Sunday, October 30, 2011


Individual investors continue to retreat out of equities.

The retreat of the individual investor out of equities continues apace.

In September, $14 billion of domestic equity mutual funds were redeemed. This follows $26 billion taken out in August and $28 billion in July.

It looks as though 2011 will be the fifth consecutive year of outflows, an all-time record.

Meanwhile, fixed income gathered almost $10 billion last month.

There are several reasons for this risk aversion on the part of the retail investor to continue:

* a weak jobs market
* economic uncertainty
* a continued volatile stock market
* stagnating incomes ("screw")
* rising costs of the necessities of life ("flation")
* still weak home prices

Stating the obvious, MF Global Holdings has been in the news lately. The company seems to have been caught with an outsized bet on eurozone debt at a time they were funding themselves with wholesales (non-deposit) borrowings.

It reported a large loss in its latest quarter and Moody's joined Fitch in assigning a junk rating to the company's debt. As a result the company is trying to sell assets in order to stay afloat.

What is the investment lesson of MF Global?

A first step in analyzing a company one should always first look at insider transactions (available for free on Yahoo! Finance) in order to gauge the appetite of management for their own company's shares. This is almost always my first step of analysis -- even before mulling over a company's financials.

So, what gives with insider buying/selling at MF?

Despite the persistent decline in its shares, insiders (with the exception of Corzine) have almost totally avoided buying shares over the last year.

Lesson learned.

On the positive side, personal spending continues strong, up 0.6% month over month and in line with expectations. As well, the final University of Michigan sentiment index was revised up from 57.5 to 60.9, still low, however, relative to the long-term average of 87.

On the negative side, as mentioned this week, personal income was up by only 0.1%, below expectations of +0.3%. Consumption is being buoyed by a drawdown of the savings rate (not a sustainable factor to further spending gains). Indeed, the savings rate has now dropped to about 3%, the lowest savings rate in three years.

Miller Tabak's Peter Boockvar reviews the close of sovereign debt bonds.

Miller Tabak's Peter Boockvar’s review of the close of sovereign debt bonds today:

With European markets closing, Italian yields are closing at the highs of the day with the five-year yield in particular closing at the highest level since 1997 at 5.75%. The two-year yield is up by 33 basis points, to 4.75%, the most since July 2008, and the 10-year yield is back above 6% at 6.03%, up 15 basis points on the day. Yields are up sharply in Spain, too, but remain off their recent highs. Yields in Portugal are mixed, and Irish yields are down across their curve as they remain a standout relative to their neighbors.

Explain the increase in Italian and Spanish yields over the last two days.

We are told that Wednesday night's eurozone solution was aimed at stemming the debt contagion in Europe.

But, how can we explain the increase in Italian and Spanish yields over the last two days?

For example, Italy attempted to sell 8.5 billion euros in bonds with maturities out as long as 10 years yesterday. It only sold 7.9 billion euros in bonds (low bid to cover), and the yield was an inflated 6.06%.

I suppose the answer is that the markets remain skeptical of Italy's willingness to address the needed measures to control their burgeoning debt load.

Life insurers have entered an ideal environment.

Life insurance stocks have likely entered an ideal environment of rising interest rates (the long bond was down by nearly 4 points yesterday), a benign stock market, expanding sales (VA) growth and an American consumer that is indifferent to the stock market, preferring guaranteed financial products to straight out purchases of stocks.

MetLife's (MET) terrific earnings, announced after the close yesterday, underscore the strong absolute and relative profit prospects for the industry. MetLife reported a headline earnings number of $1.11 per share vs. consensus for $1.06 per share but included a series of one-time charges in the quarter (including higher variable income, the impact of severe weather/catastrophic losses, liquidation of Executive Life, insurance department charges, etc.). Without all these charges, the company would have reported EPS of $1.29 --year-to-date core ROE is 12% through the first nine months. My earnings estimate for 2011 is $5.15 a share, and, subject to share repurchases finally being authorized by the Fed, over $5.50 a share seems reasonable for 2012.

The quarter's record variable annuity sales of $8.6 billion beat forecasts by $2 billion, corporate benefit premiums more than doubled expectations, and international sales (40% of the company) were strong as well.

The shares currently trade at a large discount to book value ($47.00) and at under 7x projected earnings. Excess capital is growing fast and could exceed $4.5 billion over the next two years.

All the positive influences affecting MetLife's quarter will have a salutary impact on the other life insurers – Lincoln National (LNC), Prudential (PRU) and the like. MetLife's shares have had a roller coaster ride in recent months, but my advice remains the same: Buy MetLife (and the other life companies); it pays.


After the big day Thursday, the flat action today was exactly what the bulls wanted to see. While there was some mild profit-taking, which helped to prevent stocks from becoming even more technically extended, there was plenty of underlying buying support, which indicates that plenty of folks have been left out recently and are looking for entry points.

Being left out was the market's theme all week. Way too many folks were looking for a sell-the-news reaction to Europe. When a surprise deal was announced late Wednesday, it resulted in panic buying, then the upside move gained momentum.

We were already technically extended and had a slew of folks who were underinvested as they awaited a pullback. The action on Wednesday just created a bigger supply of potential dip buyers hungry to produce gains into the end of the year.

There are plenty of good bearish arguments to be made. It is particularly easy to question whether things have really improved in Europe after this deal, but so many folks have been burned by betting that negative fundamentals will kick in and pressure the market that they are ignoring the negatives even when they are obvious.

Thursday, October 27, 2011


Boy Genius has some info on the launch of the new Apple TV.

Last program standing today?

Gotta be on the buy side!

Run, don't walk, to read "Is It Time for a Trading Tax?" -- Knowledge@Wharton's latest missive.

It's a most interesting read!

The pending home sales number dropped by nearly 5% (month over month) compared to an expectation for a small increase. All regions in the country experienced a drop in sales.

This series tends to lead existing-home sales by about a quarter, and it portends weakness ahead.

While there is little focus on concerns this morning, the third-quarter 2011 GDP release disclosed some cautionary signs for the consumer, a continuing concern of mine.

Specifically, real disposable income was very weak, declining by 1.7% (SAAR) and essentially flat year over year.

Retail sales have been buoyed by a reduction in the personal savings rate. This can’t sustain retail sales; what is needed is growth in hours worked and a better jobs market.

Here are some headlines about the Eurozone solution from Weidmann, the head of the Bundesbank:

* Weidmann: Still Unclear How to View Greece Measures
* Weidmann: Unclear How Greece Haircut Will Be Implemented
* Weidmann: Haircut Can't Be Seen as Comfortable Escape for Greece
* Weidmann: Warns Sees Risks in Leveraging EFSF

Last night, the European leaders took a series of steps to stem the debt contagion crisis:

1. a voluntary 50% haircut on Greek debt, which will not trigger a credit default event (in line with expectations, but, quite frankly, it's ridiculous that the insurance is not triggered);
2. the EFSF will be leveraged 4x-5x, increasing the lending capacity to as much as 1.5 trillion euros, which is probably enough to defend Italy and Spain (higher than expected but a bit squishy as the structural details are to be announced over the next few months);
3. 106 billion euros in bank capital are to be raised over the next eight months by Europe's banks (a bit below expectations); and
4. IMF will give Greece another 100 billion euros.

While the moves are, in the aggregate, only slightly ahead of expectations, the market has reacted in an ebullient manner.

I had thought that the opposite would occur -- namely, that the Eurozone decision would live down to expectations, that the writedown in debt was a CDS event (with unknown financial ramifications) and would encourage other sovereign restructurings, that the bank capital raise would be problematic and reduce the availability of overall credit, that the economic impact on the European debt restructuring would be growth-deflating and that the markets around the world would pause/move lower on the news.

When I Read The News Last Night, I Figured The Dow Would Be Up 300....

I figured many were leaning the wrong way. Possibly not many saw this coming. Even most of the honest bulls will admit they are stunned by the magnitude of the gains today. The fact that we didn't even dip and were hitting new highs for the day in the last hour of trading is proof that there was very poor positioning and massive scrambling to try to get in tune with this strength; along with the machines humming, of course.

Some might argue that window dressing helped to accentuate the upside action, but, in retrospect, the idea of a 'sell the news' reaction to European news on Tuesday may have been a bit too obvious. What really surprised the market was that no one expected the Greek bailout news to hit overnight. It looked like the endless debt negotiations were set to continue for a few more weeks when trading ended Wednesday. Expectations had already declined just when the news hit this morning and that lit the fire.

Obviously at this point, the market may be extended, and possibly be in need of some consolidation, but that has been the situation for a while now. The dilemma is that the more one-sided the action has been, the bigger supply of folks who are missing out and will act as underlying support. Markets this strong produce legions of potential dip buyers.

The folks who are underinvested at this point are hoping and praying for pullbacks and many of them will jump in on the most minor pullbacks. There is a tremendous amount of anxiety about underperformance now and no shortage of folks who are underperforming.

Wednesday, October 26, 2011


China's potential commitment to buying EFSF bonds is nothing more than a token gesture.

Does anyone really think that the ailing European countries will impose real change?

Just look at Italy!

The country and its government are collapsing, and Silvio Berlusconi finally has come up with a compromise pension solution.

That solution is to raise the retirement age by two years, to 67, and, get this, by the year 2026!

There will be no change as to the length of service that permits workers to retire at age 61 after 35 years of service.

My view is that our market will be hostage to Europe for some time. The Band-Aids will be value-deflating, as leadership (over there) will be timid, tame and largely ineffective.

Then there is our Super Committee!

Super, no! Ineffective, yes!

I expect that, of the $1.2 trillion deficit reduction target, as little as $500 billion will be agreed upon, with the balance coming from the automatic cuts to be effective in January 2013.

In summary, a lot of can-kicking, both here and over there!

I agree with Peter Boockvar of Miller Tabak on the story that the Chinese will participate in the purchase of bonds issued by EFSF:

The market is rallying on the story that China will buy bonds issued by the EFSF. This is not a surprise as they expressed interest back in January,, and China is not doing this out of the goodness of their heart. EFSF is AAA rated paper (assuming France keeps theirs) and the diversification it provides the Chinese away from US Treasuries is much different than China saying they will buy Italian, Spanish or Portuguese debt directly. Thus, this basically is the more conservative way of investing in Europe. Japan has been buying EFSF since they were first issued.

Europe is on an intractable course toward a recession (and possibly a deep one).

With regard to durable goods, September durable goods (excluding transports) was +1.7% (consensus was +0.4%), and orders for non-defense goods (excluding aircraft) were +2.4% (consensus was +0.5%).

It should be noted that goods orders (as well as automobile sales, especially light trucks) have importantly benefited from businesses taking advantage of full cash-expensing provisions that were part of the 2010 tax package -- the benefit retreats to only 50% in 2012.

So business capital spending is probably being pulled forward into 2011; my economic concerns are not in this year's final quarter but rather in the first half of 2012.

My conclusion, despite the better recent positive trends in retail sales, foreign trade and durable goods strength, is that the domestic economy is not yet out of danger.

George Costanza (Jason Alexander): [Soup Nazi gives him a look] Medium turkey chili.
[Instantly moves to the cashier]
Jerry Seinfeld: Medium crab bisque.
George Costanza: [Looks in his bag and notices no bread in it] I didn't get any bread.
Jerry Seinfeld: Just forget it. Let it go.
George Costanza: Um, excuse me, I - I think you forgot my bread.
Soup Nazi (Larry Thomas): Bread, $2 extra.
George Costanza: $2? But everyone in front of me got free bread.
Soup Nazi: You want bread?
George Costanza: Yes, please.
Soup Nazi: $3!
George Costanza: What?
[Snaps his fingers. The cashier instantly takes George's soup and gives him back his money]

-- “Seinfeld” (The Soup Nazi)

Although MET is in the process of trying to sell its bank (MetLife Bank), it is still regulated (as are all bank-holding companies) by the Fed, which must opine on all dividend increases and share buybacks.

It was the Street's understanding that the company intended (and requested permission of the Fed) to raise its dividend rate from $0.74 a share to at least $0.90 a share and to initiate a share buyback of $1.0 billion to $1.5 billion.

MetLife had already passed stress tests, so it was a big surprise when, after the close, the Fed turned down the company's requests. MetLife will now have to participate in the 2012 Comprehensive Capital Analysis and Review, delaying the company's ability to raise the dividend and buy back stock until a year from now -- at the earliest.

Even if Met Life sheds its bank (given changes in rules governing the Financial Stability Oversight Council under new rules contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act), however, it is still unclear whether the company will be considered a systemically important institution and, as such, still under the Fed's supervision. If so, it might not be until 2013 when any capital management decisions will be permitted.

It is hard to understand this decision (which entails only about $1 billion to be returned to shareholders) in light of the $16 billion acquisition of AIG's Alico subsidiary less than a year ago, the company's strong excess capital position and given that MetLife never tapped TARP.

There could only be three reasons for this decision:

1. Overregulation (probable!);
2. MetLife's management dropped the ball in the presentation and defense of its strong capital position (not likely!); or
3. Authorities could be concerned about the company's rapid top-line variable annuity growth -- EPS are due to be reported on Oct. 27 -- and possible problems in hedging its growing book of assets (long shot reason!).

MetLife's fundamental picture is excellent, with return on equity likely to gradually rise to almost 13% by 2013.

Nevertheless, the Fed's decision last night will likely weigh on the company's shares and could also cause collateral damage in the shares of its insurance peers (which were already negatively impacted yesterday by a large fall in bond yields).

Tuesday Thoughts

GS' monthly pension outlook made some interesting observations on rebalancing.

Today Goldman Sachs' monthly pension outlook has made some interesting observations on the rebalancing subject:

* As of close on Oct. 24th, Goldman's desk models estimate $28.80 billion of equity selling from pension rebalancers.
* For the month of October, equities outperformed fixed income, with the S&P 500 outperforming U.S. T-notes by 12.97%. (This resulted in monthly estimated rebalancing flow of $19.33 billion out of equities).
* Lastly, Goldman saw one "trigger" event on Oct. 10 which the firm estimates nets to $9.47 billion in equity selling.

If the domestic economy is so strong (as many of the bullish cabal contend), then why is the yield on the 10-year bond moving lower again?

My view is that we will see some tentative signs of agreement over the next 24 hours regarding the eurozone debt crisis.

My view is also that Europe will live down to expectations and that any announcement will simply be can-kicking in its approach.

Austerity measures will exacerbate the current weakening of economic growth in Europe.

The only question is how deep the 2012 recession will be in Europe.

The Case-Shiller home price index dropped by 0.05% in August (-3.8% year over year),
The decline was worse than expected, represents the lowest level since early 2011 and is only modestly above 2003 prices.

The residential real estate market will likely scrape along the bottom for a few more years regardless of HARP or any other government intervention aimed at clearing the unsold inventory.

Resources (energy and water): The world is moving east. Rising demand, stemming from the continued industrialization in the developing world and the emergence of a middle class, places pressure on the supply of all resources. Besides energy (where there are plenty of candidates), I would look at the water sector -- PHO and CGW are 2 ETFs that can give investors representation in an emerging imbalance between demand and supply for this important resource.

Housing: The companies that stand best-positioned to find the solution to the massive overhang and shadow inventory of unsold homes will prosper mightily -- that is, those that maintain, remediate and bring to market for sale foreclosed properties. Anti-housing plays are in a growth-y area, with a long runway that will only get better in the years ahead. The only company I have been able to identify thus far is ASPS.

Social communications/networking: There will likely be a new company, similar to Facebook, or a company that sells unique devices, similar to AAPL, that changes the world. I have no clue what company it might be, nor does anyone else right now.
Once again, the market celebrated the rescue of European banks.

Unfortunately, all that really came out of this much-anticipated summit was some general understandings. The actual details have yet to be worked out. It was just another agreement to agree, but some talk that China may invest in the bailout gave the move a little extra jig.

It is easy to be skeptical about positive news out of Europe because we have been seeing the same nonsense for so long. Nothing is ever really resolved, but there are constant assurances that progress is being made and that everything will be fine. If you don't have some doubts, you just aren't paying enough attention.

Tuesday - Correction

After the recent breakout move on light volume, the market was extended and in need of some consolidation, which is exactly what we had today. Breadth was around 4:1 negative and volume was light, but overall, it was run-of-the-mill corrective action.

Precious metals where the only safe haven, which is something we haven't seen in a while. Stocks moved in lockstep again, but this time it was to the downside.

One of reasons that the selling kicked in is a widely anticipated sell-the-news reaction to the European Summit. It really is a perfect setup for profit taking as that news hits, but traders are always anxious to stay a step ahead so they started selling today rather than wait for the real news.

It didn't help that we had poor earnings from the likes of NFLX, FSLR, MMM and CMI. The news flow out of Europe was quiet, but that is likely to change tomorrow.

Monday, October 24, 2011


Will a 60% haircut on Greek debt trigger credit default swap events?

While the market momentum is impressive, the economic backdrop both here and over there is less than impressive and the marginal impact of more quantitative wheezing seems questionable.

Consider that the U.S. economy, under a zero-interest-rate policy, has been able to muster less than 2% real growth through the first three quarters of the year.

China manufacturing data came in better than expected, while Europe fell short.

China's October flash manufacturing index came in at 51.1 as compared to expectations of 50.0 and 49.4 recorded in the prior month. This is a temporary blow to the hard-landing thesis in China, and it probably helps to explain the outsized move of $0.15 in copper today. (The rally since Friday in copper is the largest since March 2009).

By contrast, the October eurozone flash composite PMI fell to 47.2, well below September's 49.1 and consensus of 48.9. Both manufacturing and services declined. This is the sixth consecutive monthly drop and is now at the lowest reading in 2.25 years. The weakest component was new orders at 45.4.

Waiting For Europe

Despite being "technically extended" on light volume, the market continues to hold up well on optimism that a solution to the European debt crisis is forthcoming. The continued strength may actually be more a function of discouraged bears that are afraid they will continue to be squeezed rather than real buyers convinced that the worst is over, but it is keeping the uptrend intact regardless.

What seems to be driving this action again is poor positioning by bulls who never added sufficient long exposure when the market went straight back up after hitting a new annual low to start the month. There just wasn't any good dip-buying opportunity once we reversed, and so we end up with steady chasing even though the technical picture is less than ideal.

The bears will again point out that volume was light, but that seems to be almost a contrary indicator these days. Our best upside moves seem to occur on steadily declining volume, which keeps traditionalists off balance.

Also, we had positive breadth again with about 4600 gainers to just over a 1000 decliners. This tendency of stocks to move together is a function of the focus on headline news and the use of exchange-traded funds and computerized trading. Individual stock picking continues to provide little benefit in a market that is all about timing the news.

Few market players seem convinced that a solid and long-lasting European solution is forthcoming, which means the risk of a sell-the-news reaction is high. The most uncomfortable thing about this Europe-driven rally is that there has been no actual agreement or policy. All there has been is hopeful comments that something will eventual be decided upon that will be effective.

The big risk is that the market will be disappointed when Europe actually has to execute rather than just issue vague statements about how a solution is forthcoming.

Friday, October 21, 2011

Friday Thoughts


The company’s quarterly report was a bit of a disappointment, but I maintain my positive view.

Most of the miss to expectations was non-operating -- $5 million loss from hedge fund seed and a much higher effective tax rate (46% vs. 35%).

Fund inflows and institutional inflows were reasonably strong (at $1.5 billion, respectively), but market depreciation (at -$7.2 billion) was slightly worse than forecast.

Comp and benefit line was within expectations.

Run, don’t walk, to read Zero Hedge’s take on the student loan bubble.

Apple, Baidu, Schlumberger, GE, Microsoft and Citigroup are conspicuously weak.

Does a two-year low in the Chinese stock market concern anyone besides me?

Skepticism, on the part of both retail and institutional investors, is at an extreme.

The U.S. stock market is already trading at a discount to its historic valuations -- at only about 12x 2012 S&P profits while the yield on the 10-year note stands at only 2.15%. By contrast over the past 50 years, stocks have averaged 15x while the yield on the 10-year note has averaged 6.67% (or over 3x the current yield).

Remember, catastrophic (Black Swan) events rarely occur. Obviously. Despite the disparate interests, the eurozone's leaders are fully aware of the consequences of inaction. They will address the serious debt issues in the days ahead, and the market might have already priced in the eurozone's problems.

The U.S. stock market has gone nowhere for years. Skepticism, on the part of both retail and institutional investors, is seemingly at an extreme (as measured by domestic equity outflows and low net invested exposure of the hedge fund community).

Thursday Thoughts

Run, don't waklk, to read Jeff Matthews’, comments on Apple's slowing store sales.

Most market participants are now, to use a poker term, "on tilt." The term means to be in a state of confusion.

The one question that every bear should ask as we go into "the most important weekend" is this: Has the market discounted the negatives that appear to be relatively well understood?

In the fullness of time, the eurozone will come to some sort of solution to paper over its debt problems. In all likelihood, the solution will be weak-kneed, lacking with power of resolution.

After the 'resolution' of the European crisis, we have to address the downside implications for that region's economic growth rate. Toward that end, last night Germany reduced its GDP forecast for 2012 to +1.0% from a previous projection of +1.8%. I would expect further revisions lower in the country’s growth outlook in the months ahead.

With Germany being the "best house in a bad neighborhood," one can only envision how weak the European region's aggregate growth rate will be in 2012-2014.

It is clear European demand has meaningfully weakened. As an example, AXP discussed in last night's conference call that European billed business softened throughout the quarter (and that October's trend worsened).

Europe is in a recession, and the only question is how deep -- that is where the next debate will unfold.

I believe this will help to explain why an Oct. 23 eurozone agreement will be met with a muted response.


Earnings that the market didn't like from IBM and AAPL created downside pressure this week, but optimism about a potential solution to European debt provided solid underlying support and kept the bears off balance. Market players remained intently focused on European headlines and, ultimately, the hope that next week's meetings will resolve the crisis held the market up. It also didn't hurt that the bears and underinvested bulls were caught out of position yet again.

It seems like a straightforward cause-and-effect relationship between optimism and buying this week, but the underlying market action is anything but easy. We continue to have very correlated action between stocks. They all move in one direction or the other, which is the hallmark of exchange-traded funds and computerized and high-frequency trading.

Stock picking does not matter at the moment. All that matters now is timing the reaction to headlines. It doesn't matter what stocks you buy since they all move together, but it causes a lot of consternation for traders who focus on charts and fundamentals as a way to produce superior returns. They have no edge in this market and there isn't much they can do about it until the focus shifts away from the headlines. If you are a stock picker rather than a market timer, this is not an easy market.

Earnings have been a mixed bag so far, but we still have many more in the next couple of weeks and that is good for stock pickers. I'm optimistic that we might see the focus on Europe cool off and that stock picking will return to vogue, but with window-dressing pressures kicking in next week, the computers are very likely to stay busy.

Despite skepticism about Europe and the manipulated feel of much of the action, the bulls have the advantage. Window dressing should give them additional edge.


The market action was mixed today, which is probably healthy as we could use some consolidation. Unfortunately, the trading was so sensitive to headlines out of Europe that it was hard to build any confidence.

Breadth was negative but there were bounces in banks, oils and retail, which offset weakness in precious metals, chips and coal. AAPL struggled again, which kept the Nasdaq in the red, but big-caps generally outperformed small-caps.

The intense focus on European news is becoming tiresome, as is the lack of leadership. The action isn't that bad as we near the upper end of the trading range, but no stock is exhibiting great relative strength or taking a leadership role. Apple filled that need for a while, but now nothing is catching the attention of the "hot money" speculators who are always hunting for momentum.

The lack of clear leadership is a consequence of the very strong correlation among stocks. Everything is trading in lockstep to macro-economic headlines. Exchange-traded funds and high-frequency trading only reinforce that behavior. There is no alpha, so no one is focusing on individual stocks.

Wednesday, October 19, 2011

Wednesday Thoughts

Will the austerity imposed and the economic ramifications of a bailout put Europe in deep trouble for years?

The question I ask myself on this eurozone bailout is not whether there will be a large bailout but whether the austerity imposed and the economic ramifications will put Europe in deep trouble over years and years.

The DJIA has gained only 80 points since Dec. 31, 1999.

24 years ago (the day of the 1987 market crash), the DJIA lost 508 points; since then, it has gained 9839 points but only 80 have come from Dec. 31, 1999!

An anecdotal report suggests that Steve Jobs was working on future product development the day before he died.

Screwflation has been an ongoing theme of mine this year.
Apropos to the rising cost of necessities (while wages stagnate) was the +0.4% month-over-month (+4.6% year-over-year) and three-month annualized +5.7% increase in food price inflation.

Since food represents twice the weighting of energy costs in the CPI, this could further threaten the recovery in retail sales that we saw in September.

After the close AAPL reported a miss to expectations for the first time in 26 quarters. (While the forward guidance was upbeat, it was not as good as the headline, as the next quarter includes an extra week.)

The common (very) upbeat refrain on Apple from the Street of Dreams (and almost every Wall Street analyst) this morning goes something like this:

"Buy the dip in Apple, as we view this morning's pullback as an attractive buying opportunity ahead of what should be a very strong upcoming quarter, as the company benefits from several important product introductions."

-- Every Wall Street analyst today!

I fully recognize (as does the entire investing universe) that after deducting the tax-affected repatriated cash, Apple's shares appear inexpensive. This has been the case for some time.

But, if I were an Apple shareholder, I would be asking myself the following eight questions this morning:

1. Valuation is rarely a market catalyst. Who doesn't know that Apple's valuation, excluding its cash position, appears inexpensive?
2. In reading the analysts' earnings post mortem and explanation of why the company missed on the bottom line, why is it only now so obvious to analysts that Apple has been impacted by iPhone purchase deferrals ahead of the introduction of the iPhone 4S? Why wasn't that included in analysts' estimates?
3. In my few decades of investing experience, when companies cite the impact of weather, seasonality or product transitions (as was the case with Apple) as reasons for a profit miss, it is usually a sign of a company's maturing (sales and earnings) growth cycle. Have we seen a peak in growth rates at Apple, and beyond the quarter catch-up, might we begin to see decelerating growth at Apple in 2012-2014?
4. Size matters. Should investors be surprised that, with annual revenue having risen (fiscal 2011 September year just completed) to over $108 billion, sales and profit growth will become more difficult going forward? Fiscal 2014 sales are projected to approach $200 billion. Have the outlook and expectations for Apple grown too optimistic?
5. A 3 million unit shortfall in iPhone sales and slightly weaker iPad numbers (11.1 million vs. consensus of 11.6 million, but there were estimates for 13 million units!) resulted in the profit miss. Are investors overestimating the short-term growth prospects for the overall tablet market? And what about the weakening trend in iPod unit sales (down 27% year over year) that signal a secular decline in the product category? Doesn't this place more pressure on the success of future new products?
6. Apple's corporate and product success are well known. Are these success too well known as manifested in a near unanimity of bullishness on the part of Wall Street's sell side?
7. The ownership of Apple shares are broad, and institutional sentiment toward the company appears to be approaching a positive extreme. One could argue that the long side in Apple is crowded. Doesn't everyone own the stock? Who will be the next investor in Apple's shares that will catapult the valuation and shares toward the next and higher level?
8. Most recognize that Steve Jobs has already thought about and has contributed to another few years of new product innovation. But will the miss last night revive the issue whether the remarkable disruptive innovation instituted by Jobs (in the past) can be continued into the future after his imprint is removed?

Tuesday Thoughts

AAPL has just missed consensus view -- its first shortfall in almost seven years. While I understand that there is currently a product transition going on in the iPhone, Apple's release was a poor one relative to expectations. Indeed, the whisper number was above $8.50/share, a full $1.50/share higher than the actual earnings reported.

The market's daily gyrations are causing more harm than good.

This setting of volatility is further hurting investor confidence -- at a time when it is already wounded.

JPM conducted a conference call on the European debt crisis this afternoon.

Below are the firm’s comments:

* A 200-billion- to 300-billion-euro bank recapitalization plan will be approved on Oct. 23. Banks will get up to nine months to satisfy the recap objectives (either through asset sales or equity raises). If the aforementioned is not accomplished, either the EFSF or the specific country where the bank is domiciled will make up the difference. Anything short of 200 euros or six months to satisfy the requirements will disappoint the markets.
* JPMorgan doesn't expect an Oct. 23 announcement of the Greek restructuring. JPMorgan puts the restructuring at 60% and expects the banks to object to this plan and more "discussion" to follow. The next 8-billion-euro support of Greece will be announced at the meeting.
* An announcement will be made on the EFSF subsidy at the Oct. 23 meeting. The EFSF financing will take the form of an insurance policy allowing the program to be leveraged by about 2.5:1 (up to 1 trillion euros), and the first 20% to 30% of losses of newly issued weak sovereign bonds will be guaranteed. JPMorgan says the size of the deal will serve to ring-fence Spain and Italy from Greece.
* JPMorgan remains skeptical that what is proposed will be effective, and the firm’s conclusion is that the equity markets will not ultimately like the outcome.

An interesting observation from Peter Boockvar of Miller Tabak on what the VIX consistently over 30 means:

Quantifying what a VIX consistently above 30 really means, today is the 59th trading day in a row where the S&P 500 has moved 1%+ between the high and low of the day.

Kotak -

[T]he financial stocks, which have been devastated for four years, are currently positioned for a buying opportunity. In Cumberland’s case, we have scaled into financials several times and taken up the weights in the regional banks. So far, that is proving the correct course of action. We have taken the overall financials exposure above market weight. We continue to be a scaled buyer in financials.

Ten days ago, the entire banking system of the United States was for sale below its stated book value. One could argue it was for sale below its tangible book value, which means you could buy all the banks in the United States at stock exchange prices trading for less than their liquidation value. Clearly, that is an absurd pricing level.

Are banks now sound? Answer: some are, some are not. Are there still problems ahead in the financials and in the banking sector? Obviously, yes. Is regulatory change an issue? Again, yes. Are earnings derived from net interest margin an issue? Once again, yes. Does that mean that banks are dead forever? Our answer is a resounding no.

The time to enter a sector and start to take up the weights is when it has been devastated in a bear market for several years and priced to an extreme. When you price the entire banking sector below its liquidation value, below its tangible book value, you are seeing a pricing level in a climate where all the bad news is known or identified. Only then are you are defining an entry point. Further, the financial sector has lost ten percentage points of the value share of the stock market since its peak. Think about this sector where it once was 24% of the market weight and derived 40% of the market’s earnings. Now it is 14% of the market weight. Its earnings are substantially down from the peak earnings that were extant five years ago when everyone wanted to own financials.

Nevertheless, while there will be intermittent trading (sardine) opportunities in the sector, I see these factors as valuation/profit headwinds for years to come:

1. The big money center banks are suffering under the burden of cumbersome and expensive regulatory initiatives; they are the piñatas of populism.
2. Higher ROE businesses (e.g., prop trading) are being reduced in size under the pressure of No. 1.
3. The specter of low interest rates continues to pressure net interest margins -- and this won’t change for many quarters according to Fed. Bank industry profit models benefit from higher interest rates, as banks have an imbalance of rate sensitive assets over rate sensitive liabilities.
4. The capital markets outlook remains lackluster.
5. Legacy issues continue to be costly (e. g., mortgages), as measured by both legal expenses and losses.
6. Subpar worldwide economic growth and limited improvement in the employment rate suggest that the credit quality recovery of the past two years is maturing.
7. Earnings power models for the bank sector have been revised lower almost every quarter and probably still remain too high. There is little low-hanging business fruit left in the way of pricing banking products (e.g., the imposition of a $5-a-month charge for checking won't dent the secular pressures).

Asset Managers Are Vulnerable to Disintermediation

I would remain short asset managers, especially those such as Franklin Resources (BEN) that have had disproportionate growth in non-U.S. fixed income and are now exposed to the threat of disintermediation (bond fund outflows), retail investors' disinterest in equities and depreciation in bond funds’ asset values due to continued euro instability and the inevitability of higher interest rates.

Life Insurance Is Stupid Cheap

While life insurance stocks act nearly as poorly as bank shares and are similarly subject to valuation/earnings risk from an extended period of low interest rates, many of the other headwinds facing bank stocks are not apparent to the insurance sector. The recent share price weakness can be seen as an opportunity, as the industry's fundamentals remain on sound footing. As contrasted to the banks, earnings and ROEs are going to continue to expand, as the demand for structured, guaranteed financial products (as retail investors remain risk-averse and avoid the equity markets) continues the strong growth experience of second quarter 2011 in the quarters ahead.

At a 30% discount to book value and at under 7x projected 2012 profits, the life insurance sector is stupid cheap.


Nonrecurring items had a significant impact on results at the bank.

A number of significant items affected results at BAC.

In summary, nonrecurring gains of about $10.5 billion and nonrecurring losses of about $5.5 billion netted out about $5 billion of nonrecurring gains.

There are about 10.6 billion shares outstanding, so approximately $0.44 per share in nonrecurring gains to report.

BofA came in with a headline EPS of $0.56, or $6.2 billion, compared to the consensus of $0.20 for quarter.

Taking out $5 billion net nonrecurring items from the reported of $6.2 billion of income, on an adjusted basis, the bank only earned about $1.2 billion or $0.12 per share, according to my quick analysis, a miss of about $0.08 per share.

China's third-quarter 2011 GDP supposedly grew at a 9.1% pace, slightly below expectations of 9.2% growth and down from second-quarter 2011's 9.5%.

The German October monthly poll showed the ZEW's headline economic sentiment index dropped for the eighth consecutive month to -48.3 from -43.3 in September, below the consensus forecast in a Reuters poll for a decrease to -45.0. This was the lowest level in nearly three years.

Monday Thoughts


Based in Costa Mesa, Calif., the shares trade at around $29 (down from nearly $50 in May 2011), which is in line with its book value.

Subtracting $8 a share in net cash, the company trades at less than 7x projected 2011 EPS of $3.20 (which might prove conservative).

Given the company's "growthy" end-market positioning, Ceradyne's average annual growth in profits should exceed 10% (per annum) in the years ahead. (Again, this might be conservative as well).

By means of background:

[Ceradyne is] in the development, manufacture, and marketing of technical ceramic products, ceramic powders, and components for defense, industrial, automotive/diesel, and commercial applications in the United States and internationally. The company’s products include lightweight ceramic armor and combat helmets for soldiers and other military applications; ceramic industrial components for erosion and corrosion resistant applications; ceramic powders, including boron carbide, boron nitride, titanium diboride, calcium hexaboride, zirconium diboride, and fused silica, which are used in manufacturing armor and a range of industrial and consumer products; evaporation boats for metallization of materials for food packaging and other products; and ceramic diesel engine components.

Bill King (The King Report) points out the divergence between consumer confidence and retail sales is growing increasingly conspicuous.

On Occupy Wall Street

Higher taxes and fewer tax loopholes for the wealthy and large corporations seem inevitable.

Since Yesterday, a book by Frederick Lewis Allen; was a popular historian of the 1930s and 1940s. Published in 1940, it turned out to be a shrewd, concise, wonderfully written account of America in the ’30s.

It also turned out to be something else: a reminder of why history matters….

In Since Yesterday, bankers are vilified; homes are foreclosed on; people desperately search for work -- just like today. Businessmen speak of the need for “confidence,” a word that “enters the vocabulary only when confidence is lacking.” Elsewhere Allen writes, “No longer were vital economic decisions made at international conferences of bankers; now they were made only by the political leaders of states....”

Toward the end of his book, Allen sums up the mood of the country. By 1939, people were weary of hard economic times, but they were also weary of Roosevelt’s endless experiments. Many modern historians believe that Roosevelt’s biggest problem was not that he’d done too much, but that he’d done too little -- that the Depression required a response bigger than even Roosevelt’s New Deal.

-- Joe Nocera, The New York Times ("The 1930s Sure Sound Familiar”; Oct. 14, 2011)

In four weeks, Occupy Wall Street has gone from an ad hoc aggregation of annoying protestors to a potentially important part of the national debate about the disparity between the haves and have-nots.

There is a broken feeling in the way many Americans view their future. The younger the person, it seems, the more the shallowness and despair that exists.

The primal screams of Zuccotti Park in New York City reflect the economic inequities that have accelerated since the Great Decession of 2007-2009, as well as the outrage associated with past bailouts and too-big-to-fail public policy that is seen as having socialized risks and privatized profits.

* The 400 wealthiest Americans have a greater combined net worth than the bottom 150 million Americans.
* The top 1% of Americans possess more wealth than the entire bottom 90%.
* In the Bush expansion from 2002 to 2007, 65% of the economic gains went to the richest 1%.

Occupy Wall Street embodies the zeitgeist of populism and is a continuance of a growing economic desperation that has existed over the last 10 years and that has worsened as U.S. unemployment has failed to recover over the last three years.

Between June 2009, when the recession officially ended, and June 2011, inflation-adjusted median household income fell 6.7%, to $49,909, according to a study by two former Census Bureau officials. During the recession -- from December 2007 to June 2009 -- household income fell 3.2%.

-- Robert Pear, The New York Times, (“Recession Officially Over, U.S. Incomes Kept Falling”; Oct. 9, 2011)

Screwflation - the average Joe has seen his wages stagnate (actually in last decade the average income has dropped by 7%) while the costs of the necessities of life have gone up measurably. Corporations, by contrast, have taken an outsized share of GDP and income -- as they relentlessly cut fixed costs (read: chopping jobs) over the last decade.

Meanwhile structural unemployment has deepened, stemming from a talent/skills mismatch, globalization (it became cheaper to manufacture abroad because salaries are far lower and burdensome and costly regulations don’t exist overseas), rapid technological change (which has replaced many jobs), the increased and accepted use of temporary workers as a permanent feature of the jobs market, the loss of mobility (caused by a 35% drop in home prices) and the absence of an economic growth engine to replace the role of a booming housing market that accounted for more than one-third of the job creation of the last economic cycle.

With nearly 17% of our country’s workers either unemployed or underemployed, Occupy Wall Street's frustration with these conditions are understandable.

I am in favor of Occupy Wall Street, if it means getting justice and indicting executives from the small cabal of banks and investment banking firms, who sliced and diced mortgages into financial derivatives of mass destruction that poisoned the world's financial system; if it means prosecuting the lenders who, with no- or low-document mortgages, recklessly enticed consumers into mortgage loans that were dead at birth, count me in.

The fact that no one from FNM, FRE, ML (BAC), Countrywide Financial or Lehman Brothers is rotting in jail is appalling to me.

But I don't favor the focus being on the rich; that anger is misaligned. Yes, the rich have gotten a great deal in this country, and it is likely that that deal will not be so great in the future (read: higher marginal tax rates), but the culprits are the politicians (both Republican and Democrats) that have been bought by the lobbyists, who represent small and large corporations and the wealthy.

I favor and would support Occupy Wall Street if their message were clearer -- and if that message and target was geared not toward the rich (and their Upper East Side townhouses) but rather took a southerly route toward our dysfunctional and divided political representatives in Washington, D.C., who are unable to seriously address our country’s structural issues (e.g., our fiscal imbalances and structural unemployment) with outside-of-the-envelope, pro-growth fiscal solutions.

We need change, but the direction and context of Occupy Wall Street’s message of change would be far better served if it was based not only physically but in substance toward our political representatives in our nation’s capital rather than in a park in Lower Manhattan.

For three years, ever since the 2007-2009 economic crisis that nearly decimated the world’s financial system, Americans have been increasingly frustrated and have sought a solution to reverse their worsening (absolute and relative to large corporations and the wealthy) economic standing, but their efforts have often been scattered, unorganized, ineffective and short-lived -- as if they were floundering from one protest to another.

At first, the dissatisfaction with the status quo led to the political tsunami in November 2008, when President Obama and the Democratic Party captured control of Washington, D.C. Then, the Tea Party emerged as a formidable political force within and outside the Republican Party.

The latest lashing out and the newest movement, Occupy Wall Street (which, according to a new NBC poll, has resonated favorably with 54% of Americans compared to only 27% for the Tea Party), is now gaining traction in the U.S. and abroad -- and is yet another in a series of manifestations of anger and discontent toward the wealthy that has shaped our political and social landscape.

What Does Occupy Wall Street Mean to Investors?

The emergence of populism and the underlying discontent associated with economic inequalities as manifested in Occupy Wall Street are already part of the national agenda and seem destined to play a visible role in the November 2012 elections.

Most recently, greater financial regulation has already been enacted through the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Burdened by a more cumbersome and expensive regulatory environment, bank stocks have been become the piñata of populism -- and have been among the worst performing stock sectors.

Look for other industries (e.g., health care, energy and even utilities) to be challenged by the headwinds and the pressure from the imposition of more costly regulatory burdens in a growing populist context.

In the fullness of time, Occupy Wall Street’s social imperative -- namely, that the wealthy and largest companies have benefited disproportionately from the last decade's growth -- seems almost certainly to be destined to result in a far greater financial/tax burden for those two groups over the next decade, through the implementation of higher taxes and the elimination of tax loopholes.

If I am correct, this helps to partially explain the below-average historic P/E multiples that exist today (especially relative to inflation and interest rates), as current valuations could be reflecting the rising expectation of increased regulatory costs associated with conducting business and an expectation of higher corporate tax rates (that will be responsible, all things being equal, in lowering after-tax corporate profits).

Occupy Wall Street and its older sibling, the political tsunami of November 2008 (that led to the ascent of the Democratic Party), are contributing factors toward a pendulum swinging away from the policies that are perceived by many to have set the stage for the last economic crisis.

Whether one agrees or disagrees with Occupy Wall Street and its goals, the already emerging trends (that it is encouraging) of greater regulation and higher taxes aimed toward the wealthy and large corporations are corporate-profit- and valuation-deflating.


The sun did come 'round and sneak up beside us again, despite AAPL's earnings miss and the Spanish debt downgrade overnight. The market started the day with mixed action. A strong report from INTC helped to offset the negatives, and the bears were fearful of another "Europe Is Saved!" headline, but the bulls never gained traction and the market dripped steadily lower all afternoon.

The most notable aspect of the action today was the lack of energy. Breadth could have been worse, but the only major sector in positive territory was utilities. Banks reversed after a good start, and even a frisky INTC could not keep the semiconductors in positive territory. Oil, gold, steel, commodities and retail all acted poorly.

The action was more reflective of a lack of buying interest than aggressive selling. There wasn't a catalyst for the bulls to keep on pushing, especially as we test overhead resistance and don't have a particularly strong foundation to build for any further move.


INTC earnings often mark a turning point for the market, and AAPL is probably the most-loved stock in existence.

AAPL earnings are always an interesting exercise in psychology because everyone knows, without a doubt, the company will beat estimates -- it's just a matter of by how much. Over the last four quarters it has beaten by 13.7%, 19.1%, 19.2% and 33.6%, respectively. That last quarter was well ahead of the whisper number and the stock reacted strongly, even though it already had a straight up move going into the report.

For the fiscal fourth quarter, the average estimate is for earnings of $7.28 per share. I believe the market will be looking for that to be surpassed by 15% to 20%, which would be $8.37 to $8.73. Anything under $8.50 is likely to invite profit taking, especially since the stock has had a good run the last couple of weeks. The other thing to note is that AAPL is notorious for low-balling guidance, and that is expected, but any talk about growth slowing will be treated harshly.

AAPL management has been masterful in the way it has managed earnings, but that hurdle is quite high because it isn't possible to keep expectations low -- anything less than a great quarter will disappoint some.

INTC in some ways is a more important report than AAPL, as it tends to be a bellwether for the technology group. It was INTC earnings that kicked off the huge rally that started in 2009, and a poor report has marked bumpy earnings seasons in the past.

Like many other stocks, INTC has made a big move recently and is running into resistance, so the risk of a sell-the-news reaction is high. INTC typically beats by a few cents, but guidance is the key. A poor INTC report on the heels of IBM's disappointment last night will make for tough going in the technology sector.

Saturday, October 15, 2011


in terms of economics (or anything else, for that matter), does holding a grudge ever really "work?" is forgiveness the key? the first step to economic recovery?


The price action over the last ten days or so is impressive, but it has become almost routine since the bottom in March 2009. I don't know how many times we have come back from the so-called "brink" of a breakdown and then went straight up on low volume. We cut through resistance levels and never even give the dip buyers a chance to jump in.

What makes the moves even more challenging is that they occur when there are excellent bearish arguments. I don't think anyone would dispute the fact that Europe is still a mess and that the economic situation in the U.S. is still very challenging. Despite a clear agreement on the negatives, or maybe because of it, the market acts like it doesn't have a worry in the world and simply crushes the skeptics who look for us to roll back over.

The contrary nature of the market is aided to a great degree by high-frequency and computerized trading, which exploits the fact that too many folks are out of position for this sort of action. The machines keep pushing as consternation about the one-way nature of the market grows.

The lesson is clear. We cannot underestimate the ability of the market to trend higher, even though both technicals and fundamentals are questionable at best. The fact that it is so easy to make a negative case against this market is the number one reason why many are finding it so hard to short it.

Next week, earnings reports will be hitting in abundance, especially AAPL and INTC.

Thursday, October 13, 2011


After this morning's selling pressure, the dip buyers are more aggressive and have the market at the highs of the day. There's still plenty of red on the screens, but it's a relief to see normal action instead of the relentless one-way move that made bears and underinvested bulls so uncomfortable.

Many reported it felt like human beings are trading today, not computer programs.

This makes me more positive about the market than I felt with the recent straight-up moves. I am more confident that individual stock picking will become important again with back-and-forth action, instead of everything moving together in one direction.

Perhaps I'm being overly optimistic to expect the market to trade in more "normal" fashion, but action like today's makes me think that maybe there are still humans out there who trade logically.

Wednesday Thoughts

Rumor is that large firms are considering shedding their bank holdings to get around the Volcker Rule.

My view is that, given that these companies are pinatas of populism today, it would be very difficult for, say, GS, to skirt the regulation by shedding its bank status.

Reuters reports:

Losses for private investors on Greek debt in the second financing package for Athens are likely to be between 30% and 50%, rather than the earlier agreed 21%, eurozone officials said on Wednesday."

Life insurance stocks trade at a 30% discount to book value and at less than 7x earnings.

With interest rates rising, life insurance stocks should begin to benefit.

They are "stupid cheap" at a 30% discount to book value and at less than 7x earnings. LNC; MET; PRU; etc.

Mr. Market will do what Mr. Market does -- and that is to make the most people suffer.

"The fact that people are even talking about the government stepping in to shore up the banks, when two months ago people thought there was nothing wrong with the Chinese banks, should tell you just how seriously this situation is deteriorating."
-- Jim Chanos

Run, don't walk, to listen to Jim Chanos talk on Bloomberg on China's banks, real estate and politics.

Tuesday Thoughts

According to a FT report, European banks will receive a higher-than-expected limit on their capital levels.

The Financial Times just reported:

European authorities plan to set a higher-than-expected capital threshold for the region’s banks and give them six to nine months to achieve that level or face government recapitalizations under the auspices of the eurozone’s 440 billion euro rescue fund.

From Bianco:

Inflation is both a concept and a measurement.

On one level, in concept, we are still seeing a fear of deflation.

On another level, the measures of inflation look like they are going higher. (the tips breakeven is still elevated)

Below is a recap of Jim Bianco’s session from the ‘Big Picture’ conference.

From Jim Bianco:

Market correlations are at the highest level in eight years. Among stocks, the correlation is an amazing 84% relative to the underlying index. (As an example, 494/500 of all the S&P stocks were up yesterday in the big advance.)

The shared fundamental is that the U.S. government and the world's central bankers will do whatever has to be done. The current amount of government intervention is unprecedented (at 30% of GDP, higher by a factor of 6x relative to history). The market understands this, and the government’s role is the primary reason why correlation is high.

What gets correlations to go away? This will only occur when the governments' and central bankers' roles decrease.

These correlations will continue in the near term.

There is one important divergence today -- that is, the difference between the message of the fixed-income and equity markets. Stated simply, credit spreads are widening and credit is underperforming, while stocks are advancing.

The market is now less a market of stocks -- rather, it has become a stock market.

The most crowded trades continue to be long gold and long AAPL. As a contrarian, I would be concerned if I were overweighted.

Probably the next big economic debate will not be recession vs. non-recession; but whether the domestic economy is entering an extended period of subpar and uneven growth that will be difficult for corporations to navigate and produce much in the way of profit advancement. This "new normal," influenced by structural headwinds, will likely limit the market's upside potential and discourages me from expanding my net long exposure at current price levels (and particularly after such a sharp move to the upside).

Run, don’t walk, to read Andrew Ross Sorkin’s ‘Volatility, Thy Name Is E.T.F.” in The New York Times.

Response by the bear: Personal income is 80% of the economy and is in the process of rolling over. Practically everything hinges on this particular metric; only a drop in the savings rate is preventing more serious erosion in consumer spending.

As an aside, both ISMs are where they were in November 2007, and I don't recall that they presaged a "muddle through" 2008 at that time.

We slide to 1075, everyone is freaking out. Too many positive divergences and we get another (tenth?) short-covering rally in past two months, and now there's no recession.

I'm being called "too draconian" now because there is a new plan for Europe! This is all surreal.

Everyone adjusts for Verizon when the August payroll data come out; nobody does it when September data are released, and with that we had almost no jobs growth!

What an economy.

-- David Rosenberg, Gluskin Sheff + Associates

Wednesday Market

Just when it started to feel like we might never pull back again, we managed a weak finish. The S&P 500 topped out almost perfectly at the 1220 resistance level, where the computer programs shut down and we fell fast into the closing bell.

Ironically, volume finally picked up and we had a technical accumulation day. But we are very extended and resistance finally seems to matter. Breadth was solid again, around 4:1 positive, but that isn't a big surprise since stocks have been trading in highly correlated fashion for a while.

I'm sure there are plenty of bears and underinvested bulls breathing a sigh of relief to finally see a little late selling, but you have to wonder if we are going to see much downside momentum. Straight up moves like those we have had over the past week create a lot of market players looking to buy dips. They missed out as the market ran away and now they want to make sure it doesn't happen again.

On the other hand, if you look at the action within the trading range since the beginning of August, the pullbacks following one of these V-ish bounces have been quite sharp. I attribute that to the high-frequency trading programs that go into reverse and help build momentum to the downside once we top out.

I doubt that too many folks are unhappy about a little weakness. The bears for obvious reasons and the bulls because we simply need some rest after this fast, low-volume, 10% move.

Tuesday Market

The market started the day technically extended and the news flow was benign, but the bears were still unable to gain traction.

It isn't difficult to make a good case for some sort of pullback here, but the market is staying very sticky the upside. There seems to be more fear of being caught in a short squeeze or missing a runaway market than there is about any sort of rollover.

AA kicked off the earnings season with its typical miss. The only reason this stock receives any attention is because it's first to report. If it reported a week later, it would largely be ignored.

We also have news of Slovakia rejecting the European Financial Stability Facility deal in Europe and that is causing some minor selling after hours. This is probably a very minor roadblock, but it will draw out a painful situation even longer. Ironically, the hope that some sort of European rescue deal will get done sooner or later is providing much of the underlying market support.

We end the day in much the same position we started. We are still extended and still bumping into overhead resistance, but stubborn underlying support and a tendency toward short squeezes makes the bears uncomfortable. It remains a challenging trading environment, but with earnings reports starting to roll out, conditions should change soon.

Monday, October 10, 2011

Could Be Trouble Later

It was one of those joyless positive days where the indices were up big and breadth was extremely strong but volume was the lightest in a month and there was far more grumbling than excitement about the action. We even saw another big squeeze of the shorts who were looking for a fade in the final hour. Too many folks never managed to put much money to work and the bears, who were looking for a quick rollover, just added fuel to the fire.

It all boils down to just one thing: After the sharp spike up last week, too many people simply were not prepared for this sort of action. That seems to be the new normal for the market, but it isn't easy to keep expecting the market to do what seems the most unlikely. There were no obvious positive headlines today, other than some vague plans to make plans to solve the European debt crisis. But once the buying took hold, it just kept on running, as the bulls scrambled to participate and the top-calling bears were continuously squeezed. The winning approach was to go contrary to the contrarians who wanted to fade strength.

I believe conditions are good for positive action during earnings season, but action like we saw today does not make for a good foundation. Many traders are greatly frustrated by this action, which is part of what keeps it going. But they have good reason not to be very trusting when the action has such a manipulated feel to it. Even if you do understand the psychology of what is occurring, it's still extremely difficult to trade.

Friday, October 7, 2011


Run, don’t walk, to read Zero Hedge’s take on the next subprime trade (and implosion).

The BLS’s chart of the year-over-year change in average hourly earnings looks dour.

This is the fifth consecutive month in a row in which job growth was less than population growth.

In September, nonfarm payrolls rose 103,00, but I am reminded by Boenning & Scattergood's Rick Farr that population growth is averaging about 200,000 a month. So the increase last month is half of what is needed in order to lower the unemployment rate.

Germany thinks it should be a last resort, while France wants what’s good for France now.

Eurozone will meltdown in two to three weeks so will the European banking system if eurozone leaders don’t address crisis in a credible way.... We are not just talking about a relatively small Belgian bank, we are talking about the largest banks in the world -- the largest banks in Germany, the largest banks in France -- that will spread to the United Kingdom; it will spread everywhere because the global financial system is so interconnected.

-- Robert Shapiro, IMF Advisor

Thursday Thoughts

Run, don’t walk, to read Reuters' aggregation of eurozone banks in need of additional capital.

No shock and awe from the ECB -- more tame and timid.

In Trichet's last meeting, he signaled a neutral view on interest rates and increases from three to six months to 12 to 13 months on bank liquidity facilities.

Disappointingly, he indicated that he did not want the ECB to leverage up the ESFS.

The Jobs legacy is that Apple is built to last.

Importantly the accumulated profits from Apple's remarkable success is almost an "endowment model" or an insurance policy for the company to maintain its future market share leadership. With over $80 billion of cash currently on its balance sheet, Apple is uniquely positioned to spend at least five percent per year to "guarantee' that market leadership goal. Thanks to Steve Jobs, no other competitor is anywhere close to being as well positioned over the next decade.

- Doug Kass, Apple: With and After Steve Jobs (Sept. 6, 2011)

What I found very interesting about AAPL's Steve Jobs is that his personal life, especially his early upbringing, was so unusual and nontraditional:

* He was an orphan.
* He dropped out of Reed College after one semester.
* He dropped LSD, calling his acid trips "one of the two or three most important things done in life."
* Became a Buddhist and traveled to India to visit his Hindu guru for spiritual enlightenment.
* While in his teens, he joined Atari as a computer technician (and produced a circuit board for the game Breakout) in order to pay for a spiritual retreat to India. (He cheats his partner Wozniak out of a few hundred dollars in a project to reduce the number of chips in the Atari product).
* He dated Joan Baez very briefly because he idolized Bob Dylan (and Dylan was previously Baez's lover).
* He also idolized The Beatles. (“My model for business is The Beatles: They were four guys that kept each other's negative tendencies in check; they balanced each other. And the total was greater than the sum of the parts. Great things in business are not done by one person, they are done by a team of people.”
* He buys a huge mansion in Woodside, California but lives in it in a virtually unfurnished state.

"Remembering that I'll be dead soon is the most important tool I've ever encountered to help me make the big choices in life."

-- Steve Jobs, Stanford University commencement speech

The ECB decision to keep interest rates unchanged may be viewed as unfriendly to risk assets.

Wednesday Thoughts

I have heard that MSFT has no interest in acquiring all of Yahoo!. They might, however, have some interest in some of the smaller pieces of the company.

Rumor has it that Europe's banks will be stress tested based on a larger writedown of Greek debt.

One additional point on the proposed tax repatriation holiday of overseas profits: It may increase corporate dividend payouts, but it not likely to make much of an impact on creating jobs.

It didn’t when a modified version of an overseas tax holiday was introduced in 2004, and it won’t in 2012-13.

The odds of a repatriation of overseas profits are still low despite the introduction of possible legislation.

The reason is that it is more likely to be included in a more far-reaching tax-reform package, and it is unlikely for this legislation to be introduced until the November 2012 elections are decided.

"We are hearing that a large number of hedge funds are going to cash, unable to figure out this market and trying to avoid further losses."

-- Whitney Tilson

I am a realist, and I recognize that there are numerous economic and stock market challenges. And I also recognize that investor sentiment is not the sine qua non and that the threat of premature accumulation (a Bruce Berkowitz term) can be dangerous to your financial well-being.

Two of the most brilliant investors of our time, Berkshire Hathaway's (BRK.A/BRK.B) Warren Buffett and Baupost Group's Seth Klarman, have written about the lack of visibility and difficulty in timing market bottoms:

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month -- or a year -- from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over....

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value….

Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

-- Warren Buffett (2008)

While it is always tempting to try to time the market and wait for the bottom to be reached (as if it would be obvious when it arrived), such a strategy has proven over the years to be deeply flawed. Historically, little volume transacts at the bottom or on the way back up, and competition from other buyers will be much greater when the markets settle down and the economy begins to recover. Moreover, the price recovery from a bottom can be very swift. Therefore, an investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better.

-- Seth Klarman (2009)

As a reflection of the loss in investor confidence, hedge fund net exposure is now at the lowest level since April, 2009. Individual investors, too, have dramatically abandoned the U.S. stock market. In June nearly $21 billion was redeemed from domestic equity funds by retail investors. In July almost $29 billion was withdrawn and, in August, it has been estimated that more than $35 billion poured out. The $85 billion of outflows from June to August will likely approach the previous three-month record of $88 billion, which came out of domestic equity funds between September and November of 2008! Thus far in 2011, individual investors have sold about $75 billion of domestic equity funds, only $10 billion less than last year's total outflows. Astonishingly, since the beginning of 2007, domestic equity mutual funds have had net outflows of more than $400 billion (in the same period, $835 billion of fixed-income funds have been purchased!).That spread between stock outflows and bond inflows -- $1.235 trillion -- is unprecedented in the annals of financial history.

-- Doug Kass, “Where I Now Stand”

Tuesday Thoughts

A great new feature/app has just been announced for the iPhone -- a "location-based reminder." This app sets a reminder or alarm, as an example, to buy dog food when you might pass in front of a PetSmart.

1. the US dollar vs. the euro;
2. the price of copper;
3. the price of gold;
4. the price of Morgan Stanley's common stock; and
5. the price of General Motors' common stock

On October 3, 2008, the S&P 500 closed at 1099.23, the exact same level that it closed at last night.

This memo was sent by James Gorman last night to the employees at Morgan Stanley (MS) in order to clarify "the confusion and misinformation":

Over the past few weeks, there has been an enormous amount of confusion and misinformation about Morgan Stanley and others in our peer group. In fragile markets, where fear triumphs over common sense, these things are bound to happen. It is easy to try to respond to the rumor of the day, but that is not usually productive. Instead we should let balanced third parties do their own analysis and let the facts speak.

To help you wade through the maze of numbers and information, it might be worth reading two analyst reports that were published this morning. One is from Howard Chen at Credit Suisse that examines Capital, Funding and Liquidity at Morgan Stanley and Goldman Sachs and, in some detail, highlights the dramatic improvement to our financial strength over the last three years. The other is from Matthew Burnell at Wells Fargo, who writes about Eurozone and Derivative exposure for the sector and plainly underscores that our exposure to the Eurozone and France in particular is not a concern.

I encourage you to stay focused on your job, remember that we are a client-focused Firm and do what you need to do to help our clients navigate this turbulence. It is in times like these when our professionalism, market wisdom and client focus are truly valued.

The U.S. stock market, on a P/E multiple basis, appears to be discounting 2011 S&P 500 earnings of about $78 a share, which I believe will turn out too low. (The current rate of earnings is annualizing at $100 a share in third quarter 2011). But, given risk premiums (earnings yield less corporate bond yields), the market is discounting 2012 S&P profits of slightly under $60 a share, which, to me, seems ridiculous.

Though the last two recessions saw sharp profits downturns, the average recessionary earnings drop is only about 16%. Today, corporations are well positioned from a balance sheet (liquidity and inventory-wise) compared to those previous periods.

I finally think Yahoo! is in play, and the most likely buyers would be Alibaba and private equity firm Silver Lake, which recently provided Alibaba with financing.

Monday Thoughts

When the book is written, we will find out that a good portion of the selling over the last two days was redemption-related.

Rumors abound that several financially heavy funds have been liquidating their bank and non-bank financial holdings over the last week.

I believe that redemptions are an important reagent to the recent selling, so I believe this one.

Why is the decline in the markets (and the technical breakdown) picking up steam?
Why are there such obvious signs of recession/deflation when the numbers do not indicate anything near a recession of late?
Why are GS and MS reeling under such continuous selling pressure?
How significant are the hedge fund redemptions?
What is the catalyst to reverse the market's decline?


A quick squeeze and fade in the final hour of trading made it clear that the high-frequency traders are in control of this market, but it still was quite a good week for the bulls. After breaking to new lows for the year on Monday and struggling most of the day on Tuesday, we reversed big in the final hour of trading and ran straight up for two more days.

The move into resistance set the stage for a sell-the-news reaction to a slightly-better-than-horrible monthly jobs report, and downgrades of Italian and Spanish debt by the credit rating agency Fitch helped matters along. The end result was that we were saved from another leg down and are right back in the middle of the trading range that has been in place since early August.

Since the trading range began, reversal days like today have tended to see downside momentum build a bit, so it is going to be interesting to see if the pattern continues next week.

Yesterday's Market

One of the unusual things about the trading range that the market has been in since early August is the vigor of the bounces. We are seeing our fifth bounce in the last two months and, once again, we have a string of strong upside days on declining volume with no intervening weakness.

What is most interesting about these bounces is their V shape. We go from a near breakdown (or an actual breakdown this past week) to an immediate straight-up recovery. There is no pause, hesitation or consolidation. We just go from straight down to straight up.

I suspect that this action is a function of computerized trading, which is highly dependent on creating momentum. Basing and consolidating action doesn't create opportunities for computers. They need to keep things moving at all times to make money, which means there's never a transitional phase.

Wednesday Market

The bears were looking to weakness in financials to bring a swift end to a big bounce that kicked in Tuesday afternoon, but reversals in AAPL and GOOG, strength in technology and commodities, and even YHOO takeover talk (which is now being called into question after the close) more than offset the struggling banks.

The biggest positive that the bulls have going for them is that the bears are worried they will be squeezed by more news about bailouts or rescues in Europe. We have spiked up so often on various rumors, plans and ideas that you just can't be too comfortable on the short side, although the situation still looks far from a resolution.

While the potential for positive news is keeping the bears at bay, it hasn't been all that easy for the bulls, either. Individual stock picking is not producing much relative performance as stocks continue to move as a group on macroeconomic matters. It is primarily a market for timing bounces and pullbacks, rather than astute selection of quality names.

Tuesday Market

After the intense selling Monday, conditions were ripe for a snap-back rally today. We finally did see a solid upside move in the final 45 minutes of trading, but it sure wasn't easy for the bulls. The morning bounce fizzled at midday on continued chaos in Europe and then AAPL surprised a lot of folks when it didn't announce the much-anticipated iPhone 5.

Just when it looked like we were going to take out the opening lows, we had some well-timed Europe-is-saved news. The machines kicked in and the squeeze was on. The market blasted straight up and caught just about everyone by surprise. Many traders are saying that it was some of the craziest action they have ever seen.

The big question now is whether this very chaotic action today changes anything. Is the bottom now in? Are we ready to rally into the end of the year?

Monday Market

We had a good example today of the old saying that oversold markets can become even more oversold. Given the intense selling pressure last week and the high level of negativity, a number of market players were looking for a bounce, but once the early strength fizzled out, it was a sea of selling. The contrarians threw in the towel, and the technical traders, who have been playing bounces off the August lows, lost some confidence as well.

Breadth was extremely poor today at around 8 to 1 negative. Volume picked up as well, but what I found most troublesome was that almost 1,500 stocks hit new 12-month lows today. That smacks of downside momentum and is not indicative of a market about to make a lasting low.

When the number of news lows starts to contract, that will be a sign that some stocks are starting to turn up.

Monday, October 3, 2011

Thoughts - Friday

The September Chicago manufacturing index came in at 60.4 this morning (expectations were for 55.0 and 56.5 actual in August), for the best print in five months that was modestly above its six-month average and well above the long-term average of 54.5. At recession points, a 35 or less reading occurs.

Moreover, the orders component rallied month over month (the most since October 2009), meaning that capital spending is staying relatively firm. So, too, did the employment and production components rise materially month over month, well above the six-month and long-term averages.

And, another boost to growth was the big drop in prices paid, which will buoy profit margins and consumer real incomes.

This means that the national ISM (Monday release), which had been whispered at 45 at the beginning of this week, will likely be in the high 40s.

Meanwhile University of Michigan September consumer confidence came in at 59.4 compared to 55.7 in August and against expectations of 57.7. The 59.4 is substantially below the long-term average of around 85, but it is improving. Importantly, current and future assessments of activity rose as inflationary expectations dropped.

Quant trading, high-frequency trading and leveraged ETFs are vehicles/strategies that not only are permanently undermining investors' and consumers' confidence but are adversely impacting real economic activity; they could even be described as forms of financial terrorism.

So sick is a phrase with much versatility at the poker table. “Sick call,” “you are sick,” “sick game,” are just some of the ways this term is used. It can mean a horrible stroke of bad luck, truly amazing and almost unbelievable and/or an amazing stroke of genius beyond comprehension.

* Example No. 1: “I can't believe that I got in with pocket aces, hit a set and went all-in only to have Howard Lederer hit a sick runner-runner straight on me. The whole thing is just sick.”
* Example No. 2: “I can't believe I am sitting next to Tom "Durrr" Dwan and Phil Ivey at my table, it's sick!”
* Example No. 3: “The villain moved all-in at the river, and Doyle Brunson tanked before calling with only an ace-high hand. The villain turned over complete rags, and "Texas Dolly" makes yet another sick read.”

The proximate cause of our so-sick and volatile market is not the eurozone crisis nor the ambiguity of our domestic growth trajectory; moves such as yesterday are made and exaggerated by intraday reweighting of leveraged ETFs and by the disproportionate impact price momentum based high-frequency trading strategies. (Again, just ask your friendly institutional trader; there was little in the way of natural orders during the wild moves in the afternoon session on Thursday.)

These high-frequency, momentum-based trading strategies and leveraged ETFs are raising volatility dramatically, and, in turn, the confidence in the marketplace is eroding quickly.

More important, this instability is (to paraphrase George Soros) causing a reflexive and negative impact on the real economy. As such, high-frequency-trading strategies and uber-leveraged ETFs are the new weapons of mass destruction, and perhaps, instead of calling on the SEC, we should be reporting this to the Pentagon, CIA and FBI.

While the SEC sits idly by day after day, this wild price action (such as yesterday) slowly erodes investors’ confidence in the marketplace.

I am convinced that, in the fullness of time, the SEC will recognize the damage that has taken place in our markets.

I am equally convinced that, by the time they do, it will be way, way too late.

European inflation rose at a 3% pace -- 2.5% was consensus and less than a 2% target for the ECB. This complicates the notion that there is a need for interest rates to be reduced at the next ECB meeting.

Meanwhile growth in Europe is slowing. As an example, Germany's retail sales in August dropped by a greater-than-expected 2.9%. The DAX has responded negatively.

Away from Europe, there was more negative economic news overnight. China's manufacturing sector according to the HSBC/Markit Index was unchanged in September, at a contractionary 49.9. The Shanghai Index was down again and has fallen to the lowest level since early 2009.

South Korea's August industrial product dropped by a greater-than-expected 1.9% against a lesser decline of -0.3% in July.

Thoughts - Thursday

Is the tax system in the U.S. fair?

Run, don’t walk, to read what Knowledge@Wharton has to say about the Buffett Rule in “Fair -- or Unbalanced? Decoding the Buffett Rule Debate.”

These markets don’t trust the better claims report -- and for good reason. While claims improved, the government mentioned that the data reflected some seasonal issues that might have overstated the drop.


It's only fitting that one of the worst quarters in some time ended with the well-respected Economic Cycle Research Institute (ECRI) saying that the U.S. economy is "tipping into a new recession." Many market players have been fighting the idea of a double-dip recession, but ECRI is the tipping point and we are now more fully pricing it in.

The market has been struggling since breaking down in early August, and the action this week raised fears that another down leg is coming. The bull's argument has been that we aren't going to have a double-dip recession and even if the economy is poor, it's already priced in.

But this week's action called that conclusion into question.

Technically, the S&P 500 is holding above key support at 1120 to 1125, but the more often we beat on those levels, the more likely they will fail. And it sure looks like another test is coming. The technicians may be correct in believing it would be healthy for the market longer-term to breach that support and have a washout that triggers the stops that are set there. The market would be healthier if you got rid of the bulls clinging to the hope that support will hold. Once they give up, we will be in better position to heal. Or so they say.

On the positive side, this breakdown is a good set up for a recovery as third-quarter earnings hit and positive end-of-the-year seasonality kicks in.

The mood is downright negative. The contrarian bulls are hopeful that it is so negative that we run out of sellers, but one of the lessons of this market has been that trends have a tendency to last longer than most people think is reasonable.

Thursday - Liquidation

The action today can be summed up in one word: peculiar.

The Dow Jones Industrial Average was up more than 100 points and NYSE breadth was nearly 2:1 positive, but virtually every big-cap momentum name was down and the Nasdaq-100 was solidly red.

The most likely explanation is that some large momentum-based funds are being liquidated and, in fact, there are rumors of one $3 billion fund with large positions in names such as PCLN, BIDU, WYNN, NFLX, MCP, YOKU and others being sold aggressively today.

A late bounce, which was probably machine-driven, took us well off the intraday lows. It was an extremely deceptive day if you only looked at any one index in isolation. Small-caps and big-cap momentum names were very poor while the more conservative, low-beta names outperformed.

Usually this sort of mixed-up action is not a healthy sign, as market players are obviously confused. The window-dressing action in less-obvious names helped hold us up, but the liquidation of momentum names tells us that big players are in trouble and it's very likely we'll see more liquidations after the quarter ends. Stock picking is useless at this time.