Why I am still in Cash

I am a great believer in the health of the economy. The earnings releases and other data points just reinforce how strong things are.

However, I am focused on the next Fed meeting August 8th.
1. Fed does nothing
2. Fed raises rates and says "we're done"
3. Fed raises rates and maintains options to do it again

It's all about the sacrifice ratio - how much economic growth the Fed will sacrifice to keep inflation down. Because we do have inflation well above their targets.

I have sat out the last 2 weeks (which have been very positive ones in the market). I have basically been willing to sit out a few points of gain rather than lose more if rates are hiked. Because I think that we are in either option 2 or 3, and the odds are that the market won't like either one.

If I'm wrong, then we'll get back in.

Meanwhile, the riskier model - Turbo - has several positions.

WFMI and Why LR is still in cash

WFMI got slammed today. Down 11%. They nailed earnings but had a slight sales miss. And I mean slight: they missed by $20M or 1.4%.

Is this a sign of consumer spending slowdown or just over-aggressive expectations? I vote for the latter. I think that belt tightening is happening but not for the WFMI customer base. These are wealthier folks for whom higher gas prices are an annoyance but not a behavior changer.

Does the drop make WFMI a buy? I've said that I think WFMI is overvalued based on P/E. They are growing just over 20% in earnings and have a 49 P/E. I feel that that is still unreasonable.

This is a great company with a great future. I would like to buy it at a cheaper price. Something in the 30s is more reasonable to me.
----------------------------------------

Last week the market surged 350 points. This week it is down 100 points so far. We remain in cash. Is that smart?

I look at the market as follows:
3 weeks ago Israel/Lebanon conflict starts. Dow was at 11,100
2 weeks ago Israel conflict really kicks off. Oil surges. Dow drops to 10,747
1 week ago Oil eases as the Lebanon/Israel conflict stays contained. Bernanke makes positive comments. Dow is at 11,051
Today Dow is at 11,100

In other words, the market sank and recovered on Israel/Lebanon and spillover issues. I don't think that we are on the way up. I do think that inflation fears and a likely rate hike will push the market down. So I am waiting for next week (the 8th) before moving. As always, it is something I review on a day-to-day basis.

Interesting Housing Anecdote

For a few months I have been using a friend's experience to defend my contention that housing was not just softening but dropping.

To re-cap the story, my friends put their house on the market in late February. They live in one of the Bay Areas more desireable areas. At $899K, the house was priced using comps and had a slight year-over-year increase. They had a further advantage in that there was only one other home <$1M at the time.

The home has good and bad points. It's a 3/2 with a decent back yard and almost 1600 square feet. It has outdated features and it needs a major overhaul (kitchen, bathrooms, windows), but that's pretty common for homes here. The biggest drawback is that it is on a main street.

The sellers bought another house and need to sell this one.

Very few folks visited and my friends didn't get any offers. They did get one offer with a contingency and the buyer backed out. The house went back on the market in May and at a lower price $859K. They lowered the price as a low-ball tactic - attract more buyers by offering a steal of a price. Almost 3 months later, the house is still for sale. They have lowered the price to $829K. That's almost a 10% price drop. Meanwhile, the house is costing them almost $5K per month out of pocket because they get no write-off: it's their 2nd home now.

Is my friends' experience unusual? I don't think so. Having options, buyers are once again paying for value and discounting were it applies. In this case, the reality of this being a dumpy house on a busy street in a desireable neighborhood makes it significantly less valuable than a nicer home on a quieter street in the same neighborhood. Common sense is returning.

These folks are close to a fire sale panic - they are staring at taking $100K less than they expected (when you include the ongoing $5K per month carrying costs).

Meanwhile, I'm sitting here and thinking that they will get a low-ball offer of around $790K. And that contributes to the overall trend that will anchor the comps downward. As new buyers emerge for next year, they will use the lower comps and further weakening market to argue for a price lower than this year's.

Housing Bubble bust is on

Slow and Steady? Not at all.
May housing numbers were revised downwards. June housing numbers were down 5.3% Y/Y and well below expectations.

What else can we expect to see?
New housing construction is slowing fast.
http://news.yahoo.com/s/ap/20060730/ap_on_re_us/condos_on_hold
Demand is disappearing for existing homes, so why build more.

Meanwhile builders are rushing to finish projects already begun. There is now 7 months of inventory on the market. Rather than lower prices, they offer incentives.
http://news.yahoo.com/s/nm/20060728/us_nm/bizfeature_mortgages_dc_2
Like free swimming pools.
"Extravagant incentives are most prevalent in states such as Florida, California and Nevada, where home prices had risen the most but are now seeing the sharpest softening, analysts say"
But those are developers. What about buyers?
"Speculators have driven up prices by flipping units, he said. But they're now leaving the market — driving down demand — and putting up for sale properties they own, adding to the glut."

"Many condo projects are priced high, in part because developers have to recoup the high prices they paid for land. But most buyers can't afford it."
Developers may be willing to sell at cost.

Housing prices set to plunge.
According to the recent June housing details, housing prices are flat nationwide. A review of metro areas shows that prices are already dropping in major metro areas. That's bad, considering that this is when prices are supposed to go up during the summertime strength.

Add the fact that thousands of new houses are coming onto the market and will be priced aggressively.

http://www.nytimes.com/2006/07/29/business/29charts.html?ref=business
The article rightly says that buyers and sellers are in a stand-off. Buyers don't want to buy at these prices and sellers don't want to drop prices. I guarantee that sellers will blink first. They have to because most of them are speculators. "Increased competition in a shrinking market" and only developers have the deep pockets to weather it out.

What will happen

I think that in 6 months, you will see developers freaking out. The summertime sales results will be clear in the statistics by October. Before that time, anecdotes of aggressive selling will be rampant. Developers won't wait for written proof, the way the general public does.

But developers still need to unload the housing. And so do the speculators. It's hard to estimate the actual gap between demand and supply, and that figure is decidedly local. For example, ~50 miles East and North of San Francisco in the CentralValley (Sacramento, Stockton, Fresno) is a major over supply. Housing supply has dramatically exceeded demand, prices are dropping already and foreclosures are up. 5% of all houses in that area are now for sale

http://www.mercurynews.com/mld/mercurynews/business/14976554.htm

Contrast that with the busy Silicon valley where 1% of all homes are for sale. That figure will double in 3 months as ~ 2000 new homes come on line.

Or Alameda, where the number of homes for sale has skyrocketed over the past year from 2000 to 14,000.

The focus will be on condos - the only affordable option to owning. Watch price competition between nice new condos and really crappy homes. Also, buyers will be insisting on contingencies that call for them to buy the house assuming they sell their own house. Anyone without contingencies will have an edge.

Builders will focus on squeezing more out of the land (which is the sore spot) by building up: more 3 story homes and townhouses.

Meanwhile, the value of the land will drop because builders will stop chasing it - they can't buy, build and sell. That doesn't help the ordinary retail home buyer much, however.

I look around Cupertino, Sunnyvale and Milpitas and I count 5,000~10,000 new townhomes and homes coming online shortly. Are there an additional 5,000~10,000 families waiting to buy? I would say yes. I don't see job growth (where is the massive biotech hiring? Silicon Valley is hiring - but not folks who live here). So these are more renters who seek to buy. And renters can wait.

I would say that developers won't slash prices for another 4 months, and then they will move aggressively. The fire selling will start in earnest in early 2007.

Meanwhile, folks who have to re-finance will get very burned and seek to unload as well.

May will be a massive fire sale building up speed to September.

The only safe place to be is in apartment rentals, especially higher end. A lot of people will move out of houses either to sell at the peak or because they just can't afford the house anymore. I don't have any suggestions at the moment, but an apartment rental REIT would make sense.

In my estimation, I think what will make sellers blink and drop prices 10%, and it's not the developers, it will be the sales agents. When homes aren't selling, they starve. The only way to coaxe buyers into buying is to lower the price. I do think that there are buyers but they are waiting for homes to drop in price. Pent up demand will only emerge as housing prices drop.

And agents will start telling sellers to do so. They will be the strongest advocates of housing price realities. Imagine that: a selling agent is actually the buyer's best friend.

The selling agent will point out the downsides of waiting to sell. They will also point out the costs of buying a home and letting their other home languish unsold for months - at least 5% of the home's value. And they might nit get that other home if they write contingencies tied to selling their first home.

Remember: the Real Estate Agents don't care about the housing price as much as they care about selling the home. While the 2 agents split the 6% commission (watch that drop to 5% btw as competition heats up), their agencies keep 4%. So the average RE agent gets 1% of the home sale price as his/her commission. A $50,000 drop in price means a $500 lower commission. if that's a $1 Million house, we are dropping the commission from $10,000 to $9,500. They don't care. They don't care if you drop the price $100,000. They need to sell these homes. They have no patience and no desire to starve while a greedy seller tries to pocket much more profit than they are rightly entitled to earn.

San Diego and Sacramento have already begun seeing roughly 2 years of price appreciation wiped out. If the same happened in the Bay Area, home prices would drop from ~$750K to ~$550K. San Diego, like the Bay Area, is considered a special market where prices never go down because of its special climate, business factors and land scarcity.

Meanwhile, office vacancy rates in Silicon valley remain flat. Businesses are not growing here. So I am left to wonder where the demand will be when we hit a recession and thousands get lai doff.

Stock Review: Part 2

More overviews of stocks.

PTSI - A vanilla trucking company that continues to surprise. They keep growing earnings ~40% each quarter and show no signs of slowing down. They are immune to oil price increases - those surcharges are passed on to customers. The key is margin growth: 85% of their costs are flat (fuel cost increases are offset with fuel surcharges).

PWR - PWR is part o fthe value chain of laying electrical and optical cable. Earnings growth is expected to rise 300% on a 20% revenue increase. My belief is that regular telephone companies must start offering video or they risk a slow and painful death to cable companies. The only option that I can see is to use optical fibre - laying optical fibre to each home. They would use companies like PWR to do the actual cable deployment.

RFMD - They had solid earnings on revenue growth of some 50%. RFMD is very cell phone dependent and I continue to have concerns about cell phone growth. But I love how they have a cheap forward P/E

STX - Komag and IVAC released strong earnings. I think that STX will do very well, although a slowdown in iPod sales will be offset by DVR sales. The PC sales slowdown will be dulled somewhat by an increase from game players (in a few months). Storage continues to be strong as well. In other words - there is growth but it is probably barely double digit. STX will be gaining from margin gains following its acquisition. There may be better opportunities. Meanwhile, I suspect that the price movement is an example of buy-on-the-rumor.

TIE - Strong earnings, expectations beaten, forecasts raised - everything I expect from TIE. TIE expects to reach $2 per share for 2006. A tthe same time, it will be adding production by year end. I am very positive about the company's prospects, but I don't feel that the market is behind it.

TRID - As expected, a blowout quarter. Sales up 150%. Earnings remain cloudy due to the options issue, but I'll assume that they at least come close to expectations. That gives them a ~25 P/E. Analysts continue to show only admiration for the company, but the market is mostly wary. I would suggest that they are amongst the most undervalued companies I have reviewed.

TRN - railroad cars and trucks. I am fascinated by this mundane company with strong sales growth. I definitely think that they are undervalued and worth buying at this price.

TTI - Like GRP, another drilling equipment/services company with a lot of oomph. I think that they will beat earnings. A buy.

VOL - Down 15% in 5 days. After beating expectations by almost 70%, it's been almost 8 weeks since their earnings. So they are settling down a bit.

WCC - Wesco's in the construction business and has been punished for it. It doubled earnings Y/Y and beat expectations by 10%. Nevertheless, I do see a winding down so I would avoid.

WIRE - Live by the sword, die by the sword. WIRE is a copper play
http://finance.yahoo.com/q/bc?t=3m&s=WIRE&l=on&z=m&q=l&c=pcu
And copper is back in fashion. Or at least not as oversold.

WSO - Air conditioning services. And this heat wave will boost their success. They just had earnings increase 27% last quarter, and I bet this quarter will be stronger. One of the reasons I own them is because of the housing construction boom: everyone will need air conditioning support.

ZOLT - Who knows? Seriously, this is a small company that could be huge. There is strong demand for their product.

ZRAN - They beat earnings but gave a weak Q3 forcast: potentially 5% drop in revenue. I don't like that fuzziness, otherwise I would say that they are a screaming buy.

GHL - Strong performance this quarter: earnings doubled Y/Y. I continue to be concerned about the insider shares that will get sold and dilute the value. However, they move exactly as the competition LAZ & GS except that GHL has the stock share overhang.
http://finance.yahoo.com/q/bc?t=6m&s=GHL&l=on&z=m&q=l&c=laz
http://finance.yahoo.com/q/bc?t=6m&s=GHL&l=on&z=m&q=l&c=gs
M&A continues to be a powerful draw. I recomend GS over GHL at this time.

ITG - I like this financial trading company. Slow and steady growth.

MRVL - What a beaten down stock. Close to its 52 week low, the price and PEG are now at the right level to get back in. A definite BUY.

PCP - I own this company and I just watch it grow. It was hit during the last 3 months but is back almost all the way. It supplies critical parts to Boeing and the military and sees solid growth.

CSH - Down following pre-earnings excitement. I see the long arm of an investment fund at work here - unloading post earnings. The company is growing and is well positioned for any slowdown. To be brutally honest, pawnbrokers and the like do better in bad times, and a slowdown in the housing industry will affect blue collar workers the hardest.
That being said, the market values their competition more highly:
http://finance.yahoo.com/q/bc?s=CSH&t=3m&l=on&z=m&q=l&c=ezpw
I find that strange considering that CSH is better value: better margins and lower P/E.

CELG - I feel that this is an overhyped company and the recent earnings continue to make me feel that way. Very little growth but a ~90 forward P/E.

SNDK - This is huge: SNDK is buying Msystems (FLSH). This was announced today and probably the reason for the recent stock run-up. This is a good move.

AKAM - Downloading has yet to peak. Movie downloading is still second to buying CDs. Meanwhile, TV show and movie downloading is just starting. AKAM is the leader here and there is plenty of room for others as well. In fact, if you are a cable company offering VoD, why not add music and movie download capability as well. Just as NFLX made Blockbuster a dinosaur, I suspect AKAM will suffer from Comcast or TWC VoD capabilities.
But demand is strong for this service.

GILD - Stable growth but margins are suffering.

WFMI - I love Whole Foods. They are growing and they have no competition to speak of. Sure, Walmart and Safeway and others want in, but they are just not going to do more than nibble at the edges. That being said, WFMI has a 51 P/E and that's just too high for me.

WHR (Whirlpool) - Sales rose 33% and profits fell 20%. Take out the Maytag acquisition and sales were up only 5%. And that 33% was 5% below expectations. Meanwhile, even with the extra sales, profits fell 20%. Hmmm, what isn't right here? WHR also admitted that materials costs are rising but it hopes to offset this with price increases.
WHR has cut expected North American unit shipment growth from 4% to 2%. North America is responsible for 75% of total sales.
So to net it out - growth is slowing but they hope to maintain sales by raising prices 12%.
So I am correct that the housing slowdown is affecting sales. I am incorrect that the hit would be felt now.
The question is whether things will get worse going forward. WHR is counting on at least keeping sales unit flat in North America and raising prices 12%. In their corner is sizeable market share (aka pricing strength), more homes being built (demand for appliances), and new products (hey! wireless refrigerators). I think a housing slowdown will be deeper than they expect, the pricing strength will not materialize, and nobody cares about their new products.
Meanwhile, they have to sell many of the companies they bought along with Maytag (Amana, Hoover). I expect them to have to take a writedown in goodwill because I doubt they will get full price during a housing slowdown.

ETH - Furniture is not quite done, it seems. Revenue rose 12% and earnings rose 15%. Not quite the drop that I expected. Nevertheless, I take comfort in the fact that they have stated slower expectations going forward. It has said that it doesn't have as much business as they expected ("written business").
Competitors are less excited. Stanley, Furniture Brands and LaZ Boys have admitted that problems are about to happen in the furniture business.

CPWM (Cost Plus) - Another in our housing stocks. Nothing new

RSH - Radioshack is struggling to stay afloat. They will fall 10% on bad news or a bad day in the market

NVL - They just got handed a default notice. Good for us.

Stock review: Part 1

Putting aside the STOPs that pulled us out of stocks, these are the stocks that I have discussed. As you will see, companies that I stumped for came through with solid earnings results.

AMX - Up 10% since we started investing in them a few weeks ago. They added 7 million users to their client base and earnings were up 33% Y/Y and beat analyst expectations. Half of the surprise came from a one-time event, but the story is about improving margins. I expect margins to continue to improve as efficiencies improve: declining incremental costs associated with the increasing client base

AAPL - Back in November I began saying that AAPL was overpriced relative to iPod business. In February I advised folks to short it. It fell from the high 70s to a recent low of $50. The day of earnings release I advised folks to close out the put orders. Good thing too - they ran from $51 that day to $65 this week. Excitement is building for the back-to-school and holiday sales, but I think AAPL will disappoint. Watch for Microsoft to launch an anti-trust lawsuit against AAPL contesting the iTunes monopoly: songs downloaded from iTunes store can not be played on anything but an iPod.

BMHC - Back in November I began saying that BMHC was a problem. In February I advised folks to short it. It has fallen from the high 30s to $21.

CCJ - Uranium. I like them, even if the stock is flat. The EU and India will need uranium. The revenue and earnings are strong: 45% and 366% respectively. But they are slowing a bit next quarter.

DIS - Pirates brought in the gold and continues to do solidly. International markets haven't been tapped yet and then there is the DVD market. I heard that the video game is lousy. In general, this movie plus the holiday travel to Disneyland parks should be putting bounce into Disney's step but not so far. Given the impact that Pirates will have on the next quarter earnings, this is one to consider for a 5%~10% short term upside.

DO - What a great quarter. Earnings up over 300% on a revenue jump of 81%. The downside to this story is that it is nearly 100% utilized, which makes near-term upside surprises practically impossible. Upside will come next year and when they are able to add additional offshore rigs. This is a stock to own long term - their earnings are projected to grow 300% over the next 15 months. But for the near term, I would look at DO as accumulate on weakness. They may also raise dividend rates.
I suspect that some contracts are expiring over the next few months, enabling DO to charge much higher rates, but that is limited. Any rig coming off contract today could get an additional $100K per day or $36M extra in pure annual profit.
With 129M shares outstanding, that's an extra $0.29 per share or $6 per share price at 20 P/E. Good, but not exciting. More rigs are what matters.

EMT - Sales up 10% and earnings up 41%. This has a $16 price that we want to hit and then leave.

ESV - Another drilling winner. Earnings up 200% on a 100% increase in sales. As I mentioned in previous posts prior to earnings release, ESV's prices jumped 75% during the quarter. Like DO, ESV is challenged by 97% utilization rates. Where do they go from here?
"Our rig construction projects remain on schedule and within budget. Our new ultra-high specification jackup rig, ENSCO 108, is scheduled for delivery in the second quarter of 2007. The rig is already committed for work in Southeast Asia following delivery. ENSCO 8500 and ENSCO 8501, our two new ultra-deepwater semisubmersible rigs, are scheduled for delivery in the second quarter of 2008 and first quarter of 2009, respectively. Both rigs are being built against firm multi-year contracts."
You should hear 2 things: strong demand and limited supply. ESV like all other drill related companies are maxed out. To give an idea of the value of 1 rig: daily rates are touching $200K. One rig delivers ~$72M per year in revenue.

ET - Strong results. After boosting earnings 50%, ET raised earnings outlook ~10%. They are firing on all cylinders: accounts grew 58% and trades stayed fairly strong in the face of the Q2 turmoil in the markets: daily trading shrank from 180,00 to 161,000. They are also getting strength out of the merger - lower operating costs with higher revenues.
The one thing I like about ET is their forward looking marketing. They are entering China - and that's something that will only help. imagine the margin income as Chinese traders discover the opportunity to get cash and bypass banks.

GRP - Yes, please. Another big quarter for an oil drilling company. Earnings up 50% on a 36% revenue jump. And margins increased as well (sorry, bad pun). Profit for the drill bits segment of their business increased 98% on 25% revenue increase. They also increased earnings expectations. And they are incredibly cheap: 18 P/E

ISIL - Another misunderstood chip company. Earnings were up 150% on a 35% jump in earnings. Sequential earnings were also up. But ISIL got hit because of some exposure to the PC market. I think that this is actually in ISIL's benefit: they are the ones benefitting from a PC slowdown because they are more nimble than bigger players. ISIL is stealing business from bigger companies.
Nevertheless, the upside here is limited.

JBLU - This stock hops around. JBLU continues to grow the business and there is some margin improvement. But they are at the mercy of oil prices.

JLG - Construction continues to be strong, but you wouldn't know that by looking at JLG's stock price. Even CAT raised earnings expectations. Watch for a run to $22. Not a long term buy - construction will be slowing down soon.

JNPR - We own puts on JNPR and they had a market sympathy move. Consolidation among their customers is hurting them. I expect nothing but bad news from them.

JOYG - You wouldn't feel any joy owning this stock. Another casualty of a disconnect between earnings and stock price. They will have incredible earnings. However, like JLG, they are at the tail-end of the boom.

MDR - Another oil and energy equipment/services company poised to show strong results. This is a buy. Probably LEAPs.

NTRI - I loved what NTRI produced this past quarter, but there's a reason we have been out of them. I think that they are fairly valued. Oh, don't get me wrong: I still love them. I like the way they are bringing Dan Marino onboard as a celebrity spokesperson. Women are bombarded by whats-her-name at Weight Watchers. Men are as big a market (pun intended) and they are untargetted.
The company is doing great: earnings up ~300% on 220% revenue jump, beating expectations by almost 20% and 10% respectively. Margins are strong.
I almost jumped back in when the company shed (heh heh) $13. But I do worry when the president quits so abruptly. I am re-thinking them.

NUAN - After crushing earnings for 3+ quarters, NUAN only met expectations last quarter. They dropped ~40% in price. Creeping back up, the stock price is starting to show faith in the numbers: expectations of 100% sales/earnings growth. I love the NUAN story and this is a buy. Ever since I heard that they came out with a Hindi version of their voice recognition software, I knew that we had a strong management at the company. a NUAN deployed system is even cheaper than using a help desk in bangalore. Watch Indian companies use it to make themselves even more aggressive

Week 38 Performance: LiveRocket up 0.12%

Week 38
Dow 3.26%
S&P 3.15%
NASDAQ 3.66%
LiveRocket 0.12%

YTD
Dow 4.69%
S&P 2.48%
NASDAQ -5.03%
LiveRocket 19.38%

Since Inception (Nov 4, 2005)
Dow 6.6%
S&P 4.9%
NASDAQ -3.5%
LiveRocket 30.74%

With the exception of EMT, we have been in cash. As I explained last week, I wanted to see how the market would react to the housing results. Housing reports showed much steeper declines as well as price drops in key markets. The market didn't care.

I also wanted to see a consistent consolidation in the markets and that seems to be happening. The week was very strong.

The remaining question is whether the Fed will raise rates again. The market has voted in favor of no more rate increases. It believes that a slowdown is acceptable as long as there is interest rate visibility. In fact, the market surged on Bernanke comments that were interpreted to mean no more rate hikes.

I am still not on board yet. First of all, I think much of the recovery last week was partly a recovery from the prior week's drop from the Israel/Lebanon conflict. Second, I am not convinced that rate hikes are over. And a rate hike will hit the market hard.

While GDP is dropping (from 5% in Q1 to ~2.5% in Q2) inflation continues to rise. The Fed may assume that its efforts to slow down the GDP may be sufficient to create the desired inflationary slowdown as well. Indeed, many people think that the Fed should ignore the increasing inflation rate. Inflation is a lagging metric - so future inflation may be lower. Second, housing and oil drive most of the increase - take out housing, food and oil and prices are tame.

But that is a false reading of the facts. The reality is that inflation is very present. The May CPI drop was actually driven by a large drop in oil prices. The June core CPI (which excludes oil and food) was UP MORE THAN EXPECTED. It hit 0.3% and was higher than 0.2% expected. This is the 4th straight month that the core CPI has hit 0.3%. The Fed wants a much lower rate.

The challenge is that the inflation is caused by oil. For example, airplane ticket prices drove up some of the CPI - those ticket increases caused by higher fuel costs.

I think the Fed has a challenge: it can not control oil prices but it can not ignore inflation. The only thing the Fed can do is to accpet a new, higher inflation target that reflects the higher costs of oil. In which case no more rate hikes.
-----------------------------------------
Last week I suggested taking LEAPs if you wanted to invest in the market.
Specifically, I pointed to the Jan 08 ESV $40, then trading at $7.70. They now trade for $12.

ESV was, as I predicted, a massive hit - price doubled 20%.