Monthly Archives: January 2010

smartphones, netbooks…now smartbooks?

January 7, 2010 By in Industry Analysis, Technology Tags: , , Leave a comment

At the CES…

On the eve of the annual Consumer Electronics Show, which opens today in Las Vegas, Freescale Semiconductor, among others, has been generating a lot of publicity about a new kind of internet-connected mini-PC to be debuted there–the smartbook.

…the smartbook comes out

Intended to be a cross between a smartphone and a netbook, the smartbook is a multimedia, internet tablet device that has the following features:

–ARM-based microprocessor, manufactured by cellphone-oriented semiconductor companies like Freescale, Qualcomm or Texas Instruments

–Linux/Android operating system, therefore instant boot up

–7″ touchscreen

–4-64 GB internal storage

–10 hour+ battery life

–wi-fi, GPS, optional G3 connectivity

–sub-$200 price point

The target market seems to be teenagers who don’t need wordprocessing or spreadsheet capability or iTunes (according to the Wall Street Journal the ARM processors aren’t powerful enough to handle any of these jobs) but who want to sign up for a 3G cellphone data plan to keep them constantly online.

It sounds like the original netbook idea…

Apart from the lack of a productivity suite, the smartphone sounds a lot like the original netbook idea from Asus–small screen, light, linux os, wi-fi, little internal storage.

…that didn’t work out so well

Although the original Asus machine sold well, it’s important to note that customers quickly voiced their preference for a larger screen, more internal storage and an(y) operating system other than linux.  And they were happy to pay extra to get all that.  Given this experience, why would anyone go back to the original design?

Relevant data from Apple?

There’s also an interesting, if vaguely weird, report from mobile consulting firm Flurry suggesting that sales of the iPod Touch are beginning to outpace sales of the iPhone.

Assuming the analysis proves to be accurate, why would that be?  Is the ATT mobile service so poor that consumers are keeping their traditional cellphones and getting their Apple fix through the iPod Touch?  Or is it that buying a $200 iPod Touch for a teenager or sub-teen and having him use free wi-fi is a much different economic proposition from buying a subsidized $200 iPhone and contracting to spend another $100 a month on a two-year data plan?

My money is on the latter.  In fact, I think that even if someone paid me $1,000 to take a smartbook, the cost of the data plan would make it a bad deal.  Maybe that’s just me, though.  (By the way, if investors make the leap from the Flurry report to the notion that the iPhone market in the US is becoming saturated, the fact that sales of the much-less-lucrative iPod Touch are booming will be cold comfort.)  My instinct is also that the chipmakers sponsoring the smartbook asked their engineers what they could make rather than their marketers what customers would want to buy.

It will be interesting to see if/how the market for smartbooks develops.  One positive note:  I’ve read that an Asus subsidiary is very enthusiastic about them.  And Asus seems to me to have its hand squarely on the pulse of the computer market.

A 2010 equity portfolio: where the US market stands now

January 6, 2010 By in Shaping a portfolio for 2010, Strategy Tags: , , , , , , , , , Leave a comment

Facts and figures from the 2009 stock market

The S&P 500 ended 2009 at a level of 1115.  This represented a gain of 26.5% on a total return basis for the year.  Capital change made up 23.5% of that and dividend payments 3%.

The median stock was up 29% or so, meaning that smaller capitalization issues outperformed their larger brethren.

Recovery from the market lows of early March was even more dramatic, with the index up 67% since then.  The rise represents a reversal of about half the market losses since the highs of 2007.

S&P estimates earnings for 2010 on the 500 index at about $76, meaning the benchmark stands on a p/e ratio of 14.5x expected year-ahead results.  Value Line, which uses a very different methodology in estimating a market p/e, arrives at a roughly equivalent result–one suggesting also that smaller stocks are now trading on somewhat higher p/e ratings than large caps.

The prospective dividend yield on the market is 2%.

What they imply for 2010

Multiples are no longer at the give-it-away-for-free levels of March, but they’re not really expensive, either versus history or versus other asset classes.  At the moment, cash returns effectively nothing.  And the stock earnings yield (the upside-down p/e that academics prefer) of 6.9% compares favorably with the 10-year Treasury coupon of 3.9% and the 30-year of 4.7% (both of which will likely rise as the year progresses).

Over the past several months, S&P has steadily been revising the $76 figure upward.  If history is any guide, it will continue to do so.  Why is that?  Several reasons:

–the effect of operating leverage (the outsized effect on earnings of small changes in revenues) is notoriously difficult to forecast around turning points in the economy,

–analysts don’t want to look foolish by publishing numbers that turn out to be too high,

–institutional customers want conservative figures and probably won’t trust anything else,

–companies are doubtless exerting their usual pressure on analysts to conform to company “guidance” that leaves room for positive earnings surprises, and

–most earnings estimates originate in New York, the epicenter of the financial meltdown, where people are gloomier than elsewhere in the US (except possibly for the large bonus-collecting bankers who created the problems).

Editorializing aside, the first reason, operating leverage, is by far the most important factor.

If we figure that the actual eps number will end up being, say, $80, then the market is trading on under 14x earnings for 2010.

A 15% advance for the market this year?

I think it wouldn’t be at all unreasonable to think the S&P could rise by 10%-15% from here by yearend.  That would mean a rough target for the market of being at 1225-1275 in December.

How the bull market has played out so far

You can find what I’ve written about bull markets in my posts from the first half of last year.  In addition, I recently came across an excellent article on the subject written by Sam Stovall, the chief equity strategist for S&P.  It’s short and well worth reading.

On page 6 of the article, Mr. Stovall presents a chart in which he has compiled the performance by sector of the S&P 500 in the first year of recovery from every bear market (ten of them) since World War II.  He has also aggregated the results, so we can see what the average performance of sectors and the market has been.

Three points in particular stand out to me:

1. The rebound from the lows this time has been much faster than from prior bottoms.  Recovery from the second oil shock, up 52% in the first year, is the closest to the 2009 performance.  The average first-year bounceback was 33%.

2.  Sector returns are more widely dispersed in the current return than in earlier ones, especially for sectors that have underperformed to date.  For example, relative to the index return, defensive sectors have performed as follows:

——————–2009————-average bull market

Telecom                  -38%——————- -13%

Utilities                  -30%——————- -11%

Staples                   -24%——————– -4%

Healthcare                  -22%——————- flat.

Among the outperforming sectors, Materials is the only outlier.  This sector is up 19% more than the index vs. a typical performance of flat.  (I’ve excluded Financials from this list because of their most unusual performance during this cycle.)

Another sector I find interesting is IT, which is up a lot, but at the index +15 percentage points it is about in line with its recovery average of the index +16.

What does all this mean?

I think the numbers say that the lagging sectors are so far behind the index that at some point they are going to have to play catch up.   A trader would doubtless want to overweight the laggards in hopes that a rally will come soon.  My preference would be to keep these sectors at neutral weight and be prepared to underweight them if/when they show a period of relative outperformance.

I find the technology performance reassuring.  IT is a sector I like, but I’ve been bothered a bit by the fact that it is fast approaching 20% of the market, a relatively large size for any sector.

Growth vs. Value

In the first year of a typical upturn, value stocks outperform growth stocks.  The Stovall research shows this same pattern continuing during the current upturn.  In fact, 2009 shows the sharpest outperformance for value of any bull market listed.  This would seem to imply that the stock market is trumpeting the start of a vigorous economic rebound that will carry even the most commodity-like firm along with it.  I don’t think that’s correct.

The numbers for the bull market so far are certainly correct.  But if we take a slightly different time frame, we see a somewhat different picture.  Looking at full-year 2009, we see significant outperformance of growth over value.  Why the difference?

Bank stocks are classified as value stocks.  They’re the  sector that cratered in early 2009.  They rebounded by 135% through November, possibly creating the illusion of a value stock market when, ex banks, there hasn’t been one.

Of course, especially if you know that I’m a growth stock investor, you may be thinking (as I have been while writing this) that he doesn’t like what the data say so he’s manipulating the facts away.  A fair point.  It may be that the stock market is signaling a stronger upturn than the consensus expects and I’m just not hearing the message.

I’ll deal with this issue in my next post, on where I think we should be putting our equity money.  The short answer:  I’ll concede I have a point that may have questionable origins.  There’s no need for me to make this issue a keystone of my investment strategy, however.  Better to have a couple of good ideas to organize investments around and reject the rest than incorporate a dozen half-baked ones into a portfolio.

Nevertheless, I should also be on the lookout for signs that the recovery may be stronger than I, or the consensus, expect.

Participation

There’s still a lot of money on the sidelines, although it has begun to trickle back in small amounts into stocks over the past few months.  As I’ve mentioned in a previous post in this series, individual investors have been mostly absent so far from the stock market during the rebound.  They have, instead, been seeking the “safety” of bond funds, a decision that will probably cause a considerable degree of financial pain as/when the Fed begins to raise rates back to normal.

The current asset allocation is bullish for stocks, since at some point continuing reasonable equity performance will compel individuals to increase their equity exposure.

A 2010 equity portfolio: the repair process (or, the macroeconomic background)

January 4, 2010 By in Shaping a portfolio for 2010, Strategy Tags: , , , , , , , , Leave a comment

My world economic “to do” list, with emphasis on the US

This is my checklist of the major economic problems produced by the financial crisis, and where I think we now stand:

1.  world trade. Trade finance is more or less back to normal.  Areas outside the US and the EU which have not been infected by our banking problems have stabilized faster than expected and are beginning to grow again.

China is perhaps the best example.  But the Reserve Bank of Australia has recently announced that it has completed the process of bringing short-term interest rates up from their emergency low early in 2009 to a neutral level.  Singapore is the latest to declare that its economy is looking up again.

Unlike Japan during its heyday, China is taking an active role in world economic affairs, not only by purchasing assets in other developing countries but also dispensing foreign aid.  This serves a dual purpose–spreading China’s influence abroad, as well as shrinking its gigantic pile of US$ reserves.

2.  global economic growth

The economic consensus is that 2010 will be a year of “above trend” economic growth around the world.  Taken by itself, this is a pretty meaningless statement–sort of like saying that things could be looking up for the New Jersey Nets basketball team (now 3-30).

After an economic low point and the application of expansive monetary and fiscal policy, there’s always a bounceback.  For economies like China, India or Brazil, economists seem to be predicting a return to business as usual.  But the forecasts for the US and EU, which appear clustered around 3% real growth for the year, are above trend but only by a tiny bit.  They’re not much more than half the level one would expect in the typical economic rebound.

If the US and EU forecasts are economists’ best guesses and not an attempt to guard against printing a number that may be too high, they are predicting that it will be years before the developed world shakes off the negative effects of the financial crisis.

The estimates have some common-sense plausibility.  Typically, consumer rebounds are driven by renewed purchases of homes, cars and other household durables.  With 25% of homeowners holding mortgage debt that’s more than their homes are worth and with 10% unemployment, will spending have the typical oomph to it?  Maybe not.  On the other hand, economists have always underestimated the resilience of the American consumer.

3. confidence in the US$.

–Are foreigners continuing to buy Treasury securities?–yes, especially at the short end, where the potential for currency losses is smallest.

–will the US do what is necessary to protect foreign creditors from a decline in the real value of their Treasury holdings?  that is,

———-will the Fed raise short-term interest rates from their emergency lows to neutral?–yes (remember, short rates will probably go up by 175-200 bp before the Fed is through)

———-will Congress create a sound fiscal policy that will guard against dollar depreciation?–probably not. I don’t think anyone expects fiscal responsibility from Congress, though.  That’s why buyers are sticking to short maturities and why the Chinese are so eager to reduce their dollar holdings.  My guess, though, is that the world expects at least some action by Congress, other than creating inflation, to narrow the budget deficit.  What Congress actually does could be a source of either positive or negative surprise.  I’d lean more toward protecting against the negative than benefiting from the positive.

4.  financial companies. A lot of progress has been made, but significantly more remains to be done.

–trade finance is back to normal

–business lending.  High yield issuance is booming, as large firms are seeking the greater certainty of the bond market.  This is true in Europe, where companies have traditionally been much more reliant on bank financing, as well as the US.  Smaller firms seem to be waiting for final word on what their health care costs will be before spending on expansion.

–regional banks.  Many are up to their eyes in construction loans, not an enviable position to be in.  So they’re not lending either.

–consumer lending.  Good luck trying to get a loan.  High losses on derivatives, mortgages and credit cards have made all banks squeamish about new commitments.

–stock finance.  It’s booming in emerging markets…not so much in the US and Europe.

–investors.  Data from the Investment Company Institute, the trade association of the investment management industry, seem (to me, anyway) to show that individuals are continuing to act in the same vein they have for about a year.  That is, they are:

-reducing money market holdings

-reducing domestic equity mutual fund holdings

-buying exchange traded equity funds instead

-buying taxable bond funds

rearranging their equity holdings to reduce their exposure to the US and increase it to foreign markets, especially emerging countries.

(One way of making sense of this is to say investors are following a barbell strategy, balancing what they perceive as very risky assets (emerging market equities) against ultra-safe ones (bonds).  Or you might say they’re buying everything but US stocks.  Personally, I don’t get it all, but only time will tell whether this is a prudent strategy or not.)

5.  US industrial firms. Overall, US business have shown strong profit growth in the second half of 2009, mostly as a result of cost-cutting.   Larger firms have begun to indicate that sales are either stabilizing or improving and that they intend to start purchasing new equipment and rehiring workers in 2010.  Temporary help is already on the rise.  Sales to non-US buyers are an area of particular strength, at least in part due to the weakness of the US$.

Smaller firms, on the other hand, appear to be more cautious.  Several reasons:

–they tend to have little overseas exposure, where economies are stronger,

–many are suppliers to larger US firms, and their revenues tend to lag on the way up, as a result,

–some are concerned about the effect new health care legislation will have on their profits.

It’s probably also important to distinguish between manufacturing and service companies.  On the manufacturing side, many publicly-traded industrial companies produce consumer durables, an area I tend to worry about.  IT companies, on the other hand, appear to be doing exceptionally well.  (See the very interesting, if somewhat specialized, blog by tech veteran Daniel Nenni, who points out that semiconductor companies are anticipating an unusually strong first quarter during what is typically a seasonal lull.)

Service companies are, I think, in better shape than manufacturers.  They are also the area where the US has a true competitive advantage over foreign firms–although “creative destruction” is heavily rewriting the formulae for success in entertainment and publishing.

6. The US consumer. It’s a mixed picture.

a.  the positives

–Housing prices probably bottomed sometime in late spring or early summer.

–Layoffs are slowing, and the labor situation may reverse into net hiring in the next few months.

–Holiday spending appears to have been better than (low) expectations.

–Almost two years of recession would imply considerable “pent-up demand” for consumer durables.

b.  the negatives

–Consumers are continuing to trade down, implying they are still not feeling very confident

–Banks are still severely rationing credit to consumers, as well as dramatically raising the cost of maintaining credit card balances

–companies may have discovered during the downturn that they can operate with fewer workers than they thought.  If so, unemployment may remain higher for longer than in past recoveries.  For perhaps different reasons, I think this is the consensus expectation.

c. past patterns

The timing of US business cycle recoveries has been unique, in that the American consumer has typically picked up first and industry has followed later on.  The opposite is true in the rest of the world.  Perhaps the most dangerous words in all of investing are, “It’s different this time.”, but, like the economists forecasting a sub-par recovery,  I wonder…

That’s it for this post.  Next, I want to write about what stock markets have been doing and what their performance seems to be implying for the future.  Then I’ll write about where I see the possibilities to profit this year from the current lay of the land.

2009 hedge fund performance–a bad year following an unusual one

January 3, 2010 By in Absolute vs. relative performance, hedge funds Tags: , , , , , Leave a comment

Up 19% over the past year, according to the FT

The Financial Times published an article early on December 31st proclaiming that hedge funds produced gains of 19% for investors in 2009.

How could they know so soon?

My first thought was, How could anyone know this, with one trading day still to go before yearend?   So I checked the referenced Hedge Fund Research website and found that the 19% figure is performance is actually for the twelve months ending November 30, 2009.  Other sites show performance as somewhat lower.

Way under the S&P

In all cases, though, performance was way below the 25%+ return an S&P 500 index fund would have achieved over the same time span.  In the relative performance world, losing over 600 basis points to the index in a year is really bad. It would mean at the very least no bonus and could easily result in your being fired.

The 2009 numbers reinforced my view–which I still hold–that hedge funds are by and large a marketing phenomenon, the successor to oil and gas or real estate limited partnerships.  They feed the egos of the buyers by establishing that they’re wealthy enough to “need” the product, while delivering net returns that are inferior to more prosaic vehicles like stock and bond index funds.  Their leading characteristic is that they generate huge fees for the product promoters.

Look at 2008, though!

Then I looked at the 2008 hedge fund numbers.

Hedge fund performance aggregators show average results for 2008 that range from -15% to -18%, depending on the source.  This compares with -38% for the S&P 500 and -13% for an indexed balanced fund (a fund indexed 60% each to large-cap US stocks and 40% to long-term Treasury bonds).

How could relative performance have been this good vs. stocks?  How could a simple balanced fund–devoid of exotic trading strategies (and high fees) have done better?

Twists and turns

Hedge fund performance may not have been quite so good as advertised, for one thing.  There are several complicating factors in 2008 results, namely:

—survivor bias. 700 hedge funds, or about 10% of the worldwide total, went out of business in 2008.  That’s a BIG percentage. They were presumably not the best performers.  So by default the survivors look a bit better.

—withdrawals not allowed. Unlike mutual funds or ETFs, hedge funds are able to–and in 2008 did on a widespread basis–decline investor requests to return their money.  This reduced downward pressure on any illiquid holdings of the hedge funds.  At the same time, it probably put additional negative pressure on non-hedge fund assets, which would an owner would, by default, be forced to sell if he needed to raise cash.

—pricing issues. A recent NYU academic study covering about 10% of the industry, commissioned by a hedge fund due diligence firm, found that 28% of the hedge funds analyzed provided incorrect or unverifiable information about investment performance, assets under management or other investment issues.  In a fifth of the cases, managers lied in face-to-face interviews about investment performance, assets under management or their education or experience, even though they knew the interviewers were going to check all the information given (see my post Are hedge funds honest?:  an NYU study for details).

This raises the question of whether some hedge funds used “creative” pricing techniques to ascribe a high value to illiquid assets, in the same way that the big commercial and investment banks did–thereby overstating their investment results.

Customers were not happy

You might guess that the questions raised above mean the actual performance of hedge funds in 2008 was closer to -20% to -22% than the -15% to -18% reported.  But even that is still a mile better than the -38% the S&P achieved, a distance so large that it indicates a significant performance differential, absent Bernie Madoff-style accounting.

In relative performance-land, -22% would make you, if not exactly a hero, at least a top-level performer.  Why, then, have hedge fund customers been unhappy?

My thoughts as to why

I have several guesses, but–not being an institutional hedge fund customer–I honestly don’t know.  Here’s what I think:

1.  Clients knew intellectually that hedge fund managers might freeze redemptions, but really didn’t believe it would ever happen.  Purchasers underestimated the illiquidity of hedge fund holdings and may have mischaracterized them to their bosses.

2.  They really believed the credo of absolute performance–that in a down year for other asset classes, hedge funds wouldn’t lose money.  If your expectation is + something, -15% looks really ugly.

3.  In the same vein, clients who invested in hedge funds in 2003 experienced a string of years of underperforming an S&P index fund.  I can almost hear the hedge fund marketers saying that the big payoff from holding on would come in the inevitable down year for the stock market.  After all, that’s what happened in 2001-2002.

Well, the down year came and, with it, significant outperformance of the S&P.  But maybe it was only enough to offset the underperformance of the prior five years.  And in 2009 underperformance resumed.  If it walks like a low-beta stock fund and quacks like one, too, what makes it a hedge fund, other than the fee structure?

4.  Clients could have achieved hedge fund results, or maybe better, in 2008 with a more prudent allocation among asset classes.

Where to from here?

Anecdotal evidence suggests that assets under management in the hedge fund industry have stabilized and net inflows are beginning again for the first time in two years.  Hedge Fund Research indicates this as well.

The MAN Group, a publicly-traded hedge fund group (whose statements I think are therefore more reliable than those of the industry in general) said in November that withdrawals from Europe were being partially offset in the first half by new money coming in from the Middle East and Asia.

Barclays Capital, in a news release filled with corporate-speak from its prime brokerage division, emphasizes it’s being told by its hedge fund customers about gross inflows, but is not clear about the net situation.  It does say that the sales cycle is taking longer, as potential investors require a clearer explanation of exactly what a given hedge fund manager does. In addition to being better informed before turning over their assets, Barclay’s seems to indicate that clients are redirecting money away from smaller hedge funds (where in the past most of the very good returns have been achieved) toward their larger, more established rivals.

It will be interesting to see how fully the hedge fund industry will be able to recover from its long period of not-as-promised performance, and the scandals like that of Madoff and Galleon that have emerged during the financial markets collapse.

There are powerful constituencies in the hedge fund corner.  Wall Street now depends heavily on hedge fund trading revenues; its margin borrowing is the life-blood of the brokers’ prime brokerage arms.

More important from the pension fund perspective, though, hedge fund consulting is the latest offshoot of the pension fund consulting business, which derives very large income from being hired (as a kind of risk-shifting away from the pension plans themselves) to perform the pension plans’ task of creating an asset allocation plan, and analyzing and selecting specialist managers to implement it.  Consultants ply their trade among asset managers, as well, advising them on how to make themselves appealing to pension clients.  Here, at least from a short-term point of view, it’s in all the players’ economic interests to have increasingly complex and specialized products to ponder, since these allow maximum risk-shifting and generate maximum fees.

On the other hand, the fact that hedge funds in general don’t perform as advertised is a powerful force in the other direction.

We’ll see.