“Favorable” Foreign Exchange

…is one way of saying that a weak U.S. dollar helps boost quarterly revenue and earnings. This observation is made by companies with significant international sales and who report financial results in U.S. dollars.

This is extremely important for equity investors using the S&P500 as their benchmark. According to Standard & Poor’s research, around 48% of S&P 500 company revenues are generated outside of the U.S.

So, one could argue that the weak U.S. dollar partially explains why the S&P 500 has done so well in the last six months. In March, the S&P hit its low of the year when the dollar hit its high. When you overlay a chart of the S&P500, which is now trading at a year-to-date high, with the U.S. Dollar Index (DXY), which is now trading at a year-to-date low, you will easily notice the inverse correlation.

The U.S. dollar was actually at lower levels for much of Q3 2008, which means it should have an unfavorable impact on year-over-year comparisons this year. However, most corporate managers assume stable foreign exchange rates when issuing guidance. As such, if the U.S. dollar weakened since the last time earnings guidance was issued, Q3 sales and earnings will be better-than-expected…ceteris paribus.

But based on the persistent divergence in stocks and U.S. dollar, this may already be priced in.

If you’re unwilling or unable to sell your internationally exposed equity positions and you’re concerned that a rising dollar could eat into earnings, then you may want to hedge your position by going long the dollar. You can do so with an ETF like PowerShares DB U.S. Dollar Bullish Fund (UUP).

Mega Millions Mentality

Last Friday, I did not win the $336 million Mega Millions jackpot. But I played. Sure, the chances of hitting the right numbers are only 1 in 175 million. Even if you hit the numbers, you may have to split the winnings. And this is all before taxes.

But how often are you presented with an opportunity to earn a 336,000,000% pre-tax ROI on a minimum investment of $1? And in the worst-case scenario, you lose a buck.

Obviously, playing the lottery is not a prudent investment strategy. But the mentality of taking unreasonable risks for unlikely returns exists in the stock markets. Consider bankrupt companies whose stocks are worthless. Lehman Brothers (LEHMQ.PK) hit 32 cents on August 31, just a day after trading at 5 cents. Motors Liquidation Company (MTLQQ.PK), formerly known as General Motors, traded as high as $1.20 on August 12. Each stock sees millions of trades every day. But neither is trading on fundamentals. Even if a company were to emerge from bankruptcy, the old common equity is almost always cancelled. In other words, the stock price movements of bankrupt companies are not signs of life; they’re more like postmortem muscle spasms during rigor mortis.

However, if you were savvy enough to buy low and sell high in August, you could’ve gained up to 700% on LEHMA and 140% on MTLQQ.

Then there are the stocks on government-sponsored life-support including Freddie Mac (FRE), Fannie Mae (FNM), and AIG (AIG). Even after significant declines in recent days, these stocks are up between 260-350% in just six months. However, many question the rationale behind these price moves. Some analysts have suggested the common equity in these companies could be worth nothing. Even the more bullish arguments for these stocks come with warnings of high uncertainty.

My favorite pitch goes like this: “FRE and FNM were $60 stocks two years ago! They’re trading at under $2 right now! I could see them at $10. But if I get $5, that’s still a pretty good return.” It’s an unsound argument but not unused. Structurally, it’s very similar to the rationalization that goes into buying a lottery ticket: limited downside and tremendous upside. And you have to pay to play.

Perhaps you’re disciplined enough to avoid irrational investment decisions. But it would be totally irrational to ignore the existence of irrational behavior in the markets. According to La Fleur’s World Lottery Almanac, Americans spend around $50 billion each year on lottery tickets. Surely this includes a lot of amateur and professional traders and money managers who are unknowingly bringing that mega millions mentality into the stock markets. They see tickers for FRE, FNM, and AIG go across their monitors. Some might also follow the pink sheet action of bankrupt companies. They know these are not good investments, but the allure of outlandish gains is irresistible, even if those gains are highly unlikely.


Full Disclosure: Author is long FRE and 1 mega millions ticket.

Cash For the Credit-Worthy

Cash for clunkers will not generate major incremental sales for automakers like Ford (F). Some of the 489,000 cars sold under the program were made by consumers who were already in the market to upgrade their vehicles. Some represent future sales that have been pulled forward. This sentiment is shared by J.D. Power and Associates, who recently boosted their 2009 auto sales forecast by 300,000 units, but cut their 2010 forecast by 100,000 units. This reflects a net gain of 200,000 over a two year period, during which 21.8 million cars are expected to be sold.

However, on a per dollar basis, cash for clunkers will be more effective in stimulating the economy than the 2008 tax rebate checks. While much of the tax rebates went toward paying down debt, the clunker cash is more likely to go back into the economy through personal consumption.

Consider those who are participating in cash for clunkers. If Jane Smith qualified for a $4,500 rebate and purchased a $15,000 Toyota Corolla, she has to make a $10,500 financial outlay. This is not a small amount of money. She is likely to take out an auto loan, which is only available to the credit-worthy. Furthermore, if she were in a tight financial situation, she would probably stick with her clunker, which is in driveable condition.

Jane is a confident consumer who won’t save that $4,500. She will spend it on a big screen TV, a family vacation, or a fancy dinner-all good for the economy right now.

This isn’t the only government program that rewards credit-worthy consumers who are likely to spend before saving. There’s also the $8,000 first-time homebuyer tax credit. The Wall Street Journal recently reported on a pending cash for appliance program. Again, this program will not provide a major long-run incremental sales boost to Whirlpool (WHR) and Electrolux (ELUXY). It just puts extra cash in the pockets of the customer, who can spend it on something else.

Obviously, I’m not happy that my tax dollars are going to people who don’t need it. But when it comes to economic stimulus, I prefer programs that reward the credit-worthy and encourage them to spend over programs that bailout the debt-laden.

The Emperor's New 787 Dreamliner

Boeing’s 787 Dreamliner was originally scheduled to fly in September 2007. Just a few days before the maiden flight, management announced what would be the beginning of a 2+ year delay. That’s long even by airline standards. In its five or six announcements—it’s hard to keep count—management blamed everything from a shortage of fasteners to incomplete software to a labor strike.

The latest delay was announced on June 23, 2009. Management said, “first flight of the 787 Dreamliner will be postponed due to a need to reinforce an area within the side-of-body section of the aircraft.” I’m not an aerospace engineer, so I won’t say how I really feel about that. Regarding first flight and aircraft deliveries, they said, “It will be several weeks before the new schedule is available.”

Several weeks later on July 22, 2009, Boeing announced their Q2 financial results. Regarding the 787, they said “The company expects to complete its assessment of the schedule and financial implications during the third quarter.” Not only have they delayed first flight, they have also delayed the new schedule for first flight. They also added that they recently completed “low-speed taxi tests on the first flight test aircraft.” I guess you learn to walk before you run…or fly. Again, I’m not an aerospace engineer.

At this point, I have lost confidence in management and I am only 99% sure that the Dreamliner will eventually get off the ground. While I think it would be risky to bet against BA stock at current levels, I would not recommend you buy it either. If that 1% disaster comes true, shares will take a Black Swan-style swan dive.

S&P 500's Stealth Earnings Growth

How can analysts expect S&P 500 earnings to grow from $49 in 2008, to $55 in 2009, and $74 in 2010? One explanation is turnover on the index.

Let's consider the impact of General Motors. According to data compiled by S&P's Howard Silverblatt on June 2, Q2 consumer discretionary sector earnings were expected to fall 75.6% year-over-year. This was due to the massive loss estimated for GM. But now that GM has been removed from the S&P 500, Q2 consumer discretionary earnings are expected to jump 36.6% year-over-year. It's clear how changing a constituent can have a material impact on the index's earnings estimates and valuations.


And GM isn't the only money loser that got booted from the index in the last year or so. Lehman Brothers, Freddie Mac, and Fannie Mae bled money for the S&P 500 in 2008, but they're not in the index today. This could at least partially explain the expectation for 300% year-over-year earnings growth in the S&P 500's financials sector in Q2.

Morgan Stanley and the Future of Research

The Financial Times recently reported Morgan Stanley tapped a 15 year old summer intern for some insight into "How Teenagers Consume Media." The introduction reads, "Without claiming representation or statistical accuracy, his piece provides one of the clearest and most thought provoking insights we have seen."

So, as the requirement to provide independent third party research expires in the next few weeks (Global Research Analyst Settlement), is this a preview of research to come? It's cheap (Hello, cost savings!), it has no statistical basis (Nassim Taleb would be proud), and it's independent (How corrupt could a teenager be?).

Of course, I don't really expect research departments to be taken over by high school kids. However, I do expect to see an increasing use of unconventional research. Surely, statistical study will reveal that conventional research made you very little, if any, money in recent years.

Religionomics

Here's a conversation topic you might not want to bring to the dinner table. (and I can't take credit for coining the term.)

On Tuesday, the Vatican published Caritas in Veritate (Charity in Truth), an encyclical of Pope Benedict XVI. Among other things, there is a need "To manage the global economy; to revive economies hit by the crisis; to avoid any deterioration of the present crisis and the greater imbalances that would result...," proclaimed the Holy Father. "For all this, there is an urgent need of a true world political authority...regulated by law, to observe consistently the principles of susidiarity and solidarity..." et cetera. And only a month ago, we were arguing that President Obama's financial reform plan would give too much power to the Fed.

As I see it, in order to establish a "world political authority", you need world agreement, which is another way of saying world peace. At the very least, world peace is a long ways off.

The Pope isn't the only renown religious figure to dabble in economic commentary. Famed ultra-conservative televangelist, Pat Robertson, annually makes a set of predictions for the year. On January 2, 2008, he claimed God told him that oil would rise to $150/barrel, the stock market would crash, and the world would enter a recession. But before you run to your nearest church, you should know that he doesn't have stellar track record of annual forecasts: Robertson predicted there would be a major terrorist attack on U.S. soil in 2007.

Obviously, the Pope and Pat Robertson are very different indeed. But despite the Protestant Reformation, the two spiritual leaders share some similar beliefs. For one, they are both opponents of abortion and contraception. And here's where our conversation gets freaknomic (to borrow a term from Stephen Levitt and Stephen Dubner).

Set aside your stance on abortion and contraception for a moment. In Irrational Exuberance, Robert Shiller notes:

"Advances in birth control technology (the pill was invented in 1959 and became widely available by the mid-1960s in the United States and many other countries) and social changes that accepted the legality of contraception and abortion were instrumental in lowering the rate of population growth, as were growing urbanization and advances in education and economic aspiration levels. Now the Baby Boom and the subsequent Baby Bust have created a looming social security crisis in many countries of the world: when the Boomers grow old and finally retire, the number of young working people available to support the elderly population will decline worldwide."

In other words, contraception and abortion are taking taxable individuals out of our future workforce.

But Shiller's point may be an oversimplification. More people could mean more unemployed. Also, anyone who read Freakonomics could tell you that Stephen Levitt has long argued falling crime rates can be traced back to the legalization of abortion due to Roe v. Wade in 1973.

I won't try to get to the bottom of any of the issues mentioned above. The point I'm trying to make is that economics, religion, sociology, et cetera, are not mutually exclusive. Social and religious choices are not without economic consequences. It's popular for young people to claim that they are social liberals/economic conservatives. But even that distinction doesn't get rid of the highly contentious political gray area.

Sam Ro Now on MoneyMasters

I'm now a regular contributor to the blog, MoneyMasters with Vahan Janjigian. Check it out for a variety of good commentary and opinions on the markets and the economy.

I will also continue posting to the Educated Guesser.

Rolling Stone on Goldman Sachs

Rolling Stone's Matt Taibbi recently published a colorful and slightly biased history of Goldman Sachs. (Read it here for free.) It gets good at the end when the author suggests Barack Obama and Al Gore are puppets in Goldman’s plan to rip off America through cap-and-trade.

Stocks Could Fall in the Near Term

As expected, stocks have climbed significantly since March lows. However, I'm getting nervous that stocks have rebounded too much too fast. Here's a report I helped author and publish Thursday, June 11 for Forbes Special Situation Survey subscribers.


Special Report

Although the Federal government now owns large chunks of formerly blue-chip companies, it seems investors have overcome their fear that capitalism is about to end. In fact, they now seem to believe that the worst of our financial and economic crisis is over. As a result, they are once again willing to put money at risk as evidenced by a number of factors. Spreads between yields on corporate bonds and Treasury securities have shrunk, the CBOE Volatility Index has declined significantly, and stock prices are up 40% from their March 9 lows. Yet despite this increased appetite for risk, we remain concerned that stocks will see another pullback. While there is plenty of evidence that the economy is deteriorating at a slower rate, we see nothing to suggest it is getting better.

First quarter earnings provided one catalyst for the stock market’s rally. Earnings were down from a year ago, but for the most part, they were better than expected. Many of the positive surprises were due to lower raw material and energy costs as well as layoffs and other aggressive cost cutting activities. More recently, however, commodity prices have been on an upswing. The Goldman Sachs Commodity Index, a composite of energy, metals, and agricultural goods, is up 41% from its recent low. The Energy Information Administration, which in January had forecasted an average price of $43.25 for a barrel of crude oil for 2009, recently upped its forecast to $58.70. With oil currently selling for more than $70 per barrel, it may have to revise its forecast again. This rapid rise in commodity prices will squeeze gross profit margins for many companies.

Furthermore, corporate layoffs have pushed the unemployment rate to 9.4%, its highest level since 1983. Yet those fortunate to remain employed are getting squeezed. A recent survey conducted by Challenger, Gray & Christmas indicates that 52% of companies have cut or frozen salaries. Many have eliminated benefits such as contributions to 401(k) plans. On top of this, the national average price of gasoline is up almost 60% since the start of the year. Less income and higher gasoline prices will reduce consumer spending, the most important component of GDP.

In addition, housing, where all the problems began, remains troubled. Sales may be stabilizing, but prices are still plunging. The government tried to help by forcing mortgage rates to below 5%. However, the long-end of the Treasury yield curve has suddenly jumped and so have mortgage rates. Higher mortgage rates will only prolong the housing crisis.

In short, the economy is still deteriorating. Yes, things may be getting worse at a slower rate, but they are still getting worse. We agree that a rally off the March 9 lows was fully justified. We also agree that even at current prices stocks are attractive from a long-term perspective. However, we also believe stocks have climbed too far too fast and a retest of the lows is inevitable. We are not suggesting you sell and get out of the market. Instead, take advantage of a pullback if it occurs to put more money into your favorite stocks.

Understanding the Dow Jones

I apologize for the lack of new posts. I've been spending a lot of time studying for the Chartered Financial Analyst exam. It turns out I've been wasting my time because this brief video clip explains it all.

The American Taxpayer is Getting Bamboozled!

You heard me: bamboozled. After taking tens of billions of dollars of our taxpayer money, AIG is doling out $165 million in bonuses to its Financial Products unit. This is the unit that has recklessly sold trillions of dollars worth of CDSs, or default insurance.

Don't get me wrong. I fully support paying out bonuses to top producers in profitable business units. But that principle does not apply here. This is outrageous. Let's get their names and make 'em famous.

March 12, '09. What a Day.

February retail sales were better than expected.

Bank of America's CEO, Ken Lewis, says business is profitable again.

GM says they don't need a previously requested $2 billion government loan.

Standard & Poor's says GE's credit is in better shape than we thought.

Congress and the SEC are finally going to review the mark-to-market rule, which arguably largely responsible for the credit market freeze.

And Bernie Madoff finally goes to jail.

Any one of these headlines would've caused the markets to rise, but we got them all at once. Three consecutive days of market gains is tough to get, but we got it. In the last three days, the Dow Jones roared ahead by 623 points to close at 7170 today. That's a 9.5% gain in your stock portfolio in under a week.

It's Not Just About Length, Ladies

Many ask, "How Long will this Recession Last?"
If payrolls fall by 1 job, consumer spending falls by 1 cent, home prices fall by $1, investment accounts fall by 1%, etc., then we are in recession. This type of recession could last for years, but would it really be that bad?

Depth Matters
An updated official estimate of economic activity said Q4 (Oct-Dec 2008) GDP fell 6.8%. A month ago, that estimate was 3.8%. In other words, the recession is deeper than what officials had initially measured. A recent survey revealed that economists were expecting a 5.4% decline. In other words, the recession is also deeper than what was expected.

Among other things, a deeper recession means more jobs are being lost and less money is being earned.

How Many Hairs are Attached to This Thing?
Think of the recession like you would a Brazilian wax. If you pull the waxing strip slowly, it will last a long time. If you pull it quickly, the pain is substantial but it's over quickly. Regardless, the number of hairs attached to the strip also reveal something about how much pain you will feel.

Recessions take the economy to a base level from which growth can start again. There's a bottom somewhere. We can get there quickly, or we can get there slowly. (Many, including myself, would argue it's better to get there quickly.) But remember, it may be just as important to ask "where is that bottom?" as it is to ask "when will we get there?".

Gov't Aid is Actually a Hindrance. Might be a Good Thing.

During my sophomore year of college, I asked my parents for $100 to help with some of my expenses. They were more than happy to help. But they made me regret asking.

They would call me almost everyday, asking if I was okay. They'd ask if I was starving. When I visited, they'd question me about any new clothes. They would tell me I should only wait for sales. They'd constantly lecture me about going out to eat. If I had to go out to eat, they would tell me how I should order. They actually told me not to fly home for Thanksgiving because I would be flying back for Christmas in just few weeks. Et cetera, et cetera, et cetera...

In hindsight, I would've rather starved then ask for that money. But I can't say I didn't learn a valuable lesson: never ask parents for money, EVER AGAIN.

Banks with TARP Money
The government has been giving a lot of shit to banks who have taxpayer money via the TARP. Among other things, the government wants to put a cap on compensation. More recently, Morgan Stanley and Northern Trust have come under pressure for sponsoring golf tournaments.

Gov't Mismanagement
Maybe, managers don't need to be paid much and banks don't need to sponsor events. But when you cap pay, you lose top performers to the competition. Many boutique banks are already reporting an influx of this type of talent. When you stop sponsoring events, you risk losing the reputation of your brand.

Like Depositing Money at the DMV
You see, the government wants banks to be run like the Post Office and the DMV. Dirty floors, limited hours, and long lines. It's cheaper to fund operations, but they'll lose a lot of business to the competition. And this is not what I want when my tax dollars are being used to invest in these very institutions.

Payback Time
This bank bailout came with a lot of strings attached. It turns out that government aid is actually a hindrance. Gov't influence is destroying the value of these firms. The managers realize this, and they'll never forget it.

Goldman Sachs and JP Morgan said they never wanted TARP money, and they plan to pay it back ASAP. Northern Trust says they're doing everything they can to pay back the TARP money. They HATE having the government this close.

A Bright Future
I've become much more responsible with my personal finances. Nowadays, I don't think just about earning money. I think about earning and saving enough money so that I never have to ask for money out of desperation from anyone ever again.

Once the banks start paying back the government money, I believe that they'll do whatever they can to keep the government away.

Not a GI Bill

In the wake of war and depression, the GI Bill sent a generation to college and created the largest middle class in history. (Applause.)
-President Obama to joint session of Congress, Feb. 24 2009

Let me remind you that I voted for Obama, and I support him. I'm PrObama. But it is a mistake to compare the current economic spending/investing activity to the GI Bill.

The GI Bill financed college educations, offered unemployment compensation, and extended home and small business loans. But this support was given to veterans returning from World War II. Let me tell you something about these veterans. They were soldiers who were trained in things like leadership, teamwork, and strategy. They were taught discipline and had a sense of responsibility for others. These are the types of people you want running businesses. These are the types of people who will use their educations. These are the types of people you want to invest in. These people knew not to take for granted what they had in this country.

The beneficiaries of the current plan include greedy people ranging from short-sighted bankers to irresponsible borrowers. From an economic standpoint, you can make an argument that these people currently need government aid. Of course, the non-greedy are getting aid too.

But don't expect to get the same kind of return on investment that we got from the GI Bill.

Marx's Prediction

This quote was forwarded to me in an email:

Owners of capital will stimulate the working class to buy more and more expensive goods, houses and technology, pushing them to take more and more expensive credit, until debt becomes unbearable. The unpaid debt will lead to the bankruptcy of banks, which will have to be nationalised, and the State will have to take the road which will eventually lead to Communism.
-Karl Marx

I haven't been able to confirm this, but it sounds like something he would say.

A Third Grader's Perspective on Economic Stimulus

$816 billion / 4 million jobs = $204,000/job

This is an oversimplistic way of looking at economics. But most of us make less than $204k/year, so the aggressiveness of the plan is pretty clear.

Lewis and Dimon Lead the Confidence Rebound

Money Where There Mouths Are
How can we restore confidence in the banks and the financial system? Here's a start: today we found out Ken Lewis and Jamie Dimon independently put their own money on the line. Lewis, the CEO of Bank of America, bought 200,000 shares of Bank of America stock for around $1.2 million. Dimon, the CEO of JP Morgan Chase, bought 500,000 shares of JP Morgan Chase for around $11.5 million.

Who could understand the big banks better than the bankers running those banks?

Maybe the financial system won't collapse afterall.

Job Cuts So Bad, It's Good?!

The Data
This morning we found out that U.S. employers cut 524,000 jobs in December. The unemployment rate hit 7.2%. The data is ugly, any way you look at it.

The History
2.59 million jobs were cut in 2008. This is the worst number since 1945. The unemployment rate is at a 15 year high.

The Surprise
Unlike previous job reports, which I noted in my Oct. 11, Nov. 7, and Dec. 5, the new data was roughly in line with expectations. Economists were expecting 525,000 job cuts and 7% unemployment.

Although the data is bad, I can no longer argue that the economists were being overly optimistic. It seems like the experts have come to grips with how bad things are.

A Review
When I started this blog in Oct 11, the U.S. lost 760,000 jobs through September. Most of you know that I've been extremely negative with regard to the economic outlook. More negative than most. However, I never imagined we would've lost 2.59 million by year end.

Always Darkest Before the Dawn
It has taken several months for the public to come to grips with reality. Even president-elect Obama will tell you things will get worse before it gets better.

But there's good news in this bad news. The high degree of concern has made consumers and businesses extremely conservative. When spending sinks and job losses soar, we are more likely to get to the bottom of the recession sooner than later.

In other words, we can get a short, deep recession. Most argue this is better than a long, drawn out recession. You'd probably agree it's better to have things be really bad, but for a short period of time. Think about the brazilian wax; short and painful, but preferred over hair-by-hair tweezer plucks.

If we can get to the bottom of the recession, then we can start growing again. It's that simple.

One More Thing...
The purpose of this blog was to cut through the BS, and communicate the reality. I believe the media is now telling you exactly how bad it is...in English.

So, until that changes, expect fewer posts. You can get your information from the newspaper.