Wednesday, August 30, 2006

Will Capex Take Over For The Consumer?

Ah, the thoughts of a new bull market are upon us. China is booming. India is booming. Global demand for American goods and services are expected to continue. The real estate slow down will be a soft landing. Hold on a minute. Someone is at the door. It's Goldilocks! The one and only Miss Goldilocks Economy. By the way, where'd she get that last name? Is she Greenspan's niece? She's carrying a box of chocolates and a bouquet of flowers as well. She said she just paid a visit to the Three Bears and they've called off the feud. Oh, how I wish that she would take my hand in life's long journey. Don't we all hope for Goldilocks as the commentators on CNBC do? As the Wall Street crowd does? Wish and hope will get you a buck and a Coke where I come from. (Aren't those Brothers Grimm Germanic fairy tales really uplifting? There's a real happy-go-lucky group of folks. Now you know where the word "grim" comes from. I'm allowed to make that joke because I'm of German origin.)

So, anyone ever hear how someone on CNBC or a financial advisor liked technology this cycle? Yeah, there were some technology companies that did "ok" this cycle but they were consumer focused. As a group, technology capex is a wreck. So much so people are actually telling you these companies will never perform again. Their day is over. Kaput. Too big. Too passe. Too yesterday. Too much competition. Freeeee software is taking over the world. So were you invested in technology or were you invested in energy, materials, developing markets, mortgage companies and homebuilders as you should have been? Did your advisor guide you using sound strategy? Does your advisor have a heartbeat? If you were in Microsoft, IBM, EMC, Oracle, SAP, Cisco and other dogs this cycle at the advice of a professional, you need another professional.

Europe and Asia have far outspent the US in percentage terms for investment this cycle. Why? Because they lagged in the late 1990s when the entire world was investing in the US. What if I told you information technology in the US has been in a recession or worse since 2000 and only global fiscal stimulus saved it from a total collapse? That without demand from Asia and Europe, these company's stocks would be even closer to zero? You wouldn't believe it would you? Have you seen the technology capex numbers this cycle? Recently? Marvelous aren't they? What about all of that cash on hand? How come its not being invested in capex? Because in a recession there is less demand for dollars. Why do you think mergers and acquisitions has been so good this cycle? Because capex spending is in the tank. Companies are better off buying their competitors than investing in capex. After looking at the chart I post tomorrow, would you possibly believe me? Goldilocks left the party six years ago.
posted by TimingLogic at 6:25 PM links to this post

Are You Positioned Defensively?

First, my promised economic post has turned into War and Peace, volume II. It's about 75% finished but it's also fourteen pages single spaced. Thank goodness I excelled in typing class which was also the most practical education I ever received. I can't wait for the day of more robust voice processors because my fingers are killing me. I'm not giving a time table as to when it the economic post will be up because I've actually been advised not to post it. It does seem rather foolish to post something at no-charge that no money manager or mainstream economist on Wall Street seems to either talk about or understand. I'm still debating with myself. So, in the mean time let's go back to another topic: the markets.

This is a very dangerous market. Those who believe we are making a major assault to significantly higher highs are likely going to be disappointed. Yes, some of the indices are nearing or even marginally exceeding their highs by a few points but internals are awful and it is the "supposed" defensive sectors leading us higher: REITS, healthcare, utilities, food stuffs, staples. Companies like Anheuser Busch, Pfizer, Pepsi, Altria, McCormick, AT&T and others are making the new high list along with alot of garbage stocks such as preferreds and funds. This is the "ugly" list of companies which have been ignored for years except by dividend or extremely conservative investors. Ultimately, investors, traders and the like will drive these companies so high, and I think that time is very near, that they are no longer safe value plays. ie, Altria at $65 paid a handsome dividend that at $85 isn't looking so handsome. On the other end of the scale, Anheuser's business is being clobbered right now and there is zero rationale to drive its price up 20% just because people drink beer when the economy slows. If many of us dour types are right, these bets are misplaced and we'll see defensive stocks eventually bathe along with the rest of the markets. While many are calling on a recession, I have seen no one state that defensive stocks will take a slide as well. Hey, you've got to be original sometimes.

Finally, a comment about semiconductors. We are seeing some very good strength in semiconductors. This is all based two arguments here. One is that they were beaten to death so they deserve a reflex rally. The other is that the old cycle is over and the new cycle will be led by capital goods. So, as I mentioned in the pairs trading post, it's oil and semis. Money flows out of oil and flows into semis. Remember this market flow because it's repeatable and usable as we cycle back and forth. Very big mistake in my estimation other than if you are a very agile trader. Buying semis here means you think we are going to see the Fed reflate and save all of mankind very soon. Anyone who thinks the Fed can save the economy is likely to be disappointed. If the Fed starts lowering rates significantly with today's macro environment, that could likely have as much damage as raising rates further. The Fed needs to step aside. Otherwise we'll eventually have the Fed braking and accelerating at the same time. The markets will really love that one.
posted by TimingLogic at 9:07 AM links to this post

Thursday, August 24, 2006

The Global Economic Outlook

My next post will likely require three, four or five hours of effort by the time I organize my thoughts and dump them into something digestible. I seldom share everything I'm thinking but as it pertains to this topic, I plan to lay out my view of world dynamics and how they will play out over the coming year(s). Whether you live in Asia, Europe, Africa or the Americas, my intent is to share where we are and where we are likely going using entirely economic theory as a premise. The big picture, if you will.

It might take me a week to find the time but since I see no other source providing such a perspective, I hope it will be of value. Stay tuned.
posted by TimingLogic at 3:50 PM links to this post

Wednesday, August 23, 2006

Ford's Way Forward

"I fear that we have awakened a sleeping giant and filled him with terrible resolve."

-Japanese Admiral Isoroku Yamamoto

The quote above is a reminder that sometimes it takes crisis to awaken the powerful resolve of society or companies. I've dedicated a fair amount of time on this blog to the state of the American automobile industry. As GM goes, so goes the economy still holds true today. Regardless of whether the American auto industry has downsized or direct employment has fallen, the supply chain fingers are massive. Millions upon millions of American's economic livelihood is tied to GM, Ford and DaimlerChrysler.

I've been critical of the Big Three so long I don't think I've ever said much of anything positive until recently when I posted these companies were finally going to turn after forty years of mismanagement. America's auto industry has had the most arrogant and most insular management of any companies on earth. I've worked with the Big Three as a consultant, I've worked with teams of people who have worked with the Big Three, I've got friends & family who work for the Big Three. I simply cannot overstate how awful the management teams of these companies are. They have been beyond awful for at least forty, maybe fifty years. I don't know how many times I can saw awful but I've worked with companies that have managed to file Chapter 11 that had management teams leaps ahead of the Big Three. And, anyone who thinks a CEO of a $200 billion company has to be good at something, I could cite failure after failure for forty years to prove that simply is not the case. Go back and read my prior posts. Leadership is an uncommon value and leadership in Detroit has been on hiatus.

The Big Three cultures have operated on the premise that you never share bad news with the boss. And that credo moves right up the food chain to the CEO. Bad news is not tolerated. While that may sound amazingly difficult to believe it is an extremely prevalent culture in insular societies be it a company or a country. If you are unable to admit to your shortcomings, how do you ever address them? It's the same trap we all fall into in our lives. It's Joe's fault at work. It's my spouse's fault we are having problems. It's the government's fault we spend too much. It's the other person's problem.

In the auto business it's manufacturing complaining about engineering delivering an unbuildable car. It's engineering complaining that the designers have a design which cannot be engineered. It's focus groups and marketing research which has been bastardized to the point of garbage in-garbage out. It's........the Pontiac Aztek. It's.......the Ford Crown Victoria. But mostly it's accounting trying to tell the designers the quality of material they can use, telling procurement how much money they can spend regardless of component quality and engineering how much money they can spend. To wrap it all together is a malaise and arrogance without any type of leadership.

Let me tell you something. The proverbial stuff has finally hit the fan. I know I've made this statement already within the past few months but the acceleration even today is exciting and quite unbelievable for me. Moral is in the gutter. Rats are leaving the sinking ships. Layoffs are massive. While I view layoffs as the ultimate measurable factor of management failure and it sickens me to see people's lives devastated, and they are being devastated, now is the time to work for an American automobile company. The leaders will rise through the ranks swiftly and within a reasonable number of years, global economics permitting, these companies will be shining stars unlike any time since the post World War II glory days. GM and Ford are busting out. They are becoming places designers and engineers once again want to work. The car guys and gals are taking back these companies and the admission that they have forsaken their customers is what finally inks the deal.

There is so much talent within GM and Ford it is nearly unimaginable and the cream is starting to rise. They may go bankrupt to relieve their retirement burdens at some point but these are companies on the move and bankruptcy, if it happens, is simply a chapter on the way to renewed greatness. And, they are moving at lightning speed comparative to anytime in their history. Crisis creates opportunity and there is one massive crisis in Detroit.

While GM's product pipeline is much stronger and much richer, I believe Ford has assembled some of the best young leaders in the auto business. I am a huge fan of Bill Ford and Mark Fields. I've probably worked with one hundred of the top companies in America. You get a feel for the winners and the losers. In how they treat their employees, in how they define their responsibilities, in how they attack internal malaise and in the type of organizational culture they create. There is no doubt in my mind Bill Ford has the right stuff and so does his inner circle. The crescendo of naysayers inside of Ford is deafening. While I believe in one type of management, positive leadership, there are many inside of insular organizations who will do anything to sabotage transformational efforts. There is a general resistance to change in the human psyche. These people need to either join the winning team and lead the company into a new and exciting era of innovation or they need to find another calling in life. In terms every sports fan understands, you are either Donovan McNabb or Terrell Owens. Corporate culture can become a virus working to kill a company from the inside out. Ford himself has issued this ultimatum and his recent actions have surely convinced those who thought they could outlast this effort as just the latest in many failed turnarounds.

Never in my lifetime would I ever expect any senior executive of the Big Three put such a critical self evaluation and feedback forum on the net. This is some serious introspection folks. This turnaround is the real deal. Watching these nine video clips was an emotional experience for me. This is the type of opportunity that could get me back into the corporate world. And, it just so happens Mark Fields cut his teeth with the same company in the same position as I did. Mark Fields are you out there? I want to join your team!

posted by TimingLogic at 12:35 PM links to this post

Tuesday, August 22, 2006

German Investor Confidence

Over the years I have found the mainstream journalism lacking in the US. So, I have tried to find sources of strong journalism on business outside of the US. The world we live in does not revolve around America exclusively and what is happening in the world's second and third largest economy, Japan and Germany, should be of primary importance to investors. As should China and the rest of the world.

Finfacts is one of the best sites for global business, economic and finance data I have found. It is far and way better than any US site I have found and I hit it every morning. Today is a front page story on Germany's plunge in investor confidence. Remember, Germany is the world's largest industrial goods exporter. Capex spending going to take over for the consumer? Fuel for a rally? Hardly. Some additional comments re sentiment later this week.

If the story falls off the front page by the time you read this, the direct link to the story and chart is here.

If you have found any good sites, email me or post it within the feedback forum as I'm always looking.
posted by TimingLogic at 9:12 AM links to this post

Sunday, August 20, 2006

Pairs Trading and Phelps Dodge

Finally! Here's my pairs trading post. I believe this strategy will soon make significant sense. It hasn't unfolded yet but sometimes markets don't oblige exactly when you want them to. First let's take a cursory look at pairs trading or more commonly called spread trading. Spread trading seems to have found its beginning in the futures market from all of my reading. I don't know who first developed such a strategy but Morgan Stanley takes some credit for birthing it. The concept involves finding two commodities or investments which are highly correlated. They can be positively correlated or negatively correlated. Doesn't matter. They can be seasonally correlated like heating oil and gasoline or they can be inflation oriented like copper and gold or they can be business cycle correlated like semiconductors and oil companies.

Spread trading is a tremendous opportunity to reduce risk while taking very aggressive positions. For equity investors, I guess something like covered calls or strangles or straddles or some other risk reducing strategy would likely resonate. Using stocks as opposed to futures contracts or options contracts is alot easier and cleaner. You don't have to decide which months to invest in, you don't need to hit the trade just perfectly, you don't have a time decay issue and a host full of other issues.

So, the concept is something like this. I don't care if prices go up or down. All I care about is the spread between the prices. So, both investments could go down, up or a combination. The way it works is to take equal dollar positions in two investments when the spread has reached historical extremes, conditions merit a possible reversal of trend or seasonality takes hold. Now, there is alot of very sophisticated work out there around spread trading so I'm really boiling this down the introduction of a concept. Joe Ross has written extensively of this for futures and there are a handful of other good books on the topic over at Amazon. An example of this approach may have been to short semiconductors in 2000 and go long the OIH ETF. Or, go long Exxon which pays a higher dividend than the ETF. (Or in the future use the actual Oil ETF and a semi ETF.)

Now, you might ask yourself why you wouldn't just short SMH. That's a valid point. But, it is an unhedged position. Hedging has the potential to reduce risk and you don't need to know which way the market is going to move. All you care about is the spread. There are specific benefits in the futures market you aren't going to get in the equities market such as reduced margin compared to owning the two individual futures contracts as well as some other benefits. Without thinking too much, there are likely half a dozen other reasons. Read a book. Hopefully, you get the concept.

Now let's break the concept down into the possible scenarios and let's do it using Phelps Dodge, a copper producer, and Newmont mining, a gold producer. Addendum: I actually just reread this post after typing it up last night. I realized I never explicitly stated the trade involves going long Newmont and short Phelps Dodge. Most probably knew this but as a point of clarification I am inserting this point. You could just as easily do this with copper and gold futures but there are alot of implications as I mentioned above such as which contracts to use, getting creamed by sophisticated traders, contract expiration, time value losses, etc. As an aside, you'll likely be able to do this with the gold ETF and a copper ETF at some point in the future. Rumors of a copper ETF have been floating for some time.

Today, the spread between copper and gold is historically very extreme. It's the most extreme on this side of the trade as it has been in twenty years. In fact, going from memory, I believe it is nearly as extreme as it was in the early 1970s commodity explosion. I believe copper topped somewhere near $2.50ish and gold was around $400ish in 1973. Today copper is still around $3.70ish and gold around $650ish. So, the spread in 1973 was about 160:1 and today it is about 160:1. This is all from memory as I am too lazy to look it up but exact numbers aren't relevant to the strategy. Now compare this to the opposite extremes when the gold/copper ratio has reached approximately 500:1. ie, Gold at $250 to $350 and copper at $0.50 to $0.70.

What sentiment does this ratio share with you at its extremes? At 160:1 it is telling you the future economic growth is expected to be off the charts positive. At 500:1 it is telling you economic growth is going to be in the gutter. There could also be implications as it pertains to inflation but let's try to keep this as simple as possible. So, what's the economic future? Will the economy boom on or will it crater. Well, who cares? Seriously. Who cares? In spread trading you really don't care. All you care about is making money on the spread and you want the spread to change. Both stocks go up and it is possible to make money. Both go down or one goes down and one goes up, ditto. Remember this point. In a recession, higher order capital goods typically fall faster than money or money equivalents. Copper is an input into the capital goods sector. While gold is neither, it is considered by many a pseudo money equivalent. Especially in times of heightened uncertainty, deflation or inflation. Back to the trade. Two variables=>Four possible outcomes. Remember the time in the cycle when you consider these four scenarios. No statistics, historical returns or probabilities. That would mean I would actually have to do something. If the trade is of interest to you, the data for such analysis is available.

1) Copper rises and gold rises. In this scenario, you make money if gold rises more than copper. Given high commodity prices eventually creates inflation and economic malaise, is copper going to rise faster than gold at this time in the cycle? Especially if the cycle is slowing or worse? Likely not because from these prices if copper made a significant run, we'd be looking at hyper inflationary pressures and gold would do a moon rocket likely beyond that of copper. High odds of a positive return in the trade.

2) Copper rises and gold drops. Again, similar scenario to the first outcome. At an extreme spread where copper as a percent of gold is already at twenty year highs, what is the chance the spread will go against you with gold moving the opposite direction to copper? High odds of a positive return in the trade.

3) Copper falls and Gold rises. If an economic slow down is near, economically sensitive copper has likely peaked and on a relative term will likely fall faster than gold. High odds of a positive return in the trade.

4) Copper falls and Gold falls. Again, a plausible outcome if inflation is tamed or the economy slows. Yet, in periods of higher risk, copper is going to fall faster than gold which is a hedge for both inflationary and deflationary environments.

There you have it. The trade hasn't set up yet as far as what it would take for me to enter but I'm anticipating it will relatively soon. Go make some money. Just don't do it using my post as it isn't advice.
posted by TimingLogic at 10:19 PM links to this post

Thursday, August 17, 2006

Oh Come On!

Jeff Matthews busted me over at his blog for trying to slip him a "roofie". ie, A post with a few four letter words. Nothing extreme and nothing off topic either. Especially when some moron who espouses to have a science degree from Wal-mart University tries to compare climatologist's and other scientific genius's findings today re global warming to ""Copernicus when told "the Sun is rotating around the Earth."" Ok, we are back on this topic again. Some dolt dissing sound science. What's next? We throw out microbiology? astrophysics? mathematics? organic chemistry? Hey partner, I think most of us have progressed past the flat earth theory. Ok, I guess Stephen Hawking, who has been squawking about the scientific facts surrounding climate change is a bonehead too?

What fun is life without full use of the English language? Geesh, I'm usually "PGish" rated but you mean I actually have to be British all the time? What's so wrong with Yahoo Message Board-type language as he calls it?

Our childhood experiences have a profound impact on our lives. Now I remember as a kid listening to an interview with Don Shula who just so happened to be a hero of mine. (I've since dropped the hero worship gig except for imperfect people who rose above to make a difference in the life of others like Rosa Parks, Martin Luther King, Mahatma Ghandi, Jesus, the Dali Lama errr is it Salvadore Dali and the Dalai a few other select people.) Anyway the interviewer asked how Don resolved us colorful vocabulary with his faith. He answered that he was pretty sure God didn't care much what came out of his mouth. From there I was set free. Born again! A penitent man. I've since learned that those who don't enjoy some amount of cursing or let their guard down every so often are more likely to be lunatics, serial killers, sociopaths and generally smoldering furnaces. :)

Come on Jeff loosen up! I'm green and I'm damn proud of it!
posted by TimingLogic at 10:27 PM links to this post

A Few More Comments About This Week's Action

Amazing. That is what I feel when I read many of my favorite blogs and see the emotional swings back and forth over the last few weeks. The Dow is about fifty points higher than it was two months ago and the vibe seems to have totally changed. Just a week ago gloomers were pointing to the end of mankind and perma-bulls are now courting Goldilocks. The gloomers have been quite quiet over the massive assault this week. I'm sure they are questioning their dire predictions for the end of civilization. This run has caught many off guard. I never discount wild action during this week for reasons previously mentioned. This is a week of wonder if you like volatility. I love volatility. If every day were like the last three, whether up or down, I'd day trade for a living. That said, I surely didn't expect the semis to make as large of a move as they did. I'm not sure I see the data supporting a short covering rally as Cramer has mentioned but maybe that is what happened. In any event, big money has the ability to do big things whenever it feels like it. Those moves are usually temporary but markets are absolutely manipulated in the short run.

One needs to maintain their senses through this week. Yes the semis have made a massive assault. But, without adding it up, I would say the annualized return over the past three or four days is probably 700%. So, put your logic cap on and ask yourself if this type of action is sustainable over time. Remember, most semis and semi equipment companies are guiding downward in their future business outlook. Are they headed for a 700% return this year? A 70% return? A 7% return? The semis have been in a bear market pretty much since December of 2003 as defined by the HOLDRS and the classical definition of a bear market. I noted about a month ago that semiconductor stocks would be selling below a price of zero within a month or two if they kept up their then rate of decline and that it would not continue.

So, why the massive move in semis? And, you need to understand it is highly concentrated in the semis, telecom, retail and some ancillary tech buying as well. Look at the open interest in the SMH August options. Something funny going on there in the distribution. A little low volume summer gamesmanship? AMD had gone from $45 to 18 in two months. What did everyone expect? AMD would continue on that descent for another year? In fact, I wrote this very sentence a month or so ago. If that were to happen that would put the decline at another $120 in absolute terms.

I had this same discussion with a friend who called me in a panic in July. "What do I do?". Well, I said the same thing to him as I have said many times before. Stocks don't go straight up and they don't go straight down. Well, at least since trading curbs they don't. At that time the Naz was down over ten percent in a short period of time. I told him at the current pace of decline the market would end up at zero by the end of the year and if I were him I would hold for an impending reflex of some sorts. Reflexes are typical and natural. People find value. People form different opinions about the future. Big money sees an opportunity to jam heavily shorted positions. Whatever.

One must remember there will be a rotation out of late stage businesses into early stage businesses as the bulls and buy & hold crew anticipates a soft landing. They look down their chart and see someone told them which sectors lead an economic recovery or in this case a mid cycle resumption. I have no idea if this is the start of such a sustained move or not. I can tell you my most important quantitative work is not confirming this move. But, is everyone always right? If so, I want some of that action. But right now I am not inclined to chase.

But as I wrote with homebuilders there will be investors that have found value in AMD, as an example, down 70%. Personally, I find zero value in semis at this point but let's see what happens. The point is as money rotates into early stage stocks, these companies will find support be it temporary or lasting or be it here or later. The economic data has not progressed far enough for the bulls to throw in the towel so they are going to do what they always do: buy the dips. One day that strategy will fail should we have a hard landing. I see no way around a hard landing.

If a new bull market begins, you aren't going to miss it. The homebuilders, semis, retailers, tech, durables and half a dozen other sectors are such a mess it would take them three to six months just to get back to 2004, 2005 or 2006 highs. Then we have an assault to higher highs beyond that. Logic, logic, logic. We all must fight our emotions. All we saw the last few days was some gyrating. And, might I add some very weak gyrating as time passed.
posted by TimingLogic at 12:37 PM links to this post

Wednesday, August 16, 2006

Ducati Desmosedici RR

Only if..........

I've owned motorcycles since the age of sixteen. There is nothing more adrenaline pumping than the psychotic sport bikes of today and little less exhilarating than the freedom of riding a motorcycle.

Heretofore, the fastest motorcycles available to the public have been the Suzuki Hayabusa and the Kawasaki ZX-14. But neither of these bikes are truly capable sport bikes. With massive heft they are basically straight line performance machines. Now comes the mother of all things bad, the Ducati Desmosedici. A $70,000 Grand Prix Superbike reproduction which sold its annual supply within five hours. Not saying much with the limited production but Ducati has a rabid following. The Desmosedici is an engineering marvel and truly a work of mechanical art. Oh, and it has 205 horsepower! OMG this is more than the Corvette of the mid-70s when it was choked down with emissions regulations. This is a bicycle with a motor and it has 205HP.

Without released performance numbers, I would guesstimate zero to sixty miles per hour times of about two seconds and zero to one hundred miles per hour in approximately four seconds. One, two, three, four. That is, if anyone buying one of these monsters could actually keep the bike down under such a massive explosion of power. I might be able to do something like seven seconds or eight seconds but you must be an assassin to do 4 seconds. Superbike racers are incredible athletes with tremendous balance, hand-eye coordination and superb endurance. Flopping a four hundred pound machine around a road course while exceeding two hundred miles per hour and doing it lap after lap requires tremendous natural ability. It also takes nerves of steel. I would imagine professional cyclists would have the psychological profile to be great traders.

While I cannot post the direct link to the Desmosedici, at the top of Ducati's web site is a "click here" link to the Desmosedici and a downloadable MP3 of its raw deafening power.

What relevance does this have to anything? Ducati is an extremely well cultivated brand. They are laser focused on what they do and there is none better. Period. So much so they are a Harvard case study. Also, here and here and here. Globally the Ducati brand probably has more accreted value than anyone except Harley-Davidson. They are steeped in heritage, they deliver tremendous quality, their bikes are works of art and the engineering is superb. They nurture their image through fantastic multi-channel marketing and branding efforts and, hey, they are Italian. And who the hell knows how to make a mechanical work of art better than Italians? Since their target audience is complementary to Harley, they have few challengers sans the occasional Guzzi, BMW, MV Agusta or Japanese sport bike buyer who secretly dreams of owning a Ducati.

In case anyone is feeling generous, I do accept gifts.
posted by TimingLogic at 11:33 PM links to this post

Options Expiration Week

Ok, some I'm late on my pairs trading post. My goal is to try to update this blog three to four times a week. Since most of my postings involve a fair amount of writing or work, I tend to blog less than if I were simply providing brief commentary on links or third party data. I'll do that at times too but I'm never going to be posting once or twice per day.

So, are we headed for a summer rally given the pricing action this week? Well, once again I point you to the disclaimer clearly posted on my site. But, the answer is still no given my work. Could we bounce around a little on the upside? Sure. A major new assault higher? Extremely high odds answer of no. Remember, there are those who predict and use opinion to decide their investments and there are those who use quantitative analysis. ie, Clearly measurable data and mathematical algorithms. Math has no opinion and while it may yield questionable results at times, that is usually because the author has made a mistake. Math never lies. It doesn't need to. Investment pontificators and opinionators do a swell job of that.

If you are an investor, there are some basic things you should understand. One of them pertains to this week. The third week of the month is options expiration week. It's also futures and a few other things but let's keep it to options. The market price action options week is often such that it has nothing to do with the prevailing market conditions or trend. ie, A raging bull may end the week down or vice versa. There are many theories for this but none of them an exact science. One is options pinning where prices gravitate towards strike prices with high open interest. One is that options tend to expire where the most pain is inflicted based on a distribution of all puts and calls. Regardless, one should not get too enthusiastic or bearish based on pricing action during options expiration week.
posted by TimingLogic at 9:55 AM links to this post

Monday, August 14, 2006

Japan's Deflationary Recovery Is In Jeopardy

Japan is an amazing country and Tokyo is one of if not the most amazing cities on earth. While I realize it may sound absolutely ridiculous, Japan's economic dominance in Asia will likely not be threatened any time soon. While economic development in China may or may not continue at a frenetic pace for decades to come, that does not necessarily translate into economic leadership. Overpopulation does not guarantee anything other than tremendous socio-economic challenges which have likely contributed to China's economic hibernation for centuries. I guess one could argue the massive corruption and stagnation caused by communism and before that the exploitation of colonial powers but that's best covered in a book by subject matter experts.

There are some troubling signs out of Japan. First off, the recovery from deflation has been highly suspect and too early to call yet we've heard many confidently make this statement. I guess if viewed in a vacuum, I'd be more confident. Monetary conditions are still very restrictive and I believe the BOJ made a big mistake raising rates. I'm sure there was some international pressure on that move. If you follow the GICS indices, you would see that Japan's economic recovery is tracking quite similarly to the US. Base materials, energy and construction oriented export engines of growth have fueled the Nikkei. Domestic and consumer centric indices have suffered. The prediction is that the consumer centric economy will pick up the pace. That assumption is predicated on the higher order capital goods experiencing a slow down or recession and/or significant wage growth and is steeped in theory yet to translate into quantifiable data.

Bloomberg reports tonight that the Japanese service sector unexpectedly contracted by a significant 0.6%. This is just one of a handful of poor economic releases recently. While Japan is far and away the most stable major economy in Asia, I believe the global dynamics are going to present a serious challenge to Japan's economy going forward. That said, if I were to invest anywhere in Asia, it would be Japanese high yielding stocks. Investing in Japan would also provide a mild currency hedge should the politicos in Washington find it convenient to devalue the dollar against Asian currencies as they did under Reagan. Wisdomtree has a few such funds which appear mildly interesting.
posted by TimingLogic at 10:48 PM links to this post

Sunday, August 13, 2006

Buying Stocks at 52 Week Lows

Over at Barry Ritholtz's blog there has been alot of discussion lately about buying stocks whose price has hit 52 week lows. Barry is one of the few public figures on Wall Street who gets "it". His blog is a good read on most topics other than Microsoft's business outlook, eventual demise to freeware and inability to innovate. Got that Barry? :)

Why is it that more on Wall Street who get it aren't trotted out for public consumption? I could never figure this out. Is it because Wall Street truly wants the public to be clueless as many have stated? Or is it that most on Wall Street really don't get it as the old 80-20 rule predicts? (80% of investment professionals are subpar or worse. A surety in the deflation of many egos and inflated salaries.) Based on my twenty years of business experience, my vote is Pareto was right. I do know there is a desire to keep secrets on Wall Street. Quantitative work done by mathematicians, physicists, engineers and other technically inclined people are usually reserved for proprietary trading desks and extremely wealthy clients.

To digress a moment on this topic, I recently had a Vice President and CFA at Merrill Lynch tell me their private equity group had access to the same information as Goldman Sachs' proprietary trading team. I didn't even respond. He didn't get it and it wasn't worth it. Between him and I there was enough energy in the room to power a sixty watt light bulb. The intellectual capacity developing strategies at Goldman has enough energy to light the eastern seaboard. They aren't MBAs or finance degrees either. Another validation of the 80-20 rule as Wall Street covets both. (More on that in a later post when I profile the greatest quantitative trader of our time.)

Anyhow, back to the discussion of 52 week lows. I understand what Barry is stating. He wants to buy strong stocks not dogs and that is generally true. Yet, there is a time to buy dogs and you need to understand the cycle fundamentals to know which 52 week lows to buy or have the quantitative tools to make the best investments. I prefer mathematical tools because math doesn't have an opinion but either approach is valid if you take the time to become a subject matter expert.

Above is the chart of a stock I have profiled more than any other on this blog: Phelps Dodge. Why? Because I am enamored with this stock. It has the most powerful normalized positive volume of nearly any large cap stock this cycle. It has been ridden hard and I believe it's going to be put away wet. Overlaid on the chart is normalized positive volume as I have outlined in prior posts. Any guess where you should have bought this stock? How about at or near its 52 week low in late 2002 or early 2003? Doing so would have yielded an incredible return this cycle. Per prior comments, there are three clear Elliott wave patterns on the price chart. There are also three clear waves on the normalized positive volume chart. On this particular chart I have also included a blue outline of volume to get a clearer picture of its direction. Positive volume peaked this last time when Phelps was violently up twenty percent then down twenty percent in a matter of a few weeks. A sign of a top? The 2006 prices look like a war zone with gaps all over the place. That is highly unusual on a weekly chart and tells an ominous story. One of indecision which is also validated by the many dojis which are highly uncommon in such large weekly clusters. There are enough graveyard dojis, inverted hammers, dojis, evening stars, abandoned babies and every other Tom, Dick and Harry bearish candlestick patterns on this chart to give one ample warning of impending risk. My goal is to stay clear of risk. Beyond risk, one can only use an educated guess at what will happen next.

Along those lines, will positive volume turn north for another leg up in the stock as it has in prior moves up this cycle? Or will it continue downward for months or longer with weak rallies? The moral of the story? Buy 52 week lows like everyone should have done with Valero, Phelps Dodge, Titanium Metals and Exxon Mobil but know why and when to buy them.

My next post will be using Phelps in a hedged strategy called pairs trading. The time is likely near to initiate such a trade. Until then, au revoir.
posted by TimingLogic at 9:44 AM links to this post

Wednesday, August 09, 2006

If History Is A Barometer, The Transports Are Headed For A Likely Disaster And Soon To Follow Are The Utilities

As I had noted on here a month ago, the Transports had fulfilled their Elliott wave pattern and were likely topping. Or, as I had noted in my personal journal on April 1, the Transports were driving off of a cliff. "There is absolutely zero doubt and I am so confident that this is the fifth blow off wave for Transports this cycle. Now, what would really scare me is if the Transports rose through this resistance to rise another ten percent to a resistance line going back to 1929! Ominous? A correction in the Transports of earthquake magnitude?"

What does the future hold for the Transports? Well, nobody knows exactly. But, let's look at a few facts:
@The economy is slowing
@The building materials space is cratering
@Consumer spending of discretionary items, many of which are manufactured in Asia, slowing
@Auto sales for the big three are cratering
@Corresponding raw materials needed for durables production are slowing
@The raw energy materials needed to build all of this slowing

So, why have the Transports boomed this cycle? All of the reasons above. The Transports have been this overbought two times since the Great Depression of 1929. In those two occurrences Transports fell approximately 90% and 60%. Are we close to a bottom with Transports down 20%? You be the judge. I am of the opinion that over the long term prices revert to their mean. That means just not Transports but consumer spending, energy prices, building prices and on and on and on.

It's obvious and easy for anyone to pick up the newspaper and look at the price of a stock and see it has fallen. Wow, the Transports are down 20% or 10% or whatever. But what is more prudent as an quantitative investor is to be able to actually predict tops with some degree of accuracy using the tools at their disposal. As the greatest speculator of the twentieth century, Jesse Livermore, said, "I knew it was foolish to ever catch the tops or the bottoms of the moves. It is always better to sell large holdings into an advancing market when there is plenty of volume. The same is true on the short side; you are best to cover the short position after a steep fast decline."

So, under the same premise of selling large holdings into advancing markets, the S&P Utility Index is advancing. The index is near its all time high as we speak. That is bullish, right? Long term bond rates are low. Utilities are defensive, right? They pay a decent 3-5% dividend yield on average. The Fed will soon be easing, right? Well, I guess that all depends. If I told you utilities have reached this level of overbought only three times since the Great Depression and in those times they have fallen approximately 90%, 60% and 60% would that be defensive? Is it worth the risk? What did Jesse Livermore say?
posted by TimingLogic at 1:07 PM links to this post

Tuesday, August 08, 2006

What Is Google's Strategy To Remain Relevant Part Deux

The world is already changing since the my post in mid June looking at Google and their potential irrelevance as the web matures from the crude beast of today. While people are already calling YouTube and other simplistic offerings examples of Web 2.0, I simply couldn't disagree more. We likely won't see truly innovative Web 2.0 solutions until the next innovation cycle starts post 2010. These current fits and starts are simply experimentation on the way to major breakthroughs of the future. For now, enjoy hacking away on your keyboard, viewing YouTube videos and doing crude searches on Google tethered to your cable modem.

What is changing is Google's reach. Times will likely never be better within the framework of Google's current business model. That is not to say their future won't be bright or that they will end up irrelevent. But, the global economy has likely peaked and, if so, so will ad spending. Especially ad spending for a consumer who will lead us into this slowdown versus 2001's mild slowdown where they kept spending, thus fueling Google's growth through this cycle.

In addition, the global communications, media and content providers are starting to flex their muscle as they develop clarity into future strategy. All surely want to either reduce their dependence on Google and other third parties, negotiate partnerships on more equitable terms and want to drive more value via their proprietary efforts. ie, It is not in the best interests of Disney or Verizon or Sprint or Apple or Time Warner or the New York Times or Sony or Bertelsmann to be in a disadvantageous position relative to Google or Yahoo. On a totally separate but similar note, it is not in the best interests of Verizon, as an example, to make Apple rich by adopting an iTunes phone hence the fact that no one has yet announced an Apple branded product for their network. Apple's best bet for a next generation wireless handheld/phone is via WiMax and mobile internet telephony adoption versus Sprint, Cingular, Verizon or ATT Wireless. Of course, all of the aforementioned providers have designs on controlling wireless internet access, music, content distribution as well as the ad revenue associated with it. My point is that the net is still in its infancy and to assume the future will be set by the leaders of this moment is not a sure bet.

So, in a world where we become untethered from our PC to a more pervasive awareness of the net, how again does Google generate revenue? If you are using a Verizon portable device or Sprint WiMax network to access the net, how does Google generate ad revenue? This is already a problem for Google in a significantly more advanced wireless society such as Japan. It is not uncommon for a Japanese youth to go without a PC yet they all are adept mobile internet users. If it is a natural progression that American youth adapt to the mobile wireless culture as Paul Kedrosky notes and I believe is inevitable, how will Google replace lost revenue from search? What is Google's current penetration in an untethered society such as with the ultra sophisticated Japanese youth? Without having those break downs, I doubt very well at all. Yes, there is a new announcement of streaming video and ad banners with MTV to other sites and yes their are other methods of attempting to transform their business model, but will new sources of revenue be adopted on a wide scale as Google paid search is today? Will Verizon control future ads and streaming video on its network as it does today via VCast?

In addition, what of this MySpace deal? $900 million payment to Fox with an estimated $225 million of Google revenue over the life of the deal. I have to be missing something. I'm too lazy to dig too deep but this deal would have been a loss generator for MSN or Yahoo to quote an analyst. So, will it really be profitable for Google? Or the AOL deal? $1 billion investment to protect their existing revenue stream from Yahoo or MSN? Or what about the ridiculous waste of dollars on its ever growing stream of unsuccessful products in an effort to create alternative sources of revenue? Money doesn't grow on trees. While it appears it does for Google, that is not a phenomenon which will last forever.

My point is that Google has a very cloudy future that no one seems to recognize. They seem to be spending alot of money for unproven revenue streams as well as protecting their existing sources of revenue. There are deep pocketed content providers, network providers, media companies and undiscovered competitors which make a company so reliant on one source of revenue vulnerable over the long term. As I said before, remember how long it took for Google to eat Yahoo's lunch. How long would it take for the next Google(s) to eat Google's lunch? Maybe never but Google has made alot of enemies and all gunning for the leader. Just a thought to ponder when contemplating Google as an investment in these uncertain times.
posted by TimingLogic at 2:12 PM links to this post

Monday, August 07, 2006

The Tragedy of Gap Stores: A Lesson In Poor Leadership

Above is the five year price chart of Gap Stores. Obviously not a good time for The Gap, Banana Republic and Old Navy. This bull market from 2002 till today was a consumer driven recovery while the technology sector took a break from its massive blowoff of the late 1990s. Yet, The Gap has languished with very poor same store comps, slow revenue growth and poor profitability. In my estimation, this is due solely to ineffective leadership. For the first time in its history, The Gap is under leadership of someone other than the founder.

That being said, could someone please tell me how it is possible to screw up anything more closely tied to Americana than the Gap brand? The Gap was once an unassailable powerhouse of marketing, fashionable merchandising, quality and superior customer service. Loyal customers kept coming back year after year as the Gap became synonymous with retailing success. The specialty retailing lineup of losers never seemed to be able to crack The Gap code. The Gap and its Banana Republic & Old Navy brands are now under water. A company which cannot seem to fight its way out of a paper bag. The brand equity has diminished greatly as loyal customers left in droves for more innovative specialty merchants which provided customers with what they wanted while The Gap kept missing the mark.

Is it a coincidence that the founder stepped aside and a former Disney executive and now CEO of The Gap (since 2002) has been left to run pell mell in his effort to destroy a piece of Americana? Well, under Donald Fisher $1,000 invested in The Gap at their IPO would have returned $214,000. That is after a devastating bubble market correction in 2000 which wiped away alot of Gap shareholder value. The new CEO? Well, my information is not completely up to date but not too long ago he had $50+ million in stock options. He received this for destroying shareholder value, destroying brand equity, losing loyal customers and likely forcing strong merchandising talent out the door. Hey Gap board, where the hell is the CEO improvement plan? At that level of pay, you perform or you are out. Isn't four years of losing customers enough? So, when the board doesn't do its job and police the CEO, who polices the board? It should be the shareholders but they seem unable to build a consensus either.

So, what went wrong? Technology? Supply Chain? Product cycle times? Costs out of control? What? All of these things are important if you are a bank like Wal-mart which basically feeds off of its float. Obviously all of this is important but. That's a big but. For specialty retailers it's all about merchandise. You've got to know your customer, what they want and merchandise your store with the right mix and environment of goods. They do not have merchandise the customer wants. Frankly, I wonder if The Gap even knows who its customer is anymore. What does The Gap need to do? It's actually quite simple.

1) They need new leadership. If you can't make it work after four years, you don't have the right stuff.
2) Recognize the failures are your own and take responsibility. ie, Our strategy is failing our loyal customers.
3) Refocus on your core strengths and core brand values which made you the envy of specialty retailing
3) Listen to your customers and then give the customers what they want
4) Develop a plan of action
5) Execute, execute, execute
posted by TimingLogic at 1:09 PM links to this post

Saturday, August 05, 2006

Oil Services & Valero

I've had a handful of posts surrounding the oil service sector and oil stocks in general. The July post of Valero here was an early indication that oil stocks are likely peaking. Now, in the last few days, Leuthold, an institutional advisory service has been quoted on Bloomberg as saying oil company insiders are selling massive and record amounts of stock. A coincidence? I think not. William Greehy, one of the biggest sellers, is one very astute CEO and it is simply not a coincidence he is liquidating massive amounts of stock for the first time in his tenure at Valero.

The quantitative work shown here has been a validation of a likely change in trend for oil stocks. And, for those who believe high oil means oil stocks are defensive with their low PE ratios, think again. These stocks are extremely risky at this time in the cycle. With massive profit increases these companies are still selling at multiples of ten to twelve times earnings. That low multiple is a value trap. The market is a discounting mechanism. It is telling you that the good times are not sustainable by only rewarding oil stocks with a low PE in an extremely cyclical business. In the 1970s as oil companies were printing money and oil was higher than today in inflation adjusted terms, energy stocks saw massive slides during inflationary recessive times. It would not be unusual to see these companies lose 50% or more of their value if a full blown recession develops.

I'll say it again, those expecting a weakness into seasonally weak October with a new bull market then developing later this year are highly mistaken. There are significant cycles at work which will likely trump the oft followed mid-term election cycle.
posted by TimingLogic at 4:15 PM links to this post

Friday, August 04, 2006

The Futures Traders Are Gaming The Market

Today we opened up big. Actually, before the market opened the Dow futures were up nearly one hundred points. This on the back of a bad jobs report. There were zero buyers through this posting at nearly 1:00 pm. We are now negative on most of the indices. The futures players are gaming people right now. It's like a cat pawing at a dead mouse and "long" investors are the dead mouse. Markets just don't fall off of a cliff in most instances and there are enough signs if you are observant.

I'm not going to give buy & sell signals or investment advice on here but if the S&P has been in a plus or minus 2.5% range for nearly sixty trading days and in a plus or minus 1% range for nearly thirty trading days and can make no progress, the market isn't forming a bottom where we are going appreciably higher on some magic carpet ride. That is not how markets work. Our rally is likely ending soon. My trading model is still on a sell or short from the May top. We may yet get a strong rally this year but this does not appear to be it.

While it is merely a guess, I would expect we will not get any attempt at a rally until we get to 1300 on the NDX. But, I wouldn't bank on it either. The market leaders are so overbought it's nearly unbelievable to me that people continue to say the market is oversold. What we will likely see is a rotational selling into the leaders this cycle. The bulls have been holding the line here awaiting the incoming data and Fed's next move. Don't expect a flood of buyers to step in if the data continues to erode and the Fed hikes. If the smart money gets more and more clarity, there could be a dearth of buyers and we could see a little more aggressive free fall. You don't need sellers for a market to drop. All you need is a buyer's strike. Daily gyrations are hard to anticipate at times so this is just a little forecasting folly based on logic. The market is totally illogical at times so.........
posted by TimingLogic at 12:41 PM links to this post

Wednesday, August 02, 2006

Follow Up On The Oil Service Sector

As I mentioned earlier in the week, I would post a chart of the oil services sector ETF, OIH, later this week which is significantly more telling. Looking at the first chart I posted, there is really nothing to be interpreted other than OIH is in an uptrend and the volume over the past few years has exploded. That is why volume is most telling data in evaluating equities. Above is the same chart of OIH. Overlaid on the chart are positive volume surges. Even though the first chart clearly showed volume has increase by ten fold over the last few years, the volume data on this chart shows a different story. In addition, the above volume data is normalized and takes into account seasonal patterns of higher and lower volume.

So, what does this chart tell me? I obviously see three significant pulses as the oil services sector exploded. The first and most powerful pulse happened in 2002 near the beginning of this bull market. This is the accumulation phase. This is when the sophisticated money and strategic thinkers were getting into oil. The people that knew oil was going to run before it became obvious: Goldman Sachs, Merrill Lynch, etc. Not their clients mind you but their proprietary trading desks which would be the leaders in driving oil higher. The second pulse was based on fundamentals. Earnings started coming in that were ahead of expectations. Upward revisions of fundamentals were becoming common. Here, the masses started accumulating oil stocks: money managers and smart individual traders. Finally, we have the last pulse. This is when the crowd started buying. Group think. Water cooler talk. Peak oil. Oil to $100 (which I noted earlier was a possibility). We are running out of oil. Mania. And, the bulls who were buying in 2001, 2002 and 2003 were buying $20 million condos in New York City because they were printing money.

Remember, in 2001 and 2002 an oil futures contract could be purchased for a few thousand in margin. 8,000 barrels in an oil futures contract. So, if oil goes up $50 a barrel and you roll that contract all the way through you are looking at $400,000 on an initial investment of a few thousand bucks. Now, let's say a big trader owned 10,000 contracts. Well, you can do the math. $400,000*10,000. Now you know why Goldman has been ringing the register with tens of billions in trading profits this cycle. They didn't go that buying Yahoo.

So, to summarize I sort of view this as the fundamentals behind the concept of Elliot Wave theory. The theory is based on repeatable human behavior which can manifest itself in patterns. Usually three upward waves. Notice, that even though the final wave on the first chart has significantly more volume behind it, on the volume chart, it has the weakest normalized volume. Is interest in oil fading? Does the smart money know something we don't?

So, in closing, could the oil service sector go to new highs? Sure it could. Will it stay there? Well, I could win the lottery. Could the enthusiasm return and drive positive volume through the roof again? Well, of course. But, there's one fly in the ointment. For enthusiasm to return to the oil service sector would require it do something that has never done in any business cycle this century. Remember, human behavior never changes.
posted by TimingLogic at 4:44 PM links to this post

Tuesday, August 01, 2006

Auto Sales Reported. Is The End Of Times Near?

That is a sadistic joke. Well, the apparent perkiness on GM's turnaround efforts were short lived. Of course, we knew that. GM is simply hacking away at itself to achieve profitability rather than solving the real issues: sales leadership. Think of it as someone who has plastic surgery to remove their excess weight but does not change their eating habits. You should view GM in the same light until they consistently restore sales growth and the right product mix into the market. All we see today is a GM which has a smaller book value and less instrinsic value as it continues to bludgeon itself or the term I like is it is committing seppuku and has been for forty years of slashing. The good news is that GM has a massive product introduction planned for the next three years. The bad news is they sales success now.

Today, the reality sets in. GM is seeing market share losses and sales losses accelerate within North America. The numbers we are seeing out of GM are extremely serious. People are simply overestimating the health of GM. For that matter Ford, Daimler Chrysler and Nissan are all reporting staggering sales drops. Total sales drops of 20 to 35% will lead to catastrophic consequences for these companies should they continue. At this rate GM and Ford will each burn through over ten billion or more in cash this year from what I've read. Their cash flow is negative or close to negative and simply cannot continue with such high capital requirements.

A little secret. Transportation stocks were warning you of this report. Trucking and railroads in the US are highly correlated to the health of the auto business in addition to being correlated to this commodity boom and current account deficit trade boom. While my data is dated, autos were once the largest clients of rails. Are they still?

While I am long term bullish on GM, and for that matter Ford, I am very negative on their investability. They have cut so far into the muscle of these companies that the critical mass required to maintain their pension plans is likely beyond repair. Eventual reorganizations will likely be required. Such a mess will only fuel debate within the national health care and pension crisis. Under such situations, outside interests will finally have control over how GM and Ford execute their business strategties. They will not wait for forty years to see GM turn the corner as shareholders have. Crisis creates opportunity and there is tremendous opportunity within Ford and GM.
posted by TimingLogic at 2:11 PM links to this post