Monthly Archives: July 2010

“search neutrality” –Google’s newest challenge? the ITA acquisition

July 19, 2010 By in Current Market Thoughts, Industry Analysis, internet, Stock ideas Tags: , , , , , , , , , , Leave a comment

Everybody is by now familiar with the topic of net neutrality.  This is the question of whether the owners of high-speed transmission networks for internet traffic have the right to regulate the flow of data, assigning some information to what is in effect the slow lane while allowing other content to barrel ahead in express.

This issue still hasn’t been fully dealt with.  As I posted in April, the FCC ordered Comcast to stop interfering with traffic through BitTorrent, a peer-to-peer file-sharing service that the ISP claimed was using up too much bandwidth.  Comcast sued, on grounds that the FCC didn’t have the authority to issue it such an order–and won.

The FCC responded by moving to reclassify Comcast as a public utility, like phone companies ATT or Verizon, so that it would have the regulatory authority it needed.  This opens a whole political can of worms, however, so it’s still not clear where matters stand.

GOOG’s ITA purchase

The wheel of competition has recently taken a turn in a different, but related, direction with Google’s agreement to buy ITA Software, founded by MIT scientists and now held by private equity, for $700 million.  ITA makes the airline database search software that powers the air part of travel sites for online agencies like Kayak and Orbitz, as well as for the online sales sites of Continental Air.

GOOG’s isn’t the first purchase of this type.  Two years ago, MSFT paid $115 million for the smaller private company Farecast, which is at the heart of MSFT’s Bing Travel service.  But ITA is bigger and already services significant third-party customers.

unhappy campers

Not everyone is happy with this development–especially not Barry Diller, CEO of online travel agent (and former MSFT subsidiary) Expedia.  He’s worried that if/when it acquires ITA, GOOG will promote its own services over those of EXPE.

This assumes, of course, that GOOG will follow MSFT’s lead and create a travel site similar to Bing Travel.  That may well happen.  In paid search, a prospective GOOG Travel could outbid everyone else for keywords, since this would just be transferring revenue from one GOOG pocket (travel) to another (search).  It’s not so clear that would happen in any unfair manner in unpaid search.  The reputational, and legal, risk to GOOG is too high, I think, for that to occur.

EXPE isn’t out of the woods by any means, however–in my opinion.  It’s possible that the combination of GOOG and ITA professionals will produce new travel software that’s significantly better than anything on the market today.  Maybe ITA can do this alone, with GOOG financial support.

Suppose that instead of using ITA software itself  GOOG offers it for free to any travel site that is willing to allow GOOG advertising on it. This is basically what it did with cellphone operating system software.   That would give any takers a 10%-15% cost advantage over sites which either develop their own travel software or buy it from third parties.  It would also make it easier for new firms to enter the market.  Any way you look at is, GOOG offering ITA for free would  lower the value of any database technology that a company like EXPE holds.

That’s Mr. Diller’s real problem, I think.  If so, he can’t just say this–that there’s something wrong with a new market entrant turning up with better, lower-cost technology.  Search neutrality may be the best weapon he has to fight with.

Where/how active management counts: a BNP Paribas study

July 18, 2010 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Stock ideas, Strategy Tags: , , , , , , Leave a comment

The FundQuest study

FundQuest, an investment consulting arm of the European bank, BNP-Paribas, recently issued a report on a study it performed analyzing thirty years of Morningstar mutual fund data.  The study tries to determine when active portfolio management has been successful.

the results

general portfolio characteristics

According to FundQuest, there are three general characteristics of overall actively managed portfolios that are highly correlated with investment success.  they are:

–manager tenure.  The best portfolios are those with the longest-serving managers.  Having managed a number of portfolios for fifteen years or more, I’m tempted to blindly agree with this conclusion.  But even after a pause for consideration I still think it’s true.  Occasionally, a weak manager may survive for an extended period, based on great marketing or office-political skills.  But they’re the exception.  Poor performance leads quickly to clients withdrawing their money from a manager, which, in turn, leads to his dismissal.

–low expenses.  I guess this one makes sense, too.  On the one hand, a ind group can hope to distinguish itself by having excellent performance, which may or may not happen.  But so long as it sets reasonable risk parameters for its managers–in other words, as long as it has some reason to think its investment performance won’t be truly terrible–it has a good chance of delivering superior returns to clients if it has low expenses.

This may also be just a statement about economies of scale.  Successful managers draw in more assets, which tends to lower their administrative expenses, if not management fees.

–low volatility.  The study doesn’t give an adequate explanation, in my mind.  This is a complex issue that I have strong view on (I don’t like volatility as a risk measure at all!). I’ll just leave it at that.


More interestingly, the study enumerates several factors that, contrary to conventional wisdom, it says have no bearing on performance:

–turnover ratio.  That is, a calculation of the dollar amount of securities bought (or sold) during a year, as a percentage of average assets.  Conventional wisdom in the consulting community is that the lower the turnover the better.  The conventional arguments are two:  trading makes the manager feel good but runs up costs and adds no value;  lots of trading means the manager has no strategy.

–fund size.  Conventional wisdom says that smaller funds have a wider array of stocks they can buy in significant size, and that they’re more niumble.

–number of holdings/concentration of fund in its top ten stocks.  This ends up being a closet way of separating growth managers from their value compatriots.  Growth managers typically run highly-concentrated, fifty-stock portfolios; value managers will typically have over a hundred (maybe two hundred–how they follow them all is a mystery to me), and as a result run a less concentrated top ten.

What I find interesting is that pension consultants thrive on collecting and analyzing such data, even though Paribas suggests it has no value.

overall manager trends

Hang onto your hat for this one. I’m really surprised by the finding.

FundQuest says that the typical manager underperforms his index during bull markets and outperforms in bear markets.  Whether he’s a value manager or a growth manager makes no difference.

But–and this is the signal to grab hold of your hat–this results from the fact that managers run portfolios with a beta of about .8.  In other words, managers as a group are risk-averse.  In the aggregate, they take considerably less risk than the market. If we use an (unspecified in the report) correction for risk, the performance situation reverses itself.  On this basis, managers outperform in bull markets and underperform in bear markets.

It makes some sense as a business decision that mutual fund managers should have as a high-level objective to minimize possible losses, even at the possible cost of performance during up markets.  One of my first bosses used to frequently say the pain of underperformance lasts long after the glow of outperformance has gone.

I’m just not sure that it’s right to factor that decision out of the evaluation of manager performance, as Paribas does.

The conventional wisdom, by the way, is that growth managers outperform in up markets and underperform when stock prices are going down.  Value managers are thought to do the opposite.

manager specifics

FundQuest lists five types of funds where active managers outperform in upcycles and down.  They are, with the most successful first:

Emerging Markets Bonds

Industrials

Consumer Staples

World Allocation

Foreign Large Growth.


In addition to these groups, winners in up markets include:

Mid-cap Value

Small Growth

High Yield

Utilities

Commodity-related and many foreign categories.

Winners in down markets also include:

Energy

Large Value

Small Value

World Stock.

Two things strike me about these lists.  The first is the prevalence of foreign-oriented or world funds. I don’t think this is particularly surprising, although others may.  To my mind, US-trained managers have a considerable technological edge as securities analysts vs. their counterparts in foreign market.  Yes, there may be as many foreign-generated reports.  But read the latter, ask yourself how much content there is in them and you’ll see what I mean.

The second is the nearly complete absence of domestic growth funds on the outperformance charts.  I have no explanation.  Growth investing is generally thought of as being more difficult to do than value investing.  As a result, there are supposedly only a few truly excellent growth managers, in a field made up of  less-talented wannabes.  Still, that’s really stretching for an explanation.  (If I hadn’t been a growth investor for most of my career, I’d have no trouble finding an answer.  I’d say growth investing is all smoke and mirrors.)

What to do with this information? The FundQuest recommendation, which seems good to me, is to try to use actively managed funds in areas where managers have a demonstrated ability to beat their markets, and buy index funds in the rest.


Minutes of the June 22/23, 2010 Federal Open Market Committee

July 16, 2010 By in Current Market Thoughts, Discounting, economics, Portfolio management, Recent Market Action, securities markets, stock market, Strategy Tags: , , , , , , , , , , , , , Leave a comment

the June OMC meeting

The minutes of the Federal Reserve Open Market Committee meeting of June 22-23 were released on July 14th.

To my mind, the truly striking development in this report is not the economic numbers themselves.  It’s the fact that for the first time since world stock markets bottomed in March of last year, the forecasts of the country’s near-term economic prospects by the 17 members of the OMC (5 governors + the 12 presidents of the regional Federal Reserve banks) have stopped going up.  In fact, they’ve gone–at least temporarily–into reverse.

The Fed now thinks real GDP growth in 2010, at 3.3%, will be .25% less than it thought in April.  The unemployment rate is expected to remain about .2% higher than previously estimated, at 9.4% this year and 8.5% next.

What’s changed?

To be clear, the Fed believes that the US economy is in the process of a moderate, but self-sustaining economic recovery, where “inventory adjustments and fiscal stimulus were no longer the main factors supporting economic expansion.”  But it also thinks that several factors, most of them external, have recently emerged that put a firm upper limit on how fast the economy can advance.

They are:

–financial troubles in Europe

–the rise in the dollar, and

–weakness in stock prices (even with the recent rally from just about 1000 on the S&P 500, Wall Street remains 10% below the high water mark achieved earlier in the year).

They add to business and consumer uncertainties, real estate weakness and reluctance of banks to lend, as sources of the headwinds the domestic economy is facing.

The good news, then, is that the US is on an upward course.  The bad news is that what we see now is as good as it gets.

the US economy:  plusses and minuses

–industrial production gains are “strong and widespread,” with IT investment growing rapidly,

—but capacity utilization remains low enough that companies aren’t going to invest in plant and equipment for expansion (vs. replacement or upgrade) for some time to come.

–labor demand continues to firm,

—but the proportion of workers jobless for more than half a year, already unusually high, continues to rise.

–bank credit, “which had been contracting for some time, was showing some tentative signs of stabilizing,”

—but commercial real estate is weak, with no bottom in sight,

—and consumer credit keeps on contracting.

–inflation remains unusually low, with deflation a risk,

—but the current lack of inflation has not yet caused Americans to adjust their inflation expectations down, thus raising the deflation risk.

the bottom line

Economic growth will remain muted, and unemployment will therefore  remain unusually high for an extended period of time, with most OMC members expecting “the convergence process (to normal unemployment levels) to take no more than five to six years (emphasis added).”

In consequence, inflation will remain unusually low for a similar extended period, gradually rising to around 2%.

long-run projections

change in real GDP      2.4%-3.0%

unemployment rate     5.0%-6.3%

CPE inflation     1.5%-2.0%

investment implications

Wall Street has always been able to draw a clear distinction between sectors it thinks will perform well and those it thinks will perform badly.  And it has usually been able to separate that judgment from one about whether the overall market will go up or down.

Foreign stock markets have routinely been able to draw a similar kind of high-level distinction between the prospects for the home-country economy and those for international regions.  They have usually been able to vary their holdings between domestic- and foreign-oriented companies, and to disconnect that decision from one about whether the market will go up or down.

Right now, the US economy overall, and consumer-oriented sectors in particular, seem to me to be relegated to the laggard column for some time to come. It also seems to me that the overall market is cheap.  Or, as the Fed put it in its minutes, “The spread between the staff’s estimate of the expected real return on equities…and…the expected return on a 10-year Treasury note…increased from its already elevated level.”

American investors have clearly been able to make the inter-sector judgment without difficulty.  If the market can do the same for the foreign-domestic judgment–and that remains to be seen–IT and international-trade related firms should have smooth sailing in the year ahead.

two other thoughts

The notion that the economy won’t be back to normal for the next half-decade is shocking, but given the enormous amount of damage done by the financial crisis (the Washington-Wall Street complex) it’s not that surprising.  The realization of this fact is probably the cause of the large amount of public outrage directed at politicians and investment/commercial bankers.

Although the negative news about GDP growth and extended high unemployment have been widely reported, the Fed projections have barely made a ripple in the stock market.  Presumably, this means that investors have already discounted most of this n stock prices already.


add trains (cargo, anyway) to boats and planes: they’re all making good money again

July 15, 2010 By in earnings conference calls, economics, Industry Analysis, Stock ideas, Transport Tags: , , , , , , , Leave a comment

In an earlier post, I pointed out that world trade was beginning to boom again.  Evidence of this was coming from comments from the shipping industry trade association and from FedEx.  Several more bullish pieces of evidence have come in since.

containers

European container shipping giant Maersk announced last week that its container business was doing much better than expected, and that as a result it was raising its full-year earnings guidance from “a modest profit” to a profit of more than $3.5 billion.  Ironically, the restructuring of French container shipper CMA CGM has reportedly been complicated by the fact that the company has recently swung from big losses to substantial profits.  In both cases, the key element in the turnaround is improvement in the Asia-Europe route.

Expeditors International (EXPD) chimed in with similar sentiments two days ago.

CSX

The most stunning of the June quarter earnings reports I have seen has been INTC’s.  But the most interesting, to my mind, has been been the one from CSX.  Why?  The railroad is an east-of the -Mississippi shipper of intermediate industrial materials, autos and coal.  Its revenues were up 22% year over year, based on increased volume.  Operating earnings were up by a third, despite flat unit volumes in the agricultural and housing-related (forest products) businesses.  Chemicals, Metals, Phosphates and Autos were the stars.

I have no opinion on CSX as a stock.  And railroads are a mystery to me.  But the good results seem to show that we’re starting to see a pulse again in general industrial activities in the US–not just the areas where the US is a world leader, but also ones that serve the daily needs of the domestic economy.

How does all this square with the just-released June minutes of the Fed’s Open Market Committee, in which it shaved a bit off its economic growth forecast, and slowed the rate at which it thinks unemployment will fall?  That’s tomorrow’s post.

INTC’s June 2010 quarter: stellar performance with more on the way

July 14, 2010 By in Current Market Thoughts, earnings conference calls, economics, Industry Analysis, internet, Stock ideas, Strategy, Technology Tags: , , , , , , , , Leave a comment

the quarter

I listened to the INTC 2Q2010 conference call last night.  The three-month period established a whole raft of new operating performance records.  Earnings per share came in at $.51 vs the analysts’ consensus of $.43.  Six-months’ eps was $.94, with the seasonally stronger second half just beginning.  $2 a share for the year, a number I would have thought six months ago would be impossible for the company to reach, now looks achievable.  from the way the usually cautious company management is talking, next year could be 20% better.

The most important message from the INTC quarter to Wall Street is, I think, that corporations are in the early stage of what could be a significant capital spending boom–implying they see their profits starting to accelerate.  In particular, the US, a laggard to date, is beginning to perk up.

the details

1.  Revenues were unusually strong, at $10.8 billion.  This is up 5% quarter on quarter at a time when typical seasonality would have called for a 2% revenue drop.

All regions of the world were unexpectedly strong.

Consumer notebook sales remained brisk, but the real boost to the quarter came from business customers.  Several aspects to this:

–companies are starting to adopt Windows 7 and are replacing their wretchedly old PC stock as they do so

–firms are also feeling good enough about their prospects that they are buying more powerful, higher-end (read: more profitable for INTC) products

–the server mix is also improving both because companies have more cash to upgrade and because the internet data center business (growing 170% yoy) is booming.

2.  INTC has increasingly good control of costs.  Gross margin was a record 67% in the quarter, which was about four percentage points better than in the first three months of the year.  Virtually all of the increase came from lower-cost manufacturing.  Only one point came from the effect of higher sales.  INTC sees no reason for the margin to contract from this level any time soon.

3.  Customer inventories are low.  The Iceland volcano, sovereign credit worries in the EU and the consequent decline of the euro caused Europe-oriented OEMs and distributors to run down stocks.  End demand from big businesses is unaffected, however.  Distributors are busily reconfiguring machines–less memory, less sophisticated graphics–to try to keep consumer price points from moving up too much.  At some point, presumably during the second half, customers will likely bring stocks up to normal levels, creating extra demand for INTC chips.

the second half–and beyond

1.  Customer reviews of INTC’s next family of chips, named Sandy Bridge, have been the most favorable in some time.  As a result, INTC is accelerating Sandy Bridge’s introduction–suggesting INTC believes corporate demand will continue to be strong for at the very least the next year.

2.  The Atom chip is plateauing, although the introduction of dual core Atoms spurred 16% quarter on quarter growth in June.  The next market for this chip is likely imbedded devices, like Google TV, DVD players and set-top boxes.

tablets

Unlike AAPL, which never saw a netbook it didn’t hate, INTC appears very relaxed about the introduction of tablets.  The company thinks that the netbook was a much bigger threat to cannibalize notebooks.  Given that the category proved additive to the overall mobile business, it expects the same to be true for tablets.  At this point, it’s hard to know whether INTC will have that much presence in the tablet category, but there are at least 30 Atom-configured tablets being displayed at trade shows.

conclusions

At potentially 10x next year’s eps, and yielding 3%, the stock looks cheap to me (I don’t own it, though).   My sense is that the Wall Street consensus thinks 2010 is a cyclical peak for INTC’s earnings.  My guess is that the peak, if there is going to be a significant high point followed by a sharp decline, isn’t until 2012.

Sales to corporations are going much, much better than the company thought several months ago.  This is a positive statement, not only about business confidence, but also about how firms have raised their forecasts of their own revenue and profit prospects for this year and next.

INTC is boosting its estimate of its tax rate for 2010 from 31% to 32%, since it now anticipates a greater proportion of its business than it earlier expected will come from high tax-rate areas (read: the US).  I think this is a very bullish sign for Wall Street that most analysts will probably overlook.