Tuesday, December 23, 2008

Tick-Tock Tick-Tock Goes the Investment Clock

The Tick-Tock of the Investment Clock continues. As expected, the bond market rally bell curve has moved slightly forward from dead over from the treasury market to a little more over the high yield market. The HYG bond fund has moved from $64.30 on December 11 to $74 yesterday. The JNK fund moved from 27 on December 12 to 29.11 yesterday. These increases do not look large until you remember that these funds are throwing off 12% yields and that we are early in the move.

The bell curve bubble has moved forward up and down the line.

1) Commodities are clearly on the down hill side of the bubble. This bubble continues to deflate but not as rapidly as before. Wholesale gasoline prices suggest a retail price of $1.48 within 10 days. Copper went from $4.20 per pound to $1.48 as quickly as the first plunge on a roller coaster, zoomed over the next little hill and is now down to $1.23. Slack demand should ultimately push copper all the way down to 50 cents but that could be after a significant bump. The momentum is dying because prices are moving below the marginal cost of production at some facilities. Some marginal mines and some of the "gooey" oil fields will have to be idled before the final bottom is made. Gasoline prices are likely to bounce back up 50 cents or so by summer, before falling even lower next winter.

2) The peak of the bell curve has moved over to the bond market, indeed it is even starting to shift from treasuries to corporates. Low interest rates are dramatically improving the outlook for future profits and are reducing the risk of defaults. Numerous companies are taking advantage of a chance of a lifetime. Companies that have cash are buying back their own debt at pennies on the dollar. In 2002, I purchased Nextel when it had a negative book value and a ton of high priced debt outstanding. The company had cash flow. The stock went from $2.90 per share to $28 per share over 3 years or so. A big part of the move was that it bought back much of the debt for 50 or 60 cents on the dollar. Companies are making needed adjustments. By laying off workers and making other cut backs, they are cutting loose cash tied up in marginal production. Some of the found cash is being used to buy back bonds. Such a situation leads to a healthier balance sheet in a hurry. Eventually, forward looking businesses will need to expand production to increase profits, but in the short run, buying ones own debt cheap is an easy decision.

3) The bell curve over the stock market sector is also moving forward. Over 16 days, the financial sector is up 22.3%. Last summer, the talk was all about MEI, Materials, Energy and Industrials. Over the last 16 days, energy was up 2%, Materials up 8 and Industrials up 8.4. The air is also going out of defensive sectors with utilities up 2.2%, Consumer Staples up 8.1% and health care up 10.2%. Those who remember the last recession know that bank stocks had fully recovered by the time the average stock started to move.

The rotation to small cap value is also well underway. In the 9 years after the 73-74 real estate recession, the average small stock went up 1579%. There are energy, material and industrial stocks within the small cap value category but, even so, IWN was up 17.4% while energy was up 2%. Small cap value funds are a good way to play small cap bank stocks as these are well represented.

4) The turn in real estate continues. On November 18, I posted a portfolio on Yahoo. Here are the results: CAL up 36%, REM up 16%, REZ up 13.5%, HYG up 6.8%, IJR up 5.07%, BRK-B up 2.8%, TIP up 4.2% and GOOG up .6%. REM and REZ are both related to real estate. REM is a mortgage REIT and REZ is a residential REIT. The total value of the portfolio has increased from $10,000 to over $10,900 in a little over a month. I will sell the TIP today to purchase a IWN.

Refinancing is a booming business. Yes, one needs a job and a good credit rating, which most homeowners have. Balance sheets are being improved by homeowners who are paying off old debts, such as car loans with consolidated loans against homes.

The housing market is improving in most markets. While home sales are low, they are concentrated in used homes, many of which are being sold to get rid of mortgage deficiencies. The new buyer gets a bargain and the mortgage company gets a weak loan paid-off; one that might be carried on the books at a deep discount. Banker friends expect horrible profit numbers for the quarter but they may be surprised as the value of mortgage backed securities are starting to move up.

In my portfolio, my favorite stock, CAL, was my top performer and my second most favorite stock, GOOG was my worst performer. I am not worried about GOOG for the long term. In 2009 and 2010 there will be a proliferation of hand held, low cost, wireless computers on the market. Yesterday, Staples, which does not typically have the best prices, offered an HP mini-notebook for $349. A couple of weeks ago, COSCO offered a very similar HP, if not the same one, for $449 and an Acer model for $349. AT&T is offering the Acer Mini in the Winston-Salem market for $99 with a two year data plan, connected by cell, WiMax or WiFi (automatically the cheapest service available).

Among other things, GOOG will make bundles off the free GPS software it offers for these machines and for internet connected cell phones. As more unlimited service wireless networks come available, whey would anyone buy a separate GPS? Search for coffee on a wireless GPS device and GOOG will be more than happy to show you the locations of the nearest KrispyKreem, MickyD's and Starbucks. The advertising costs for the vendors will be lowered, the customers will get their coffee at the closest vendor of their choice and Google will make an extra 15 cents.


Despite my love for Google, I must say that Facebook is coming on strong. As I recall, MSFT purchased 4% of this company for $15 Billion a couple of years ago. Social networks are spreading like wildfire, Facebook is the leader and social networks compete with a lot of "Google functions". Email, blogging, photo-video sharing, group scheduling, and much more are "improved products" on social networks. The move from party line phone lines to private lines is somewhat analogous of the move from e-mail to Facebook mail. For example, members of a church can share with "friends" without giving out their email address to the public. If you are a Facebook member, send me an invitation to be your friend and I will share my growing wall of charts with you.

Infrastructure Boondoggle

There is talk that the Obama administration will go for an 800 Billion Dollar infrastructure bill. This silly move comes on the 50th anniversary of "I, Pencil" by Leonard Read. If you have not read this letter, do a google search for the Leonard Read Foundation as it is posted there.

The point here is that it takes the input of millions of people to determine if a pencil should be made and, if so, another complex system to make one. Planned economies such as the old Soviet Union have demonstrated time and again that it is impossible for central planners to make the right amounts of the right products at fair prices.

One of Obama's big planning ideas today is that we need more mass transportation, smaller and fewer cars and more electric cars. At the same time, the Obama administration is intent on pushing up the price of concrete and steel by building roads and bridges for what we need less of. By pushing up the price of steel and concrete, the price of electricity will go up, as it takes tons of steel and concrete to build windmill, conventional or nuclear power plants. Why not let the market decide what should be built?

Oh! yeah I forgot, Obama owes unions thousands of Davis-Bacon jobs. He has to pay the unions back for his campaign contributions. To fill campaign coffers for the 2012 election, we must pay a lot of people $50 per hour, in wages and benefits, to lean on a shovel.

Dan Mitchel has posted an excellent anti Keynesian video at the Cato Institute. It shows how borrowing money to build roads does not stimulate an economy. It simple shifts the stimulus around. Instead of building power plants where they are needed the most, we will build bridges and dog parks in "political neighborhoods".

The good news is that the economic clock will continue to tick-tock forward. The economic clock will largely ignore the wasteful government spending. The great depression was prolonged when the government increased taxes in order to pay people to lean on shovels. Some of the mistakes of the great depression are not being repeated. This time, the tax increases needed to pay back the money borrowed to pay people to lean on shovels will come after the economy has returned to health. Politicians will enjoy believing and telling that their road building scam had something to do with it.