Q2 GDP and Trade data reviewed

The Q2 GDP numbers came out and some interesting trends pop up.

Before I dive into them, I want to point out 3 things:
1. Focus on trends not the exact numbers.
* The numbers always get revised. For example, the Q4 2007 GDP was just revised from a positive 0.6% to -0.2%. Is that a big difference? Yes and no. Yes, because it’s a contraction. Also, a 1% swing is $110B in real dollars. And no because once we are <1% style="color:#ff0000;">* Don't lose the forest for the trees: the direction is important. For 2007, we were seeing 4.8% growth, and now we’re struggling to stay positive. That is a big contraction.
2. The numbers are skewed by the stimulus package. $130B of stimulus checks happens to equal the exact growth in consumer spending for Q2.
3. Housing exaggerated the growth just as it is exaggerating the pullback.
This is very important to understand and I’ve pointed it out before. When I say ‘Housing’, I mean fixed investment in residential structures. The buying and selling of houses, not the spending on furniture and so forth.

For 4 years, housing prices rose ~20% each year. So the annual market went from $300B in Year 1 to $360B in Year 2. That added ~0.5% to the GDP. After 4 years, housing went from contributing 3% to GDP to suddenly meaning 6% of GDP. In 2005, quarterly residential was $600B+ vs $360B the recent quarter.
Naturally, as housing prices fall, that contribution drops. And it takes GDP with it.
Housing as a % of GDP
2006 5.0% (~$550B)
2007 4.1% (~$450B)
2008 Q2 3.1% ($370B)

So a slower GDP does not in itself mean anything about the broader economy. It just means that at least one sector is no longer contributing as much.

In the case of housing, the drop in value is quite large. The last 4 quarters saw $1.6T in residential investment vs. $2T the previous 4 quarters. Poof – there goes $400B of GDP contribution. Which really wasn’t anything productive – just trading.

I want to focus, instead, on which sectors seem to be rising and which seem to be falling.
Comparing Q2 2008 to Q2 2006, we see
Nominal Inflation adjusted
Food 0.4% no change
Gas 0.5% no change
Motor vehicles -0.5% -0.4%
Furniture -0.1% 0.6%
Medical 0.5% 0.3%
Non-residential
structures 0.7% 0.6%
Residential
structures -2.4% -1.9%
Transportation -0.5% -0.5%
High tech 0.2% 0.8%
Business
Inventories -1.2% -1.1%
Exports 2.2% 1.6%
Imports 1.5% -0.5%
Government 1.1% no change

By the way, 0.5% GDP growth is ~$60B in 2000 dollars. It’s meaningful.

Notice the anomalies.
As a rule, spending in nominal dollars is always higher than inflation adjusted. But somehow furniture and high tech spending in today’s dollars is a lot lower than it is in inflation adjusted dollars.
ALERT – that shows something is wrong with the adjusting done by government algorithms. In other words, the nominal numbers dovetail closer to reality:
1. Furniture spending is down not up. If people are not buying houses and foreclosures are in the millions, and furniture companies are going bankrupt, there is no way to believe that the spending on Furniture is up $100B in 2 years.
2. High tech spending is flat, not up. Again, with businesses in trouble, high tech is affected.
3. Imports are up a lot more. It's massaging the oil/gas prices at work. Oil and related products are only 25% of total imports in 2008 year-to-date but they are 55% of the total import growth. Neutralize growth in oil and you see the slower import growth.

Now look at the other anomalies.
It is simply wrong to say that, after inflation, spending on food and gas hasn’t grown. We know for a fact that gas prices have tripled but inflation is supposedly up only 7% in 2 years.

Stick with the nominal data.

Fine. So GDP confirms a slowdown in general, and specifically in a few places. Lets really call out which sectors are growing (and worth buying) and which are slowing (and worth selling).

Compare the 2008 year-to-date (Jan-May) exports with 2007 year-to-date, the top 20 growing areas are:
Item Change ($M) Change %
Fuel oil 7,572 157%
Nonmonetary gold 4,544 86%
Soybeans 3,697 96%
Petroleum products, other 3,471 46%
Civilian aircraft 2,922 16%
Wheat 2,784 115%
Corn 2,293 55%
Plastic materials 1,899 16%
Gem diamonds 1,768 38%
Telecom equipment 1,765 15%
Precious metals, other 1,699 53%
Chemicals-organic 1,593 13%
Steelmaking materials 1,477 37%
Meat, poultry, etc. 1,472 39%
Chemicals-fertilizers 1,433 63%
Materials handling
equipment 1,270 28%
Medicinal equipment 1,267 13%
Industrial engines 1,240 17%
Chemicals-other 1,186 14%
Toys, games, and
sporting goods 1,070 27%
Metallurgical grade coal 989 90%

Oil, food and coal rank as the fastest growth areas.

And the same comparison for imports:
Item Change $M Change %
Crude oil 56,797 39.4%
Fuel oil 5,462 31.7%
Petroleum products, other 3,005 14.0%
Liquefied petroleum gases 2,965 37.5%
Other household goods 2,681 10.4%
Industrial machines, other 1,775 11.5%
TV's, VCR's, etc 1,727 9.8%
Chemicals-organic 1,591 16.9%
Chemicals-fertilizers 1,560 29.5%
Telecom equipment 1,245 6.6%
Gem diamonds 1,241 13.9%
Steelmaking materials 1,239 30.3%
Industrial engines 1,210 16.4%
Nonmonetary gold 1,189 39.7%
Computers 1,051 6.0%
Food oils, oilseeds 1,008 47.0%
Medicinal equipment 980 8.9%
Engines-civilian aircraft 977 16.4%
Electric apparatus 863 5.6%
Feedstuff and foodgrains 839 42.7%

Except for oil and other energy items, import growth is pretty tepid.

Look at the sharpest drops in exports and imports. Exports show very minimal drop, in fact.
Item Change ($M) Change %
Computer accessories -1,115 -8%
Tobacco, manufactured -162 -30%
Logs and lumber -148 -7%
Apparel, household goods - textile -52 -3%
Finished textile supplies -51 -5%
Tapes, audio and visual -50 -19%
Hides and skins -32 -4%
Stereo equipment, etc. -23 -2%
Textile, sewing machines -21 -4%
Cotton fiber cloth -12 -1%
Vessels, excluding scrap -9 -22%
Leather and furs -1 0%
Jewelry, etc 4 0%
Spacecraft, excluding military 7 233%
Hair, waste materials 8 3%
Glassware, chinaware 8 4%
Fish and shellfish 9 1%
Sports apparel and gear 15 6%
Nursery stock, etc. 16 9%
Nontextile floor tiles 19 10%

Except for computer accessories, there is growth almost everywhere.

Now imports
Item Change ($M) Change %
Lumber -876 -42.2%
Stereo equipment, etc -815 -28.2%
Computer accessories -704 -2.6%
Business machines and equipment -685 -31.2%
Shingles, wallboard -657 -18.4%
Apparel, textiles, nonwool or cotton -600 -4.8%
Apparel, household goods - cotton -589 -2.8%
Jewelry -562 -11.2%
Household appliances -546 -7.1%
Bauxite and aluminum -414 -8.0%
Zinc -366 -41.0%
Furniture, household goods, etc. -358 -3.6%
Stone, sand, cement, etc. -352 -15.4%
Blank tapes, audio & visual -292 -38.4%
Nickel -278 -15.5%
Meat products -244 -7.9%
Motorcycles and parts -237 -14.6%
Camping apparel and gear -117 -3.7%
Alcoholic beverages, excluding wine -105 -5.0%
Plywood and veneers -97 -9.3%
Nontextile floor tiles -97 -9.1%
Newsprint -82 -8.3%

Quite a lot of consumer items are dropping: stereo, computer, clothing, furniture, jewelry, household appliances, motorcycles, alcohol, and so forth. And so are residential and non-residential related items

What's also interesting is that this represents $9.6B of fewer imports for 5 months. if this pace accelerates and even invades other areas, it's easily a $30B reduction in imports. That is noticeable to many of our trading partners.

Add it up and we see a lot of export growth, especially for commodity goods like oil, coal and some food.
We see a slowdown in imports, especially for consumer durables.

In my next post, I’ll show how I track this data back to the specific stocks in which we hold positions.

GDP Disappoints

Professional analysts don't seem to be very good.
Take yesterday's EIA report on US oil stockpiles. (It's a big report that swings oil prices because it surveys and reports supplies of various oil products, which in turn provides visibility to demand.) On every metric analysts were completely wrong. Instead of supplies being up 400,000 barrels, they were down 1.4M barrels. And so on.

The analysts are at it again with the GDP. Instead of the report being 2.3% growth, it came in at 1.9%.
http://biz.yahoo.com/cnnm/080731/073108_gdp.html

To be honest, it doesn't really matter. The government bought the GDP growth with $130B in stimulus checks. Literally.

* Q2 GDP of $12.3T, of which $8.6T was personal consumption

* $130B in stimulus checks = 1.9% of $8.6T.

It's really that straightforward.

And what it means is that GDP was actually 0% without the food stamps... I mean stimulus checks.

Reading the report is pretty sobering.
http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
1. Inflation was 4.2%
2. Imports are down 6% - and that's after the rapid rise in oil prices. That means consumer spending is way down
3. The auto industry's deperession drove out 1% of GDP
4. Inventories shrunk a whopping $62B (they shrank $10B the previous quarter)

But there are some bright spots as well
1. Exports are up 9%
2. Housing construction related spending is still shrinking but at a slower rate. I won't say bottom, but it's there in 2 or 3 quarters.

Of the 1.9% growth
* 1% was consumer spending
- 0.54% food and clothing
- 0.41% medical


* Government spending. Up 6.7% vs 5.8% in the first quarter. This is largely from raises that went into place at the beginning of the year, as well as heavy defense spending increases

At the same time, GDP was revised downwards as follows:
Q4 2007 GDP -0.6%
Q1 2008 GDP 0.9%

I'll do a separate, more comprehensive GDP review, but the message is very clear: consumers and businesses are cutting way back.

Quick updates

A slew of companies reported earnings and I have not reviewed the details. But basically, without looking at the score, the home team of Oil is yelling "We're #1."

From a trading perspective, I pulled the trigger too soon on those calls. Fortunately, we have many months fo rth eprices to catch up.
Fundamentally, it looks like the approach was more or less sound: the target companies are showing signs of strong growth.

There have been some misses. OSG missed expectations because they tried a bad hedging strategy. But their business is booming, so I have hopes that they turn around before January.

I won't go stock by stock at this time, but I will say that there is a clear anti-energy sentiment that is suddenly pushing the energy stocks down. I take that to mean that hedge funds are either on the sidelines or actually shorting these stocks. Eventually, they will return: energy is the only place that is still booming and still showing the ability to beat expectations and raise guidance.

ETFC continues to plunk away around $3. I am watching for another <$3 move to accumulat emore. The strategy here is long term: at some point in 12 months, I believe that this stock will move to $5.

TRID I waited to sell on the assumption that it might creep up a few pennies over the next few days. But I am selling, make no mistake.

The Ultrashorts are so volatile it isn't funny. Again, time will tell.

I was also wrong that the Bear would return. Instead, we are retracing the move up. It suggests that we will move down again. Until now, the rally was because oil was dropping - but it rose yesterday even though oil rose. Perhaps it was the new Housing Bill. It sure wasn't all the bad news. In any case, the market is looking for reasons to stay or go - it has no current direction.

In this kind of sideways market, it i sonly a matter of time before it finds direction. An dI think that it will be downward. We have an upcoming Fed meeting, and that may be the trigger.

In the meantime, if all this market lurching is driving you crazy, don't look. Go short everything except Agriculture and energy. Then look away.

Recent DUG/QID purchases

I bought in yesterday for trading purposes.
I see us in a trading range and want to buy on the lows and sel lon the highs.

However, with a stronge rdollar, I expect oil prices to sag a bit. So i won't jump out of DUG just yet

TRID "Fredo. You broke my heart. You broke my heart!"

That's it, we're done.

TRID simply can't get its act together. I was willing to give new management 3 quarters to do something, and there is nothing here.

We will take our loss and walk away. And I won't look back.

ETFC - Doing fine

Most analysts missed the point about ETFC: if you are going to bottom-fish, you buy when most of the bad news is out but before the good news is all in. Of course there’s mixed news, but the picture brightens each quarter.

The way to understand ETFC is to look at it as two separate businesses: a brokerage and a lending business. The brokerage is doing amazingly well while the lending business is limping along

The brokerage:
* Trade volume was up 7% over last year. The value of that trade was similarly strong versus last year
* Margin business was up 11% over the previous quarter (not sure what it was last year)
* Customer cash and deposits were $33.7B and up $1.8B since last year’s low
* Total accounts are up 196,000 since last year (30,000 in the last quarter)
* Generated $170M in profits for 1 quarter.

So how did $170M in profits turn into $95M in losses? First, they are increasing their capital reserves in the event of more debt failure. Second, they are losing money on the debt.

Now, this is important. The amount they choose to put aside is somewhat discretionary. That is, they are deliberately taking money away from the profits and putting it aside for a rainy-day. So instead of inflating profits, they are artificially deflating them. Nice. I like this correct and conservative approach. It’s quite refreshing and I will invest in management like this.

They have already put aside $620M and the Etrade Canada deal will bring them close to $1.2B

But the balance sheet is awful because of the debt.
1. Reduced undrawn lines of credit to $3.7B – that is, money folks can borrow and ETrade is obligated to offer. ETFC would have to put aside cash reserves to cover this credit, and they don’t want to expose themselves. This is a 49% reduction from $7.2B. It basically allows them to preserve capital to where they need it.
2. Swapped debt for equity – They reduced $121M in debt by cash and $27M shares
3. Have $1.8B in cash. This is in addition to reserves for losses and next quarter’s $500M Etrade Canada cash (aka the $1.3B on capital reserves).
4. Planning for $1.5B in mortgage related losses. Frankly, I wonder if this is low. It represents ~12% of their mortgage package. They pointed to 2 things
* They use Case-Shiller for the metro areas to project failure rates (with 15% being the minimum). This is very solid and smart.
* 2007 loans are only 11% of their total loan portfolio (2007 was a year of really shoddy lending standards and high foreclosure likelihood)
5. Loan delinquencies grew to $111M but it seems to peaking after 4 quarters. Not sure if this is a trend or not, but it helped them this last quarter.
6. In process of writing off FNM/FRE investments of $330M. They will probably take a $120M loss next quarter.

So what are they going to be worth in 4 quarters?
- They sold Etrade Canada for ~$3.5K per account. ETFC currently has 4.5M+ accounts, which puts a value of $16B on the brokerage. But TDAmeritrade has 6.3M accounts and is valued at $10.6B or ~$1.7K per account. Using the lower figure puts ETFC’s brokerage value at $8B
- Add in $2B for current cash and new profits.
- Take out the bad debt. The absolute worst case is a 50% loss on $23B or $11.5B. The likely worst case is a 30% loss or $6B. They have $1.2B as of next quarter. So the worst cases are that they have a net loss of $4.8B~$10B.

So that gives them a liquidation value of $0~$5.2B. That’s a stock value of $0~$10. The gap between the $3 price today and the $0/$10 valuation is the debt. Every month the debt could be improving or worsening – it’s hard to say. A $3 stock price implies a $10B loss on the $23B portfolio or a 43% loss.

So what are the real risks here
1. Brokerage business droops in a downturn – this is a definite probability. I think the $2B cash/profit figure I use above already bakes that in.
2. Current spreads droop: they are generating an average 2.72% above borrowing costs on the cash. I don’t give this a high probability, even in the face of a rate hike.
3. Mortgage and HELOC business gets worse – this is a definite probability. It would take years to cover the debt write-down. However, the other $13B in debt is implicitly performing and throwing off some profit.

In effect, it really depends on the exposure to the debt and their ability to meet capitalization requirements. The latter point is what drives insolvency and emergencies. They have a total 5% capital-to-debt coverage and access to 50% from the Fed. I don’t see an emergency here.

A final key point is the short ratio - ~30% of the shares are short.

This is a 4 quarter story. If we can have an average $3.50 cost and the stock moves >$4 in 4 quarters, that’s still a 14% return. But I am shooting for a $6+ valuation this time next year.

Buying QID & DUG

Buying
100 shares QID $44.54
100 shares DUG $35.43

Is this why oil went up so fast recently?

http://www.investmentrarities.com/07-21-08.html

You have to scrol ldown to the bottom to get the message.
The issue is that the group that monitors oil futures trading just found that 1 trader was controlling 10% of the entire futures market. This analysis confirms a rumor that i had read where a hedge fund had taken a massive short position in oil and, caught by th eprie rise, had to take an equal long position. Unfortunately, they had to keep adding and adding because the short position kept collapsing.

How that affected the market: someone had to buy a lot of oil future contracts, an din a hurry. WIthoutthis demand, oil futures will come down.

"There was an extraordinary development in the Commitment of Traders Report (COT) for this week. The CFTC issued a special announcement concerning the energy markets. Do to recent pressure, principally by lawmakers, on the CFTC to do something about oil prices, the Commission took a closer look at large traders in the energy market. You can read the special announcement for yourself -
http://www.cftc.gov/marketreports/commitmentsoftraders/index.htm
What you won’t read in the announcement is the real story. That you can only get from studying the different tables provided. Please allow me to summarize what those tables reveal. As a result of the closer scrutiny, the CFTC suddenly "discovered" that a very large trader in crude oil needed to be reclassified from the commercial category to the non-commercial category because the position that this trader held did not represent a bona fide hedge and was, therefore, a speculative position.
What was shocking about this position is its size. This one trader held a spread position of 147.000 contracts in NYMEX crude oil futures and a spread position of 326,000 contracts in futures and options combined, a position of more than 10% of both the entire futures market and futures and options combined. While this percentage of concentration does not come close to the concentrations in silver or gold, it was still largely unknown that one trader held such a large position in crude oil, even if it was a spread position (being long and short different contract months simultaneously.
Of course, the CFTC did not identify this trader by name, as that is contrary to current law (why, I am not sure), but the Commission clearly revealed the trader by size. To give you some perspective of the size of this trader’s futures only position, in the non-commercial spread category to which the position was reclassified, this single trader holds a position more than 90 times as large as the average trader in this category (147,000 contracts vs. an average spread position of 1,630 contracts). How could such a dominant position not control spread price changes?

Planning for the week ahead.

Over the past 3 months, the Dow, NASDAQ and S&P are exhibiting the exact same characteristics.
1. A narrow trading range for 6 weeks
2. A sudden down move
3. A narrow (4%) trading range the last few weeks.
(FYI - Blue candles are down days and white candles are up days)

Look even closer and you will spot that the big moves down are prefaced by a major, one-day down move. We just saw one on Thursday imho.

Drill down and look at the last week, and you will see a very important and revealing move. On July 15th, all markets hit the bottom of the range and on July 15th they shot up. What we see is a challenge to the bottom followed by a brief rally. You can see it earlier around May 6th and May 20th.

What is important to notice is that the brief rally fizzles: it doesn’t break through the top of the range. In fact, we see very big down days immediately after. Like we just saw Thursday last week.

Ok, so that’s the descriptive part. Here’s the prescriptive part.
We are going to re-explore the bottom of the range and if we go below the range, we will see a bear move down.

In other words:
1. The next few weeks will be a move down.
Dow = 11,000
NASDAQ = 2,200
S&P = 1,225
2. Either the markets will continue down further or we will bounce in this trading range for 3~6 weeks

How to play this
Regardless of whether we are stuck in a trading range or heading for a deeper, bear leg down, the best bet is to be negative the markets. I’m thinking QID, for starters.

Also, there is a remaining issue of whether we should be trading (holding only for a short time) or buying and holding. If we are heading down, then a buy and hold strategy makes more sense. What I’ll do is watch as we head to the bottom of the ranges. If we break through, then we hold. If we bounce, then it’s a trading situation: we look to sell some shorts and go a bit long.

Almost anything can trigger the down move, but my technical review suggests that the market is primed to go down.

This obviously concerns me regarding the Calls and ETFC.
I am thinking about writing some $4 ETFC covered calls. If it dips <$2.80, I’ll buy more.
The calls are mainly an energy play and I am hoping that they will behave differently. They look very oversold at a time when the market moved up. If they behave as a market hedge, then that is good. Especially if the market goes breaks down further.