Clear Indexes Ideas

Gloom and Doom, or the Usual Bumpy Ride?

There are a few things we can be certain about in the markets. They do not go straight in any direction and we will experience good and bad markets in each decade. How high and low the markets will fluctuate are just some of the things that we do not know.

According to the press, the subprime lending market is in shambles. Their question: will it destroy the banking industry or just the mortgage industry? The press also questions if the hedge funds will ride in and save the industry while pocketing all of the winnings for themselves. The answer is probably any of these scenarios could take place at one place and time or another. Its influence on the overall equity market has been minimal to date.

Two of the common predictions made in the press earlier this year were: 2007 is the year that large cap stocks will dominate market gains, and corporate earnings increases are now going to be only two to three percent. Despite the surge in the Dow, mid cap stocks have strongly outperformed large caps. Part of the issue of the common misconception is the way the Dow is calculated which I covered last week in a blog post available at http://www.clearamideas.com/clearam_ideas/2007/05/indexes_is_the_.html.

The second myth that is not holding true is that corporate earnings are in the lower single digits. True they are not growing at the record pace set last year, but they are very far from disappointing, especially after the far lower expectations that Wall Street analysts set up for us. In retrospect, it seems that a surprise to the upside was almost inevitable. Companies in the S&P 500 Index through May 11 reported an average earnings gain of 13% in the quarter, according to data compiled by Bloomberg making it the 19th straight quarter in the period ended March 31 of double digit gains. The last time growth was less than 10% was the second quarter of 2002. Jeff Sommer published a piece in the NY Times last week with some other great statistics.

The numbers tell the story. By the end of this week the vast majority of the companies in the Standard & Poor’s 500-stock index will have reported their earnings. And so far, overall results have been terrific — especially when compared with the consensus expectations on Wall Street.

With 89 percent of S.& P. 500 reports in hand, Thomson Financial calculated that earnings in the first quarter were running 10 percent higher than in the same period a year earlier — a number in line with the kind of double-digit increases investors have taken as their birthright during this long bull market.

What’s more, about two-thirds of companies have treated investors to positive earnings surprises for the first quarter.

For now the prospects of companies in the US markets continues to look good. Last week China opened it doors on the outbound lane allowing investments by banks overseas. Yesterday, the Chinese government announced a $3 billion investment in The Blackstone Group, its first investment from the massive war cheat of foreign exchange reserves into a company. It is willing to do this huge investment with no voting rights. This investment is right smack in the heart of the US investment world. We look at that as a vote of confidence and stability in the United States. Despite the lack of confidence in the current administration, our continued occupation of Iraq, rising energy prices, trade imbalance and the falling dollar, the Chinese government is making its first, and a material investment here.

There are always many reasons to see the glass half empty. It is good to see some real verified numbers here and investment coming from abroad. Taken together, they demonstrate that the glass just may be half full.

The Fed Stays Pat

Earlier this week the Federal Reserve Open Market Committee, for a sixth straight meeting said the economy seemed likely to keep growing at its current pace and voted unanimously to keep current interest rate at 5.25%. The central bank also softened its tone about possible rate hikes alluding to future policy adjustments without specifying rate increases as it has in the past.

Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth.

That day, the market went wild posting its biggest gain in months (yes we beat the market that day).

Since no one feels they can take The Fed at its word and love to read between the lines we have analyzed the reviews and other data to offer these observations:

The Bad News
Housing has subtracted from economic growth for the past five quarters, and lenders could cut back credit if mortgage distress rises. Distress is defaults and late payments.

The Mortgage Bankers Association said last week that delinquency rates on subprime mortgages rose to 13.3% the highest since September 2002. Foreclosure rates on all mortgages rose to highest level since the first quarter of 2004 (which turned out to be a great year for the market). Business spending in the fourth quarter was also weak. Corporate purchases of equipment and software declined at a 3.2% annual rate the last quarter of 2006, the most since the final three months of 2002 (and then the market took off in 2003). Shipments in January of non-defense capital goods excluding aircraft reduced 2.7%, the most since September 2001.

More Bad News?
Government reports this month showed unemployment fell to 4.5% and industrial production gained 1.0% in February and consumer prices rose 2.4% from a year ago.

Also found in the Fed statement:

inflation could be sustained by high resource utilization

This seemingly minor statement is referring to the tight job market and high rate of industrial-capacity usage. Some interpret it as a potential inflationary sign, yet the Fed removed that sentiment from its main statement.

Wait a Minute, there may be a reason
If our factories are humming and employment is up, will those factors catch up in other numbers? Chairman Bernanke is getting used to his job and realizing how to play his hand very close to the vest.

It stands to reason that positive consumer sentiment influenced by the Fed and the reaction of the stock market Wednesday may loosen pocketbooks, first with consumers followed by businesses. If employment is high, then there is income at most levels of the economy to pay for goods and services.

None of the above outlined circumstances are necessarily very bad or very good. Yes, we need housing and the mortgage market to stabilize. We also need to look at growth in all areas. From our perch we do not see fast drastic moves in the overall economy. The stock market moves daily on rumors and sentiment. Or is it, as they teach in business school, ever so efficient?

Taking my tongue out of my cheek, the real answers will be revealed in quarterly earnings statements, and you already know what we do with those numbers.

Have a good weekend.

Retail: Half Empty or Half Full, it Depends Who You Ask.

If you ask the Wall Street Journal, the consumer spending glass is half empty. I disagree and interrupt the numbers differently as this holiday shopping season is estimated at a 6.6% increase over last year's. This is a materially large gain compared to inflation in my opinion. The Journal article bases its well documented case on comparisons to last year's 8.7% increase.

Holiday spending between Thanksgiving and Christmas rose a disappointing 6.6% over last year, according to SpendingPulse, a retail-sales data service from MasterCard International's MasterCard Advisors Unit. Last holiday, sales climbed 8.7%. "People were expecting a lot more momentum," said Michael McNamara, vice president of research and analysis for MasterCard Advisors. "Retail sales are growing, but at a more moderate pace compared with last holiday."

The bigger picture here in my opinion is that the American consumer is demonstrating growth by still spending at a rate that well exceeds inflation. Exceeding 8.7% is not a preference for those of us Fed watching, concerned about inflation, wages and therefore interest rates.

I am paying particularly close attention to post Christmas sales, which are all too predictable. The big purchase this year at my house will be a new LCD TV. My kids were more than willing to wait for the big post holiday sales for our purchase. This mark down mentality has got to hurt margins at some retailers and therefore profits. When discussing business variables, most analysts are referring to costs such as advertising and additional holiday labor. What "variable" shouldn't be, which we see all too often these days is variable revenue, where the percent mark down is the variable therefore moving quarterly revenue and margin numbers. This will be reported at earnings time and most easily measured in operating margins which are already as low as 4.48% at department stores. Not all retailers are playing this game. New merchandise is one way to play it.

Many stores are putting out fresh spring products hoping to sell them at full price to shoppers brandishing gift cards. Sales of gift cards are expected to total $25 billion this holiday, $6 billion more than last year. Best Buy Co. said it had already racked up more than $1 billion in gift cards by last week.

The high end of the market also seems to be doing OK without the discounts, and not just in NY and Fairfield County CT where the Wall Street and Hedge Fund bonuses are fueling pruchases.

Last week, Hermès at South Coast Plaza, in Costa Mesa, Calif., sold a $140,000 Birkin bag with a diamond clasp while Pioneer Electronics sold out of its stock of $1,500 Blu-ray videodisc players. Six thousand shoppers blitzed through a Tiffany & Co. store on Wednesday and Thursday, while Louis Vuitton was among the busiest stores in the plaza, according to the center's executive director of marketing, Debra Gunn Downing.

"It seems to me like everybody is buying," said Ron Heller, a Mercedes-Benz dealer in Boerne, Texas, who was clutching a Ralph Lauren shopping bag -- holding a gift for his girlfriend -- Saturday night at a Neiman Marcus in San Antonio. "I have been to four or five luxury stores tonight and they all seem to be full. With the Dow hitting an all-time high, I think that there's a paper wealth that a lot of us are feeling."

There is of course a big online component to this story as Nielsen//NetRatings announced that visits to the Holiday eShopping Index grew 20% this season for the week ending 12/10, from 469 million to 563 million.

Shopping destination sites are as below.

Top Online Shopping Destinations for Week Ending 12/10/06 (U.S., Home and Work)
Site	x000 Week Ending 12/11/05	x000 Week Ending 12/10/06	Year Over Year Growth
eBay	30,433	34,203	12%
Amazon	24,466	25,015	2%
Wal-Mart Stores	11,560	13,941	21%
Target	9,847	12,310	25%
Overstock.com	7,608	8,633	13%
Source: Nielsen//NetRatings, December 2006

The bottom line is that this was a good year, and as always, a year with distinct winners and losers. When investing utilizing revenue and traffic information, there are several questions to ask:

Is the company growing faster than its peers?
Is this a turnaround situation for growth or earnings?
How well are the sales increases being managed, meaning discounts and advertising versus word of mouth and brand? It is all about costs. Is the company really making money or just moving merchandise?
Do I want to invest in distribution (retailers) or manufacturers (like Apple)?

Strong operating margins lead to profits, leading to surprises in earnings reports. Many traders prefer top line to bottom line growth, but firms like mine; Clear Asset Management which are mid to long term investors seek a history of both.

Today in history:
In 1776, at approximately 8 a.m., General George Washington's Continental Army reached the outskirts of Trenton, New Jersey, and surprised the Hessian force guarding the city. Still groggy from the previous evening's festivities, nearly 1,000 Hessians were captured at the cost of four American lives.

In 1966, the first day of the first Kwanzaa was celebrated in Los Angeles under the direction of Maulana Karenga, the chair of Black Studies at California State University at Long Beach.

What We Can Learn From the Census for 2007

I am borrowing some stats from a piece I read this week by Nina M. Lentini at mediapost.com, which is a marketing site where investors can occasionally gain insights.

US citizens invested $159.50 billion to improve and repair their homes last year at the same time as new, one-family home square footage increased to 2,227 square feet.

The census reports that a record low 14% of Americans moved to a new home last year versus 20% who moved two decades ago, proving that Americans are moving less. Meanwhile older and wealthier Baby Boomers, the ones turning 60 (there are 10,000 more every day) are spending more money on second homes. This requires buying two of everything, from furniture to toothbrushes.

Next year, according to the Census, adults and teens will spend nearly five months watching television, surfing the Internet, reading daily newspapers and listening to personal music devices.

While surfing the web, 97 million adults read the news in 2005, 92 million made a purchase, 91 million made a travel reservation, 16 million networked for business or pleasure, 13 million created a blog and 8 million of them are working in of home-based businesses with one third of them being women.

The trends may be investable. As we see become a nation that stays put, we are far from shut-ins based on travel stats. In 2007 consumer spending may take direction from the Baby Boomers’ housing habits and our entire country’s media-related habits. Understanding the sectors that directly profit from these trends and the sectors that service and supply them may prove to be wise investments.

Another Positive For Homebuilders

An interesting statistic on mortgage rates influencing housing; according to Freddie Mac the average rate on a 30-year fixed-rate mortgage dropped to 6.14% this week from 6.18% last week. This week last year, the average rate was 6.26%.

Retail by the Numbers

It is the consumer that drives the economy. The holiday season is where anywhere from 205-40% of all sales are made. The data used in this post is aggregated from three research reports from: MasterCard, Discover Card and an online survey conducted by General Growth Properties, Inc.

This Friday, the day after Thanksgiving, is known as “Black Friday.” This is the day that retailers historically would hit the profit mark (Being in the black means being profitable). If you think it means that you should stay home because there will be too many shoppers out that day, it actually ranks as the sixth busiest day. Black Friday used to be synonymous with the official launch of the holiday shopping season. Personally, I have already seen Santa Claus on street corners here in New York starting the day after Halloween. This Black Friday many stores, including Wal-Mart, KB Toys and J.C. Penney, are opening their doors at 5 a.m. As we get count down to 12/25 we will begin to see stores open until midnight!

The busiest day in 2005 was December 23 and MasterCard said its transaction data predicts 12/23 will be the busiest shopping day again this year. I remember in years past, 12/24 as the busiest day, but this year it falls on a Sunday. In the GGP study 56% claim they will start their holiday shopping before Thanksgiving. Will this work out to be true or false, given that most people procrastinate? The retail revenue numbers will verify or nullify this claim.

The web is the fasting growing shopping mall in the world and is not to be left out of these stats. The mainstream media has come up with a catchy phrase for the web too. It is the Monday after Thanksgiving, known as “Cyber Monday.” This is also a self-perpetuating myth as it is the ninth most active online shopping day in terms of transactions processed. Most people do their holiday shopping just before Christmas. The biggest action on the web last year was 12/5, somewhat driven by cheap shipping deadlines.

This year, consumers plan to spend most of their holiday budget on clothing and accessories, and on gift cards (see my 11/22 post) and gift certificates. More will be spent than on toys, games and sporting goods.

Where they shop:
84% department stores
41% electronics stores
32% at warehouse membership clubs
31% at specialty retail stores
66% at the Mall

How they pay:
35% debit cards   
33% credit cards
Only
12% cash
6% checks

What they will purchase (note the difference to the store statistics)
Electronics (25%)
Apparel (23%)
Jewelry 5%

How much they will spend:
55% up to $500
25% $500 to $1,000.

On average, consumers expect to spend $879 on holiday gifts this year, compared with approximately $632 in 2005.

I saved my favorite stat for last. Only in America, 55% surveyed want cash or gift cards as a holiday present.

Get Ready for Gift Card Accounting

Last year a lot of holiday shopping occurred as the; buy yourself what ever you want on me program, also known as gift cards. Last holiday shopping season, November 2005 and then in January 2006 I had commented for Bloomberg TV and radio about the tremendous impact of gift cards. Essentially, stores take in the cash for a gift card but most stores do not account the transaction as revenue until merchandise has been exchanged for the card. Not unlike the old travelers checks game, some cards are lost, tossed into the back of dressers and never used. There is quite the profit margin on those, yet they are not ever booked as revenue. Additionally, stores have the use of the cash, sometimes for months. Most cards are redeemed by February and redemptions slowly fade out until June. After June they are assumed to not be redeemed.

This is an accounting and revenue recognition issue. It shows up in operating margins and other places that quants like us like to dig. The issue is the numbers are skewed. There is also a play in the short term bond market. Gift cards are bigger and bigger numbers each year, over $18 billion in the 2005 holiday season.

We are waiting to see how the big four accounting firms jigger the books. Of course, some of us will be watching very closely.

Is It All Over for Oil?

My dark hypothesis is that oil prices may once again begin to march. Although I can present a smattering of stats to support my thesis, common sense dictates that despite the pull back last week, we are anything but in a lull when it comes to oil prices. As long term investors know, the trading markets can fluctuate lulling the overall market into creating higher profits for big picture investors.

Demand isn’t going anywhere. Slowdown or not there are more light s on in this world every year. China is building more cars. The US has more cars on the road then citizens (and illegal immigrants). India’s new thriving middle class wants the same luxury items western society has including consumer electronics and cars. The fact remains that across the globe, most electricity, heat, hot water and 99% of passenger, commercial and heavy vehicles are powered by petroleum-based products.

Alternatives can not come to market fast enough. Even if a cost effective alternative motor system was released today and could be mass produced, it would take more than a decade for acceptance and the retiring of existing vehicles. Gasoline substitutes and additives are a placebo to placate the liberals. We need a steady stream of incremental changes over 20 years to evolve us off dead dinosaurs and onto renewable clean energy sources. The fire in our bellies is still not there to begin to take on the challenge. The US, is just not ready.

Global unrest seems to be most prevalent in oil producing regions. The Middle East is in the same or worse political state than it has been since the end of World War II. Iran, Iraq, Algeria and Saudi Arabia are all hot beds. The recent elections in central and South America do not bode well for U.S. interests. Add in Nigeria which also does not seem to have an end to unrest in sight. The main stream media can dramatize or stabilize sentiment on just how bad it is at any given moment.

Oil is measured in Yankee Green backs and as the dollar falls or waffles, it influences oil prices. A cheap dollar policy or a strong dollar policy will greatly influence oil prices. For now with stable to potentially lower interest rates, current Fed policy isn’t going to help oil prices.

Yesterday marked the first heavy jacket day in NYC. It was below 40 degrees when the typical trader waited for their train this morning. It will be interesting to see where oil goes once they are seeking the radiators to warm themselves, and I don’t mean the band from New Orleans. Human nature affects trading.

All this stew needs to boil is for our government to replenish the strategic oil reserves that were tapped when oil hit its peak earlier this year.

Check out the price of oil the first of each week since September. Look at pump prices as we approach Thanksgiving. They are rising. Look again in mid January, just eight weeks away. You may want to re-read this post.

On Holiday: Only male turkeys (toms) gobble. Females (hens) make a clicking noise. Hens are attracted for mating when a tom gobbles. Wild toms love to gobble when they hear loud sounds or settle in for the night (borrowed from Plan Sponsor’s News Dash). I’m off until Monday, have a happy Thanksgiving.

More Dirty Laundry; aka Lucky CEOs

Today both the WSJ and the NY Times wrote easily accessible articles (translated, not the front page but easily found) with the results of academic studies on the backdating of option grants. The studies conducted by a Harvard Law School professor, a Cornell University professor and the French business school all come out to relatively the same conclusions; long time CEOs with limited independent board members seem to have higher pay than their peers and are more likely to have options dated at the low of their eligible period adding millions more to their compensation. Their well chosen title for study says it all; “Lucky CEOs.”

Democracy dictates that politicians work for the citizens it serves and if they are not doing a good job or have their hand too deep in our pockets, at specific intervals we can vote them out, although we rarely do. Actually, incumbency is the best determinate of an election. Sitting CEOs without strong independent boards hold the same incumbency advantage. CEOs are supposed to work for their shareholders. It is their primary job to; enhance shareholder value. In return they are generously compensated. The granting of stock options makes sense. In fact there are studies showing that the more options a CEO and senior management have, those companies are more likely to deliver better stock prices over the mid to long term. These aligned motives make sense. What is immoral, and should be illegal is senior management taking an additional advantage having options granted to them at unfairly favorable prices.

The study examined the timing of stock option grants from 1996 through 2005; using 19,000 grants made by 6,000 companies for 8,800 CEOs.

The professors found that 2,329 or 12% to 850 CEOs were granted at monthly low prices. That number may expand by several hundred companies if the second and third lowest prices of the month are included. Only 4% were granted at monthly highs. Statistically, roughly 5% should have been granted at monthly lows or highs, based on 20 trading days in a month.

The study shows that high-technology firms were the most egregious, where an estimated 32% of unscheduled grants were backdated.

The complete study can be found here: http://www.law.harvard.edu/programs/olin_center/corporate_governance/papers/LuckyCEOs_Bebchuk-Grinstein-Peyer.pdf

From my perspective continues to prove that Sarbanes Oxley works. That the law when followed is adding controls in public companies that strengthen governance and are shareholder friendly. I believe we have not seen the end of the scandals and that after options backdating there will be the next “big discovery” to clean up the book and send another few executives to the pokey.

Businesses want the SEC and other regulators to use their oversight and rules to water down Sarbox. They claim the expenses are too high and that we are losing IPOs to Europe and Asia.

The flip side of this issue is that the statistics show that too many firms are not clean. They are not abiding by the highest standards. This may seem cynical, but some CEOs may want the laws changed to keep them far away from prison. Essentially, the way they look at it is that acting immorally need not be illegal. I remain in the camp that wrong is wrong and further state that if it’s not aimed at enhancing all shareholders’ value, it shouldn’t be legal and have consequences that are a “no brainer” deterrent.

For Halloween I’m Long Manhattan

This post is all about three-dimensional mathematics and how this breed of math brings practical real-world happiness to my kids (this post is to be taken tongue firmly in cheek). My friends in the burbs like to remind me of the trick or treating rituals we enjoyed and always why I should move my family out of Manhattan and next door to them. I love them, but the math simply doesn’t work.

As kids we were driven to the other end of town and trick or treated our way home. I walked what seemed like miles for generally a fair sized bag of the goal; “candy.” I also collected for UNICEF and with no cheating, frequently had one of the larger hauls for cause number two the next day at school. The downside was that it took forever. I missed any and all parties, plus I usually got in trouble for coming home late and frozen solid.

The city is quite different. Parades and parties can be found in most parks the weekend before Halloween. Kids wear the costumes more frequently than in the burbs, elevating the ROI on costume purchasing or creation.

Next is the more important equation; candy/mile/hour. Now of course the city is more packed together, so starting at brownstones and stores (yes we trick or treat stores in Manhattan) will obviously yield a greater return per mile. This is simple 2-D math. Weather will not be a factor today as the forecast in unusually nice. Weather is usually another checkbox in the city’s favor.

The big advantage is the third “D” - vertical. Our friends, 4 blocks away, live in a 12 story building. There are approximately 20 apartments per floor. So that no residents get annoyed, willing participants post flyers on their door inviting children to ring them for mostly treats, occasionally tricks, or not. Kids can efficiently skip the unmarked doors.

In under an hour, their bags are completely filled, and no one in NYC would even consider loose candy, its all in original sealed packaging. This means a fast parental check of the bag and the usual toll for performing this service, there is time left over for parties, and for my kids; homework. Yes, home work, how else will they grow up to measure and calculate the efficiencies of their 3-D world?

The stats: Parents Magazine reports in 2005: $3.3 billion spent, $1.16 billion of it on candy. Gourmet reports 35 million pounds of candy corn are produced each year, and for the science buffs; its nearly nine billion pieces or if placed end to end enough to circle the moon almost four times. Kiplinger reports that 90% of parents admit to snagging candy from their kids stash. Thank you NY Times for compiling the stats.

Speaking of Candy: If you have not heard Seinfeld’s take on the topic and Halloween its worth the download (http://youtube.com/watch?v=lIFBUKKeqU4).