Tuesday, December 30, 2008

I Wish I was That Optimistic

Doug Kass published his list of possible surprises for 2009 here. I'm reading his annual lists with great interest for several years. What can I say, his 2008 list was great! Unfortunately, there was no deflation in it. And Doug still hasn't recognized deflation as the main current event.

That's the main problem with this list. Surprises 2-6 are contingent on great success of government house market rescue program. Never mind that this program has to be approved by Congress somehow, it's just doesn't exist. I have very high opinion of Larry Summers, I think he is the greatest economist alive, but he doesn't live on mount Olympus and doesn't have supernatural powers. I just don't see how any program can save housing market in the 2nd quarter of 2009. Maybe bulldozing the whole neighborhoods? A lot of them? Of course, lower mortgage rates can help. First of all they would help people who have good credit rating, have a house they can afford and wants to refinance. Give me 4.5% and I refinance. Unfortunately, that would do nothing for the housing market. It would put some more money into hands of people who won't spend them anyway.

Surprise 1 is interesting, but I don't see how to make money off it.

Surprises 7-9 and 11 completely contradict idea of housing market recovery and stock market boom.

Surprise 14 is, again, contingent on recovering economy. Even then, Microsoft is not buying Yahoo!. Somehow I believe Ballmer that they are not interested. Some deal is possible, but Microsoft doesn't sit on a pile of cash anymore, it doesn't have 20 billion ready. It might be able to raise money, but I don't see a reason why. Again and again most analysts, traders and investors make the same mistake: merger of software or internet companies is not 1980s style corporate merger. Software and 'net companies have most of their real value in people, not in equipment and real estate. If you buy Yahoo and dismantle it, you get less than you paid. Much less.

Surprises 18 and 19 are long overdue. It might be a good time to short remaining newspapers. Deadwood press is becoming obsolete.

And surprise 20 is really no surprise. Middle East build up is a real bubble. Need to think if there is some money to be made here.

Full disclosure: at the time of publication author did not have positions in any companies mentioned. Positions can change any time.

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CLosing BIP

Closed Brookfield Infrastructure Partners position today.

Full disclosure: at the time of publication author did not have any positions in BIP. Positions can change any time.

Monday, December 29, 2008

Selling BIP

Started selling Brookfield Infrastructure Partners (BIP) today. This is the stock I've got as a dividend on my Brookfield Asset Management (BAM) position. The price is low, sure, but I think it's going to stay this way for a while. Reason for selling: I don't want to mess with partnership tax forms. Position isn't big enough, easier to close it.

I really wish US tax code was much simpler.

Full disclosure: at the time of publication author did have a long position in BIP. Positions can change any time.

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Sunday, December 28, 2008

Oil Future Market: Unwinding The Bubble

Almost every day since July I'm reading (correction, scrolling through and mostly ignoring) articles, declaring oil price bottom and setting "natural" price targets for oil. In August those targets were in range between $150 and $200 (last one by Goldman Sachs, I still want to know if their traders listened to their analysts and if so, how much money they lost in result). Currently range moved to something like $80 to $100. What a bunch of crap! And I completely refuse to discuss bunk "Peak Oil" theory here.

First of all, I don't know where oil price is going in the short term. Second, if price of oil was defined by supply and demand of real commodity, price should stabilize somewhere between $50 and $60, which is current marginal cost of Canadian oil sands companies and deep water extraction. I can't seriously accept claims that Middle East costs are reaching $120. Yeah, sure, if you think that Iran's development of nuclear arms, Saudi's money going to support the most reactionary, most antisemitic mosques in the world, Venezuela's stupid government spending on arms and "social" projects are parts of cost of oil, I have a dozen bridges in Minnesota for 99 years rent. If you strip all the crap, cost of Middle East oil still doesn't exceed $25. Situation in Russia is a little bit worse, but still cost of most producers doesn't exceed $40, translated into price of light sweet crude. And still deep water oil and oil sands production is the most expensive to extract and thus gives us good estimate of marginal cost.

So, in the long term oil should stabilize between $50 and $60. But this is the long term. In the short term, there is a small problem with oil price. And the problem is, since the beginning of 2007 price of oil as a commodity was separated from price of future contracts. Starting in the end of 2006, lots of money went into future contracts of oil. Hedge funds bought a huge number of oil contracts, creating a bubble which peaked in July. They were helped by sovereign wealth funds, endowment funds and even state pension funds.

In July oil bubble popped. I was naive then, thought that oil should gradually fall to about $90 by year end and settle to around $50 in couple of years. Boy, was I wrong! I stupidly sold PowerShares DB Crude Oil Double Short ETN (DTO) in August. You know what happened next.

Why oil is keeping going down? Surely, at under $40, marginal producers should just stop production and wait until price is good enough for them. That would be true if oil market was a pure commodity market. But we have future market which was separated from physical market for more than a year. Looks like marginal producers decided to sell future oil production while prices were still high. Can't say for everyone, but Devon (DVN) did exactly that in August, according to Jim Cramer. Interesting picture: oil already sold for $100+ competes with oil coming to spot and short term future market. Guess where prices should go?

That's why it's impossible to predict short term oil price: margin cost does not define market price. I don't know how long this situation will persist. But in the short term, oil can go up or down. Huge supply of oil in inventories, including floating ones (tankers contracted exclusively to hold oil for several months) creates a ceiling which would be hard to breach short term. Can it go much lower? Sure. I wouldn't bet on $15 oil, but it might happen. Would this price be sustainable? No, hell no. But it can happen. And I probably will be a buyer of U.S. Oil Fund ETF (USO) or something similar then. Can price go higher from here? Sure. But unless we have some big event, like big Middle East war, or war between Venezuela and Colombia, with US participation, I just don't see price above $60 for 2009.

Of course, futures market can still surprise us. But most funds don't have money to create big bubbles now. A lot of hedge funds are under huge redemption obligations. Some of them are gated, i.e. they refuse redemptions, but in any case they are in no position for big speculation. Endowment and pension funds are in worse condition. Most of them probably will replace management for more conservative one (which would be the right move), which will automatically exclude them from any future markets.

Until oil futures bubble is completely worked out and price starts reflecting real supply/demand situation, don't expect expensive oil.

Full disclosure: at the time of publication author did not have any positions in USO or DTO. Positions can change any time.

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Tuesday, December 23, 2008

Adding to TBT position

Added to TBT position today. Looks like I started it too early, we'll see. Quite possible that Treasuries buyers are right and I am wrong. Only three or four weeks left to find out.

Full disclosure: at the time of publication author had a long position in TBT. Positions can change any time.

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Sunday, December 21, 2008

Dollar Carry Trade Is Bigger Than I Thought

Just got new information on Friday: it's a little bit easier to get dollar credit in Russia for good businesses than credit in local currency. Means that I was wrong in my previous post: dollar carry trade is returning to Russia. Then it should be returning to other places as well, including Brazil and Asia.

I don't know if this is good or bad news. Definitely, fall of dollar in the last three weeks was caused by carry trade. Can dollar fall even more? Don't know, depends pretty much on loan repayment conditions. If most loans were short term, repayment is coming right now for monthly and four week loans, and borrowers will have to buy dollars to pay back. But they might choose to refinance the loan. At the same time more borrowers will get loans from carry trade.

Bad thing, dollars are still not going to US businesses. And this situation reminds pretty much Japan in 1990s. When Bank of Japan cut rates to zero, yen carry trade exploded, but local businesses still couldn't get credit cheap enough.

There is hope, it's coming from two sources:
1. Events are moving much, much faster now, than in Japan in 1990s.
2. US enterprising spirit. It always invents something new, something the whole world needs. Not always good things, but always new: personal computers, mass adoption of cell phones, commercial software. Also collateral debt obligations and multiple financial derivatives.

If we follow Japan's path, dollar rate should stabilize at current or little bit lower rate. Don't see how to make money off it, unless you participate in dollar carry trade.

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Wednesday, December 17, 2008

Fed Non-Event

How does it feel runnin' around
How does it feel watchin' from upside down?

(Slade, How Does It Feel?)

First of all, sad congratulations to myself. I predicted here, in January, Fed's rate below 1% by January 2009. Doesn't make me feel good.

Yesterday's target rate cut by Fed doesn't mean anything. Real rate, as reported here, was mostly below 0.5% for a long time and below 0.25% since December 5. Unfortunately, most commentators could even read Fed's statement right. "Quantitative easing" really means that nothing in Fed's arsenal is working. Fed is desperately trying to stop deflation by any means possible. It's flooding banks with money. And where is this money going? Treasuries are up, I'm not sure they were that high even during the Great Depression. OK, so a lot of dollars went for Treasuries. Dollar is down. It feels very wrong in deflationary environment. But there is a probable explanation: dollar carry trade. Trade to Euro zone, because almost nobody is lending to anybody else. Maybe China, but I wouldn't bet on it. Not Russia, not Latin America. I'm thinking if there is a way to make money off it, but dynamics are not obvious. The main problem though is that money is not going to where it's needed: businesses. And Great Depression 2.0 is not off the table exactly because businesses can't get credit. So what's next, uncle Ben? Direct lending to businesses? Throwing money down from helicopters?

Some time ago one of my articles was called "Why Doom And Gloom?". Now I see the answer. Well, there were successful businesses during Great Depression. There were great businesses launched during Great Depression. Doesn't mean I want to see GD 2.0.

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Monday, December 15, 2008

Changed Facts Or Public Service?

Jim Cramer repeated today on his "Mad Money" show that Great Depression 2.0 is off the table now. His mantra is "When facts change I change too". I'm signing under this statement any time. The only problem I see, facts haven't changed, yet. Yes, Fed is trying to flood economy with money, but this money doesn't go farther than Treasuries. Yes, there is TARP program. All it can really do is to help banks to conform to reserve requirements. Yes, there might be some help to GM and Chrysler which at least will keep some people employed. But so far, we are in deflation. GD 2.0 is not off the table until we see at least some inflation.

But Jim also said one thing which reminds me of my life in Soviet Union. He said that proclaiming Great Depression would be bad public service or something like that. This is the first time when Jim really speaks the same language as Lenin, whose portrait he is keeping in his studio (he thinks they look similar, nothing of the sort, by the way). No Jim, saying what's "good for the public" instead of truth is a very bad public service. It's just a lie. I understand that politicians are lying (sorry, saying what public wants to hear instead of truth) quite often and always make corrections for that. But Jim Cramer is no politician! He was a hedge fund manager, extremely successful, and he never forgets to remind us about it. He gives investment advice, i.e. telling people how to make money. Tell me honestly, Jim, would you buy now counting on recovery or counting on possible Great Depression? I don't care about public good when investing. I only think about my money. For public good, I donate to charities, I vote, maybe some of my articles are for public good too (not for money, that's for sure).

Fortunately, Jim's investment advice isn't tainted by this approach. I agree with advice to buy high yield companies with reliable dividends and acted on it. But there are some new filters in my head when watching Jim.

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Friday, December 12, 2008

Stocks, Bonds And Commodities

They say on Wall Street, that if stocks and bonds point to different directions, bonds are usually right.

Bonds are pointing to Great Depression 2.0. No doubts here. Treasuries are at GD levels, corporate bonds are too, selling new bonds issues is almost as hard as in 1930s.

Stocks? I don't understand where are they pointing. Market is down big for the year. We had a local bottom, with obvious capitulation, on November 20. Market is up since then, but S&P didn't break 900 and trading in a 800-900 range. It can go either way from here.

The strangest thing right now is behavior of commodities, including gold. Fall of dollar is strange as well. This week commodities market is screaming "Inflation!". Dollar confirms. But Treasuries yields don't predict any significant inflation. More like deflation.

What's in future? Stocks don't say. Bonds say we are in GD 2.0 already. Commodities say inflation and recovery. Last year, when commodities and stocks were pointing to growth and bonds to recession, bonds were right. If they are right now, bad.

My crystal ball is all misty. The only thing I know is that dollar fall this week doesn't make any sense to me. If it continues to fall, I probably will buy DRR, to play on dollar recovery.

Opened TBT position today, as a way of shorting Treasuries. I'm also looking at ProShares UltraShort Lehman 7-10 Year Treasury ETF (PST).

Full disclosure: at the time of publication author had a long position in TBT and no positions in PST or DRR. Positions can change any time.

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Wednesday, December 10, 2008

Treasuries Craze And Window Dressing

I want to propose one more explanation to current bubble in Treasuries. It was noted that current prices of Treasuries can be explained by financial panic, possibility of Great Depression 2.0 or combination of both. I also noted here that between August and October dollar and Treasuries were both going up and after mid-November dollar is more or less stable, when Treasuries shot up sharply.

One theory which can explain current growth of Treasuries (which means drop of yields) is window dressing. Funds which lost big on commodity and stock markets this year need to show that they are currently in safe investments. What can be safer than Treasuries! And total size of those funds is enormous. There are trillions of dollars in various pension, endowment and sovereign wealth funds. They were managed badly, invested a lot of money in commodities in the last and first half of this year, lost huge amounts and now desperate to show investors that their money is safe. And because this money was invested in dollar denominated assets before, funds don't need to buy dollars, hence dollar stabilization.

I still don't discount financial panic and Great Depression 2.0 (or Great Recession). But I want to play on window dressing. The easiest way to do it for individual investor is to go short iShares Lehman 20+ Year Treasury Bond (TLT) or, better yet, go long UltraShort Lehman 20+ Treasury ProShares (TBT). I think to buy some TBT shares into year end and sell in the first half of January. There is some risk still, so due diligence still applies: buying small positions on the way down and selling at the first sign that trade might go wrong.

Full disclosure: at the time of publication author had no positions in TBT, TLT or any other stocks related to treasuries. Positions can change any time.

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Tuesday, December 9, 2008

Range Confirmed.

Looks like Dow Jones range 8000-9000 is confirmed for now. Turnaround Tuesday (Thanks, Todd Harrison, for coining this term) stopped big rally.

My apologies to Jim Cramer. He is no dancing bull. He understands that we are in a trading market. He understands that it's way too early to talk about recovery. And idea from today's show to buy auto companies convertibles is very interesting. I'm looking at Ford convertible now (F-PS). Not at after hours prices though.

Treasuries craze continues. People are buying 3 month bonds for no interest! No, it's too early to short Treasuries. I'll wait.

I see that my yesterday article on Microsoft was quite popular. It was my view as an investor. I'm trying to separate my view as IT specialist from that. From investor's point of view, MSFT has a lot of hidden value, which can be unlocked by splitting company.

Full disclosure: at the time of publication author had no positions in MSFT or F-PS. Positions can change any time.

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Monday, December 8, 2008

Microsoft: Crumbling Empire?

Interesting news: the share of computers with Microsoft Windows OS surfing the web dropped below 90% (article here).

Of course, Microsoft (MSFT) is still an enormous cash machine. It still has a near monopoly on corporate desktop and laptop market. Many investors might assume that company still can produce great returns. But I think Empire is cracking.

Let's take a look at the last quarterly report (quarter ended September 30), available here.

Operating income by divisions.
Client division, i.e. Windows for desktop/laptop: 3267 million, slightly less than a year ago.
Server and Tools division, i.e. Windows Server, SQL Server, Exchange and other things: 1151 million, or 20% more than a year ago.
Business division (Office): 3311 million, 20% increase.
Entertainment and devices (Xbox and Windows Mobile): 178 million, slight increase.
Online services: loss of 480 million, compared to 267 million a year ago.

This is operating income. If you look at it from corporate point of view, Entertainment and devices is in red, and online division is a huge sinkhole.

Balance sheet looks healthy. Lots of cash. Small problem is that all that cash and then some is already allocated for a huge buyback. Microsoft, first time in it's corporate life, is issuing debt. It has enough free cash flow to service it, so debt shouldn't be a problem.

It looks like a picture of a very healthy company, maybe with some small problems. What can possibly go wrong? The answer is simple: real competition. Let's see by divisions.

Client division: strong competition from Apple (AAPL) on the upper end. And competition from Linux in subnotebooks (AKA netbooks) segment. The last one is so bad for Microsoft, that it had to do unthinkable: issue licenses for product they wanted to retire, Windows XP, specifically for subnotebooks. Competition is mostly localized to the home computer segment so far. Microsoft still dominates client OS market for the businesses for now. There are couple of small problems here though: businesses mostly refuse to upgrade to Vista (no additional revenue), and Apple starts penetrating into enterprise.

Windows Server: Strong competition from Linux. UNIX is still in business too.
SQL Server: Very strong competition from all sides: Oracle, IBM DB2, open source (MySQL, PostgreSQL, Ingress).
Exchange: No serious competition so far.

Business division: no serious competition to Office. Companies have an option of switching to open source (Openoffice), but reluctant to do so.

Entertainment and devices: very stiff competition. For Xbox it's Sony PlayStation and Nintendo Wii, for Windows Mobile it's Apple iPhone, running OS X, Google Android and Linux.

Last but not least: Web services. It's not that Microsoft has competition here. It's that Microsoft is not a competition for others. Companies with which MSFT wants to compete are profitable: Yahoo! (YHOO) and Google (GOOG). Attempt to throw huge money on this problem doesn't help.

How fast Microsoft can die? That's a big, $180 billion question. Thing is, tech companies sometimes can die fast, like CDC or Wang Computers. They can linger for many years (as Jim Cramer says, dead companies walking), like Unisys (UIS). Or they can reinvent themselves, like IBM, which is more like an integrator than a tech company.

I don't think Microsoft can reinvent itself. It never could compete on even field. All its victories in competition were achieved by "leveraging" its OS monopoly. Now, when this monopoly itself is under question, what can Microsoft do? It's still possible that company can survive for many more years, just on the sheer inertia of huge installed base. The best decision would be to split into two or three companies. Just close the Web shop (no one in his sound mind would ever buy it), sell entertainment and mobile, if there is a buyer. Core businesses need to be changed too. OS development has to be completely changed. Every successful OS right now is UNIX or Linux based. The only way to make a good OS is to take BSD UNIX and add some proprietary GUI, like Apple did. You can even call it Windows Berkeley. Office can do just fine. Mobile shop has to be closed too, it can't compete on its own with Apple and Google. I see separate OS company, Office company and Enterprise Server company (Exchange and SQL Server). Resulting companies can be much smaller, drastically cutting costs.

Can company do that? I don't think so. But I'm watching Microsoft now. If there is any hint of a split, I am a buyer.

Full disclosure: at the time of publication author had long positions in AAPL and GOOG and no positions in other companies mentioned. Positions can change any time.

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Friday, December 5, 2008

Dancing Bulls And Great Recession

Cramer joined the troop! For several weeks he blasted dancing bulls, preached capital preservation and was as bearish as Jim ever can. Now he has converted. It's not Damask road, but pretty close.

What happened? Did we get great new economic reports? Nah, everything was doom and gloom, today's employment report just finishing the picture. Jim got his cool-aid from two facts: Dow didn't test 8000 level since November 24, and market up today, despite bad news. Well, first fact really means something, technical signal in a pure technical market. I actually think that November 20 was a local bottom, which might hold for a while, and mentioned it here. My main indicator was a kind of capitulation we had on Nov 20. As for the second signal... We are in a trader's market, technical one. We are trading in Dow 8000-9000 range, or 800-900 S&P range. 200 Dow points up or down, what difference does it make?

Bad sign for me: Doug Kass is also bullish, although short term. Last several times Jim and Doug were both bullish, market fell big, if I remember it right. Wanted to check it through thestreet.com, but site is so badly organized, you need to spend hours if you want to go back more than couple of months.

I liked a new term "Great Recession", mentioned today on CNBC. That's almost acceptance. With such speed, we can get real acceptance real soon. Like in February or March. It's almost funny, but this term might be more correct that "Great Depression 2.0". If we start getting out of it in 2010, it's not a depression. Deep recession, yes. Lot's of people suffer and many more will suffer. But it will be over fairly quick. I hope. Because there is another possibility: Japanese disease.

But even my best forecast (spring of 2010) doesn't match bull market now. Market leads economy by half a year, usually. Then bottom should be in fall of 2009, a year from now. Market might hold current level or go lower. It's not likely to go much higher.

Of course, I can be wrong. Actually, I want to be wrong.

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Thursday, December 4, 2008

Dollar And Treasuries: Dichotomy

Let's take a closer look at behavior of dollar and treasuries lately. Here I mused that treasuries are pointing to financial panic, when dollar isn't.

On the graph below UUP, is a proxy for dollar, compared with TLT, long-term treasuries ETF. Y axis is a percentage change of these ETFs since July 1 of this year.

Vertical lines split this chart into 4 periods. As we can see, in the first period, from July 1 until about October 6, both dollar and treasuries moved slowly up. My idea at the time was that world was running scared from all asset classes into US Treasuries, buying a lot of dollars along the way. That would be worldwide financial panic.

Then we have period from October 6 until October 24. Treasuries were moving sideways and a little bit lower, but dollar was in a parabolic rise. Was it dollar carry trade unwinding?

Next period, between October 27 and November 17. Both ETFs trade in range.

And the most interesting part, after November 17. Dollar still trades in range, but we have rapid, insane rise in treasuries. Coupled with failures to deliver, this amount to real panic buying. What's happening? We can't attribute this to the international buyers, because dollar is not rising. My best guess is that funds of different kind (endowment, sovereign, state and companies pension etc.) are moving into treasuries from other asset classes. They already lost hundreds of billions (maybe trillions) of dollars on stock, bond and commodities markets. Looks like now they are investing in the safest paper possible. Trouble is, at these price levels, treasuries are lousy investment. You need to hold them for decades to get any kind of return.

Can we make money off this? Doug Kass thinks it's time to short treasuries, for example here. He is currently short TLT. I don't want to do it, yet. First of all, it's dangerous to short bubbles. Second, failures to deliver probably keep a lid on the prices, which can go even higher. Last, but not least: treasuries prices are at Great Depression levels right now. If we are in GD 2.0, they might remain at high levels for a long time. I will be watching for inflation data. If we start getting any inflation at all, then it's time to short treasuries. If we get into depression, then time to short will be when this fact is accepted. I'll short when I see New York Times headline "Great Depression II!".

Full disclosure: at the time of publication author had no positions in UUP, TLT or any other stocks related to treasuries. Positions can change any time.

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Wednesday, December 3, 2008

CEG: Ringing The Register

Good news: I expected to make respectable 10% on Constellation Energy (CEG) arbitrage. Today it jumped to more than $29 in the morning trade. Sold it, of course, right there and then.

Reason for a jump is simple: Electricite de France is in bidding war for the company with Buffett's MidAmerican Energy. OK, I can take gifts from the market.

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Monday, December 1, 2008

Oh, Dear...

When I wrote my yesterday's entry, I didn't expect it that bad. Looks like we have a new range. If October action was mostly for S&P between 900 and 1000 (or for SPY between 90 and 100), now it moves to between 750 and 900 (maybe between 800 and 900, if we have upside action tomorrow). I'm probably a (very cautious) buyer at this level. Just for a trade. Probably SPY, it's hard to guess individual socks in this market.

Bad thing if we break below 750. Looks like it's the level where most traders have their stops. If they are stopped out, we can easily go to 680 in couple of days.

I used to look at any action from fundamental point of view, usually. But this is not the usual market. Fundamentals don't matter. They will, eventually. Problem is, nobody knows how low can we go...

Bernanke astonished me today. He acts like we are in Great Depression 2.0. But he absolutely denied that we are having one. Is it PR or conviction?

Full disclosure: at the time of publication author had no positions in SPY. Positions can change any time.

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