go and what we are doing about it.

But, keep in mind that earnings season is very strong and stocks ultimately are priced based upon earnings and investor sentiment. Earnings are strong, but investors are temporarily frightened by Europe – but 13 hours from now, that may change. As long as earnings are strong, there is fundamental support for stock prices since sentiment can change like the direction of the wind.

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