It’s where stocks are going that counts, not where they’ve been (l)

It’s not where they’ve been…

It’s easy for anyone, including professional investors, to become paralyzed into inaction by sharp recent price rises, either of the market as a whole or of individual stocks.  Every once in a while, at market tops (in other words, about once every four years), this is the correct stance.  Most of the time, though, it’s not.

Our current situation is a case in point.  The S&P 500 is up 60% from the lows in March.  It’s up 18%, year to date.  Economically sensitive stocks have doubled or tripled off the lows.  Highly financially leveraged firms that seemed on the brink of disaster last winter can be up 5x, or even 10x, from the absolute bottom.  But unless you can somehow go back in time and transact at those prices, the have limited relevance to our investment situation today.

You may regret not having bought, or be patting yourself on the back for having had the courage to act.   Neither emotional state of mind will necessarily help you in your role as an investor, which is to make money from this point on.

(I think it would be instructive, however, to go back and review what pundits were saying about the market at any time from April or May on.  I’m confident that at every point you would find commentators saying the market had gone “too far, too fast,” and was “due for a pullback.”  Their advice?  “Wait for a correction.”  This is what the consensus always says in the early stages of a bull market.  And it’s always wrong.  If you want more information on this topic, look at my posts from March and April.)

The only relevant investment question is “What comes next?”

…it’s where they’re going that counts.

The stock market is a futures market.  The most important questions are always:

what are future profits likely to be–either for the market as a whole, or for sectors or individual stocks you may be looking at?

how much of that is reflected in today’s stock price?

what doesn’t the consensus not yet understand, or what is it not yet looking at?

Where are we now?

I read a research report recently whose summary was, in effect, we’re six months from the bottom and two years from the top.  This conclusion is a variation on the typical four-year inventory/interest rate/election cycle that has been a rough and ready timing tool at least since the Second World War.  The idea is that the stock market goes up for 2 1/2 years, more or less, and then down for 1 1/2.

I don’t whether the precise timing will hold in this cycle, but I do think the spirit of the remark is correct.

We’re way past the panic of March, when investors were convinced (by stunning congressional ineptitude, in my opinion) that Washington lacked the skills to fix the financial crisis.  We now are beginning to get confirmation from other economic indicators of what stocks (a powerful leading indicator themselves) have been telling us for a while–that the recession has just about run its course and that corporate profits are about to rise substantially.

What we haven’t yet begun to do is to make meaningful estimates of what corporate profits are likely to be for 2010 and beyond.  In a way, I think investors as a whole are stuck in the error of looking backward rather than forward.  Perhaps taken aback by the magnitude of the stock market decline, the consensus seems to be unable to imagine the good things that can happen next year and the year after that.  Remember, the S&P would need to rise almost another 50% to reach the last high-water market of 2007.

Who knows whether we’ll reach the 2007 market highs in the US in the current cycle.  On the one hand, it’s hard to imagine the financial stocks, which were such a big part of the market then, playing the same role this time around.  In fact, the previous cycle leaders are most often non-factors for a long while from that point.  On the other, technological and communication innovation is blazing along at a torrid pace.  And, of course, the steep decline we’ve had in the dollar (more to come, I think) make the old highs a less daunting target in local currency terms.

In any event, the economic environment is likely to be supportive for stocks for the next two years or so. I can imagine two main scenarios.  You can probably imagine more (post them as comments, if you like).  Mine are:

1.  plain vanilla The overall market rises 10% per year in 2010 and 2011, which would have the S&P 500 a bit above 1300 by the end of the period.  Overweighting of economically sensitive sectors makes a few percentage points of outperformance possible.  Returns would be much better than those on bonds or cash.

2. late Seventies redux The overall market meanders in a trendless way, making little progress over the next two years.  This general result disguises powerful underlying sectoral movements, both positive and negative, that more or less cancel each other out in the market aggregate.  My guess would be that tech, materials, energy, entertainment all outperform substantially.  Staples utilities, financials are all left behind.  Eventually consumer discretionary joins the positive column.  The net result is that substantial outperformance is possible.  (The key statistic of the second half of the Seventies, in my opinion, is that the smallest 100 by market capitalization of the S&P 500 outperformed the index by at least 25 percentage points each year.)

Sinopharm: the latest Hong Kong IPO; good news for WYNN and LVS

The Hong Kong IPO market is alive and well.  Sinopharm, the largest drug distributor on the mainland, came public yesterday.  The offering, which raised HK$8.73 billion, was almost 600x oversubscribed, according to Bloomberg.  The stock was priced at the top of the range, on a 2010 price earnings multiple of 25x.

I have no opinion about the merits of Sinopharm.  It sounds like a great story and may well turn out to be the superior long-term winner that the market expects it to be.  But 600x oversubscribed means animal spirits are running high in the Hong Kong market and suggests that the timing of the IPOs of the WYNN and LVS Macau casinos couldn’t be much better.

What makes a Hong Kong IPO different; upcoming issues from WYNN and LVS

Generic IPO stuff

Any initial public offering has certain general characteristics:  an offering document, a selling syndicate, an underwriting group (which may, or may not, take ownership of the deal from the issuer),…

Underwriters and potential buyers, usually institutions, do a ritual dance around the topic of making firm indications about how many shares they want to buy.  The underwriters want to figure out what the real demand for the stock is, but they also want to create “buzz” by being able to say early in the offering period that the books are covered (that is, they have firm bids for all the shares being offered) by 3x, 5x or some larger number of times.

Bidders, for their part, often try to get a larger allocation of a “hot” issue by asking for many times the amount of stock they actually want.  In most markets, there’s no cost, other than possibly getting the underwriter annoyed or possibly getting stuck with a gigantic amount of unwanted stock if the IPO flops, for really inflating your order.  In Hong Kong, things are different, though.

How they do it in Hong Kong

In Hong Kong, the traditional rule of thumb is that a new issue is only successful if it goes up 30% or more from the offering price on the first day of trading.  Up less than that, it’s a failure.  Here’s why:

Hong Kong has a very high level of retail interest in IPOs.  And it has an unusual solution to the overbidding problem.  Applicants for IPO stock have to deposit enough funds with the underwriters to pay for all the stock they bid for, not just the amount they expect to be allocated.  In other words, if the IPO is “hot” and 30x oversubscribed, the bidder who wants 1,000 shares of a HK$1.00 stock will ask for 30,000 shares and make a HK$30,000 deposit.

You can put up your own money or have your broker arrange a loan.  Suppose the cost of this is 1% of the amount deposited (interest income from the deposits goes to the company being IPOed).  That amounts to 30% of the value of the stock you stand to receive.  Hence, the 30% rule.

Upcoming gaming IPOs will answer Macau questions for Americans

Two American casino companies, WYNN and LVS, are in the process of IPOing their interests in Macau through offerings in Hong Kong.  The WYNN IPO roadshow is slated to start on September 21st, with listing on October 9th.  The company is proposing to sell a 20% interest in its Macau subsidiary for what the market seems to expect will be US$ 1 billion.  The LVS offering will come later in the year.

It will be very interesting to see how they are received.  Two issues:

1.  Will one IPO get a higher valuation than the other? Both are looking for money to fund expansion in Macau.  But their overall corporate financial conditions are quite different.  LVS, an operator of convention-oriented properties, was caught by the financial crisis in the midst of simultaneous expansions in Las Vegas, Macau and Singapore.  WYNN, although it pressed ahead with completion of the Encore expansion of its Las Vegas Wynn Resort, has charted a much more conservative course.  This is doubtless because Steve Wynn, king of the high-roller market, lost control of his previous company, Mirage, during a prior downturn in the US industry.  It seems to me that LVS wants the IPO proceeds to keep the wolf from the door; WYNN wants to make sure it spends enough on maintenance and upgrades so it doesn’t take on the worn and tired look most of its competitors are beginning to sport.

2.  How will they stack up against the Pacific-based competition?  Arguably, the American companies have a more sophisticated product and experience with operations in a competitive marketplace.  The Macau government, it seems to me, wants WYNN and LVS to succeed and to act as a counterweight to the influence of the local operators.  And the less than pristine reputation of some of the other operators should make it more difficult to lure management talent away from any American gaming company.

On the other hand, the competitive situation can be sticky for everyone in a market where weaker competitors shift from trying to make money to trying to get their capital back out of an unwise investment.  And it’s never been clear to me how much of a reputational discount there is imbedded in the prices of the already-listed Hong Kong gaming stocks.

We’ll know soon!

Trade action: their tires vs. our chicken feet

A 35% tariff on low-end Chinese tire imports

President Obama has just approved the imposition of import tariffs for the next three years on low-end tires from China.  The duties, which will go into effect in about two weeks, start at an extra 35% charge for the first 12 months and decline to 30% and 25% in the remaining years.

Chinese tire imports have gone from next to nothing five years ago to about 1/6th of the US market in 2008, 46.9 million tires worth about $1.8 billion–or $38+ each.

A “safeguard” action

The tariffs are being imposed under the “safeguard” provisions of the World Trade Organization.  That is to say, there’s no claim that the Chinese tire makers have done anything unfair or illegal.  They’re not “dumping” output at a loss or below production cost.  They just make better cheap tires than we do–so much so that they’ve pretty much taken over the low end of the market.  “Safeguard” actions are temporary, emergency measures intended to allow a formerly protected industry time to catch its breath, regroup and reenter the fray with new, improved, better value-for-money products.

The way safeguard actions work, the US and China have a short period of time for consultations to try to resolve their differences.  Failing that, China can bring a complaint to the WTO, a process that can take two years.  Typically, the way safeguard rules are finessed, it looks to me like the tariffs tend to run out about the same time as WTO hearings are slated to begin.

China gets to put equal tariffs on imports from the US

Again, according to the rules, China gets to put tariffs on US products entering China during the time before hearings, up to the amount of the tariffs the US is putting on Chinese tires.  China has already picked out the areas it will tax:  unspecified auto parts, and cooked poultry (read: chicken feet).  The chicken feet people are understandably up in arms (as it were).  They get $.60-$.80 a pound for the things from China, “multiple” times what they get in the US.  Chicken exports to China amounted to $722 million last year.  Who’d a thunk it!!

Wait.  The story gets stranger.

Not a single tire company supported the request for tariff protection, which came from the United Steelworkers union.  Cooper, a US company that has a Chinese tire plant, actively opposed it.  That’s not quite as odd as it sounds at first, since other than Cooper and Goodyear most US-based tire plants are owned by foreign firms.  So they may be hesitant to speak their minds.  Still, no one appears eager to “regroup and reenter” the low end.  In fact, the prevailing strategy seems to be to concentrate on high-value tires within NAFTA and supply the low end through Chinese imports.

As a result, there’s no evidence that a single steelworkers manufacturing job will be saved by the tariff, though some Americans who work for the wholesalers and distributors of Chinese products will doubtless lose theirs.

Who will bear the cost of the tariffs?

The Chinese tire makers can’t eat much, if any, of it.  They say they have single-digit profit margins now.  If they lower their selling prices they open themselves to accusations of dumping.  US manufacturers don’t want the business.  Will Mexico export more?  Will the distribution chain take something off its markups?  I don’t know.  But it sounds to me as if the main effect of the tariff will be much higher prices paid by lower middle class and working poor American drivers.

And, of course, what will we do with all those tons of chicken feet that won’t make their way to China?  (Note:  for more on the virtues of American chicken feet, see the New York Times article of 9/16/09.)

Not a sensible economic move

All in all, what President Obama has done makes no economic sense.  And it has the potential to be an awful shoot-yourself-in-the-foot moment if, say, highway deaths of young families driving on worn-out tires are connected to this action.  Which implies that the president has done this for purely political reasons.  Help with a health care bill?  the price for dropping the “public option”, maybe?

Will events escalate?  I doubt it.  Autoworkers can scarcely complain about lack of government support, nor are they likely to criticize the steelworkers, no matter what China’s actions in response to the US are.  And apparently chicken ranchers aren’t labor-intensive enough, or don’t vote Democrat enough, to count.

From China’s point of view, plants producing low value-added pollution-causing chemical products, especially when owned by foreigners, are scarcely its vision for the future.  Especially for any under the patronage of unruly regional authorities, Beijing may be secretly pleased to have them shut down.  In fact, the whole “conflict” has the sense of being agreed to and pre-orchestrated behind closed doors before Obama’s tariff announcement.

The bottom line: from a human point of view, it’s hard to understand how the poorest Americans deserve to be treated this way.  From a narrowly stock market point of view, it’s a little bizarre, but this looks like a tempest in a teapot.

Last week’s company announcements–positive for tech stocks…for retail, maybe not so much?

What they said

Fedex issued a small press release on Friday, saying that the company’s August quarter earnings came in at $.58 a share, much higher than its guidance to analysts of $.30-$.45.  The November quarter looks strong as well.  Why? …a rebound in international business and cost-cutting in the US.  The first fits with the recent comments of a number of foreign governments that their countries are exiting recession sooner than expected.

A striking number of IT hardware companies have been saying that their business is better than anticipated.  The reason?…a continuing rebound in unit volume (and revenue) growth.  This contrasts with the reports of retailers worldwide, who are turning in relatively strong results, but all based on cost-cutting in a declining revenue environment.

To my mind, the most interesting announcement comes from ASML, the Netherlands-based manufacturer of wafer steppers, a type of semiconductor production equipment.  The company, which had been losing money earlier in the year, announced in a (very) short press release that is it seeing a strong pickup in orders, both from logic and memory chip makers.  It will report results on October 17th.

What makes this important is that ASML’s offerings are expensive pieces of capital equipment used for capacity expansion (the average price of a new machine shipped in the June quarter, for example, was about $46 million).  Industrial companies, and semiconductor makers in particular, almost never borrow to pay for capital equipment; the money virtually always comes from cash flow.  So this announcement means ASML’s customers are feeling a lot richer than they were six months ago and their customers are pressing them to expand.

Implications for stocks Continue reading

Why the dollar may be weaker than most people expect

China’s the reason

The bout of dollar weakness that started a few days ago seems to me, contrary to the views you hear on financial talk radio/TV, to be tied directly to the Chinese announcement that it will soon issue renminbi-denominated government bonds to foreign investors through a Hong Kong offering.

This is a (small) step toward relaxing the iron control that China has exercised over its currency.  But it’s a significant one, given that such control is what allowed China to avoid any hint of contagion during the Asian currency crisis of the late Nineties.  The move is also a necessary step in China’s severing its currency peg to the US dollar.  And it comes faster, I think, than the markets had expected–hence, the weakening dollar.

Interest rate differentials will likely move against the dollar, but…

True, many other nations have been reporting recently that their economies appear to be exiting recession more quickly than anticipated.   These countries are actively planning to restore money policy to a normal footing by raising interest rates.  In contrast, the US, the ground zero of this financial crisis, is far from being in a position to follow suit.  The widening interest rate differentials that will result from differing policy actions should by themselves cause some dollar softness.  But China’s weak renminbi-strong dollar policy has been so significant a support for the greenback that I think a change in China’s stance is a much more powerful and longer-lasting factor in determining exchange rates.

Why is China acting?

Why is China doing this?  Why now? What are the implications for stocks? Continue reading

Motors Liquidation (MTLQQ.PK): a pink sheet stock

Q is for bankrupt

My friend Tom (Hi, Tom!) mentioned this stock to me when he and his wife were visiting a week or so ago.  And, yes, an added Q at the end of a ticker symbol does mean the company in question is in bankruptcy.

What is Motors Liquidation?  As part of its Chapter 11 bankruptcy proceedings, General Motors separated its assets into two piles:  those that it thought were economically viable, and the real junk.  It  transferred the good pile into a new corporate entity that is not (yet) publicly traded, in return for a 10% interest in the new company and warrants to buy 15% more.  It left the junk, plus a lot of liabilities, inside the “old” GM, which was delisted from the New York Stock Exchange and re-tickered as GMGMQ.  The bankruptcy court’s instructions to the GMGMQ managers were  to sell what they could, pay the proceeds to GM creditors and then turn out the lights for good.

What’s inside MTLQQ?

Besides the “new” GM stock, there are a bunch of obsolete plants being taken out of service, a lot of debt, plus legal, environmental, and union claims.  MTLQQ has repeatedly said that creditors are highly unlikely to be paid in full and that, therefore, there will almost certainly be nothing left for MTLQQ shareholders.

SEC filings for MTLQQ aren’t chock full of information, but I tend to believe the MTLQQ management.  It would be hard to believe that in such a high profile and carefully scrutinized bankruptcy–one in which unions and boldholders are going to lose billions of dollars–there would be any value left for common equity holders.  Remember, too, that common shareholders are routinely wiped out in any Chapter 11 filing.

In other words, a lottery ticket has better prospects than MTLQQ.  Lotteries are set up to pay out only a fraction of what the state takes in, but that does mean something to some ticket holders.  MTLQQ is set up to pay zero.

MTLQQ generates lots of trading volume…

Yet, the stock has had average daily trading volume of over 25 million shares through July and August.  This big volume has gone through even after the regulators stopped trading for three days, changed the ticker from the initial designation of GMGMQ, doubled the Qs and issued a public warning that MTLQQ was worthless.  Here’s a link to the SEC statement.

Where is the investor interest coming from?  The SEC cites “confusing, potentially misleading information” disseminated by “rumors in fax or email newsletters, Internet message rooms or on web sites offering online stock tips.”  The Washington Post also cites interest from MIchigan residents who want to support the auto industry and who are unaware of the facts, despite having the GM restructuring going on in their own backyard.

…and trades on the pink sheets

as a “Pink Sheets Limited” stock.

True, the stock is labelled as providing “limited” information to potential investors and the pinksheets website makes it clear the company is in bankruptcy.  And, of course, Enron was an NYSE stock, so a listing pedigree isn’t a foolproof guarantee against fraud.  MTLQQ volume was, I think, produced by a combination of laziness and ignorance as well as  deception.

Nevertheless, information is the lifeblood of investing.  Information is particularly important in the case of small- or medium-sized stocks.  Domestic pink sheet stocks, almost by definition, lack this commodity.  So the mere fact of pink sheet trading should mean that you must be especially vigilant and do your own research before buying.

November 15, 2009

See my update dated today.