Market Summary: Wed. Feb. 6, 2008

Here’s what I thought was going to happen this morning after getting a good (maybe very good?) productivity number (1.8% vs. 0.5% expectations – Explanation of data): investors were going to sell the news. The negativity has come back to the market and this report is backward-looking (from January). Initially this was the case as the markets opened slightly higher and then sold off. However, they then rallied (Dow was up almost 100 points) – partly because of Disney’s strong earnings due to its entertainment division. Disney also said theme parks were still strong because the weak dollar is attracting overseas tourists and Americans aren’t spending a lot of money to travel overseas so they go somewhere domestic like Disneyworld/land.

Also, Asian markets were down big overnight (most likely because of our huge sell-off Tuesday) so I figured people would be in the selling mood. But that wasn’t the case in early morning trading. Around 10:30 am, Federal Reserve Bank of Philadelphia President said rising inflation is a concern and it could prevent the Fed from cutting interest rates even further. This announcement triggered selling. There was the expectation among traders that the Fed would cut rates at their next meeting by at least 25 bp, so stocks were being priced accordingly. However, this much-anticipated cut now is not as likely to occur. However, take this report lightly because this is the guy that was opposed to lowering rates in the first place – looks like he was outvoted.

Also, crude oil futures were down big (as were oil stocks) after the inventory report showed a build. The trade for the last few days has been: short oil and go long the airlines. You also have the upside potential in the airlines because of merger talks. Here is an article describing the possible merger of Delta and Northwest.

Macy’s said same store sales fell 7% in January and they announced 2,550 job cuts. The stock was down almost 5% on the day. Tomorrow is a big day for retailers as they announce their January sales numbers. Big names to watch are Wal-Mart and Costco. This data will give us a sense of how the holiday shopping season was (need to look at combined Dec. and Jan. sales).

Toll Brothers (a homebuilder) reported today, and in their conference call, the CEO said he doesn’t see “much light at the end of the tunnel” for the housing market. Tomorrow, we will get pending home sales data.

GM and Ford were both downgraded.

MBIA announced they were going to issue 50.3 million common shares to raise $750 million in capital in an effort to maintain their AAA credit rating (Bloomberg.com Reference article).

After the bell Cisco (CSCO) reported earnings. They were in-line with analysts’ expectations, but they offered poor guidance for next quarter (10% sales growth vs 15% expected by analysts). The stock was down 7.5% in after hours. Tech will be down big tomorrow and this report just justifies the massive selling that has occurred the past few weeks.

Tomorrow we will get the initial jobless claims number, consumer credit data, and pending home sales. Pepsi, Unilever, and Deutsche Bank report earnings tomorrow.

Liquidity vs. Solvency Crises

First, let me apologize for my disappearance recently - the workload is mounting rapidly and unfortunately my blogging is one of the first aspects of my life to get marginalized. Anyways, the following is a very clear and informative article regarding liquidity crises and solvency crises. It's fairly simple and sheds some light on the current economic conditions and more than anything, may provide a little better understanding of what the Fed does and why it does it. Definitely a worthwhile read, especially for anyone just coming to understand that markets.

Fed Cannot Resolve Solvency Crises

Bull Stocks Infrastructure

My project over the last week has been evaluating infrastructure companies. I restricted myself to those that were exceptionally well diversified internationally. I refused to look at anyone who had more than half of their revenues from the US, eliminating companies like SGR and USB. My thesis is that the expansion of infrastructure especially internationally will continue for at least the next 12-18 months. I evaluated ABB, ACM, FLR, FWLT, JEC, and MDR.

THE INVESTMENT
In my opinion the best stock AND company in the sector for my thesis is Foster Wheeler (FWLT) for the reasons below:
-Geographic diversification (12% of revenues from N America)
-Diversification across industry (Refining, Chemical, Power, Oil&Gas upstream, Pharma)
-They'rerelatively inexpensive 20x forward earnings with 20-25% growth visible for the next few yrs
-Record levels of backlog greater than annual revenue last year
-Strong cash flow
-High Margins
-Consistent cost improvement over the last 18 months

THE TRADE
That said, I think there's a better trade (rather than investment) available in the industry. It's available by going long MDR and short JEC. The cheapest stock in the sector is McDermott (MDR), well diversified internationally, focused on the oil side of things, both upstream and refining. Trades at 15x forward earnings, has a HUGE backlog, is arguably the best of all of these at building oil rigs, and has high margins.

Jacobs Engineering (JEC) is the shakiest of the companies in the sector. JEC is well diversified by industry and also has a massive backlog, give them that. They are concentrated in Europe and the US, with a decent Middle East and India presence but no China exposure. They've been growing very fast over the last 5 years, but have not been able to translate revenue growth to their bottom line profit, especially as other have improved lately (aka they're slacking in margins). Their cash flow is weak relative to others and they're not getting as good of quality terms on payment as their peers, reflected in their spiking accounts receivable. The kicker is the streets expectations: $3.72/share of earnings in 08. The company's most recent guidance is for 2.95-3.25. This is a huge gap, and I don't think the company has a 25% surprise in them, so the street has to reprice the company eventually.

All said, I think a great zero-equity strategy, barring new adverse material information coming public would be long MDR, short JEC to take advantage of the changing premiums that Wall St will pay for the companies.

Full disclosure: As of writing this at 3:20pm 2/6/08 I am long FWLT. I also have the zero equity strategy described in play on our stock game on investopedia.com in fake money, obviously.

Market Summary: Tues. Feb. 5, 2008

What was the main reason for the market’s huge decline? It was a report that signaled the service sector contracted last month (data provided by the Institute for Supply Management). This was just more evidence suggesting the economy is slowing/in a recession. This is the first reading showing a contraction since March 2003. Investors have been way too optimistic since the Fed cuts. This data definitely washed some bulls out of the market. The effects of the Fed cuts won’t be felt for at least a few months, so expect more bad news (earnings and economic) to come.

According to finance.yahoo.com, Fitch Ratings (a bond rating agency) plans to lower its rating on more than $100B in CDOs (collateralized debt obligations). This news weighed on many of the financials stocks. What does a downgrade mean? The companies’ securities (many of which are back by sub-prime mortgages) are worth much less than previously thought. Here is an in-depth article from Bloomberg.com explaining this matter.

One observation I had today: stocks opened lower and continued their decline until the close. Bonds, however, opened higher but sold off as the day progressed. Usually, bonds move inversely to stocks. Bonds tend to move mostly off of economic data while stocks move mostly off earnings (and economic data).

According to briefing.com, “the dollar gained 1% and its strength was attributed to a belief that weak economic data out of Europe might force the ECB (European Central Bank) to lower interest rates, which would narrow the favorable interest rate differential that is currently supporting the euro.”

Futures are currently pricing in a 30% chance of an intra-meeting 25 bp cut and 100% chance for a 25 bp cut at March’s meeting.

The homebuilders (Pulte Homes, KB Home, and Toll Brothers) were up after an upgrade from Banc of America Securities. Also, Goldman Sachs was downgraded by Oppenheimer & Co. Las Vegas Sands and Wynn Resorts were both upgraded by Morgan Stanley.

According to Bloomberg.com, of the 311 companies in the S&P 500 already reported, earnings have declined 23 percent year-over-year.

In earnings news, Whirlpool beat estimates and was up huge on the day. This report was quite surprising given that the economy has slowed and the consumer has cut back on big ticket items.

After the bell, Disney was up about 6% after beating analysts’ estimates.

Today, the negativity came back to the market. We almost have the same feeling we did a few weeks ago. Investors are looking for more rate cuts and waiting for more bad news from the financials. Tomorrow after the bell, Cisco reports – this report will be huge for tech because this sector has struggled mightily this year.

Merger of Equals

A new lesson for today: Merger of Equals are dumb.

Here is a recent case of Sprint Nextel falling to pieces after attempting a merger of equals.

And for the real authority, here is what Jack Welch, the greatest CEO in the history of mankind, has to say about mergers of equals, naming :

"[One of the seven pitfalls made in merging is] believing that a merger of equals can actually occur...Despite the noble intentions of those attempting them, the vast majority of MOEs self-destruct becaues of their very premise" Welch, Jack. Winning. Harper. p220

Another great example of a MOE going south: Daimler Chrystler. The merger was made in 1998, and Daimler ended up taking charge after years of squabbling and trying to figure out how to blend together two very different cultures. In August 2007, Daimler finally sold off Chrysler to Cerberus Capital Management, a dizzyingly large PE group.

Now, to be fair, Chrysler was doing awful, consistently beat up by the drop in demand for its SUVs as gas prices rose, and the biggest reason for the split is probably still staggering losses.

Airbus is another interesting case to bring up. There was never really a merger of equals, but instead Airbus was founded as a "Eurpoean" company, blending corporate governance and financial influence from multiple countries. The same holds true here as holds true in the MOE cases, it's tough to have 2 leaders. A Business Week article from October 23, 2006, entitled "Wayward Airbus" describes the situation in great detail, having this to say:

"Far from the seamless, pan-European image it likes to project, Airbus is terribly balkanized, with its factories in Germany, France, Britain, and Spain clinging to traditional operating methods and harboring cross-border jealousies. ``It is still, in part, a juxtaposition of four companies,'' Streiff told the French newspaper Le Figaro in the only interview he has given since resigning.

The reason why this article was written was, at the time, Airbus hit a huge blunder in building its A380, which was finished recently. Factories in France and Germany were using incompatible softwares to design their own designated parts of the plane. The same article called this "one of the costliest blunders in the history of commercial aviation."

A great article

This is a phenomenal article about how various investment styles fare in different parts of the stock cycle. Value guys our time is coming. The article

Market Summary: Mon. Feb. 4, 2008

I wasn’t too surprised that we were down today given last week’s huge rally. Some people were just locking in big profits and re-positioning for the week. Everything that led the market higher the last two weeks was down significantly today – retailers, homebuilders, and financials. As I said last Thursday, I feel these sectors are still a little over-bought and there is just too much negative news out there to continue the rally.

In economic news, the “factory orders” data showed an increase of 2.3% for December compared to a 1.7% gain in November. This is good news, however we are over a month past this data and the markets did not react to it.

The main catalyst driving the market down was a flurry of downgrades to the major financial companies. Wachovia and Wells Fargo were downgraded by Merrill Lynch and American Express, Capitol One, and Discover were all downgraded by UBS. Here is a great Bloomberg.com article summarizing the downgrades and also giving further insight into the homebuilders and mortgage/bond insurers. Also, there was a rumor that some private equity (PE) firms would help the bond insurers (Ambac and MBIA) – another reason they rallied last week, but an article published by the Financial Times said the PE firms would not supply any capital to these companies. Financials were the biggest losers on the day.

In earnings news, Yum! Brands and Clorox both beat earnings.

The negativity that disappeared the last two weeks has come back. It was always present; it was just the Fed rate cuts made so many people optimistic (almost too optimistic). I don’t like the feel of the market and I unless we get strong economic or earnings data, I see the trend continuing downward.

Tomorrow’s important data includes the Institute for Supply Management's January report on the service sector. The service sector accounts for just over two-thirds of the economy. This number is for January, so it will definitely move the markets because it is much more recent than the factory orders number. Big names reporting tomorrow include NLY, BHP, CME, NYX, DIS, and WHR.

Subprime winners

Looking for that illusive negative beta? How about Autonomy? It's probably too late to get on, though...

Market Summary: Fri. Feb. 1, 2008

I mentioned the other day that the Fed was probably done cutting. Well, today investors got some data that might suggest another round of cuts. The unemployment number came in at 4.9% (last month was 5.0% - this was a huge surprise), but the big news was the non-farm payroll number. Analysts were looking for an increase of 70,000, but the number actually fell by 17,000. This marked the first contraction since August 2003. Early morning trading was quite volatile, but we remained positive mostly likely because investors were looking for more rate cuts.

Also, pushing the market higher was Microsoft’s takeover bid of Yahoo for $44.6B ($31 per share). Yahoo exploded up about 50% while Microsoft was down about 6%. This offer by Microsoft was 60% above Yahoo’s Thursday closing price. Some say Microsoft is overpaying, and there is talk that Google might also make a bid. I cannot see this acquisition getting done any time soon because Google will take Microsoft to court. Here is a finance.yahoo.com article explaining some of the things that will slow down the possible acquisition.

This story of Microsoft’s takeover bid sparked talk of more M&A (mergers and acquisitions) on Wall Street. M&A cooled down significantly the second half of 2007 due to the tightening credit markets, but since the Fed has stepped in and acted aggressively, there seems to be more promise for M&A.

The Fed also announced that it will hold two more auctions in February (11^th and 25^th) to provide $60B in cash to commercial banks. The Fed said it will continue to have these auctions “for as long as necessary to address elevated pressures in short-term funding markets.”

Also in the news, Google missed analysts’ earnings expectations and the stock sunk to $520 (off of its $747 high just a few months ago). Google will be in the dog house for the next few months just like Apple and the rest of tech. Looking long term, this is a very good entry point based on valuations, but don’t look for any big short-term moves.

Right now people are very positive (especially because the Fed has realized they are behind the curve and they have some catching up to do) and I expect this rally to continue into next week. The only thing stopping it is more bad news from the mortgage and bond insurers. If a rating agency decides to downgrade Ambac or MBIA, the markets will immediately reverse course.

HereHHH is a great Bloomberg.com article that summarizes the big events of the week and what to look for next week.

This is an article which associates Japan’s boom-and-bust to the current situation in the U.S. with the sluggish housing market and the slashing of interest rates. It’s a pretty bearish scenario.

The Borg Strike

I should have finished writing this sooner, but here it is anyway. Microsoft is orchestrating a hostile takeover of Yahoo. In the red corner: Microsoft, with the tag-team support of Morgan Stanley's investment bank and the Blackstone private equity group, weighing in at a total $44.6 billion. "Microsoft's $31-per-share offer -- originally valued at $44.6 billion -- represented a 62 percent premium to Yahoo's closing price late Thursday, although it's below Yahoo's 52-week high of $34.08 reached less than four months ago."

In the (black and) blue corner cowers Yahoo!, with the hurried support of Goldman Sachs and Lehman Brothers, who are helping advise in a defense against this takeover. Their best plan: inticing someone with similarly deep pockets to bid as well: Disney, News Corp, or AT&T may have potential.

The near $45 billion offer is a bit too much for any smaller PE groups to try to tackle. The Times (same as the previous link) noted that Google (who may be your first thought for competing in a bid war with Microsoft over Yahoo!) probably couldn't get the acquisition (merger?) through the courts.

Why is MSFT doing this? Yahoo finance thinks "Although Microsoft remains the world's most valuable technology company, its position will become more precarious unless it can cultivate a more loyal Internet audience and generate more online ad revenue to subsidize the free services taken for granted on the Internet."

Will it work? FSJ doubts it. This merger comes down to Microsoft trying to catch up with Google by desperately trying to buy their best competitor. This kind of aquisition is often a last-chance kind of maneuver companies use when they aren't clever or innovative enough to organically meet their competition.

Another issue, this may be evidence of the first economic slowdown of Web 2.0 industry. Creative Capital has noticed a recent dip in myspace and facebook users and activity. Considering these companies depend entirely on their user activity, this may be indicative of a pretty harsh correction in company value down the line.

Children

very funny article. it speaks for itself

The toddlers who are running the global economy

U of I Economic Profs Weigh In On Recession

While it's hardly an elaborate analysis of the current economic state of the US, this article offers the insight of three distinguished U of I professors.

U.S. Economy Teeters