Just Sold my Cost Plus Nov Puts

Options will be the death of me. Sometimes I make killer money (TIE & JLP Calls) and sometimes I lose my shirt (TIE Calls again & CFFN Puts). In this case, I made 31% on my money, which works for me.

Cost Plus released quarterly earnings which were awful. They had to drop margins to grow their sales and that is a sign of struggling.
Hint: when you start receiving flyers in your mail box from retailers, notice the frequency. Bed Bath & Beyond went from monthly mailers to weekly, a sign of problems.

I have predicted havoc in the housing market to hit housewares and durables and I have been correct. Sadly, the market does not want to drop the stocks the way they should. And that's the general issue with investing: analysts tend to wait for the numbers to be released because they can release opinions based on facts and not judgement calls. This of course is less risky and more stupid, and this si where investing against the market makes sense.

I look at ILMN and UCCT and I see small cap companies with massive growth. I invest because I believe that the market will notice and reward.
I would rather put money down on companies to grow, but sometimes it is too tempting not to invest on the company going down. For example, JNPR & CSCO. This is a zero sum game: if JNPR is winning, CSCO is losing, and vice versa. CSCO's great release is not a sign that everyone is doing well - rather, it is a sign of JNPR doing badly. So when JNPR rose in sympathy, I considered buying puts. Same with RSH. If Best Buy and Circuit City are stealing the high end and Walmart is stealing the low end, RSH gets squeezed out.

Other times, it is not a case of one winner and one loser but all losers. There is no way on god's green earth that a housing slowdown is good for homebuilders and suppliers of things to a home. I searched for a long time for a door manufacturer and a window manufacturer to short. Think about it: there are dozens of doors in a house - cancel construction on a few thousand houses and a door maker loses hundreds of thousands of shipments. Cancel a few condo high rises in Florida, and window makers and glass makers are hurting. Compared to one refrigerator per home that gets unsold.

In the end, I found that these companies were privately held. So the best I could do is short BMHC, which has been incredibly resilient in the face of reports that they can expect 35% less business going forward. But we have to wait for the quarterly numbers to get released before we can do anything to th estock price......

That's why I shorted ETH and WHR - there are fewer places to install washing machines and a new couch. Growth will stall. It's a matter of time horizon - waiting for th emarket to accept and acknowledge.

Mellow CPI - great news

The CPI was mild after removing gas prices.

In actuality, inflation for nearly all categories is still racing at a 3%+ rate. What pushed down the CPI this time was transportation and apparel. Airlines and auto companies cut prices, while clothes dropped as stores cut prices on Fall inventory and released winter wear.

What the Fed wants to point out is that 2005 had 3.6% inflation and so far in 2006 we have ~2.4% (a bit higher when you add in food and a lot higher when you add in oil). So for Fed watchers, this is a sign that inflation is moderating for now and interest rates won't be raised.

While folks will quibble with the measurements (why should oil be removed?), the point isn't the absolute level of inflation but the direction. As long as inflation continues to remain mellow, the Fed will not raise rates. Also, note that in real terms, GDP is now approaching 0%.

This sets the stage for the next phase: the housing meltdown. A bust in the housing bubble brings 3 cumulative impacts to consumer spending:
1. Sudden drop in employment. Most of the unemployment will come from a combination of construction workers and real estate agents, with another significant portion from related industries, banking and retail. Before you dismiss these as low-paying jobs, recall that these workers earned an average of $50K, so 500,000 laid off workers is $25B less in payroll (or $12.5B less available to buy goods and services). I think the firings will begin in earnest around February/March as projects get finished and cancelled.
2. Reduction in home prices reduces homeowner consumer spending. Historically, as home prices drop, people tend to be more reluctant to spend because they feel less wealthy. Most homeowners have already pulled money out of their home equity and spent it. They are less likely or able to withdraw more. That will slow a significant chunk of spending.
3. ARM refinancing. Notice that foreclosure rates have tripled since last year and are still rising? That's because folks who weren't qualified to buy their homes got financially overstretched. The effect will pick up steam as even more folks begin to get squeezed. Bankruptcies will surge next year. The net effect is, again, less consumer spending.

Consumer spending is the engine of growth. When it slows, recessions begin. This is axiomatic. The important thing to note is that the economy is already slowing before these financial stresses hit. Imagine what will happen ove rthe next 12~18 months as the economy cools down AND these stresses hit.

That is why interest rate flexibility is so important to the Fed. If it can continue to see inflation dropping, then it can consider lowering interest rates. A lower interest rate helps companies and helps individuals who have ARMs resetting, for example. Do not expect a repeat of the 2001~2004 cycle when rates were cut and everybody splurged. Far too many people have overcommitted - to home loans, HELOCs, and 12 months free financing on that new couch. The recent economic boomlet was, if anything, bringing future spending into today.

In the meantime, the market should be happy with cooling inflation, but wary because it is actually a sign of worse things to come.

Market Still Rising

This is the stock market calculus at the moment. If interest rates don't go up and corporate earnings stay strong, then life is very, very good.

I think they have it half right: interest rates may not go up, but corporate earnings will not stay strong. I think yesterday's report on retail sales and PPI showed why. The Fed has successfully navigated the inflationary pressures of oil and a booming housing market. They held off future hikes in the hopes that moderating oil prices as well as falling housing construction demand would lessen the CPI. And I think it's working. The biggest component of inflation is consumer wages and there is pressure there, but it is offset by falling costs of goods.

As anyone who follows the concepts of the business cycle, the classic signs prior to a recession are hiring strength and wage pressures as production and prices start to fall. And that's where we are.

Where I think the market is wrong is that they ignore the flattening sales while still expecting corporate earnings to be strong. It is possible for companies at this stage to maintain strong earnings in the face of retreating sales. All they have to do is squeeze their vendors and the margins look great. That will probably be the case into the Summer - softening sales but strong earnings.

So I am wrapping up my stock review - I am concentrating on stocks that will show both strong sales and strong earnings growth. Like UCTT (which is up almost 10% since we were stopped out).

My Afternoon with Benjamin Netanyahu

I had the opportunity to meet Benjamin Netanyahu and hear him speak.
Not only was he Prime Minister of Israel back in the 90s, Mr Netanyahu was most recently the Finance Minister. During his tenure as Finance Minister, he drove major economic reforms through the country, pulling it back from being the most regulated and government dependent economy to an open market that is now leading the world in patents and technology.

He spoke about 3 things
1. Israel's huge growth and the contributing factors
2. Globalization
3. Anti-globalization

As he put it, taxes, government spending and regulations were problems for Israel. He embarked on cutting taxes, decreasing government spending as a share of GDP, and removing regulation obstacles. It worked: Israel moved into hyper growth the last few years despite fighting a costly low-level war with the Palestinians.

Netanyahu made the case that the lobal trade today is unknown in the history of mankind. That countries will be forced to compete for businesses by lowering barriers. Otherwise, you get malaise like in France. Strong players are not the owners of minerals and raw materials, but the countries that leverage mind-power. He pointed out that the benefits of this rising globalization is a better quality of life for everyone: rich and poor. To paraphrase, would you rather allow a handful of people to get super rich and a significant number of poor become middle class, or would you rather prevent a handful of people from getting super rich and keep the poor in poverty? Countries with truly impoverished people - India and China - have decided to let their people gain wealth and improve their lives. And the consequent result is increasing democracy, better education, more women's rights, and more individual rights.

He concluded by pointing out that there is massive resistance to globalization. We have seen it especially in France, which is losing out to the other Europeans in terms of growth and quality of life. He especially pointed to Militant Islam as the largest force working to fight globalization. Not only do they want to turn back the hands of time to a period 1000 years ago when Islam ruled a wide swathe of the world. They also are not rational. That is, even the Soviets in their peak could be swayed into a rational position (Cuban Missile Crisis, Berlin).

I'm not 100% behind Netanyahu's statement that China & Russia are rational. They have massacred millions of their own people.

Netanyahu went on to say that the suicidal component of Militant Islam makes it irrational. They don't care about people, their own or others, because it all brings about a holy apocalypse. His point being that if 1 Billion people follow Islam and a chunk follow Militant Islam, then that's a large number of people who actively seek not only a return to the glory days of Islam, but the death and destruction of their enemies of Islam (the US being the Big Satan).

Powerful stuff. Certainly you can argue that every stage of modernization brings anti-modernization elements out. The Luddites. The Middle East was and, to a large degree still is, incredibly feudal. Suddenly Western ways (aka individual rights and freedoms) are being thrust on them. What do they have to offer instead? Certainly not a better quality of life, but they do offer holy salvation, whcih goes beyond this world.

I suspect that at some point even China will wake up if the West really sees threats. After all, we are the Chinese markets, and an impact on us has a bigger impact on them.

Retail Sales and PPI Release Today

The Retail Sales report for October was released today together with the PPI.

First, the data.

• Sales were down 0.2% versus September
• September Sales versus August were also revised down from -0.4% to -0.8%
• Sales were up 4.5% versus October 2005
• Auto and parts sales were up a blistering 10.1% over last year

SALES ARE SHOWING SIGNS OF SLOWING
Start with Auto vehicles and parts. This represents 21% of the total number and it grew 10% YoY. The growth was due to major discounting to boost sales. If we net out Autos, retail sales were up 2.4% or just under the rate of inflation (the report does NOT adjust for prices).

Gas prices play a more interesting role. Here are the key basic data points
Oct vs Sept sales dropped ~$1.5B
Oct 2006 vs 2005 sales rose $16.3B
Gas prices alone dropped $2B from Sept to Oct, reflecting lower October fuel prices. On an annual basis, gas sales dropped ~$4.4B last year. Recall that the Katrina impact last year was to reduce fuel consumption across several states.

In effect, we have auto sales artificially boosting the numbers and Oil prices bringing them down. Adjusting for these, we get:
Oct vs Sept sales dropped ~$1B
Oct 2006 vs 2005 sales rose $13.8B

A more normalized view (excluding gas and auto) shows that we have a flattening sales picture and that sales growth YoY is 4%. By way of comparison, for the total 10 months to date, Sales (excluding autos & gas) grew 5.55%.
If we net out inflation, the growth is barely above 1%.

On a year over year basis, everything looks sound except for gas and general merchandise (Walmart).

This fits in completely with my overall view: still growing but at a slower rate. Also, the odds are that they will revise downward as they have done each month for the last 6 months.

So with growth moderating, what does that mean for interest rates? Depends on inflation. A 4% retail sales growth when inflation is 4% really means flat growth. A 4% retail sales growth when inflation is 2.5% is growth.
CPI gets released Thursday. Last month, a significant easing in CPI was met with a great sigh of relief.
The PPI today showed a large drop (-1.6%), even deeper than last month. Again, a lot of this is oil related. If you remove oil and food, the drop is much less but still present. In other words, producers are not showing inflation at this time. Having said that, it is worth noting that prices are easing for raw materials - steel, copper, lumber, granite and so forth.

Typically, prices drop for three reasons: demand is slowing, supply his rising or input costs are moderating. Certainly, with oil prices falling, production costs are lower. I think th ereal culprit is that demand is not rising as fast and that supply is catching up.

For raw materials and companies dependent on raw materials, this is not a sign of future growth potential. I would see consolidation on the near-term horizon

Buying ILMN

Buying 500 shares @$40.38

A great opportunity

Thoughts for the week

This week will be dominated by two things: economic data and options expiration. Options expired last week, and I think that applied some up pressure that forced some short covering. That pressure is gone for now. The economic data probably won't show a strong and growing economy without inflation.

In the meantime, some interesting tidbits

HOUSING
The CEO of KB Homes has left. Classic rat leaving a sinking ship.

RETAIL & CONSUMER SPENDING
Walmart is slashing prices to jumpstart a holiday boom.

OIL
Prices hit $61 and have eased again. Supply is actually tighter than it may seem. Patience is needed here. The proposed offshore ddrilling restrictions do affect companies like ESV to a certain degree - but they have left US waters for greener pastures elsewhere anyway.

INDUSTRIAL PRODUCTION
This week will likely show slowdown outside of aerospace. Avoid industrial or machinery not tied to aerospace

SEMICONDUCTOR
Volume of chip production remains high, but ASP (average sales price) pressure is strong. Only niche semi stocks or semi machinery stocks are worth considering.

DEFENSE
The heyday is over for now. Companies like Lockheed Martin look great based on historical business, but I really wonder if the Defense spending can grow to maintain their success.

What should be expected when investing?

Many of us have had a stock or two that was like a rocket. I have had the chance to own TIE, HANS, & NTRI when it seemed like every month was a new high.

The challenge that I face is recognizing that these stocks are the exception and not the rule. Otherwise I invest expecting every stock to behave like a star. The fact that some stocks can race up is a reward rather than something to be expected.

A good example is in Baseball. I want players that all have homerun potential but that can at least grind out singles and doubles. I accept players go through slumps, but I can't have falling stars on my team. A group of players that consistently perform will win the pennant.

In reviewing stocks, I am looking for solid performers. The companies that can be expected to grow their business 20%+ come rain or shine.