Friday, August 29, 2008

About Shark Watch

Friday, August 29 - 4:00 PM

Afternoon Comments

If we disregard that quick dip and pop that we saw during the New York lunch hour, the major spent the majority of today’s trading session in a very narrow range. However, we began to lose some steam as we worked our way though the final hour as consumer discretionary and financials saw some selling pressures. The trading was very thin, and that has led to some whippy action, especially in solars which proved to be a decent trading vehicle over the past few days.

While we did see some decent short-term trading, there’s no use trying to read too much into any of the action this past week. What we need to do is remain cognizant of the fact that we are still in a bear market and make sure we refrain from taking part in the whole market prediction game. The market will tell us if conditions are improving, but at this point, the bigger picture remains very poor. The good news is that the indices were able to avoid more technical damage and essentially finish out the month of August in a lateral channel.

We’ll be going over the chart this weekend and keeping an eye on individual names to see how they act on a dip, but we still see no reason to be making any big moves in what continues to be a difficult market.

Thursday, August 28, 2008

mkt today

About Shark Watch

Thursday, August 28 - 4:52 PM

Afternoon Comments

The major indices were able to follow-though to the upside, closing at the highs of the session and regaining some of the technical ground it had lost over the past several weeks. Although volume was very light once again, only one major S&P sector, energy, closed in the red (although it did finish well off the lows of the session) while financials ran up almost 4%, trailed closely by industrials and consumer discretionary, which both advanced by more than 2%. The broad-based strength, meanwhile, was quite bullish, and ended the day well over 3:1 to the positive.

We mentioned earlier in the week that some basing action in this thin trading environment might just be the thing that provides the sort of base from which the market can move higher once traders come back to their desks and volume comes back into this market. It’s just too difficult at this point, however, to put too much trust into today’s action, which was likely aided by the thin holiday trading. We’ll see if the bulls can move us past lateral resistance levels and keep the intermediate uptrend which began last month intact, but in the meantime, we’ll continue to keep our positions small and our time-frames short.

Have a great evening and we will see you tomorrow.


It is about a year ago now that the credit crisis first started affecting jumbo mortgage originator Thornburg Mortgage (TMA). In early August 2007 the stock was still trading in the low $20’s and rumors were just starting about what was soon to become a full blown crisis in the mortgage industry. Thornburg was hit hard in the fall of 2007, but it appeared that the company would continue OK on the strength of its high quality mortgage portfolio. The share price fell as low as $7.60 before recovering to the $10 range until late February. Business seemed to be going well as the 4th quarter earnings were released in February 2008 and by that time many competitors had dropped from the market and the company anticipated growing profitability.

Within 3 weeks, however, the other shoe fell. Thornburg started receiving margin call on repo agreements pledged with the company’s mortgage securities. Soon the margin calls approached $1 billion, some mortgage assets were taken by some lenders and suddenly Thornburg was within days of going out of business. To save the company, management found investors willing to provide about $1.3 billion in cash in exchange for 18% interest and a couple of billion stock warrants at a penny each. The investors also would collect the principal payments on most of Thornburg’s $20 billion (guesstimate) mortgage portfolio until the end of time unless the current shareholders agreed to a couple of changes.

First, common shareholders had to agree to the tremendous the issuance of the extra shares and the tremendous dilution that would follow. The measure was approved during the June shareholders meeting. Then the holders of several classes of Preferred Stock shares had to agree to tender at least 2/3 of the outstanding shares in exchange for $5.00 per share (they were issued at $25.00) and 3 shares of the now penny-stock common. If the preferred shareholders did not tender the required 66 2/3% of the shares, Thornburg would have no asset base to continue business. The preferred owners had until August 20 to tender their shares.

Thornburg Mortgage issued a press release to extend the tender acceptance period until September 2, but this note caught my eye (emphasis added):

As of 5:00 p.m., New York City time, on August 19, 2008, holders of Preferred Stock had tendered approximately (i) 88.7% (5,786,035 shares) of the Series C Preferred Stock; (ii) 83.5% (3,340,873 shares) of the Series D Preferred Stock; (iii) 91.7% (2,900,546 shares) of the Series E Preferred Stock and (iv) 96.2% (29,161,031 shares) of the Series F Preferred Stock.

The tender requirement has been met and Thornburg will now have the assets and capital to resume business operations. The interest rate in the borrowed funds drops to 12% and about a billion dollars of dividend earning preferred securities disappear. Today the market continues to value the very diluted company at the 25¢ a share it has traded near for the last 2 months.

During the recent conference call to explain why the company need the preferred shares to be tendered, CEO Larry Goldstone hypothesized that the book value of the company would be somewhere in the $1.00 range once the preferreds were retired and the restrictions were removed from the company’s remaining assets. In addition, Thornburg will soon be able to start originating jumbo mortgages again. This sector of the mortgage market is now almost nonexistent and TMA should be able to generate some very nice profits meeting this currently unfilled need.

I am a bit surprised the share price did not jump. Maybe the market missed the facts I outlined above or they are waiting for some further indication the company will prosper. I was very tempted to pick up a few shares yesterday, but elected to wait for more good news.

Note: I have a long position in TMA.

Wednesday, August 27, 2008

mkt today

About Shark Watch

Wednesday, August 27 - 4:26 PM

Afternoon Comments

Although they finished off the high of the session, the averages were able to close the day with solid gains. Of course, the financial media is downright ecstatic that, not only did the market advance, but they also have a convenient excuse for the upward action: the better than expected durable goods report! Be that as it may, there’s no arguing to fact that thin trading environments lend themselves to movement in either direction, and it’s just plain dangerous to read too much into the action – especially when the volume on the NYSE was again the lightest we have seen all year.

That said, the bias was positive today, and that allowed traders to concentrate on select pockets of action. A number of individual stocks acted well today, giving opportunities to traders with appropriate time-frames. We mentioned a few of those names earlier in the day, but that doesn’t mean we can suddenly trust this action. Not only does the low volume not lend itself to interpretation, but the major indices hit overhead resistance right at the developing descending resistance trendlines. We’ll see how things develop from here, but we will continue to maintain a cautious stance while we wait for volume to come back into this market.

Have a great evening and we will see you tomorrow.

is our lazy-ass government out to kill ca[italism?

can anyone from the FDIC, the Treasury, the Federal Reserve get out in front of the story?

no, we get the opposite. We get reassurances about Fannie and Freddie, even though they are now not only not helping housing to be affordable, they are making it less affordable, thereby knocking down the commercial banks. The losses are too great at FNM/FRE, so they have no room to buy more mortgages and they are paying up for money, making everyone else pay up for money, as you don't want to buy paper from a bank that is lower coupon than from FNM and FRE. Notice that every time FNM/FRE go up, the banks go down? Today's typical. What a nightmare.

And we get word from the Fed that despite the single most deflationary trend in history, the wipeout of value of the principal asset in individuals' net worth, the major worry is inflation! You can't make this stuff up. They want to take rates up, which would simply annihilate the only stream of earnings besides ATM fees: the net interest margin of the banks.

It's tough to run a laissez-faire government in a time of crisis. You can't very well be preventive, because that's interventionist. You have to be reactive, because you need events to justify actions. So we get this chronic post-crisis message.

Plus we have powerful individuals in the Fed, like Dallas President Richard Fisher, endlessly warning about inflation, even though the inflation is caused by ethanol/food, oil and steel shortages, with the latter caused by China.

No matter that July gave us the biggest commodity collapse on record, the Fed refuses to recognize the deflationary trend of housing prices because houses aren't in the consumer or producer price indices.

All of this begs the question: We have the biggest crisis in financials since 1932, and the Fed wants to be make money tighter just the course Herbert Hoover recommended to fight the Depression.

Of course all of this was predictable. But it's the philosophy, not just the out-of-touchness of these entities, that is at fault.

Just take the FDIC. Shouldn't it be recommending that we have a Resolution Mortgage Trust as a way to dump the bad loans of the IndyMacs so the rest of the bank can be sold? Do you know they have no ability to sell these banks that they are closing, and they will have to run them? You think they can run 100 banks? You think they even know how to run a bank? No. They should be selling the banks to the banks that didn't screw up, like a Hudson City or a BB&T. But why should those two banks, or any bank for that matter, buy a bank with so many bad loans? They should be setting up a "good bank, bad bank" model and getting ready for private-equity firms to buy whole bad banks.

But all of this kind of thinking implies a change in philosophy from reactive to proactive, and that's just not allowed in a laissez-faire government that extends all the way to the Federal Reserve.

Ironically, what happens now is that their lassitude and indifference and insistence that the government has no role in influencing the market will produce a gigantic tax bill that will then allow the growth of a regulatory behemoth that will dwarf any that might have occurred under a government that was pro-regulation. This moronic strategy is going to produce a regimen of intrusiveness that could hobble capitalism in this country for years.

If Treasury got ahead of things, simply wiped out the common of FNM and FRE, put them in receivership and canceled the dividends of the preferred until FNM and FRE made the money back, you would see a gigantic amount of mortgage money -- cheap mortgage money -- flood the market, as the banks that own FNM and FRE paper could mark it up and lend much more.

Nah, that requires intervention. And intervention is the enemy of this regime. Public enemy No. 1.

To which I say, the next regime will be the most interventionist in history because of these clowns.

Thanks a lot guys, you really have it figured.

Tuesday, August 26, 2008

mkt today

About Shark Watch

Tuesday, August 26 - 4:43 PM

Afternoon Comments

Although the market was able to move modestly off the lows of the session and finish the day in mixed territory, there’s no getting around the fact that this was one of the more lackluster trading sessions we’ve seen in a long time. Volume picked up over yesterday – which turned out to be the lightest of the year – but was still incredibly light.

Probably the biggest positive in the day was that yesterday’s selling pressures eased and that the major indices were able to avoid putting in lower lows. Regardless, there’s no arguing the fact that we continue to be in a very difficult trading environment. We did mention a few individual names that we traded during the day, but our scans continue to yield very little. We can’t stress enough the importance of picking your spots carefully, making sure that you stick to your own personal style of trading, and keeping those stops tight.

Have a great evening, and we will see you tomorrow.

Monday, August 25, 2008

mkt today

About Shark Watch

Monday, August 25 - 4:20 PM

Afternoon Comments

Just about the only positive thing we can say about the market today was that volume was incredibly light once again, but outside of that, the action was downright dismal. Only the S&P 500 was able to escape with a loss of less than 2%, breadth was right at 7:2 to the negative, and each of the major S&P sectors fell sharply, with the financials accelerating their losses into the close. Meanwhile, the technical conditions in the major indices continue to look precarious. Each has now been turned back from overhead resistance, and all three are in danger of putting in a fresh lower low after hitting a short-term top two weeks ago.

At this point, there are still some opportunities here and there, but the biggest thing we need to be focusing on is capital protection and making sure we don’t try to start forcing trades in this environment. Of course, that won’t stop the parade of those who insist that we’ve just been presented with yet another opportunity to buy stocks that are supposedly “on sale”, but all we need to do is take a look at our screens and the technicals to tell us that we need to be defensive. We don’t need to be putting our capital to work, hoping to catch the bottom. One will eventually come, but the key is to make sure we have enough dry power to profit when it does.

Have a great evening and we will see you tomorrow.

Friday, August 22, 2008

mkt today

About Shark Watch

Friday, August 22 - 5:07 PM

Afternoon Comments

On balance, it was a pretty decent day for the bulls. Buyout speculation regarding LEH, a $6 pullback in oil, and positive comments from the Bearded One all contributed to the upbeat sentiment and solid, broad-based gains. That said, volume looks to have been the lightest of the year – at least on the Nasdaq, and possibly the NYSE as well – and that means it’s difficult to give too much weight to today’s move. Moreover, even though both the Dow and the S&P 500 were able to reclaim their respective 50 day moving averages, neither could make progress past what looks to be developing descending resistance trendlines.

Meanwhile, as we talked about throughout the day, the number of decent technical set-ups is dwindling. Most of the day’s biggest winners have the worst looking charts, and unless you’ve been doing some bottom-fishing, then chances are you underperformed today. This oil up/market down, oil down/market up pattern lately has made it terribly difficult to build positions, but is has resulted in an environment suited to the shortest-of-term traders. On our end, we’ll continue to take quick trades where we can find them, but until we see some real improvement in the pricing action, then we’ll continue to keep capital protection as our number one goal.

Have a great weekend and we will see you on Monday.

Housing situation

I am kind of amazed at some of the things that no one seems to care about. When the FDIC seized IndyMac, it was a godsend -- get that crummy lender out of the picture. Then the FDIC announces a radical plan to allow homeowners who borrowed from them to get off the toxic 2-and-28s and teasers and go into fixed-rate loans with some forbearance. We got that this week. No one cared! No one!

How can that be? The FDIC is offering us a plan that would make it so we can root against Washington Mutual (WM) and know if that scourge of all lenders went under, we would have far fewer foreclosures because of the FDIC takeover. Also, once the loans are all under fixed rates or sent to the FHA for rehab -- as the housing legislation makes clear will happen -- we are going to see a dramatic decline in the rate of foreclosures.

Now, right now, when we see this, we are skeptical. When Wells Fargo (WFC) decided to give its borrowers more grace -- the same grace that other banks give -- we immediately figured it was a canard to mask things. But John Stumpf, the CEO, said it seemed like the right thing to do, and the bank would do better trying to work things out with lenders than throw them out on their butts. Instead, of course, the rate of foreclosures went down, and I bet ultimately the number of foreclosures will go lower.

We need time. We need time to solve the housing depression. The elements of time play out positively, because we are a growth nation that cannot have as few homes built and as few homes bought as in 1991, when we had 248 million people in this country. We now have about 310 million people. We have more than 60 million more people in this country, and we are buying as many homes as we did back then? How long can that last?

The answer, of course, is that given the dramatic overbuilding and the foreclosed homes, the oversupply will take months to burn off. But not years. The trick is to restrict supply, which wasn't being done by the homebuilders until last year, when they finally cut back the numbers -- they are now building about half the homes they did in 2006. Then we need to make it easier for people who bought homes to stay in them, so far the hardest part of the equation. Given that 14 million people bought homes between 2005 and 2007, and half took exotic mortgages to pay them, I figured there was no way that more than 3.5 million people could lose their homes (half of the half that took the 2-and-28s and the pick-a-pays and all the other nonsense). That was wrong. I am now thinking that all -- that's right, 100% -- of the people who bought homes between 2005 and 2007 are going to default. All of them! It makes too much sense not to given the home price declines.

That's why we need the FDIC to own more banks and more banks like Wells to work it through and more money from the FHA. You can see how the system is being overwhelmed by the simple equation of demand vs. supply. In 2006, for example, 7 million homes changed hands. Slightly more than 2 million were new homes. In 2008, we get half the number of new homes being built, but we are going to regurgitate 3.5 million homes that foreclosed. That gives us 3.5 million more homes on the market than we need

Historically, we get about 800,000 new homebuyers naturally in this country because of household formation demographics -- marriages, divorces, kids and the like. If you believe they all bought new homes we would still have 3.7 million more homes than we need. That's the real issue.

So, if you attack the problem that way, you can see that anything that keeps people from getting foreclosed will cut back that 3.7 million, and anything that gets people to want to buy -- tax credits for buys, lower prices for homes and perhaps a nationalization of Fannie (FNM) and Freddie (FRE) , which would reduce the price of money to buy homes -- will work off the problem over time.

If you really wanted to get granular, you can chart out what happens rather easily. The default rate on homes spikes in the first two years, particularly these years, because of all of the fraud and recklessness. Two years ago was the height of the fraud, and it continued unabated for seven more months. Right now I would venture -- we don't have hard figures -- that maybe a quarter of the defaults that will be part of the 7 million have already occurred. We're going to get the rest of the three-quarters in the next seven months. The maximum pain is in these next seven months. Once the two years that began tolling at the end March of 2007 -- the last of the really bad lending practices period -- occurs, you simply cannot have more increases in homes being foreclosed on, because you didn't have nearly as many purchases, and many of the corrupt lenders were flushed out.

Or in English, the problem peaks over the next seven months even without any intervention or stimulus or plans.

Of course, I am saying that with the FDIC's plan, WFC's changes, the FHA getting involved and the continued decline in the rate of builds and the tax credit, all of these positives are going to cause that foreclosure rate to decline slightly faster than otherwise.

Here's the bottom line. The market is factoring in three wrong things:

1. that the problem will get worse forever, rather than recognizing the peak that has to occur;

2. that nothing is being done about the demand side -- not so, because prices are coming down fast, mortgage money will get cheaper after FNM and FRE go away and there is a tax credit of size that matters; and

3. that nothing is being done to keep people in their homes -- also really wrong, because of the FDIC's plan and the FHA money meant to stem these declines.

Right now, if you think housing is going down for the next year, you are making what I think is a sucker's bet. Six months? Yes. One year? No. We will have gone through too much of the bad lending.

Oh, and remember, I am predicting 100% defaults on all non-fixed-rate loans from 2005 to 2007. No one in America is using that negative a forecast. Do you ever hear anyone say 100% of those loans from that era are going to default?

I am.

And I still think housing will bottom at the beginning of the second half of 2009. Less than one year from now.

Thursday, August 21, 2008

mkt today

About Shark Watch

Thursday, August 21 - 4:35 PM

Afternoon Comments

After a very ugly open and a $6 spike in oil, the bulls were able to battle back and take the indices into mixed territory into the close. Once again, energy and materials were the big winners on the day, but the mid-day turnaround was broad-based, with industrials and consumer discretionary able to post solid gains on the day. Moreover, even though financials, tech, staples and healthcare were the day’s losers, each of those sectors were able to finish well of the lows.

Certainly, the action today was a lot better than it could have been, but once again volume was very light. In fact, it was the lowest we have seen all week. Without a doubt, we’ll be hearing from so-called experts who will tell us that the market is ready to resume its intermediate uptrend. However, today’s action did little to repair the technical damage we saw earlier this week. There has so far been nothing to indicate that we have seen any sort of meaningful low, and it’s not likely that we’ll get any such signs in such a thin trading environment. We need to stay patient, refrain from listening to any bold predictions, pick our spots carefully, and wait for the pricing action to come to us.

Have a great evening and we will see you tomorrow.

Wednesday, August 20, 2008

mkt today

Overall, it was a disappointing day for the bulls. The market was oversold and had some good earnings from Hewlett-Packard (HPQ - commentary - Cramer's Take) to bring in buyers, but they couldn't get much going. Even with oil dipping sharply following higher-than-expected inventory numbers, the market there had limited upside. Oil rebounded later in the day, and that put the pressure back on equities.

The market continues to be highly sensitive to the movement in oil, and that could be trouble, as many of the oil and gas charts are finding support and starting to turn up. Solar energy, for example, was a leading group today, which tells us that many are looking for the freefall in oil prices to come to end.

In addition to solar energy, the commodity-related stocks, such as coal, steel, metals, mining and agriculture, lead to the upside. Chips swooned late in the day, and retailers and financials struggled as well.

This is the type of market action we had throughout the downtrend earlier in the year. Market players looked for safety in the energy and commodity names, and the rest of the market moved lower. If the theme we saw today continues, look for some retests of the lows in the indices to occur. Once again, volume was light, but this is not good action, and it's important to stay defensive.


its benchmark preferred continues to get hammered into the 16% vicinity - will leh be around much longer? (lots of smart dudes say no..........)

FNM and FRE really could go bankrupt - sorry about that bulls

Don't hear much from the Fannie (FNM) and Freddie (FRE) bulls. The silence is astounding.

There were so many people who loved these two companies and swore by them. Still do. There are so many people who think that what is happening can't be, that it simply isn't true that a group of loans made between 2005 and 2007 -- and it is just those two -- could wipe these two giants out.

They were thinking about all of the juicy fees that FNM and FRE have. They were thinking about market share and how the reversals suffered by Bear and Lehman (LEH) and all of the other former competitors to FNM and FRE were going to lead to giant earnings in 2009 and 2010. Most important, they trusted these two companies to make good loans, to actually do a good job, to not accept awful subprime fiascos or home equity joker loans (they don't do those) and to give an accounting of themselves that would have made this impossible to happen.

They thought that Alt-A loans were good ones because they went to people with real money. They didn't think these were junk loans. They thought that given the lower dollar limit of FNM's and FRE's home portfolios, the two would be safe. They thought that because there was insurance on the premiums that would be worth something; they would be safe.

The bulls always thought, in the end, that FNM and FRE were powerful and would always be rescued somehow by its myriad friends in Congress and by the regulators themselves, who the bulls thought would just look the other way. The bulls are saying, "Say it ain't so."

Well, all of the assurances and confidences and cleverness of these two companies weren't equal to their recklessness and their actual misjudging of the housing market. No one put a gun to FNM's or FRE's head. They didn't have to be reckless. But they were. Their seal of approval ending up meaning nothing. They just turned out to be another group of hucksters defeated by two years of sloppy lending in America.

What's really amazing when you think about it is that 14 million homes changed hands between 2005 and 2007, and only half of them used exotic mortgages that we all know now were pretty vicious. Most of these loans haven't even had a chance to default yet, and the ones that have were most likely not even good enough to be in FNM's or FRE's pool. No matter, whatever it was, it was enough to bring 'em down, because they were, in the end, so terrible at their jobs!

I know that they could be MBIA (MBI) -like, Lazarus-like, coming back, because of some sort of divine intervention I am not aware of.

But to me, they just seem to be companies that will have destroyed faith in stocks and faith in a lot of money managers who, now silent, stood by them.

The headline inflation number is extremely misleading

The headline's scary as all get-out: "Jump in Wholesale Prices Shows That Inflation Remains High." No way that interest rates would be going down on that. No way we should be thinking of anything but a tightening by the Fed.

But neither is the case. Rates are going down. The Fed's not going to do anything, it is scared of its own shadow and is -- as usual -- paralyzed about the big issue of the day, house price depreciation.

Which brings me to the index itself, the one that "soared" the worst in 27 years.

If one breaks down the components that screamed higher, you will understand why inflation has not only peaked but is coming down hard.

First, the big issue, before we even get to the index, the most important component in inflation isn't included in the index -- home prices. We have seen double-digit declines throughout the country and 30% to 40% declines in the big population growth areas. That they aren't included in this index or the consumer price index means that the index is a bit of a canard. If the largest and most important asset you want to buy is down big year over year, how can inflation be soaring? How?

Now, to the components:

The biggest change year over year is in iron ore and scrap steel, up 110% year over year and up 5.2% from June. The best forward indicator of scrap is the biggest scrap steel: Sims (SMS) went from $40 when this index was compiled to $26 today. The stock is even with last year. That's a 35% decline from when this number was created, and it is flat year over year.

The next, crude petroleum, is again a big decline. The price of crude had doubled year over year; now it is up a little more than 50%, but the month to month is incredible, down more than 25%.

Even bigger is the next component, natural gas. It was up 87% year over year, and up 7.8% from June 2008. Now it is down almost 50% from June and is flat year over year.

Now the next three biggies -- soybeans, corn and milk and rice -- are up 84%, 80% and 94% year over year but down month to month. And as Richard Bond, CEO of tsn says, more than half of those gains are ethanol mandate and ethanol mandate-related (farmers switching to corn because of the subsidies, driving up the other grains because of scarcity of planting). Scrap the mandate, and you'd crater these year over year. Shortening and cooking oil, up 56.5% year over year and up slightly for the month to month, would be down very big without the mandate.

Finally, home heating oil is up 80% year over year, but as the Spectra Energy (SE) CEO said recently, the switching from oil to natural gas is in earnest because of this increase, and 63% of homes are already heated by natural gas.

If you add all of these up, you are going to see a collapse of commodity prices of epic proportions.

Which is why the numbers are dead wrong about the future. If they are extrapolated to today, the Fed can declare inflation victory and cut rates. It's a gigantic difference.

Now, factor in the cost of wages, which are going to be down year over year because of unemployment, and you get a defined deflationary scenario, that would make rate cuts not only possible but probable.

So I dismiss the headlines on inflation. After you see these raw components, I hope you agree.

Reliving the savings and loan meltdown?

It was the worst of times -- or maybe not so bad. Such was the tale of three conference calls. Merrill Lynch sold $30 billion of subprime mortgage-related debt to a hedge fund for 22 cents on the dollar. Does that mean the houses underlying these debts (assuming an improbable 100% default) are worth only one-fifth of what owners paid for them?

Whereas Freddie Mac and Fannie Mae avoided any big writedowns of their dodgy "Alt-A" mortgages, on grounds they don't need to sell these to any hedge funds and will hold them to maturity, when they will be seen to have paid off after all.
[Reliving the S&L Meltdown]
Getty Images
Daniel Mudd, president and CEO of Fannie Mae, and Richard Syron, chairman and CEO of Freddie Mac, at a Capitol Hill hearing.

So Merrill's houses are worth 22 cents while Fannie and Freddie's are worth a buck?

You can reasonably posit the truth lies in between, even given the depressed credibility of all three CEOs. You can also learn a lot about the subprime state of play. The Merrill story shows how dubious mortgage debt came to be distributed far and wide, souring confidence in financial institutions. It also shows why the solution is to move these damaged credits off the balance sheets of publicly traded financial institutions (whose investors can't see through the murk and don't trust management) to private investment partnerships (whose investors can and do).

For their part, Fannie and Freddie demonstrate why these two are now the cleanup's biggest foot draggers, posing a giant risk to taxpayers.

Merrill's John Thain has caught hell from reporters and analysts because Merrill's losses have been a moving target, and because his efforts to shift assets seemed a tad cosmetic, given that Merrill agreed to finance 75% of its own fire sale. But the stock market applauded anyway. The knockdown price, more than the boss's strained credibility, was investors' best assurance that the IOUs won't return to Merrill again.

In contrast, simply nobody believes a word Fannie's Daniel Mudd and Freddie's Richard Syron are saying, because their interest now is in delaying recognition of any losses and gambling on a turnaround, using the government's credit card.

That gamble may be looking more hopeless by the day, judging by their share prices. But Congress just increased the size of the mortgages they can buy. Washington has all but thrown itself on their mercy to keep the housing market afloat. In theory, Fannie and Freddie can now Ponzi themselves to the sky -- the capital markets will continue to finance them no matter what losses they store up, or even whether they appear to be solvent.

Their only vulnerability now is political-technical -- their sinking and increasingly mirage-like capital ratios, which might embarrass Treasury Secretary Hank Paulson, our new president-plus for the economy, into blowing the whistle.

In effect, we are reliving the S&L crisis, with two giant S&Ls gambling on survival with taxpayer funds while politicians summon the will to act. Fannie and Freddie have started lending new money to delinquents to avoid foreclosures; they're dangling cash incentives in front of loan servicers to delay recognition of hopeless cases. To preserve their mostly symbolic capital, the duo also are cutting funding for new mortgages (or at least saying so to drive up mortgage spreads) just when public policy has delivered us into total dependence on them to finance home sales.

Who knows when the terminal market panic will come, forcing Mr. Paulson's hand, but it surely was helped by this week's Barron's story pronouncing Fannie and Freddie doomed.

In the meantime, the cost to taxpayers can only go higher -- Mr. Paulson would be unwise to assume Fannie and Freddie's current managements are doing a better job of earning their way out of trouble than a government receivership would. Just the opposite: Management has every reason to go for broke, risking any amount of future taxpayer losses in hopes (however faint) of shareholders living to see another day. Mr. Paulson's clear duty is to revoke these incentives before they bury us all. At this point, doing so would probably lift the entire financial sector.

And then? Make sure we never get here again by breaking Fannie and Freddie up, returning their functions to the private sector and (if we really feel more subsidy to homeowning is needed) insisting that Congress do it the fiscally honest way, through the tax code.

Tuesday, August 19, 2008

mkt today

About Shark Watch

Tuesday, August 19 - 4:25 PM

Afternoon Comments

As we have said many times over the past few weeks, the driving factors behind the recent strength in the market have been no mystery, but those were put to the test today as oil bounced $2 and inflationary data suggested that higher input prices are being passed thorough to other areas. Moreover, the continuing weakness in the financials indicates that market players are becoming increasingly uncomfortable that the worst is indeed over when it comes to the credit crisis.

Most importantly, however, is the technical damage that both the Dow and the S&P 500 took. Their respective ascending support lines have now been demonstrably breached, which means that we need to start getting defensive once again. Even though the selling over the last two days sets us up for some reflexive action to the upside, we suspect that any such move will be used as an opportunity for shorts to press further.

The good news is that, for the past several weeks, we’ve been pointing out that the decreasing volume, lack of leadership and numerous failed breakouts meant that we needed to make sure we kept our time frames very short. Those who followed that strategy are in a good position to move quickly now that the technical conditions are deteriorating.

Of course, we’ll be hearing how this pullback is a great chance to go long, but the fact remains that we are in a bear market. We’ve had several opportunities to ride counter-trend bounces along the way, but each time, they’ve failed miserably. At some point, things will change, but until we get proof that the trend has actually turned, we need to make sure our focus is on capital protection. The charts will tell us when it’s time to start building longer-term positions, and that has yet to happen.

Have a great evening and we will see you tomorrow.

Monday, August 18, 2008

mkt today

About Shark Watch

Monday, August 18 - 4:30 PM

Afternoon Comments

As we mentioned earlier in the day, the extremely light volume makes it dangerous to read too much into today’s action, but at the same time, it’s hard to disregard the technical conditions in both the Dow and the S&P 500. While the market was able to finish a bit off the lows of the session, the senior indices both gave up their respective 50 day moving averages and were barely able to find support at the intraday lows from last week. More importantly, the burgeoning ascending support lines which had been forming since this recent intermediate uptrend began several weeks ago is looking very precarious.

Certainly, buyers have shown a propensity to buy dips recently, but the question is if they are going to step up to the plate in such a thin trading environment. We’ve been saying that, while lower oil and a stronger dollar have undoubtedly been positives, the issues in the credit, housing and labor markets have not simply gone away. Moreover, lower commodities may not turn out to be the panacea many are hoping it will be, as that is an indication of lower demand and slowing growth. In fact, that notion may be starting to weigh on sentiment as today’s losses came despite another drop in crude.

We’ve also been pointing out that the averages have been forming the same sort of bearish wedges that we saw back in the March/May intermediate uptrend, and now that things are looking shaky once again, the bears have been presented with another chance to press to the downside. We’ll see if the bulls can mount a counter attack, but the thin, end of summer trading environment sure won’t make it easy.

Have a great evening and we will see you tomorrow.

Friday, August 15, 2008


We've all heard the saying that "cash is king," but in investing, I like to say that "free cash flow" (FCF) is king. Profits are great, but they don't count for much in the long-run if a company is not generating FCF. After all, FCF is the money left over after a business pays all its bills.

A few perfectly legitimate accounting adjustments can tweak earnings to management's delight, but at the end of the day, it's the cash that's left over that counts. Businesses that produce healthy amounts of free cash flow can be valued with a higher degree of certainty and margin of safety than simply going on profits.

With everyone sour on the market today, several wonderful businesses continue to pour out fantastic levels of free cash flow and are thus increasing intrinsic value while the equity price sits still. Sooner or later the stock price will catch up.
Cash Can Be Counted

Unlike profits, free cash flow can not be manipulated by the magic stroke of the accounting pen. An inventory adjustment here, extension of generous credit terms there, and you can manufacture a profit number without doing anything illegal.

However FCF, or cash flow from operations less capital expenditures, can't be manipulated through accounting changes. Remember that the value of any business is the present value of the future cash flows of the business.
Cash Cow at American Express

One of the world's most dominant consumer brands is currently trading at levels not seen for years. At $43 billion dollars, American Express (AXP) is trading at about 6 times 2007 free cash flow of some $7.5 billion. At six time's free cash flow, this would imply that Amex is trading at a free cash flow yield (annual FCF/market cap) of nearly 17%! So far, Amex has been producing healthy levels of free cash flow in 2008, suggesting that the overall business remains sound

Obviously the red flag here is the uncertainty with how the credit crisis will affect the credit card industry. It's decimated the mortgage industry, as evidenced by the billions in writedowns from Citigroup (C) , Merrill Lynch (MER) , and company.

I discussed my reasons for Amex's solid long-term prospects in an earlier article. Amex is still generating solid amounts of cash that lend credibility to the business model.

As the company operates a closed-loop network, it can keep an eye on the entire credit process (unlike possible transparency issues between banks and the other credit card processors). In my view, if Amex continues to roll in the dough, shares should be trading at around 12 times FCF or at 2007 levels, around $90 million or twice today's value.
Laying Down the Cash

Value investors love to seek out bargains in distressed industries. One such opportunity exists with Mohawk Industries (MHK) . Mohawk produces and sells floor-covering products for residential and commercial customers. It's the "residential" side of the business that has weakened and taken the stock price for a ride.

Mohawk and Shaw Carpet, a unit of Berkshire Hathaway (BRK) , have a duopoly over the carpet and flooring industry. The two command over 60% of the flooring market. At $66 a share, the market value of Mohawk is $4.6 billion. Over the three years during 2005-2007, free cash flow was $314 million, $615 million, and $710 million, respectively. So far in 2008, free cash flow has been $215 million, but that was with a $200 million charge to working capital in the first quarter.

So what's this cash worth? Let's make some quick, yet conservative assumptions. Considering the phenomenal growth rate in free cash flow over the past three years, let's assume that 2008 free cash flow comes in at $500 million, $210 million less than 2007 (we'll assume a transition year).

Beginning in 2009, it's reasonable to expect free cash to grow by 12% a year for the next four years. Given Mohawk's dominance, I think it will be much more, but let's be conservative. Let's also assume a discount rate of 10%. For a business as strong as Mohawk, 10% might be a notch too high but the goal is to get a really conservative valuation. The numbers are as follows:

Mohawk's Prodigious Free Cash Flow
Year FCF Present Value of FCF
@ 10% discount rate
2008 $500m $455m
2009 $560m $463m
2010 $627m $471m
2011 $702m $480m

The sum of the present value of the cash flows is $1.87 billion. Given that Mohawk has grown its profits and cash flow in the high teens for some time, the company's terminal value could easily be worth 15 time's free cash flow of 2011. Discounted back to the present, you get a value of $7.2 billion ($480M *15), or a total company value of approximately $9 billion ($7.2 + $1.8).

Assume shares outstanding increase by 5% percent over the four years to 72 million from 68.5 million today. Since 2004, diluted shares outstanding rose by only one million shares (less than 2%). A $9 billion market cap over 72 million shares equals a share price of $125 in 2011, up from $66 today.

And this valuation hinges on conservative assumptions, but I think it's wise to invest with a wide margin of safety.
Focus on Cold Hard Cash

Fixation on cash generation keeps your analysis focused on what counts. Of course, there will be special investment situations that will be require another set of valuation parameters, but special situation investments are few and far between. Yet in markets like these, with everyone rushing to sell at the first sign of trouble, many wonderful businesses are producing gobs of cash and going unnoticed. It won't last long.

stock market today

About Shark Watch

Friday, August 15 - 4:29 PM

Afternoon Comments

Although they ended up off the highs of the day and in mixed territory, the averages were able to do a respectable job of holding on to their recent gains. Like we’ve said, the drivers behind the improvement are no mystery, but even though it’s a pretty big stretch to think that all of the woes in the credit, housing and labor market will be made moot by lower oil and a stronger dollar, that hasn’t stopped the parade of market pundits who are absolutely convinced that we are at the cusp of a new bull market.

Even if we assume for a moment that we have clear sailing from here, that doesn’t change the fact that we are dealing with a very difficult trading environment. We’ve pointed out repeatedly the problems with failed breakouts and lack of leadership. The action has been extremely choppy, and many traders we speak with on a regular basis are getting whipsawed if they stick with positions for any length of time.

This kind of environment can be extremely frustrating, especially with the constant cheerleading from the financial media who are likely desperate for better ratings. However, as long as we keep plugging away and make sure we focus on protecting our capital, we will be in good shape to take advantage of the opportunities that will surely come our way.

Have a great weekend and we will see you on Monday.

Thursday, August 14, 2008

A strong dollar and weak commodities helped the bulls pile up some points, but volume was anemic, and there continues to be quite a bit of choppiness.

The trading is a lot tougher than the indices indicate. I continue to hear a lot of complaints from traders who are getting whipsawed in positions. Its been a market for quick trades. Building positions has been tough, as the sectors that lead one day tend to reverse the next. The heart of the problem is that market players are very low on trust and they are very quick to sell.

Even with the choppiness, the bulls do have the momentum going and they are squeezing the shorts and sucking in some idle cash from the sidelines. Many are absolutely convinced that the bear market is ending as oil comes down, the dollar finds a bottom, and the rest of the world begins to suffer like we already have.

As I've hopefully made clear, I believe this is just another bear market bounce and we have another down leg coming in the near future. The lack of volume on the move today is getting us close to the short-term top, but the key it to not be overly anticipatory but to wait for things to actually show some cracks before you press the short side.

Soft oil is making some folks complacent as you can see from the VIX.

It is a confusing market no matter what your big-picture thinking is, and we have to be very careful about being too certain about anything.

Wednesday, August 13, 2008


About Shark Watch

Wednesday, August 13 - 4:22 PM

Afternoon Comments

Although it was looking like the bulls were going to be able to engineer a pretty decent bounce earlier this afternoon despite the 3% rally in crude price, the averages rolled right back over in the final hour to close the day in negative territory. We’ve been saying that the real test for this market would come when oil bounced, and while the averages were able to close well off the lows of the session, the sharp drop in the final hour doesn’t engender a whole lot of confidence.

The lack of conviction we’ve seen now over the past two days further reinforces our suspicion that we are currently dealing with yet another bear market bounce. That said, the averages remain within their intermediate uptrends and the outperformance in the Nasdaq and Russell 2000 is certainly a market positive. We’ll see if the bulls can hold here, but we still think that it’s just a matter of time before the many negatives this market continues to face will begin to outweigh any improvement in commodities and the greenback.

Have a great evening and we will see you tomorrow.

Tuesday, August 12, 2008

sell the rails - swap csx calls for zion puts

If the momentum traders are to be obeyed -- and I think they have to be, short term -- you have to do what I hate to do and sell the rails, sell all of them because this is Day 1 of the selloff, and they never stop selling them once they are broken.

I wish I had listened to this kind of momentum nonsense when Devon (DVN - commentary - Cramer's Take) was at $123 and National Oilwell Varco (NOV - commentary - Cramer's Take) at $92. Once the momentum guys turn -- and they are turning on CSX (CSX - commentary - Cramer's Take), Norfolk Southern (NSC - commentary - Cramer's Take), Union Pacific (UNP - commentary - Cramer's Take) and Burlington (BNI - commentary - Cramer's Take) -- they just don't stop. It is terrible to have to sell down 4, but the pattern has been that there is another down-4 day coming tomorrow, and then another, and then still one more ... punctuated by a plus-2 in the middle.

I hate this stuff, but we have to own that this is the kind of market we are in.

I am seeing it in the financials too, with that group being rocked by number cuts -- same thing, Day 1. (So now Dick Bove comes in and says JPMorgan (JPM - commentary - Cramer's Take) is a perfect storm? Spare me. Just spare me.) There, too, have to give 'em wide berth. I like the financials, because I think the Fed can cut rates, but I recognize that we are going to have some rocky times in the group.

The market's obviously pretty dysfunctional here, but when you see this kind of selloff in stocks, you have to respect that it's just beginning, not ending. I would sell the rails, which have been favorites of mine. I would be a buyer of the two financials that are getting killed today, JPM and Goldman (GS - commentary - Cramer's Take), and after selling some Morgan Stanley (MS - commentary - Cramer's Take) for Action Alerts PLUS, I am looking to rebuild that one lower.

I don't know where Goldman stops. I don't know if it missed its quarter. I do know that when the smoke clears -- and the smoke will clear one day from this credit crisis -- Goldman, JPMorgan and Morgan Stanley will be the winners.

Again, as I said earlier, these big declines presage bigger declines. I don't want the rails, I do want to buy the banks on the way down in very wide scales -- the widest I have ever used in my career -- because the selling pressure is so overwhelming that it is the only way you can buy.

Random musings: I have been saying for some time that Downey (DSL - commentary - Cramer's Take) was the next Indymac. I think it's pretty obvious how bad things are. Hope for the best, but be prepared for the worst.


About Shark Watch

Tuesday, August 12 - 4:26 PM

Afternoon Comments

Unfortunately for the bulls, lower oil and a stronger dollar weren’t enough to overcome some profit-taking in recent movers and yet more bad news for the financial sector. Like we mentioned earlier, many of the stodgier consumer-related names that saw some encouraging breakouts over the past few days don’t typically gain much momentum, so it wasn’t too surprising to see investors unwilling to continue chasing many of those names higher.

The general lack of enthusiasm as the day wore on is evidenced in how volume progressed throughout the day. Although volume was on pace to be a bit heavier than it had averaged over the past five days, the pace cooled considerably as we headed towards the close. If you haven’t already, be sure to check out our volume charting tool we recently added.

Despite the fact that we pulled back today and the S&P 500 gave up its 50 day moving average, the indices continue to be in decent technical shape. The bulls will face a good test if we get more of a pullback here, and we’ll be watching to see the degree to which they are willing to buy dips. But like we said this morning, the real gut-check will come when commodities see a reflexive bounce.

Moreover, the fact that we are in a seasonally slow period only adds to the fact that the market seems to be overly sensitive to oil prices. This is still a very tricky market, and the continuing lack of leadership makes it difficult to really build any core positions. As such, we will continue to pick our spots where we can find them, but will also make sure we are keeping our time-frames very short.

Have a great evening and we will see you tomorrow.

Monday, August 11, 2008


About Shark Watch

Monday, August 11 - 4:35 PM

Afternoon Comments

Although things were looking shaky in the final hour, some last minute buying helped ensure a positive end to the day, with each of the major S&P sectors closing in the green. Consumer discretionary names in general, and retailers in particular, were the clear winners on the day, while each of the indices closed with gains of 0.71%. Certainly, even though the market finished well off the highs of the day as oil pared its early losses, the fact that the bulls were able to recover from a soft open, build on last Friday’s strong gains and make further technical progress is encouraging.

As we discussed this morning, while this market continues to face plenty of issues in regards to credit, housing and labor, the pullback in crude and bounce in the greenback is obviously starting to get folks nervous about missing out on some further action to the upside. That can prompt investors to start chasing strength, and given the fact that there is probably plenty of cash on the sidelines, it’s likely that the bulls will be given some room here in the near-term.

Have a great evening and we will see you tomorrow.

here are some stocks worth buying now - and the reasons why they are worth buying right now

Chesapeake Energy (CHK - $43.29)

1) Largest natural gas producer in the U.S.
2) Trades for 10x forward earnings, 6x cash flow
3) Savvy CEO/Co-founder who may be the most active share acquiring executive in Corporate America
4) Largest acreage in U.S, largest amount of 3-D seismic data. Massive acreage in high-potential deposits.
5) Haynesville Shale could be the most important natural gas find in the U.S. ever. CHK is the largest lease holder and initial wells producing at rates even higher than expected
6) Recent transaction to monetize 20% of the Haynesville play with PXP put an implied value of $16 billion on CHK’s operations in the area
7) 77% Q3/Q4-08 production hedged @ $9.16
8) 54% 2009 hedged @ $9.79, 7% collared $8-$10
9) 24% 2010 hedged @ $10.02, 2% collared $8-$11
10) Selling low growth, steady production long-lived assets will help the company raise a ton of money to fund aggressive drilling programs
11) Production increases still topping 20% which is difficult for companies 1/10th their size.
12) CEO is campaigning to Congress that we switch over to natural gas to fuel America. It is 2/3 more efficient than gasoline, made in America and clean. He vows to bring back $2/gallon gas equivalent.

Palomar Medical Tech (PMTI - $13.69)

1) Laser and pulsed light systems for aesthetic applications such as permanent hair reduction, skin resurfacing, photofacials, skin tightening, leg vein and acne treatment, and tattoo removal
2) Peak earnings (2006) over $2.60 per share, almost $7 per share in cash on the balance sheet
3) “Effects of a weakened economy in the United States” hurting sales. U.S. accounts for 76% of sales
4) 10% of revenue comes from licensing as PMTI controls many of the major patents in the aesthetic laser industry
5) Non-exclusive License Agreement with Procter & Gamble to exploit home-use light-based hair removal devices for women. P&G will manufacture and market and PMTI gets the royalty revenues. Since it is non-exclusive, PMTI can license IP to other consumer companies
6) Positive demographic trends: aging population with a desire to look young

Terex (TEX - $47.22)

1) Third largest manufacturer of construction equipment in the world
2) Five business segments (followed by the percentage of total sales for the past 12 months thru 03.31.08): Aerial Work Platforms (25%), Construction (20%), Cranes (25%), Materials Processing & Mining (23%), and Roadbuilding, Utility Products and Other (7%). These five segments produce equipment for use in various industries, including construction, infrastructure, quarrying, surface mining, shipping, transportation, refining and utility
3) Terex seeks to differentiate itself by dominating smaller equipment markets to reduce the appeal of large scale competition
4) A true global player with approximately 70% of 2007 sales from outside the U.S.
5) Down on worries of slowing global economic growth and increased raw material costs but we believe global growth will continue
6) Management continues to fund product development and efforts to move production closer to its international end customers
7)) Backlog expected to be realized over the next 12 months is up more than 40% year-over-year
8) Company is about halfway through a $700 million stock buyback program
9) Management has stated a goal to deliver $12 billion in annual sales by 2010, with a 12% operating profit margin and working capital levels equivalent to 15% of sales.
10) Shares trade for less than 7 times the midpoint of management's 2008 revised earnings guidance of $7 per share. TEX also boasts a current price-to-sales ratio of 0.4.

Friday, August 8, 2008


About Shark Watch

Friday, August 8 - 4:37 PM

Afternoon Comments

About the only nit we can pick about today’s trading session is that volume could have been a bit heavier. However, outside of that, there’s no arguing that it was a very strong day for the bulls. Breadth was better than 5:2 to the positive, the indices posted average returns of 2.5%, and consumer discretionary led with gains of almost 5% on big volume. Meanwhile, both the Dow and the S&P 500 were finally able to push past short-term resistance and make a higher high while the Nasdaq bounced mightily off its 50 day moving average.

Adding fuel to the fire of lower oil and a surging greenback was the fact that few were positioned to take advantage of today’s strength. It’s also safe to assume that some bears were indeed squeezed in the making of today’s trading session. Of course, the big question now is if the bulls can follow through. It’s been quite some time since we’ve seen any sort of continuity between trading sessions, and chasing strength and pressing weakness have both turned out to be losing strategies lately. As we’ve said on many occasions, one of the hallmarks of a bear market is the propensity to sell strength and buy weakness, and today’s huge rally notwithstanding, that’s exactly what we saw once again.

Yes, the market was able to see further technical improvement, which is a fact that needs be respected, but make sure you take proclamations that it will be clear sailing from here on out with a grain of salt. The only thing we’ve been able to count on recently is that nothing about this market right now is simple.

Have a great weekend, and we will see you on Monday.

options and stock volatility

I picked up some Aug 20 calls last Thursday and Friday at 90 cents and 85 cents. Last week a $1-plus move in the underlying stock price was moving the options a lot more than today's paltry 10 cents. What gives? Usually the correlations don't deviate this quickly by my, admittedly, superficial observations. Hope to get some feedback.


TIA, without knowing the specifics of the stock, its price, the specific strike you owned or what prompted the $1 price move, it's hard for me to give a definitive explanation for why there was only a paltry move in the value of the calls, but my best guess is that you have been introduced to the concept of vega risk.

Vega is change in the price of an option relative to a change in the volatility of the underlying stock. In other words, it is the dollar measure of the impact of implied volatility.

The most often and predictable occurrences of a drastic decline in implied volatility, which would lead to a relative decline in options value, occur after a known news event. These events would include earnings, an impending court ruling or expected results or approval from the FDA on a drug in its trial stages. For a more in-depth look at how to calculate an expected price move, look at this article.

Leading up to these expected events, the implied volatility of the options will usually increase, sometimes dramatically, and then, once the news is released, regardless of the outcome, implied volatility will decline. Even though we are almost through the end of earnings season, remember the acronym of PEPC, or post-earnings premium crush.

Again, the other item to keep in mind is the strike price and its delta. This article discusses how to gauge an expected effect to the options from a change in volatility of the underlying security.
Learn About Options

By far, the most frequently asked questions are inquiries into educational resources. So as we head into the vacations days of the last two weeks of August, it makes sense to provide some reading material.

Aside from leaning on this past article that lists some of my favorite books and Web sites, I'll note something new. OptionsXpress (OXPS) redesigned its Web site, which enables prospective customers to test-drive all its tools and educational material for free for 10 days.

Visitors to the site can view videos and written content based on all products and across various levels of trading experience. Previously, these services, such as mock or paper trading and educational content, were available only to customers.


Thursday, August 7, 2008


There is no mystery to SNDK's problems: it is the supply of NAND flash memory, particularly from Asian suppliers like Samsung, over the last year as the market has been flooded with chips and pricing has been horrific.

We didn't sell after the July report either, since Eli Hariri and company guided to a "0%" gross margin. It is hard to believe it could get any worse than a 0% gross margin.

We haven't sold a share of SNDK since we've written about it, even though SNDK's cash position fell $600 ml in the second quarter, and cash flow from operations was a -$327 ml. S&P cut SNDK's credit rating to "Single-B" after earnings, so we are watching it closely.

When Hariri was asked in an interview whether this was the worst environment for NAND flash he'd seen, he said no, he'd seen far worse.

Position: We remain long SNDK, TXN, Intel

rumors today

Fear-Mongering Ruled Today

I heard the rumors today, oh boy. Citigroup (C - commentary - Cramer's Take) having problems getting funding. AIG (AIG - commentary - Cramer's Take) trying to get funding. American Express (AXP - commentary - Cramer's Take) must raise capital. Chrysler in jeopardy. Government seizure of Freddie (FRE - commentary - Cramer's Take).

Yep, all over again.

It reminded me that many people simply will not return to this market until all of the above fail, and lets throw in Fannie (FNM - commentary - Cramer's Take) to boot.

I just don't think it is going to happen. I can see how people would believe that it might, though. I can see how there would be reasons to wait until all of the above happen. After all, the parade of horribles remains long and isn't getting shorter.

It is entirely possible that one or two of those might happen. I don't think that all will happen. But it is also entirely possible that we don't get another big collapse. Or that we get a government takeover of Fannie and Freddie that's creative and good.

Either way, I can see on a day like today, with the rumors flying, that there is no hope. But on Tuesday there was nothing but hope.

I bet the truth lies between and we muddle through here for awhile with Tuesdays and Thursdays being the norm for a bit until more of this nonsense works its way through the system.

bad day

For a while, it looked like some positive action in technology stocks, most notably Intel (INTC - commentary - Cramer's Take) and Microsoft (MSFT - commentary - Cramer's Take), and weak oil were going to keep the bulls' recent bounce going, but they couldn't overcome severe pressure on financials. As the financials broke down, the profit-taking hit some other sectors quite hard, such as biotechnology, which has been a market leader lately.

Small-caps saw some air pockets, as bids disappeared and breadth was quite poor at almost 3:1 negative on the NYSE. Volume wasn't too heavy, but this was an ugly reversal day and is going to stir up some action among the bears who have been standing aside and letting the bulls enjoy their bounce.

The bulls do have some relative strength in technology and chips, but they are losing financials, and there is a paucity of leadership. I'm quite concerned about the market here and am getting very defensive.

Have a good evening. I'll see you tomorrow.

Wednesday, August 6, 2008


The Path of Least Resistance Is Up ... For Now

It certainly is refreshing to see the market put together a couple of good days in a row, but the trading isn't nearly as easy as it might look. If you jumped into the leading groups Tuesday, such as banks and retailers, you would have lagged today, as the big moves came in steels, energy, coal and other groups that were weak yesterday. There are opportunities, but it's hard work and easy to churn if you make a misstep.

After a couple of strong days in a row, the bulls tend to get "performance anxiety" working for them. In a bear market, cash levels are high, and it is easy to match the indices without owning much, but when the market makes a strong move, there is sudden concern among managers that they may lag, and they are often inclined to chase rather than risk having no exposure.

There continues to be tremendous doubt about the health of this market. That means high levels of cash and an opportunity to climb the Wall of Worry as that cash inches into the market when we have some positive action.

The bulls have the edge here, but that doesn't mean it has been easy. I've heard a tremendous number of complaints from traders about how hard they have had to work to turn a profit. That is a function of a confused market with limited leadership, but for now the path of least resistance is to the upside.

Have a good evening. I'll see you tomorrow.

P.S. Volatility Can Pay

Tuesday, August 5, 2008


About Shark Watch

Tuesday, August 5 - 4:12 PM

Afternoon Comments

Taking today’s Fed statement in isolation, with all of its talk about credit market woes, housing contraction, elevated energy prices, increasing inflationary expectations and weak economic growth, you’d never think that the market would rally so strongly ahead of and after that news, but that’s exactly what it did. Of course, none of that was any real news, and market players were likely hoping that the Fed would simply stay out of its own way.

Making the action all the more interesting was the fact that, unlike yesterday, the pullback in oil and strength in the greenback triggered some heavy buying. However, the leader/laggard relationship we saw yesterday, with energy and materials acting poorly and financials and consumer discretionary leading, did carry over. Moreover, traditional defensive names like WMT, JNJ and MCD broke to fresh highs. If one theme is developing, then it seems to be that money is flowing out of commodity-related plays and into more defensive areas.

Regardless, the bulls are having their day. They’ve been able to step up before the averages really tested short-term support. However, overhead resistance is looming once again, and it remains to be seen if they have what it takes to move us past those levels this time around.

Meanwhile, we have earnings reports due out from CSCO this evening and FRE and AIG tomorrow. The confidence with which buyers pushed the market higher today was notable, and we’ll have to see if those numbers will help them keep things going.

Have a great evening and we will see you tomorrow.


ne of our longest held and top holdings is Coinstar (CSTR). The stock beat and raised estimates for the quarter and was initially up a dollar but has since retreated about $4.

The key to the story is the Redbox DVD kiosk business. It is on a path to do almost $100 million of EBITDA and IPO at a valuation of $800 million to $1 billion. If that is the case, Coinstar's share if the business -- McDonald's (MCD) owns half -- is worth around $15 a share. If the company's other businesses are worth the debt, you are creating the coin business for around 4 times EBITDA. We think the sum of the parts value is worth close to $50.

In almost any scenario, we have hard time coming up with less than the current quote, with the IPO of Redbox as a nice catalyst to unlock value. I believe that the post-earnings decline was a combination of momentum investors who were concerned by weaker comps on the coin business (though this was driven by massive and accretive installs) and those who wanted more progress on the Redbox IPO (hard to get deals done in this tape).

In addition, Blockbuster (BBI) is getting into the business with 50 kiosks. This is not news, and Redbox has 10,000, with many of the best locations locked up and a pricing model that at one-per-night disrupts Blockbuster's pricing.

Redbox has gone from negative EBITDA to $100 million in a year and is one of the true growth stories out there. An IPO should be doable when the window opens. This company has a lot of moving parts, but there is both growth and value in its business and share count. At $31, a lot can go right.

Position: Long CSTR


The stock beat and raised estimates for the quarter and was initially up a dollar but has since retreated about $4.

The key to the story is the Redbox DVD kiosk business. It is on a path to do almost $100 million of EBITDA and IPO at a valuation of $800 million to $1 billion. If that is the case, Coinstar's share if the business -- McDonald's (MCD) owns half -- is worth around $15 a share. If the company's other businesses are worth the debt, you are creating the coin business for around 4 times EBITDA. We think the sum of the parts value is worth close to $50.

In almost any scenario, we have hard time coming up with less than the current quote, with the IPO of Redbox as a nice catalyst to unlock value. I believe that the post-earnings decline was a combination of momentum investors who were concerned by weaker comps on the coin business (though this was driven by massive and accretive installs) and those who wanted more progress on the Redbox IPO (hard to get deals done in this tape).

In addition, Blockbuster (BBI) is getting into the business with 50 kiosks. This is not news, and Redbox has 10,000, with many of the best locations locked up and a pricing model that at one-per-night disrupts Blockbuster's pricing.

Redbox has gone from negative EBITDA to $100 million in a year and is one of the true growth stories out there. An IPO should be doable when the window opens. This company has a lot of moving parts, but there is both growth and value in its business and share count. At $31, a lot can go right.

Monday, August 4, 2008


Don't Be Fooled By Today's Action

What a mess of a market today. We have some pockets of absolute carnage in oil, gas, steel and various commodity-related and cyclical industries, but the DJIA managed only minor losses. With oil down, we had a few brave folks willing to buy retailers, and there was some money looking for safety in pharmaceuticals, but the selling elsewhere looked like something you expect to see only with the DJIA down 300-400 points or more.

My major complaint about the market for a while now has been that there is no upside leadership. Yes, we have a few medical and biotechnology stocks doing well and some "defensive" type plays showing relative strength, but otherwise there is absolutely nothing out there showing signs that it can lead us onward and upward. A few of the perma-bulls are hoping that maybe financials would keep on going after a huge oversold bounce, but that seems quite questionable, if not downright naive, given the growing view that there are many more shoes to drop in the sector.

It was a much worse day out there today than indicated by the major market indices. Many major stocks in the oil and commodity-related sectors had absolutely no support and were down 10% or more. There were some pockets of real fear out there and, unfortunately, that has a tendency to spread rather than drive buyers to buy other sectors.

It's a mess out there right now, and there is no reason to believe that it is going to quickly improve. Stay defensive and be patient. Better days will come, but it's going to take some time.


there is a rapid glut of oil developing because of less fear about the need to hoard oil, because of a sudden Iranian issue and because the refiners have little demand at these levels.

subprime etc

In the beginning, there were subprime mortgages. They were gathered together to make a subprime bond, and tranches were created within the subprime bond. Then those bonds were gathered to make Collateralized Debt Obligations, or CDOs, and more tranches were created. The highest of the tranches got paid first when money came in, and if there was enough, all the tranches got paid.

But they didn't stop there, and new CDOs bought tranches of other CDOs, and they were called CDOs-squared. Synthetic CDOs were created, and they were supposed to act like they owned tranches of other Mortgage-Backed Securities, but apparently didn't. Very smart people got paid a lot of money to do all this, and they seemed to forget that at the bottom was the sketchy credit of subprime mortgages.

Very little is known about exactly who owns what, so it has been unclear what values were. But Merrill (MER) finally stopped its claims of capital adequacy and a sale took place. That they financed most of the deal doesn't let them off the hook completely.

But The Economist reports that "with Merrill's net exposure to CDOs now down to $1.6 billion (the rest hedged with 'highly rated,' non-monoline counterparties), the worst of the pain is surely over -- especially since most of the securities that remain date from 2005 and earlier, before underwriting became really sloppy." About 80% of Citi's (C) remaining CDO exposure is from pre-sloppy underwriting days, and that has been marked to $.61on the dollar.

Merrill also halved its exposure to $7 billion in leveraged loans. I mentioned last week that several firms have marked their loans to finance leveraged buyouts to $.80 -- JPMorgan (JPM) and Credit Suisse (CS) among them -- and that trades of leveraged paper north of $.85 have taken place.

Then on Friday, a deal between Ambac (ABK) and Citi to settle a collateralized-debt insurance obligation between the two parties for $850 million to end a treaty guaranteeing $1.4 billion in paper allowed Ambac and MBIA to rally. Ambac had written the paper down by an extra $150 million than the settlement called for. So, at least in one instance the accounting markdown was too excessive.

It could be the worst is over. Subprime mortgages and the turbo-charged CDOs are being dealt with more openly than heretofore. Leveraged loan portfolios are being marked down and some trades are taking place. Next up will be American International Group's (AIG) earnings this Thursday.

AIG is the poster child for balance-sheet confusion. They have take $20 billion in markdowns on their Credit Default Swap portfolio, but have asserted the economic risk is a small portion of that. A report this week that is without drama and massive new writedowns would go a long way toward moving the market to the view that the end of the horrendous credit underwriting cycle might be in sight.

Sunday, August 3, 2008

read this - important

Historians are constantly reexamining the past in the hope of shedding new light on events that took place decades or centuries ago. In some cases, the revisionism may be an attempt to make the past conform to today's politically correct standards.

It's no different with economic history. There isn't a whole lot of difference, arithmetically or experientially, between an increase in real gross domestic product of 0.6 percent (old history) and a decrease of 0.2 percent (revisionist history) in the fourth quarter of last year. Eight months ago, the housing market was still imploding, loan defaults were still rising, and food and energy prices were still taking a bigger bite out of the family budget.

What the fourth-quarter minus sign does is make it easier -- more politically correct, if you will -- for the official arbiter of the U.S. business cycle, the National Bureau of Economic Research's Business Cycle Dating Committee, to declare a recession, assuming the coincident indicators they track continue to deteriorate.

In its annual benchmark revisions for 2005 through 2007, the Bureau of Economic Analysis revised real GDP down by 0.2 percentage point a year (on a fourth-quarter over fourth-quarter basis). That adjustment belies huge quarter-to-quarter swings.

For example, strong growth of 4.8 percent in both the second and third quarters of 2007 was bracketed by weak bookends: GDP rose 0.1 percent in the first quarter and declined 0.2 percent in the fourth.

Not So Hot

The BEA's first guess at second-quarter GDP growth was 1.9 percent. The drawdown in inventories subtracted almost 2 percentage points from growth while the shrinking trade deficit added 2.4 percentage points, the most in almost three decades.

Half the trade improvement was the result of a 6.6 percent annualized decline in real imports, according to Goldman Sachs Group Inc. economists. ``Imports don't fall that sharply in a strong economy, at least not in the United States,'' they wrote in a note to clients.

Residential investment fell 15.6 percent, the smallest decline in a year. Consumer spending rose 1.5 percent, shy of estimates, even with the presumed boost from one-time tax rebate checks. By the end of the second quarter, Treasury had distributed $78.3 billion in rebates as part of an economic stimulus program.

Mind the Spread

There's a more important reason economists and statisticians are interested in economic history. They are constantly constructing (and deconstructing) econometric models, creating indexes and searching for indicators that will give them a forecasting edge.

For whatever reason, most of them fail to heed the message of the yield curve, one of the more reliable harbingers of recession.

The slope of the yield curve -- the difference between a short-term rate under the direct control or influence of the central bank and a market-determined long-term rate -- has been one of the best predictors of recession over the last half century. Its stellar reputation prompted the Conference Board to add the spread to its Index of Leading Economic Indicators in the 1996 overhaul.

When the curve is inverted -- when the monetary authority is holding the overnight rate above the long rate -- it augurs bad times ahead.

In the current cycle, the fed funds/10-year spread was inverted on a monthly basis from July 2006 through December 2007. Fed officials ignored the message until the financial system blew up in their faces.

Something Strange

Policy makers argued that a ``global savings glut'' was keeping long rates low. (The reason is irrelevant.) Almost everyone else pooh-poohed the spread, saying the economy doesn't turn down when long-term interest rates are low, inversion or no inversion.

Maybe, just maybe, the inverted yield curve contributed to banks' distress. Late last year, after the banks started to own up to the extent of their losses, New York Times columnist Floyd Norris put everything in perspective.

``We should have known something was strange,'' Norris wrote in a Nov. 16 column. ``The banks were doing a lot better than they should have been doing.''

Banks borrow short and lend long. They profit handsomely from the existence of an upward sloping yield curve. They can borrow at the fed funds rate and invest in risk-free U.S. Treasuries and rack up nice profits.

Reaching for Yield

At the time, the curve was flat or inverted, and credit spreads were historically low, Norris pointed out. ``Yet the bank stocks were buoyant, and so were reported profits.''

I remember kicking myself for not putting it all together. Banks, we now know, were dabbling in AAA rated garbage in the proverbial reach for yield.

They stretched too far and are paying the price.

What's the yield curve telling us now? The 200-basis-point spread between the funds rate and 10-year Treasury yield is indicative of an expansionary monetary policy in ordinary times.

The times are hardly ordinary. Previous periods of banking- system stress -- the early 1990s, for example -- have required an extended period of a near-vertical yield curve (400 basis points in 1992) to allow the banks to heal.

It takes a wider spread to achieve the same result when banks are choosing to restrict credit availability or, worse, shrinking their balance sheets to improve capital ratios.

That's the single most-important reason the Fed isn't likely to raise its benchmark rate, currently at 2 percent, anytime soon.

The second reason is, it's politically incorrect, not to mention risky, to raise rates in recession.

Friday, August 1, 2008

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Print This Story

A Meandering Finish to the Week

By Rev Shark Contributor
8/1/2008 3:55 PM EDT
Click here for more stories by Rev Shark
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A bounce in financials after a weak start helped to hold the market up, but there was little buying interest outside of the broken banks. Oil and energy showed some early strength but that faded and regional banks moved into the forefront as the day progressed.

Other than that, not much else was going on. Breadth was close to flat and as I discussed in my prior post, the small caps indices showed some relative strength, primarily due to the outperformance in banks.

Despite proclamations to the contrary the bulls didn't show any great resolve. They chased some financials but that was it. We still are lacking any sort of good upside leadership and now that we had two strong days followed by two weak days we are mired in a trading range.

At this juncture it is a standoff and either bulls or bears can seize the advantage. It is a good time to stay open-minded and let the price action be your guide. The action isn't that fantastic but it is still strong enough to indicate that we could get a bit of a trading rally.

We have some important earnings in the financial sector such as AIG (AIG - commentary - Cramer's Take) and also Cisco Systems (CSCO - commentary - Cramer's Take) in the technology sector next week. That may serve as the catalyst for our next move.

The key things to keep in mind right now are that the market is still in a major downtrend, there is little upside leadership, and most of the recent strength is the product of bounces in broken stocks.

On the other hand, we do have some technical support and the buyers are showing some interest. I wouldn't be euphoric over this market but some bounce action is not an unreasonable possibility.

Have a good weekend. I'll see you on Monday.

P.S. Volatility Can Pay Off. Options Alerts Boasts 77.2% Total Average Return.
Drawing on his experience as a former seat-holder on the CBOE and CBOT, Steve Smith shows how options trading can lead to potential big profits, especially in this turbulent market. Options Alerts gives you Steve's best picks and, just as important, his rationale for each recommendation absolutely free when you take a trial to his premium investing service now.



Rev Shark Blog
Weighting Makes the Difference for Small-Cap ETF
8/1/2008 2:26 PM EDT
There's a good reason the Russell 2000 ETF isn't trading in sync with the other index proxies.

Rev Shark Blog
Lacking Leadership on a Slow Day
8/1/2008 12:07 PM EDT
We need new sectors to emerge, but that may not happen on a Friday in August.

Rev Shark Blog
Maintain a Cautious Stance
8/1/2008 10:21 AM EDT
Preserve capital in this still-tough environment.

James "Rev Shark" DePorre is the author of Invest Like a Shark: How a Deaf Guy with No Job and Limited Capital made a Fortune Investing in the Stock Market. He is founder and CEO of Shark Asset Management, an investment management firm, and he also operates, an interactive online community that serves and educates active investors. DePorre holds business and law degrees from the University of Michigan, is a member of the Michigan Bar Association and a former tax attorney and CPA. He lives in Anna Maria Island, Fla., with his wife and two children. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Rev Shark appreciates your feedback; click here.

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About Shark Watch

Friday, August 1 - 3:56 PM

Afternoon Comments

One of the things that have been a bit puzzling about this market lately is that the small cap indices have been outperforming all the major indices. The IWM looks much better than the SPY, DIA or QQQQ. That seems a bit illogical because small caps would tend to suffer more from tight credit and a poor domestic economy, but that isn’t the case.

So, I dug into the sector weighting a bit and that helped explain what is going on. The IWM has an 18% weighting in financials and an 8% weighting in energy compared to the SPY, which has about 14% financials and 16% energy. So, in other words, the small caps have a lot of small banks, which have been strong lately and less of the big oil and commodity names, which have been weak.

Keep that in mind for future use should you want to put on a hedge. If you believe that financials are going to roll over and energy and commodity perk back up, you’ll definitely want to use the IWM as your short vehicle.