Expect Three More Fed Rate Hikes
Posted by Eddy Elfenbein on November 10th, 2005 at 9:59 am

William Poole, the President of the St. Louis Federal Reserve Bank, said yesterday that the Fed’s interest-rate policy ought to be “risk-averse.” That may not seem like a big deal, but in the carefully-worded world of central bankers, that’s considered to be going ape shit. I’m surprised Poole wasn’t taken down with a Taser.
In English it means, or the market is taking it to mean, that the Fed is going to raise rates three more times. Until now, the market was expecting two more rate hikes—one on December 13, and another on January 31, which is also Greenspan’s last day. Now the market is also expecting another rate increase at the Fed’s March 28th meeting. That will bring the Fed funds rate up to 4.75%.
Here’s a graph of the futures contract for the Fed funds rate for next May. You can see the spike around the time of Katrina when the market thought the Fed might put off its rate hikes. Even though that was just over two months ago, the market’s perception has since changed quite dramatically.

The 10-year Treasury bond is currently yielding 4.64%, so the yield curve could be slightly inverted in just a few months. The 30-year Treasury is yielding 4.82%. Actually, it’s a 26-year bond; the U.S. Treasury hasn’t issued a 30-year in four years. But thanks to budget deficits, they’ll be returning in February.
The interest rate gap between the U.S. and Europe has been getting steadily wider, which has helped the dollar rally this year. Two straight weeks of rioting has also helped the greenback. On the other hand, the trade deficit surged to a new record in September. The trade deficit jumped 11.2% to $66.1 billion. The deficit with China was over $20 billion.

The Market Today
Posted by Eddy Elfenbein on November 9th, 2005 at 5:45 pm

The market closed its fifth straight boring-as-hell day. Not that I’m looking for excitement, but this is getting ridiculous. Let at these numbers: the Dow, +6.49 points, the Naz +3.74 and the S&P 500 +2.06. Of the 100 stocks in the S&P 100, 74 moved less than 1% today. This is like watching the WNBA. The VIX (^VIX) is now back below 13.
Here’s something a little bit interesting. After an accounting scandal earlier this year, American International Group (AIG) restated its profits for the last five years. It turns out that the company had overstated its profits by $3.9 billion. Hey, those pesky decimals can be kinda confusing. Millions, billions, kilometers, it’s all one big blur. Well, now the company is correcting the correction. AIG says that it understated the previous correction by $500 million. That’s nice to know but something tells me this story isn’t quite over.
Here’s a little tidbit from the Wall Street Journal on Hank Greenberg, AIG’s former Grand Poobah.

When AIG executives traveled with him on business, they were required to use the small pilots’ bathroom in the front of a corporate plane. A large, fancy bathroom in the back of the plane could be used only by Mr. Greenberg, his wife and their Maltese dog, Snowball, according to a former AIG executive.

A dog named Snowball? Wasn’t that Trotsky in Animal Farm? Or wait, that was a pig. But still, Snowball? The bathroom??
Moving on, the Buy List had a decent day. We beat the market again. The S&P 500 was up 0.17%, and the Buy List was up 0.44%. Both Fair Isaac (FIC) and Expeditors (EXPD) hit new 52-week highs. Danaher (DHR), the tool company, reiterated its fourth-quarter forecast. I like to see companies do that around the middle of a quarter.
Outside our Buy List, Cisco (CSCO) reported earnings after the close. I’m enjoying this because this is the first time Cisco is required to expense its stock options. Several tech stocks fought this regulation hard. Cisco regularly had its earnings inflated by about 20%.
Just two months ago, Cisco was trying to get the SEC’s approval on a shady option-expensing scheme. Fortunately, the SEC shot them down. I always enjoyed hearing people on CNBC say that Cisco has a P/E ratio of around 16. Yes, by their accounting.
For the quarter, Cisco earned 25 cents a share, 20 cents without options. Including options, the Street was looking for 24 cents a share. Starbucks (SBUX) just said that options-expensing will cost them about 9%.
And finally, General Motors (GM) fell to another 52-week low as Delphi reported that its loss widened by seven-fold.

Investing Tips
Posted by Eddy Elfenbein on November 9th, 2005 at 2:40 pm

The worst investor in the world is the investor who’s down a little, and thinks he or she can make it back by doing something dramatic. This usually involves “doubling-down,” or using a lot of margin, but it usually winds up turning a small loss into a major problem. They delude themselves into thinking that a quick fix—just this one time—can correct the shortfall.
When you’re down in an investment, you can’t let your emotions get the best of you. The first lesson is that the stock doesn’t know you own it or what price you paid. I often hear from investors who own horrible stocks but they refuse to sell because they “don’t want to book a loss.” The stock isn’t aware of your entry point. If it’s a good stock, then keep owning it. If it’s bad, then sell. It really is that simple.
Here’s a chart of Expeditors (EXPD) going back 20 years. You can see that there’s never been a time that was “too late to buy.” And with many lousy stocks, it’s never too early to sell.

Value is a relative. If Google‘s (GOOG) stock were to fall by $100 over the next few months, you’d hear people say that it’s cheap. No, it would be cheaper than it was, but it’d still be wildly overpriced. We all have different yardsticks, but good investors don’t toss theirs aside when it tells them something they don’t want to hear.
The Wall Street Journal reported that a judge has frozen the assets of a hedge fund. The manager “admitted that he had lost a large amount of money in the fund and had deviated from its original investment strategy in order to make up for losses, the SEC said.” Even pros make this mistake.
Just a few weeks ago, we saw Frontier Airlines (FRNT) plunge. I didn’t panic. I didn’t sell. I didn’t “double-down.” Instead, I waited. The storm passed, and we’re back where we were. This is why I love investing. As long as have a good strategy and high-quality stocks, sometimes the best thing to do is nothing at all.

Oil Exes on Capitol Hill
Posted by Eddy Elfenbein on November 9th, 2005 at 12:06 pm

Calling these hearings a circus would be an insult to America’s fine carnival-based economic sector.

James Mulla, chairman of ConocoPhillips, said “we are ready open our records” to dispute allegations of price gouging.
ConocoPhillips earned $3.8 billion in the third quarter, an 89% increase over a year earlier. But he said that represents only a 7.7% profit margin for every dollar of sales.
“We do not consider that a windfall,” said Mulva.

The committee’s #1 target is Lee Raymond, the CEO of ExxonMobil (XOM).

Raymond said Exxon Mobil’s exploratory and capital spending plans are based on how long it takes to bring new wells, plants or other developments into production. The company’s planners pay no heed to daily or quarterly fluctuations in crude-oil or gasoline prices in deciding when to fund a project, he said.
In 1998, when the Asian economic collapse cut global oil demand and prices dropped to $10.35 a barrel, Exxon Mobil spent $15 billion on new projects, almost twice the company’s net income, he said. This year, the company plans to spend $18 billion, up from $14.9 billion in 2004.
Exxon has raised its spending budget for this year twice in response to soaring costs to rent drilling rigs and purchase steel pipes.
“Someone could argue that in 1998 we invested way too much money,” Raymond said. “My comment is the valley will be coming. And when the valley comes, we’re going to continue to invest.”

A Dull Market
Posted by Eddy Elfenbein on November 9th, 2005 at 10:56 am

Dear Lord, this is a boring market. This is the S&P 500 for the last four days; up 0.43%, up 0.02%, up 0.22%, down 0.35%, and today we’re up 0.08%.
The Buy List is up 0.32% today. Wake me when something happens.

Hedge Funds Lost Money in October
Posted by Eddy Elfenbein on November 9th, 2005 at 10:34 am

October was a rotten month for hedge funds:

Hedge funds lost money overall in October, while strategies that trade equities fared the worst as stock prices fell, French business school Edhec said.
Long/short equity hedge funds which buy and short sell — sell a security on the expectation of buying it back cheaper at a later date — lost 2.41 percent on average in October, knocking their year-to-date returns down to 2.13 percent.
That compares with losses of 1.98 percent in October for the MSCI index of world stocks and gains of 7.10 percent in the 10 months since January.
“The month of October was characterised by the poor performance of global stock markets,” Edhec said in a statement.
“Value and small cap stocks performed even worse than the broad stock market. Stock market volatility rose.”
The Chicago Board Options Exchange’s Market Volatility Index, also known as the fear gauge and a benchmark measure of U.S. stock market volatility, hit a five-month peak of 17.19 on October 13, but has since slipped to around 13.
However that rise in volatility allowed one group of hedge funds, those that trade the different components — bond, equity, volatility — of convertible bonds, to make positive returns for the fifth month running.
Convertible bond hedge funds returned 0.24 percent in October although in the year to date they are still down 3.10 percent.
Managed futures funds, those that take directional bets in bond, stock, currency and commodity markets using computer models that give out buy or sell signals, lost 1.49 percent in October and year-to-date are up only 0.15 percent.
Event-driven strategies, which include those that aim to profit from potential takeover deals, were down 1.35 percent but up 1.28 percent for the first 10 months of this year.
“The returns for the month of October confirm the general trend over the last year, where hedge funds have performed below their historical average,” Edhec said.

Two Stocks Go Private
Posted by Eddy Elfenbein on November 9th, 2005 at 9:59 am

In Peter Lynch’s “One Up On Wall Street,” he said that he first heard about La Quinta (LQI), when has asked someone at rival Holiday Inn who their best competitor was. Lynch, who was then the manager of Fidelity Magellan, later found out that La Quinta was covered by just three analysts. His point is that some of his best investment ideas didn’t come from highly paid research analysts. He wrote:

If IBM goes bad and you bought it, the clients and bosses will ask: “What’s wrong with that damn IBM lately?” But if La Quinta Motor Inns goes bad, they’ll ask: “What’s wrong with you?”

That’s very true. Later, Lynch spent a few nights at La Quinta; he liked what he saw and bought the stock. It became a huge winner for the fund. Today, La Quinta announced that it’s going private. The Blackstone Group is buying it out for $3.4 billion.
What’s strange is that this is the second private equity deal in the last two days. Yesterday, Linens N Things (LIN) said it’s being bought out for $1.3 billion. Doesn’t anybody like the stock market anymore? Yes, I know there have been some dubious IPOs in the past, but I’m curious if going private is a trend.

Electronic Paper
Posted by Eddy Elfenbein on November 9th, 2005 at 6:25 am

Behold the future, “electronic paper.”

“Electronic paper” is a display technology that makes possible flexible or even rollable displays which, unlike current computer screens, can be read in bright sunlight.
But, much like when LCD displays came to the market, consumers are first likely to see the technology in clocks and watches. The popular example of an electronic newspaper that automatically updates itself wirelessly is still years away.
A number of companies are currently working on such displays—LG.Philips LCD and Massachusetts-based E Ink announced last month that they have developed a protype 10-inch display, and Fujitsu showed a color display in July.
Philips’ Polymer Vision unit aims to mass-produce a rollable 5-inch display by the end of 2006, and among the first consumer products is a watch with a curved electronic paper display from Seiko Epson, due to hit the Japanese market next year.
Electronic paper was invented in the 1970s at Xerox’ Palo Alto Research Center by Nick Sheridon, who now works as research director at Xerox subsidiary Gyricon, which makes electronic paper signs.
“If you remember the green-screen monitors—it drove him crazy and he was looking for something that was easier on the eyes,” Gyricon spokesman Jim Welch said.
Electronic or paper?
The technology at the heart of electronic paper? Tiny black and white particles that are suspended in capsules about the diameter of a human hair.
The particles respond to electrical charges—a negative field pushes the negatively charged black particles away to the surface, where they create a black dot. Positively charged white particles create the opposite effect.
At a 10th of a millimeter, the thickness of an ordinary sheet of paper, electronic paper is much thinner than the liquid-crystal displays (LCDs) used in today’s computers and mobile phones.
It also consumes 100 times less power because it does not require a back light and only needs electricity to change the image, not to hold it.
Like ordinary paper, it reflects light, making it readable even in difficult conditions such as direct sunlight.

I think Xerox PARC invented everything.

The Market Today
Posted by Eddy Elfenbein on November 8th, 2005 at 4:46 pm

Except for the homebuilders, it was another quiet day on Wall Street. Here’s how the 20 top homebuilders did today:

The S&P 500 lost 0.35% today and our Buy List fell 0.20%. We’re still ahead for November; 2.39% for us compared with 0.96% for the S&P 500.
There’s not much to say about today’s market. This marks four straight days of little movement. The S&P 500 has bounced between 1215 and 1225. Dell (DELL) came within a penny of matching a 52-week low. I’m curious at to what Dell will have to say on Thursday. I’m particularly interested in its guidance for next year (Dell’s fiscal year ends at the end of January). If the low end of Dell’s forecast is $1.82 a share or more, then it would give the stock a P/E ratio of less than 16.

TO & Guidant & JNJ
Posted by Eddy Elfenbein on November 8th, 2005 at 4:04 pm

On Sunday, I watched the Redskins beat the Eagles 17-10. The Eagles didn’t have their star receiver Terrell Owens, and I don’t think his presence would have made a difference. I don’t see how Owens can continue to a part of the Eagles anymore. In fact, I doubt he’ll play for an NFL team ever again. Seriously, who wants that headache?
“TO” is an immature, selfish, greedy brat. That’s not what you want from a football player. A hedge fund manager? Sure. But not a football player. He poisons whatever touches. Frankly, I think the Eagles deserve some blame simply for tolerating his antics for far too long.
You’re probably wondering where I’m going with this. After giving it some thought, I think the TO story has its parallel with some corporate mergers, or would-be mergers. As I’ve said before, I hate mega-deal mergers. They rarely work out. Executives love to declare them. They get to use business school words like “synergy” and “cross-promotion.” The stock market usually rewards the stocks, at first. But after awhile, the big deal is seen to be one big headache. Mega-mergers are the TO’s of Wall Street.
The problem is that these ”synergies” never work out. I’ll give you a great example. Fifth Third Bank (FITB) used to be an all-pro bank. (That name? The Fifth National Bank merged with the Third National. So they called it, Fifth Third. Yep, and it’s still better than Verizon.) This was a stock that creamed the market for years. They dominated banking in Ohio. From 1975 to 2002, the stock went up about 250-fold. Then they had to blow it all away. Fifth Third announced its mega-merger with Old Kent, a Michigan bank.
Suddenly, there were accounting problems. Followed by regulatory issues. Followed by a loss of market share. Now the share price has been cut in half, despite a rising market.
That’s how dangerous a bad merger is. A bank goes up 250-fold, and then falls in half. Now the word on the Street is that Fifth Third would make a great acquisition target. I mean, it’s so cheap it can’t possibly go any lower. Right? Plus, there’s synergy. It can’t miss! The latest is the Wells Fargo (WFC), or maybe US Bancorp (USB) are interested. Do these people ever learn?
We also have the story of Time Warner (TWX) desperately trying to ditch AOL. I rank this as the worst merger since the Hitler-Stalin Pact. This is The Onion from five years ago:

In the largest merger of imaginary assets in corporate history, Internet giant America Online last week acquired media megacorp Time-Warner for an unprecedented $161 billion in pretend money. “This merger will revolutionize the way invisible amounts of non-existent cash are transferred,” said Steve Case of AOL, a company whose actual revenues are a tiny fraction of its make-believe valuation. In an effort to keep pace with AOL, website blairwitchproject.com is expected to acquire General Motors sometime later this week.

The merger was going to revolutionize media. Cross-promotion! Leverage assets! Synergy! Then the bubble burst, and Time Warner was left carrying a dog. Is anyone really surprised? Microsoft (MSFT) and Google (GOOG) are now ready to square off in a fight for AOL. Actually, I’m not expecting much of a fight. I think Microsoft will win out simply because they need it more.
I don’t have anything against small mergers, or “fold ins.” Large companies are always buying up smaller companies. The problem is the “mega-merger” that’s based on concept not real business.
Look at what happened to Citigroup (C). They had the idea to make a “financial supermarket.” Hey, let’s take a mediocre bank, a mediocre insurance company, a mediocre investment bank and a mediocre retail brokerage, and smash them all together. It will make one great super-huge company! Actually, you get one gigantic mediocre mess. Notice how Lehman Brothers’ (LEH) stock keeps soaring, but Citigroup’s doesn’t. And now it’s Citi that’s selling off its insurance assets. My bet is that Citi will spin off Smith Barney and/or Salomon Brothers before the end of 2006.
Here’s a hint: You always know a merger isn’t going well when the name gets changed back. The “AOL” just disappeared from AOL Time Warner like some out-of-favor Kremlin official. Or Morgan Stanley/Dean Witter is now Morgan Stanley (MWD) again? Morgan Stanley was the epitome of the Wall Street establishment. It was originally cut loose from J.P. Morgan back in the 1930’s when banks and brokers had to part ways.
Dean Witter was the scruffy young upstart that brought Wall Street to the middle class. But together…they had Synergy!! This merger always reminded me of what Bette Davis said of Fred Astaire and Ginger Rogers: “He give her class, and she gave him sex.” How much longer does the “Chase” have in JPMorgan Chase (JPM)? Or Mobil in ExxonMobil (XOM)? Those aren’t spelling mistakes, by the way. Squished together names usually signify squished together companies. CEOs even try to synergize the alphabet. It’s what I like to call a “dumbassidea.”
Now we have to watch the sorry spectacle of Guidant (GDT) suing Johnson & Johnson (JNJ), demanding to be bought out! What are they thinking? Guidant, they’re just not that into you. Move on! Guidant did everything it could to screw up the merger, and now they’re angry that J&J has cold feet. There’s so much bad blood, how do they expect the merger to work out? Instead of $76 a share, Guidant now just wants $69. Please.
Both companies should forget about it, and pretend this whole episode never happened. It will be better for both. J&J, Guidant, TO and the Eagles never should have gotten together in the first place.