Saturday, August 11, 2012

U.S. Municipals are not the only regional government facing funding problems

Maybe Chanos' short call on China is right. It appears that municipal budgets in China are facing funding shortfalls. 
However, local governments are now under increasing funding pressure as debts come due and revenues fall. Over 17 per cent of the loans to local governments, roughly Rmb1.8tn, are due this year, according to the National Audit Administration in July 2011.

That is already throwing a big spanner in local government spending plans. Shenzhen, the city across the border from Hong Kong, will have to spend 13 per cent of its annual budget to repay debts this year, including local bonds issued in 2009 to boost the economy after financial crisis, said Southern Metropolis Daily, a local newspaper.

At the same time, many local governments reported the slowest growth of tax income since 2009. With growth slowing, Guangdong and Jiangsu, the two biggest provinces in China by GDP, experienced much slower revenue growth in the first half in 2012 from previous year, according to the two provincial governments at the end of last month.

The rest of the article can be found here.

Innovation is not just a buzzword.

I understand why it may be easy for people (myself included) to be negative in these trying times. However, we should never forget about human ingenuity and spirit-the human mind is most powerful device in all of creation. We will always come up with new and innovative, and I am talking about real innovation and not the buzz-word innovation that is thrown around casually as a marketing ploy. In any event, if you want to read about real innovation, I would suggest picking up anything by Clayton Christensen (for instance you could start here, his website). In the meantime, I thought I would provide you with an example of real innovation- the Skin Gun.

So how does this relate to investing? Well one way to make a fortune is to uncover these hidden gem opportunities- the real innovative companies- buy them and hold them forever. 

Friday, August 10, 2012

Swing on a spiral

This song just gets better with age, especially considering the deeper references. 

All that Glitters- the real time experiment continues

I am thinking I will make this a regular piece, or at least as regular as the data or news warrants. Now before I get into the details, I wanted to preface my comments by stating that I want to remain objective, but the monkey brain evolution gave me is quite surprised at how well the model (on the basis of one real-time call, because one is a trend) has worked. Either way, I will proceed with the results of my gold/precious metal stock timing model and provide some insight into the current results.

If you remember, the timing model I developed uses standard statistics on the price of gold relative to money supply and compares that to the price of precious metal stocks. I had detailed this model in past posts (found here and here). Using this relationship, I had stated that gold stocks looked attractive back in late July. As blind luck with have it, my original call heralded the near-term bottom in gold stock prices, as the Phily Gold/Silver Stock Index (ticker XUA) rallied by more than 10% from July 24th through yesterday's close.

Now that I got the self-congratulations out of the way. You may be asking, what is the model saying now. Well, the price appreciation of gold stocks has reduced their attractiveness to some degree.

I show the graphical presentation of the model above. Generally speaking and on average, a lower reading of the Z-score would indicate better appreciation going forward. On July 23, the z-score on the model was -1.11. Following the recent appreciation in gold, the z-score has increased to about -0.5. In a historical context, a reading of -0.5 or below has also provided decent return potential. However, the statistics show that as the z-score approaches the 0 level, the signal becomes less robust.

I think it is a worthwhile exercise to look at the technicals of gold and gold stocks. 

The Gold Trust spider (ticker GLD) is bumping up against the 200-day moving average while volume is almost non-existent relative to the average. The A/D line has also been in decline since peaking at July 27th. As for the GDX (Market Vectors Gold Miner ETF) is overbought on the stochastics while the volume on the upside has been falling off since August 1st. I would not be surprised to see gold and gold stocks consolidate the gains. All else being equal, I would consider buying into any consolidation, but that would also be predicated on the relationship between gold and money supply.

The beatings will continue until moral improves- Yahoo edition

I have a small position in Yahoo- thankfully it represents past gains, making the position virtually free- in my portfolios. I say thankfully as it appears that Ms. Mayer is pulling back on previous plans to return cash to shareholders and instead will pursue an empire building strategy (at least in my opinion).

The below is from the recently released 8-K.
New Chief Executive Officer and Review of Business Strategy
On July 17, 2012, Marissa Mayer became the Chief Executive Officer and a member of the Board of Directors of Yahoo! Inc. (the “Company”). As reported in our Form 10-Q for the quarter ended June 30, 2012 filed today with the Securities and Exchange Commission, Ms. Mayer is engaging in a review of the Company’s business strategy to enhance long term shareholder value. As part of that review, Ms. Mayer intends to review with the Board of Directors, among other things, the Company’s growth and acquisition strategy, the restructuring plan we began implementing in the second quarter of 2012, and the Company’s cash position and planned capital allocation strategy. This review process may lead to a reevaluation of, or changes to, our current plans, including our restructuring plan, our share repurchase program, and our previously announced plans for returning to shareholders substantially all of the after tax cash proceeds of the initial share repurchase under the Share Repurchase and Preference Share Sale Agreement we entered into on May 20, 2012 with Alibaba Group Holding Limited.

In some investor's opinion, Ms. Mayer may be attempting to build a baby-Google. If I remember correctly, Microsoft and Yahoo tried this strategy repeatedly in the past, throwing good money after bad. Neither has been able to crack Google's position as the top search engine. Unless Ms. Mayer is looking to completely re-engineer Yahoo in a new, disruptive direction, instead of fighting a David vs. Goliath battle against her former employer, I may have to rethink the position.

 ...... Just an update. I had a problem with my Yahoo email account and was asked to contact customer service. I actually had to go through Google to find out how to contact Yahoo's customer service. I hope the board gave her plenty of time to fix Yahoo;s problems. 

Traders Edge 8/10/12- Are Utilities a short?

The answer is I do not know, nor can I put together a concrete case yet. That said, I can see a short-side picture emerging in the sector. Definitely an area for more work.

The potential short-case for utilities goes like this
- Investors that had picked up utility shares for the dividend yield may rotate out of the group with the uncertainty surrounding the fiscal cliff and the possibility of the U.S. government raising the the tax rate on dividends.
- Rising input fuel prices could hurt the operating margins for independent power produces and those regulated utilities with a merchant fleet of generators. For instance, First Energy (ticker FE) and PG&E (ticker PCG) had stock prices come off the highs, on volume, following both companies announcing reduced expectations on higher input costs.
- The commodity prices for both natural gas and coal may have reached a bottom. For instance....

- As for the technical analysis of the XLU (the Utility Sector spider ETF). The trends in the RSI and the price have diverged, which I have found can be an indication of impending trend change. Ditto for the MACD. This is while the A/D line is declining.  Lastly, there appears to be some volume off the high in the group.

Thursday, August 9, 2012

Just to put a wrapper around Whitney's municipal comments

To expand on my comments from this post, the Huffpost has reported on the public pension problem. They cites figures showing that public pensions had a shortfall of $757 billion. See below

1) Public pension funds face real funding challenges in a majority of states.
In fiscal year 2010, public pension funds as a whole were only 75 percent funded and had a shortfall of $757 billion between what they should have set aside to pay for the benefits promised to workers and retirees and what they had on hand. While some states, like New York, North Carolina, and Wisconsin, have well-funded and well-managed plans, the majority of states face significant challenges. Thirty-four states were less than 80 percent funded -- a threshold many experts recommend for health pension systems.
This problem is the result of a decade of states taking pension holidays and raising benefits without paying for them, not the Great Recession. Investment gains of 20 and 13 percent in 2009 and 2010, respectively, were not nearly enough to overcome losses from the financial crisis, and pension funding levels continued to drop. The weak returns of less than 1 percent at the end of 2011 also show how hard it will be for states to invest their way out of this crisis. Initial projections suggest that funding levels will be stagnant in fiscal year 2011, and in some states will continue to drop.
2) The funding gaps have real impacts on taxpayers and states' budgets.
The pressure on state budgets springs from policy makers' failure to keep up with their pension fund contributions. States don't have to close the $757 billion gap in one year or even five. Like a home mortgage, they can spread the costs over 30 years. But they have to make their full payments as recommended by their actuaries, and each year they underfund their pensions, their costs will grow.
New York and New Jersey both had fully funded pension systems in 2000. In the following decade, New York consistently made its full contributions into its pension plans, while New Jersey failed to do so. Now New Jersey has an unfunded liability of $36 billion. To catch up, it will have to contribute $2 billion per year more than New York, even though New York has a much bigger pension system. That's $2 billion that New Jersey could be using to build roads, improve schools, and offer raises to police officers and teachers.


Still and not to put a finer point on it, municipal bond investors appear to think that this shortfall will fall hard on either pensioners, tax payers, and/or public services. For instance, see the price chart of the PIMCO California Municipal Income Fund (ticker PCQ).

How many times can Bernanke to be wrong, let me count the ways?

So Bernanke told a group of teachers (reported by Bloomberg here) that student loan debt does not threaten the stability of economy or the financial system, because these loans are backed by the government. So, does this suggest that Bernanke thinks the U.S. government will grant loan forgiveness? Does Bernanke understand where money comes from or what it is? To live in work in investment business means you are going to be wrong. But, for a top official to say something like this is borderline reckless. To walk down memory lane, lets remember Bernanke's comments on the housing bubble/economy prior to 2008.

Just as a note, student loan debt is likely to be close to $950 million when the Fed reports the second quarter Quarterly Report on Household Debt and Credit. Total student loans outstanding totaled $902 million in the first quarter this year, up from $872 million in the fourth quarter of 2011. Student loan debt, as a percent of the GDP, has more than doubled from less 3% in the first quarter of 2005 to 6.7% currently.  Don't worry though, nothing to see here.

Commodity Money in Colonial America

A great history lesson

Has a backdoor QE3 begun?

The Fed moves into the repo market- the first time it has done this in four years. I may have to reconsider the short positions.

Whitney says Municipal Budgets at Inflection Point

Reiterating here previous public statements, Meredith Whitney sates that municipal budgets are reaching an inflection point. Budgetary cuts may now turn towards decisions between pensions and other contractual obligations versus needed services. If this outlook comes to pass this map may become more important.

I do not know if this is the short of decade or if it states that Whitney is full of it, but the price chart of many municipal bond funds (for instance the PIMCO Intermediate Bond fund shown below) are not showing this cataclysmic outlook.

Traders Edge 8/9/12- A look at the sectors, Utilities a Short Candidate?

I thought I would take a different tact today and discuss the technical outlook for the market sectors.

After being range bound since May 17, the Consumer Discretionary stocks (ticker XLY) retested the May 4th swing point without enough volume (6.3 million vs. 10 million shares). The MACD has been rising but the stochastisc indicate the sector may be overbought. The XLY has been underperforming the market since peaking in late April. 

The XLE appears to have caught a bid after bottoming in June, and follows the improvement in commodity energy prices (such as the West Texas Intermediate Oil shown above). The sector appears overbought on the stochastics but both the A/D and MACD are rising significantly, suggesting that momentum and investor interest are behind the group. Watch for a potential pullback in the near-term, as shares run into the late April/Early May resistance, and a consolidation at the moving averages.

Relative to the SPY, financials (ticker XLF) have been in a downtrend since March. The relative price is trading below both the 50-day and 200-day exponential moving averages, but looks like it may be trying to consolidate. That said, the volume has been weakening on the upside moves and the sector may be setting up for a downside move into the $12 to $13 dollar level.

Healthcare stocks (ticker XLV) have been in an uptrend for about a year. I am concerned about the divergence of the price trend with the trend in the stochastics, MACD, and RSI. On a relative basis, the XLV has strongly outperformed the market since the end of March, but may test the 200-day moving average.

Industrials (ticker XLI) have been in pronounced downtrend since the beginning of 2012. With weak ISM figures world-wide and a slowing economy/industrial production rates, this is unlikely to reverse in the near term. The XLI is testing April resistance levels and is overbought. That said, the MACD and RSI are both positive.

The XLB (materials)- like their industrial cousins- is in a pronounced relative downtrend, noting the price and the moving averages are all pointing down. The price chart of the XLB is similar to that of the XLI, but the RSI and MACD appear to weak relative to industrial companies. The price is running into resistance levels established earlier in the year.

Consumer staples stocks (ticker XLP) have been in a established uptrend for, at least, a year. Both the MACD and RSI are positive for the group while the relative price is upward sloping. That said, it is interesting that the relative price of the XLP has pierced the 50-day moving average. This is a similar setup as in the healthcare group. This may suggest sector rotation away from non-cyclical names (see also the XLU below). I am unsure if this implies that investors are betting on a resurgence in economic growth (as the relative price of industrials and materials are weak), but it is something to watch. (see also this and this)

One beneficiary of the apparent sector rotation appears to be technology names (ticker XLK). Although both the RSI and MACD are positive, the volume characteristics suggest there is not enough juice on the upside here to keep the sector moving higher. The group may consolidate into the trading range established in the May-to-July time frame. The relative price of the XLK looks positive.

I use the Vanguard World Telecom ETF as a proxy for the telecom sector, as there is no telecom sector spider. The telecoms look positive, but I would wait for a pullback before establishing full positions in the group. The relative price has been in an uptrend since April and is testing the 50-day moving average.

And finally the utility group (ticker XLU). As I stated above, the XLU appears to have lost some gas relative to market. I am also concerned about the volume off the high seen on August 2nd. This setup, along with a divergence in the price trend versus the RSI and MACD may suggest a correction in the sector. This is while the A/D is in a decline.

Wednesday, August 8, 2012

On Near-Misses via Barry Ritholtz

I found the following article (via Barry Ritholtz's Big Picture blog) poignant and thought-provoking. Enjoy.
“It is the paradox of the close call. Probability wise, near misses are not successes. They are indicators of near failure. And if the flaw is systemic, it requires only a small twist of fate for the next incident to result in disaster. Rather than celebrating then ignoring close calls, we should be learning from them and doing our very best to prevent their recurrence. But we often don’t. People don’t learn from a near miss, they just say, “It worked, so let’s do it again.” Other studies have shown that the more often someone gets away with risky behavior, the more likely they are to repeat it. Modern disaster prevention can and should be about stopping trouble before it strikes, not cleaning up afterward.”
-Ben Paynter, Wired Magazine

The near miss is a misnomer. As George Carlin once said, what we really mean is a “near hit.” Carlin, whose wonderful use of language made his comedy that much sharper, used to say “A collision is a near miss . . . Boom, they nearly missed — but not quite.”
The markets have had a series of “near misses” over the past few months — assorted single stock flash crashes, trading glitches, even the Facebook IPO were all market structure collisions. The snafu with Knight Trading as they were testing new algo trading execution software was reputed to cost them $10 million per minute — about $167,667 per second. (more here)

Leaves you wondering if all the near misses we have had lately, be it economic or some computer-induced "glitch" causing the markets to roil, are not a systemic issue.

Traders Edge 8/8/12- The SPY/IWN rejected the high

The market continues its trek upward that began in or around Draghi's insistence that the ECB would do whatever it takes to save the Euro. The SPY closed over the 140 level, corresponding to the 1,400 level on the S&P 500 index, in yesterday's trading. Although the market has been trading up (and may continue to do so over the near-term), I cannot get over that the rally appears to be on fumes.

For one, you will notice that the advance over the last three trading days has occurred on what can only be considered anemic volume. The price on the SPY is also running into swing points with higher volume, suggesting there is no conviction in this move. For instance, yesterday's advance of the SPY occurred on 109.5 million shares. This is running into a swing point on May 1, where 138.8 million shares traded. Today's share count is not enough. In addition, the market looks to have rejected the $141 price level, as the SPY closed near the lows of the day. This may be a sign of a failure, noting that this morning's futures suggest a lower open. One last note, the higher move in the SPY is not being confirmed in the more economically-sensitive small-cap stocks. The IShares Russell 2000 Trust (ticker IWM) remains 7.5% off its $86.39 high logged in April 2011. I also note that the IWM also showed a price failure running into a higher volume swing point (May 3, $80.62, 61.2 million shares vs. 50.1 million shares yesterday)

The portfolios I manage have been up in recent days, due largely to the exposure to gold stocks and coal. I remain largely in cash with a small short position (largely as a hedging tool). I may consider upping my short exposure in the coming days or weeks.

The S&P 500 versus Cyclical/Non-Cyclical Companies Revisted

I really cannot get over how well the price of the Morgan Stanley Cyclical Index relative to the Dow Jones Consumer Non-Cyclical Index has tracked the price and performance of the S&P 500 over the last decade (which I spoke about here and here). That said, I also still cannot get over the feeling there is some statistical aberration or other quality inherent in both indexes, that is not otherwise readily apparent, that results in this relationship.

To that end, I further expanded my research and expanded both the time frame and the available universe. First, I used monthly price and performance figures for a period including the end of 1991 through August 2012. In addition, I expanded the available universe to include all of the stocks (excluding shares of Berkshire Hathaway, as the high share price skews the results) in the Russell 3000, a broad universe of stocks covering everything from the mega-cap to small-cap stocks.

In this study, I defined cyclical and non-cyclical stocks using two different classifications. The first being the overall volatility in sales and the second being the volatility in the stock price, the later being used on the premise that the market will anticipate fundamental inflection points. Using the standard deviation of sales and stock prices, I broke the Russell 3000 into quartiles. Companies with either low volatility of sales or stocks prices were designated as non-cyclical stocks while I designated cyclical companies has having high volatility in either sales or stock prices. For any monthly period, I added the stock prices for cyclical and non-cyclical companies, calculated the relative value relationship, and compared this relative price to the S&P 500. The results are show below.

The first chart derives the relative cyclical/non-cyclical price performance based on the volatility of sales, delineating the Russell 3000 into two separate halves.
The second chart derives the relative cyclical/non-cyclical price performance based on the volatility of sales, with cyclical (non-cyclical) companies defined as the highest (lowest) volatility quartiles. (The field in the below chart is truncated due to the tech bubble pushing the relative relationship to extraordinary highs in late 1999.)

The third chart derives the relative cyclical/non-cyclical price performance based on the volatility of stock prices, delineating the Russell 3000 into two separate halves.

The last chart derives the relative cyclical/non-cyclical price performance based on the volatility of stock prices, with cyclical (non-cyclical) companies defined as the highest (lowest) volatility quartiles.

A few items worth noting.
- The structure of all four relative price charts are very similar.
- That said, the relative price of cyclical to non-cyclical stocks based on sales has more of a flat structure over time (some of this may be due to the scaling) as compared to the relative price chart derived from stock price data.
- I think the stock price derived models are probably more robust, as stock prices capture other important factors- over and above just sales- including earnings, income and balance sheet structures, cash flows, and most important forward-looking expectations. 
- With that said, my comments will be more focused on the stock price derived results.

You should immediately notice that, over the last 20+ years, the relative price of cyclical stocks relative to non-cyclical stocks tends to capture the directional momentum of the market very well, as the relative price tends to move up and down in tandem with the market. Interestingly, the relative price performance peaked ahead of the market tops in both the late 2000's and in late 2007. In addition, the relative price turned up ahead of the market bottom in early 2002. Most interestingly, you see that the cyclical stocks never recovered their value, relative to non-cyclical stocks, since the market bottomed in early 2009. The same dynamics, although less pronounced, is seen in the sales-derived models. One particular aspect I find noteworthy is that following the market bottom in 2009, the sales derived model that is based on the top and bottom quartiles of sales volatility showed cyclical stocks increasing in value relative to non-cyclical stocks from the market bottom in 2009 through February of 2011. Since February 2001, this model has not been confirming the market rally, but has fallen off. This corresponds with the results seen in the study using the Morgan Stanley Cyclical and the Dow Jones Consumer Non-Cyclical Indexes. It also fits the pattern seen in the weekly figures from the Economic Cycle Research Institute (ECRI), the firm who has repeatedly stated their call for a recession.

Getting back to the data, despite the market approaching highs again, cyclical stocks appear to have underperformed their non-cyclical counterparts. Is this a result of a Fed manipulated market where stock prices rise on the hope of monetary stimulus and not real economic growth. I think the answer is largely yes, but more evidence is probably needed.

Monday, August 6, 2012

Cyclical vs. Defensive Indexes- Unprecedented Divergence

I stated in a previous post ( that I wanted to look at a long-term analysis of the S&P 500 versus the relative price of the Morgan Stanley Cyclical Index and the Dow Jones Consumer Non-Cyclical index. To that end, I compiled a longer-term chart that compares these indexes S&P 500 versus the relative price of Morgan Stanley Cyclical Index (ticker ^CYC on Yahoo Finance) and the IShares Dow Jones Consumer Good Index (ticker IYK), which tracks the performance of the Dow Jones Consumer Non-Cyclical Index. I present two charts below: the price trend since 2000 and the year-over-year change for the indexes.

The one thing that really stood out to me is that, except for a period early last decade, the price and the performance of the S&P 500 and the relative price of the Cyclical and Non-Cyclical indexes have never significantly diverged. That is up until now. It may just be an issue of the composition of the indexes or tracking error, but the divergence we are seeing is unprecedented versus the historical relationship for the last 12 years. Very Interesting.