GDP & Housing Revisited: I was Wrong

Last week I presented the GDP and housing data. I said that we could ignore housing data because it registered existing home sales and that selling/buying an existing home was not really producing/consuming and could be ignored.


This was wrong.


The factor I was looking at registers sales of existing homes only when they are government owned (think VA). Otherwise it registers new home sales and the investment made in those homes. That would also include upgrades to an existing home (new kitchens, for example).


As such, it absolutely reflect something produced and needs to be judged on those terms.

I apologize and would like to revisit the data and see what it tells us.

For the period Q1 03 ~ Q1 06, residential investment was additive to GDP. Generally adding 0.3% to the GDP. Also note that GDP has been bouncing around 3% for 3 years (Q4 05 being an anomaly caused by Hurricane Katrina).

The additive nature of housing reversed course Q2 06 and started to reduce GDP and at an accelerated rate:
Q2 06 -0.1%
Q3 06 -0.6%

Q4 06 -1%

Q1 07 -1.1%

At the same time, the rest of the economy has accelerated. It raced up from 2.8% to 4.1% in Q4 2006. It has eased a bit this last quarter to 3.2%, but that pace is still higher than much of 2004 & 2005.


To summarize: while housing is decelerating greally fast, the rest of the economy is accelerating.

Or is it? Before we break out the champagne, it is important to note that a lot of that growth is really due to higher spending on oil/electricity, food and medical expenses. All other items tend to be flattening out.

So we are facing an economy where residential investment has worsened far beyond a recession and the rest of the economy is growing at the expense of discretionary spending. Because food, energy and medical expenditures are necessities in the real scheme of things.

First Housing. The housing factor is a simple measure of price and volume. The media is filled with news reports that median home prices are flat across the country and that is misleading. The statistic does not weight different cities according to population: New York's housing price is factored as equal to some small Mid West town with a population of 50,000. And that's simply not right.
If we are interested in understanding what the majority of Americans will see, lets look at the major urban areas. For Q4 2006, according to NAR http://www.realtor.org/Research.nsf/files/MSAPRICESF.pdf/$FILE/MSAPRICESF.pdf :
Atlanta -2%
Boston -2.4%
Chicago 0.9%
Detroit - 1%
Dallas/FW -3.9%
Denver -0.9%
Honolulu 0%
Houston 1.6%
Kansas City - 2%
Las Vegas - 0.8%
Memphis - 1.6%
Miami - 6.2%
New Orleans -9.3%
New York 2.3%
Phoenix -2.3%
Reno -8.9%
San Francisco 2%
San Jose 2.7%
San Diego -4.5%
OC -1.3%
LA 3.2%

New York, LA and the Bay Area seem to be the only major urban areas that did not see price drops in Q4 2006. Meanwhile the Q1 2007 report won't be released until May 15th, but we know things are worse.
I look at the NAR report for directional information because the actual degree of drop is probably more severe. For example, home builders are reporting cancellation rates as high as 40% but the NAR data reports the original sale. Also, home sales reports lag current market conditions by at least 3 months. the Q4 2006 data actually reports on late summer and early Fall sales.

Whatever the case, prices were heading down before the subprime collapse of the last 4 months. Prices will continue the downward trend.

Returning to the GDP, if price is not the main cause of the drop in the residential figure, then it must be volume. We have heard from homebuilders that sales volume is down 30% on average. The current figures show only a 20% drop in value. So if prices are flat to falling and volume is dropping 30% for several quarters, that implies that the GDP figure has a lot further to fall. In fact, the numbers imply that we are heading for a figure around $300B. that's a drop of over 50%.

A further 20% drop will create a recession. I expect the first negative GDP figures to be in Q4 2006, which we won't know about until January/february 2008.

Further acclerating the drop will be massive blue collar layoffs. In Jan 2003, 6.7M workers were doing construction. http://data.bls.gov/cgi-bin/surveymost?ce That number rose to 7.72M in August 2006 and currently sits at 7.68M. About 1M construction jobs were added in 4 years. Given that we are at 2003 construction levels, that implies around 1M workers will be laid off.

I think manufacturing jobs are less exposed for two reasons. First, they have been dropping regardless of housing. Manufacturing did not grow over this time but shrank by 800K workers. Since 1999, the US has shed some 3.5M manufacturing jobs. Second, the layoffs for home supply manufacturing started last summer.

For anyone who thinks that jobs will erode slowly, I point to this week's layoffs by New Century: 2,000 employees fired without pay.

1 million people not spending money will be felt in various places. A lot of vacations won't happen (Disneyland, Carribean cruises). A lot of toys won't be bought (Harley Davidsons, Jet skis, boats, trucks, TVs). A lot of remodeling won't happen (Home Depot, Lowes). A lot more meals will be eaten at home (Safeway will be looking strong, TGI Fridays and other spots will get hit).

Another major trend will be home price erosion. I think that white collar professionals are about to get stung. I mean the financially overstretched investor who speculated on homes. And a lot of folks who bought more house than they could really afford. I think some 100,000 people will be affected and unable to spend as freely.

Every recession is different. This one will be a blue collar recession coupled with consumer spending slowdown. Against the background of a looming recession, the Fed must contend with inflation. Remember that food and energy prices are rising.

When will interest rates come down? Put differently, is the Fed interested in stimulating the economy or in keeping prices predictable? A drop in interest rates fuels inflation but stimulates the economy. I would imagine that they will make a token drop of ~0.25% sometime before September. That will be too little for the housing market.

Lastly, where will home prices end up? An indication is the recent sale by New Century of their remaining mortgage portfolio valued at $170M but purchased for $58M. http://www.latimes.com/business/investing/la-fi-newcentury5may05,1,6951879.story?coll=la-headlines-business-invest&ctrack=1&cset=true

That's a 66% price drop.

Even if they hope for a 100% gain on their investment, that's a 30% haircut in value. A deep pocket hedge fund can go years. The average Joe can't. So I expect a deeper cut in home prices.

Liverocket Week 18 Performance - Up 0.1%

Considering that the market was up and we were mostly flat, I am not happy.

Frankly, I have been challenged by some key players: CTSH, TIE, TRID, & UCTT. These 4 stocks combined to knock out gains elsewhere. I am comforted by the potential for a reversal next week in TIE and TRID. That matters because TIE and TRID represent 20% of the portfolio. UCTT I think will drift before firming up and rising again.

Meanwhile, I do suspect that we will see a shock next week. The market is overbought - it's up 10% in 8 weeks. Time for a correction and the Fed meeting may be exactly what the doctor ordered.

HIGH TECH
AMX – Up 0.5% and another 52 week high. Considering its 5% drop mid-week, I am glad to see that it maintained its position.
CTSH – Down 7.4%. Horrible – buy on the rumor, sell on the fact. Not much momentum after 4 months. I had wanted to sell at $95, and that was based on a 5% jump up on earnings. Instead, we got a 7%+ drop. I will say this: for folks concerned about salary spikes, those factors affect every Indian service company. Which means that they will start to pass costs on to customers I the form of higher prices.
NUAN – Down 1.3%. Continues to trade on low volumes. I’d say the bets have already been made and now it’s time for next week’s earnings release.
PWR – Up 5%. They picked up a slew of analyst upgrades.
TRID– Down 4%. But this is interesting: up 3.5% in afterhours on heavy volume (2M shares). This could be tied to th efollowing report http://www.forbes.com/afxnewslimited/feeds/afx/2007/05/03/afx3684694.html Essentially, Sony is shifting away from 32” TVs and buying more 40” TVs from Samsung. That means TRID.

UCTT – Down 4%. Was this week a deadcat bounce? I’d say so. I see it drifting a bit lower and then coming back up to $18+. I will look to buy more ~$14 unless weakness pushes it down even more. A lot of shorties are pushing it down and we will let them enjoy the overselling and take advantage.

OIL SERVICES/EQUIPMENT

Interestingly, today ESV, CLB, & ATW all spiked up early in the day. Same with DO. I think something is up.
ATW – Up 4.6% and a new 52 week high. No news, just pre-earnings excitement.CLB – Up 0.7%. It hit a new high today before pulling back.
ESV – Up 2.7% and hit a new 52 week high
MDR – Up 4% on 2.5X average volume and a new 52 week high.

BIOTECH
DIGE – Down 1.3% on low volume
HOLX – Up 5.5%.
IMA – Down 1.4%

OTHER
KSU – Flat.
OCN – Down 2%.
PCP – Up 2.6%.
TIE – Down 4.6%. Cramer pooh-poohed TIE. TIE needs to beat earnings in order to move this stock price up and the odds are decent that they can do that.
Throughout 2005/6 the theme was contract re-negotiation. Prices quadrupled and more, giving mammoth upside. The theme for 2007 is expanding production.
Prices: Strong and rising. That was reported last quarter and ATI’s recent report confirms that prices remain strong (ASPs increased 4% for ATI). TIE can take advantage of rising prices because only 39% of its production is committed to long term contracts. That means that Boeing is snatching up as much as it can and paying top dollar. And the dollar is weaker by 5%, which could push up TIE’s ASPs even more considering their ability to charge global prices. Lastly, on a purely year-over-year basis, ASPs are up 30%+.
Production is up: This quarter, TIE opened an expansion in Nevada for sponge production. The expansion will add 4000 tons of sponge per year or 8.8M pounds. Sponge sells for ~$10 per pound and is the raw material out of which titanium metal and alloys are made. If sold, it can generate ~$22M sales upside per quarter and if consumed it will reduce TIE’s costs, increasing earnings.

Costs: up and down. Energy costs are no doubt higher. At the same time, sponge costs will be lower because they produce more of their own.

Analysts expect 20% earnings growth year-over-year or $0.38.
Anchoring the low end is last quarter’s $0.32 (after netting out one-time gains)
Driving the high end is a 30% higher ASP and greater production. That implies closer to $0.41 or ~10% higher than expectations. To achieve this, TIE needs to get $14M more earnings.
Sales growth yield: At 34% margins, the $14M equals $43M increased sales YoY. Last quarter was $37M above Q1 2006, putting $43M within reach. Now, if prices rose an additional 4%, they could see an extra $7.7M (Some 60% of TIE’s sales is not locked into long term contracts, so $194M @ 4% = $7.7M in upside.) And then there is the extra sponge production – some of which they may be selling.
Another means to that EPS is cost management. How much cost does the extra sponge production reduce? Unknown. Even a 10% cost reduction is significant (~$2.2M per quarter or $0.015 EPS).

I see $0.41 within reach but then what? No further production comes online this year and assuming flat sales prices, 2007 EPS is ~$1.64, which is about what analysts expect. Not much blistering upside. The excitement comes in early 2008 when production again grows by ~20%.

I wonder if indeed Simmons is looking to sell. At the moment he extracts about $75M per year in salaries and dividends from the various stakes in TIMET and related investments in VHI and Contran. Selling at a 20% premium means an extra $500M in his pocket (in addition to his current stake). He can make that in 4 years and TIE’s stock will grow at least that much in 4 years. He would probably need to see 40% in order to sell. TIE at $50 sure sounds nice, but it’s wishful thinking.

The case for TRID

http://www.eetimes.com/news/semi/showArticle.jhtml?articleID=199203182

This is an article on LCD TV Sales in China. As you read it, recall that TRID has agreements with every Chinese LCD TV maker.
Key highlights of the article:
1. 24% CAGR through 2011 (for China alone)
2. Value to grow from $7B to $25B in 2011 (for China alone)
3. Volumes to grow to 55 million units from 10 million in 2006
4. Sweet spot is 40" TVs - dominated by TRID
"iSuppli believes that in 2007, the 40-inch size will be the sweet spot in the market and garner the most support from advanced LCD fabs and in terms of OEM manufacturing commitments in China. "

This is iPod level volumes, and currently dominated by TRID.

I will also point out the strong Chinese commitment and Chinese connection. Not only did TRID recently build a design center in China for $11M, the founder and several top Executives are Chinese. That does mean something.

Very few markets are growing at this rate. At some point, not only will the market re-awaken to TRID's potential, but someone will buy them. That's what I hope at least.

In the immediate term, the next few months are the time for design-ins for the next holiday season TVs. TRID will probably continue to crush the competition, bringing them a continued strong sales picture

PWR

PWR Up 5% today after releasing staggering earnings
* Earnings up 325%. Netting a one-time tax advantage, the growth was 90%. They beat expectations by 8%
* Sales up 16% and bet expectations 4%
* Margins improved from 3.7% to 4.9%

However, forward guidance was lowered for next quarter by a significant 25%.
That concerns me and I need to understand what is happening.

IMA, CTSH and other news

CTSH – Great earnings report but down ~5%.
* Revenue up 61% YoY and 8% over previous quarter. Wow. Beat analysts by 2%
* Earnings up 56%, beating expectations by 16%
* Forward guidance increased $30M in revenue and $0.03 EPS.
* European demand surged 84% (European business hit 14% of total)

Down because of concerns over slowing future growth. I think the concern is that CTSH can’t hire fast enough – the demand is there but they are struggling to meet it.
Another negative is margin pressure from wages and taxes.

I am strongly pleased by the European growth and it confirms my investing thesis that non-US growth is coming on strong.
-------------------------

IMA – Solid but nothing exciting here.
* Sales up ~25%
* Earnings up from a loss of$0.09 to a gain of $0.14. Yummy.

I think they hit expectations, so no excitement. Also, the competition upped the offer for Biosite, which means IMA would have to pay more.
I think we are going to back out of this one.

--------------------------------------------------------------------------------------------------

AMX – Up 2.7% Reverses most of the drop this week.
ATW – getting ready for earnings. Almost back to its 52 week high
CLB – Hit a new 52 week high
DIGE – Up 3% and hit a 2 month high
HOLX – Up 6%. Considering that they hit below $54 yesterday and closed today ~$63, I’d say some market manipulation took place yesterday. I say that because $54 happens to be the last bottom for the stock – and that’s where many folks would set their STOP orders. This happens too often and we got hit in February because of this imho
KSU – Up 2%
MDR – Up ~4%. And $0.08 off their 52 week high. Run MDR, run!
NUAN – Hit $15 and bounced back up hard.
PWR – Sliding still after peaking last week. Down 3.4% since then
TIE – regained a lot of ground, but still languishing
TRID – Down 10% in a few days on no news, then today 2 board of directors resign. What an obvious leak. This stock just kills me. How stinky is the company? Seriously? If I didn’t believe so much in their product and performance I wouldn’t accept this pain.
UCTT – Nice 6% tick up.
PCP – Up ~3% and bounced off their high.

TIE observation

Insider activity at TIE has come to a complete stop. No buying or selling for 4 months (Only exception was the CEO's wife's purchase of 50,000 shares in February.)

What activity there has been has been almost only purchases. In 1 year, the only sales have been November, 2006 when a Director sold 10,000 shares and in July, 2006, when another director sold 1500 shares.

But this is not about strong insider interest in the stock. It's about why activity has come to an abrupt halt.
Go back to insider buying. The CEO (Harold Simmons) bought shares as follows
12/06 50,000
11/06 20,000
10/06 200,000
9/06 150,000
8/06 100,000
7/06 484,000
5/06 200,000
4/06 50,000
3/06 307,000
You get the point. Every month for a year, the CEO has been buying shares. Not exercising options but buying shares.
Then he suddenly stops. 4 months of no buying.

Now consider a second point. Valhi just distributed TIE stock as part of its dividends.
VHI is nothing more or less than a Simmons owned shareholder of TIE (about 3.5% stake). A common complaint about dividends is that they are a form of double taxation: they are after company taxes and then the shareholder pays taxes on them as income.

Distributing the shares, however, is a form of non-taxable capital gains. So the shares go to the shareholder and tax is paid only once in the event they are cashed out.

I that what we are seeing: preparations for a buyout? Because TIE has had a phenomenal run: up 35X in 4 years. The upside going forward isn't going to be as strong. Perhaps it's time for Simmons to cash out.

TIE is mostly owned by Simmons and his family. VHI is 94% owned by Contran and the VHI CEO is non other than Harold Simmons. Contran itself is a holding company that is owned by - you guessed it - Harold Simmons and family.
Interestingly, the ownership is in the form of trusts.
Break down the TIE ownership today:
* Contran 35%
* VHI (before distribution) 3.5%
* Simmons (before distribution) 3.5%

A simple explanation is that Simmons buys to pump up the stock price. Not likely. He was buying plenty while the stock was racing up in 2005 and early 2006.

It does make sense if this is for a buyout:
1. He can't buy shares in the pre-sale period, neither can his Directors.
2. Moving shares back from VHI to Contran (and to direct shareholders) is a way to avoid double taxation in the event of a buyout. Contran is mainly held in trusts which will avoid much of the tax liability that a publicly traded corporation like VHI can not avoid.

SHFL revisited

Last year someone asked my opinion of SHFL given the Macau casino buildout.
Not only was I negative, I was very negative. I also saw something that made no sense: a rapid buildup in inventories before new business was reported.

They spiked up - making me look very foolish - before collapsing to their current 3 year low.

Fundamentals do matter - it just takes time for the market to catch up

Earnings releases next few days

For our stocks:
May 2nd ctsh, ima
May 3rd atw, pwr bmo
May 7 mdr
May 8th dige, NUAN
May 9th PCP

Other key releases
May 2 S, RIG
May 8 CSCO, DIS
May 9 BRL

IVAC Tumbles

IVAC skidded 18% today or about 30% since I predicted that they had hard times ahead.

TIE and other stock events

Today was a volatile day. That suggests that a potential transition is coming. Nervousness is here.

AMX - Continues to slide after being denied purchasing of Italtel. Whatever. the company is growing subscribers faster than expected (an extra 500K subscribers) and the margins have surged: up to 43% from ~39%. Rising revenue and significantly growing margins is what we want to see.
The only weak spot is the debt: $10B. This is actually low for a Telecom company which prefer to use debt to buy equipment.
A 20 P/E for ~100% growth. That's undervalued

ATW - Down 2% then up 2%
CTSH - Volatile (down 3% at one point, up 2% in afterhours). I expect a stock split announcement soon
NUAN - Pullback continues. Down 12% from high.
MDR - Large volume today
OCN - Down 2% before ending flat
TRID - Circuit City reported problems with LCD TV sales. Don't worry - that's because they are getting beaten by Walmart, Costco and Best Buy. In fact, CIBC chose TRID as one of their 3 chip stocks to buy. Shorts are still as high as 15%, which makes no sense to me except insofar as this is a trading stock for many, when it should be a growth stock.
UCTT - Ugggh. Down 30% from its high. Time to buy more and average down. I just hate to see a significantly undervalued company like UCTT.

TIE - Down ~6% on blowback from RTI.
RTI reported and the investment community did not like it. Down 15%. Now, the stupid part, is that their margins got hit because of non-titanium production. Ti production was actually strong.
In his analysis of RTI, Banc of America analyst Kuni M. Chen wrote:
"RTI's results were consistent with a quarterly decline in Allegheny's high performance metals segment, which includes titanium products. We believe the near term weakness is due to inventory destocking, rather than a shift in longer term fundamentals."
The analyst said investors should buy shares of Titanium Metals on any weakness. He has a $41 target price on the stock. Chen rates RTI at "Neutral" with a $99 target price and rates Allegheny at "Neutral" with a $127 target price.
A different and not necessarily comforting look at today's activity is that TIE's stock has seen no growth to pullback from whereas RTI has grown a lot, far above its 50 DMA.

HOLX has a wild day

HOLX started the day down ~6% and ended up 2%

They released earnings and they are having a fabulous time.
* earnings up ~70%, beating expectations by 70%
* sales up 79%
* Acquisition costs totalled $0.14 per share (making the upside even more striking)
* Raised 2007 EPS by 15%
I am concerned that earnings and sales are tracking so closely - it suggests no margin improvement.

Volume was 5X the average.

Now, with massive shorting (8.4%), expect to see some covering - keeping the stock up a bit

Profit taking or more?

I don't think that the sentiment is bullish right now, which is strange to see as earnings season is still underway.

If it's profit taking, no problem. If it's the sell-in-May-and-go-away, well, that's a problem.
I'm going to re-balance the portfolio this weekend. Several stocks are not doing what I want.