Monthly Archives: September 2010

FedEx’s first fiscal 2011 quarter (ended August 31st): stronger global growth

September 19, 2010 By in Asian economic development, China, earnings conference calls, economics, emerging markets, Hong Kong, Industry Analysis, Stock ideas, Strategy, Transport Tags: , , , , , , , , , , Leave a comment

the FDX report

Last Thursday FDX reported strong first quarter fiscal 2011 results.  Earnings per share were $1.02 for the three months, up 108% from the $.58 tallied in the comparable three months of fiscal 2010.

FedEx also announced plans to address the loss-making freight segment by merging FedEx Freight with FedEx National LTL (less than truckload) commercial shipping operations into one unit next January.  Despite terminal closings and layoffs, FDX expects to gain market share–and profits–with the move.

FDX upped full-year earnings per share guidance from the previous range of $4.60 – $5.20 to $4.65 – $5.25, ex merger related expenses of $150-$200 million.

By line of business, operating earnings for the quarter were as follows:

FedEx Express     $357 million vs. $104 million in the year-ago quarter

FedEx Ground     $287 million vs. $209 million

FedEx Freight     -$16 million vs. $2 million.

FedEx as bellwether

Transport has a high-beta relationship with overall economic growth.  FDX’s strong earnings performance is a good indicator that economies, around the world but especially in Asia, are continuing to expand.

Express, primarily an international business, saw international package volume rise by 19% and weight by 41%, producing revenue growth of 20%, year over year.  Small, high value packages from Asia (like cellphones or iPads) are a particular strength.  So much so that FedEx has added two scheduled daily flights from Asia over the past few months, bringing the FDX total to 12.  The company will soon boost capacity again as it replaces older airplanes with new purchases.  FDX’s planes are booked through the year-end holiday season.  Load factors are the highest they’ve been in ten years.  Customers are upgrading to premium service.

Revenues for Ground, a US-centric business, were up 13% on a 7% increase in package volume.   The volume boost comes almost completely from market share gains.  In FDX’s view, the US economy is showing “slow but sustained” growth.  The shape of the recovery is “normal.”

The US LTL industry suffers from chronic overcapacity.  Too many trucks chasing too few goods–plus contracts signed when things looked bleakest last year–are the two reasons for FDX’s poor showing in its domestic Freight business.  The company thinks it sees a remedy by using advanced software to more or less replicate the structure of its international air business on the ground at home.   Hence the merger of Freight and National LTL.

The ongoing recovery of world economies is being led by the industrial sector, and by China, India, Mexico and Brazil.  From the remarks FDX management made in its conference call, it seems to me that FDX thinks the securities analysts who follow it–and by extension, American investors generally–just don’t “get” how big these countries are.  Presumably, the international business will be a major topic of the firm’s annual analyst day in Memphis in a couple of weeks.  The main idea will likely be that the developing world is growing like a weed.  In 1980, the developed world made up two-thirds of the global economy and was twice the size of the developing nations.  Within two or three years, however, the developing world will make up over 50% of global output, more than the developed countries’ GDP.

FDX as a stock

I know what the issues are but I don’t know FDX well enough to have an opinion.

1.  At present, manufacturers are controlling the distribution of products by keeping inventories centralized and shipping them at the last minute by air.  The other alternative would be to put the output on boats and truck them to their final destination from the destination port.  The former means higher transport costs but creates extra flexibility for firms to avoid sending products to places where inventories are already high and sales are unexpectedly slow.

The current situation plays to FDX’s strengths and is a financial bonanza for it.  The company strongly believes customers are not reacting to worries about an uncertain world, but are rather taking advantage of supply chain management software advances that save them money through more precise inventory control.

Sounds reasonable to be, but I don’t know.  Not good for FDX if manufacturers go back to using boats.

2.  The domestic freight business has low barriers to entry.  FDX is trying to create one by introducing advanced software to control its commercial truck freight shipments in the same way it does internationally with air.  Its marketing research says customers want the pricing flexibility the new system will provide–and that therefore FDX will be able to make more (or at least some) money with less invested capital.

I’m big on “work smarter, not harder,” so again this sounds good.  But we still have to see.

3.  Fiscal 2011 is a transition year, filled with all sorts of one-time costs.  There are:

–maintenance for previously mothballed planes now being put back in service

–capital expenditure for new planes to service booming international package demand

–higher personnel costs from health care plus restoration of salary and benefits cut during the recession

–writeoff of merger costs, estimated at $150-$200 million.

This kind of stuff happens every once in a while.  It seems to be bothering analysts, but I don’t think it’s such a big deal–especially if #1 and #2 end up doing what FDX thinks.

If both #1 and #2 pan out, FDX looks to me like a very cheap stock.

No reversion to the mean?: El-Erian (II)

September 17, 2010 By in Constructing a Portfolio, Current Market Thoughts, growth vs value, Industry Analysis, inflation vs deflation, Investment firms, Strategy Tags: , , , , , , , , , , , Leave a comment

In yesterday’s post, I outlined the Pimco investment case, contained in a Financial Times article, which boils down to:  we’re in a time of great uncertainty, so buy government bonds.

my thoughts

For what it’s worth, I think the world is a lot less uncertain place than it was two years ago.  In a way, uncertainty is old news.  That isn’t to say our situation is good, but we now know:

1.  world governments will act to avoid the worst economic outcomes (this is the #1 worry in any macroeconomic crisis)

2.  financial regulators in the US and the EU have been doing a terrible job

3.  banks are weaker companies than we thought, and generally poorly managed, to boot.

In my opinion, a lot of this news is already reflected in security and currency prices.

What uncertainties still exist?

1.  Economically speaking, the developed world is still a fragile place.  The effects of the large excess supply of housing and business space created in the US and UK over the past few years, and of those countries stopping adding to it, are still with us.

2.  The steps that policymakers may take, and the economic effects of those actions, are hard to foresee.  The world has used up much (all?) of its safety margin for dealing with mistakes.

3.  The econometric models that economists use in predicting how our economic future will play out–essentially, elaborate trend-following devices–don’t work well in times of economic transition.  They also didn’t predict the financial meltdown.   So a major tool (bond) portfolio managers have wielded in plying their trade is out of action.  Managers are now working in a room whose lights have been turned out.  (If you believe Nobel laureate Joseph Stiglitz, however, these models were radically flawed from the outset–and were a contributing cause to our economic woes.)

3.  The behavior of economic agents, especially portfolio investors, is harder to predict.  In particular, the chances of extreme, far-from-consensus, and really bad, outcomes has increased.

What does the article conclude from this litany of sorrows?  –we are in a “world where the realized return rarely (emphasis added) equals the expected valuation.”

a curious argument

Okay.  Now comes the weird part.

We’re in a world where no one can tell how the world economy will play out and where investment managers’ portfolios are going to blow up in their faces.  But luckily for us, Mssrs. Clarida and El-Erian are affected by none of this.  They know (no explanation given) how the US economy will develop–very low growth and structural unemployment for as far as the eye can see.  They also know that while virtually every other investment strategy founders on the rocks of uncertainty, one–buy government bonds–will not.  Again, no explanation given.  Just by coincidence, both authors happen to work for a bond fund manager and have this product available for sale to us.

Another point:  The thrust of the Clarida- El-Erian argument is that economic circumstances demand that investors carefully rethink their investment strategies, because macroeconomic conditions today are radically different from what they’ve been before.  Their actual conclusion, however, is far different.  It is that investors will almost never (rarely) be able to figure things out.  In the paragraph above, I’ve pointed out that they think this situation applies to everyone except them.

My  point here is that they provide no support for the actual conclusion they draw.  What they write looks like an argument in support of a conclusion, followed by the conclusion as a logical consequence of what they said before.  But that’s just a kind of sleight of hand.  The idea that no one (except themselves) will be able to figure out what’s going on is a bald assertion, no more.

extreme outcomes don’t all favor bonds

I think it is right to give extra thought to the possibility of extreme outcomes.  In can imagine three, although I’m sure there are more:

1.  The US and EU play out like Japan since 1990.  This would mean bonds would be fine   Stocks would have a period of stability followed by maybe another 30% decline.

2.  The US and EU recover faster than we now think.  Stocks might go up by 25%.  Government bonds would fall, maybe by 15%.

3.  The rest of the world loses faith in the US and EU.  Their currencies fall by 15% vs. the rest of the world and their bond yields rise.  In this case, safety would lie in stocks, not bonds.  Stocks +35%, bonds -15%.

To me, it seems that the possibility of extreme outcomes is an argument for diversification, not  concentration in one asset class.

the authors seem to know nothing about stocks

If we exclude financial Armageddon, equity investors can operate successfully under a wide variety of economic conditions.   In particular:

Value investors do use reversion to the mean, but in a narrower sense than is used in the Pimco article.  The value investor looks for assets that are worth $100 that he can buy for $30 and hopes to sell for $60-$70.  Given that stocks are the cheapest they’ve been vs. bonds (a proxy for the cost of financing purchase of such assets) in about sixty years, this should be a fertile ground to work in.

Growth investors do have deep economic concerns, but they’re  generally microeconomic, not macro.  Will, for example, well off thirty- and forty-somethings continue to buy iPhones and iPads?  Will TIF continue to sell jewelry to Europeans trading down or to newly affluent Asians trading up?  Will the casinos in Macau keep on booming?

Yes, if world economies implode again, equities will be in trouble, at least for a while.  But equity investors don’t need to understand the entire globe to be successful.  All they need is a stable playing field and one or two places where they’re ahead of the consensus.

No more reversion to the mean?–Mohamed El-Erian (I)

September 16, 2010 By in Absolute vs. relative performance, Banks, Current Market Thoughts, Industry Analysis, Investment firms, Strategy Tags: , , , , , , , , , , Leave a comment

“uncertainty changing investment landscape”

The other day I was paging through some old newspapers that I never got to during August (yes, I read the business news on paper).  Sometimes it gives you a sense of perspective to read, a couple of weeks after the event, what trivial things people were thrilled or fearful about at a certain moment.  But mostly I got lazy when the weather got hot and read novels instead of news.  So I was catching up.

I ran across an article from August 2nd with the above title in the Financial Times. It was written by Mohamed El-Erian and Richard Clarida, a professor of economics at Columbia.  Mr. El-Erian is the chief executive of the mammoth bond manager Pimco and an occasional columnist for the FT; Mr. Clarida consults for Pimco.

I usually skip over what Mr. El-Erian writes.  It typically reflects the economic consensus.  Besides that, Mr. El-Erian has seldom been known to use one small word when six or eight big ones will do the same job.  He’s also the public marketing face of Pimco, so we know in advance what his investment conclusion will be namely:

–The global economic landscape will be bleak for many years to come.

–Therefore bonds, even at today’s super-expensive levels, are still a buy; stocks, which are the same price today as a decade ago and the cheapest they’ve been vs. bonds for sixty years, are still a sell.  Pimco’s only change to this mantra over the past year or so has been to kick dividend paying stocks off the approved list.

Nevertheless, I did read this piece.  Despite the fact Mr. El-Erian comes to his usual (horribly incorrect, in my opinion) conclusion about stocks and bonds, I’m glad I did.  For once, Mr. El-Erian wrote something really thought provoking.

I’m going to write about this in two posts.  Today I’ll outline what Mr. El-Erian says.  Tomorrow I’ll write about where I disagree.

the article

The article makes five points.  Four of them are different facets of the same idea–that the disinflationary era that began with the appointment of Paul Volcker as Fed chairman in the US almost thirty years ago is over.  As a result, we can no longer depend on continuingly rising bond prices and falling yields to bail us out of investment mistakes.  Investors have to rethink and retest their strategies.

That isn’t the interesting part.  Equity investors have been soulsearching about excessive leverage and unwarranted risk-taking since the collapse of the Internet bubble in 2000.  (If so, how did the financial meltdown happen?  Investors made three basic mistakes:  we assumed the banks’ accounting statements were reasonably accurate; we wildly overestimated the capabilities and appetite of the regulators to enforce banking and securities laws; and we attributed to bank managements a level of integrity and risk-management competence that most American industrialists possess but many in this industry didn’t.)

The intriguing point is Mr. El-Erian’s first, that “investing on ‘mean reversion’ will be less compelling” in the future.  He implicitly describes the (bond) investing process over the past twenty-five years as having two steps:

–determine the consensus economic forecast, and

–find securities whose valuations imply an outcome that deviates markedly from the consensus.  If the imbedded expectations are too pessimistic, buy the security; if they are too optimistic, sell it short.

Why won’t this work anymore?  In the past, a compilation of expectations from professional economists would form a bell curve, with the areas at and around the mean having very high probability.  The “tails” of the distribution, that is, the forecasts that deviate a lot from the consensus, were short and stubby, that is, highly unlikely and increasingly so the farther away from the consensus they were.

Today, the compilation of forecasts looks less like a bell with a sharp, fat peak in the middle, and more like a straight line with a small bump up in the center.  The economic situation around the world is so uncertain, and the policy actions governments may take to stabilize their countries so unpredictable, that there is, in effect, no solid macroeconomic consensus to bet against.  Not only that, but the more extreme “long tail” outcomes, both bad and good, have become much more likely.

What do you do in a world like this?  Mr El-Erian’s answer is (surprise, surprise)–buy bonds, sell stocks.  You do so because (government) bonds are liquid and default-free.  Therefore, they protect you against the world going to hell in a handbasket.  I guess this means individual investors haven’t been panicking over the past year or more but responding rationally to the current situation by dumping their stocks and embracing bonds.  I suppose that if you really wanted to secure yourself against the worst, you should also think about a cabin in the woods, stocked with freeze-dried food and near a good source of water, maybe with a bow and arrows in case you need to hunt.  Maybe people are.

I’m with Mr. El-Erian up until his conclusion, with which, to put it mildly, I disagree.  Not so surprising, since I’ve spent all my investing life on Wall Street.  The real question, the thought-provoking aspect of the article I’ve linked to above, is to be able to say why I disagree.  What’s wrong with what he’s saying?

More tomorrow.

high-frequency trading vs. computer-driven trading: the Trillium fine

September 15, 2010 By in Current Market Thoughts, Industry Analysis, Investment firms, Securities regulation Tags: , , , , , , , , Leave a comment

In the aftermath of the “flash crash” of a few months ago, regulatory authorities have been, almost frantically, looking for a cause.  My guess is they won’t be successful.  If there is a single culprit, I think he’s highly unlikely to come forward himself.  (Would you, if you thought you would be made a scapegoat and driven from the business?  Neither would I.)  And the complexity of Wall Street–almost any business, for that matter–comes from taking relatively simple ideas and repeating them over and over again, sometimes with subtle variations.  The result is an end product that’s difficult to unravel by anyone not immersed every day in that line of work.

But the search for an answer has apparently turned up non-related market abuses.  One of the is is the case of Trillium, a small brokerage house and some of its proprietary traders just disciplined by FINRA (the Financial INdustry Regulatory Authority).

to step back a minute

High-frequency trading (admittedly not an area I’m very familiar with, so leave comments if you want) seems to me to come in two flavors:

arbitrage This is the computer-driven search for pricing discrepancies that provide risk-free or low-risk trading opportunities.  These can be as simple as quirks in the bid-asked spreads of different market makers in the same security.  Or they can be differences in the prices of derivatives linked to the same underlying security, or closely-related securities.  Or they can be differences in the prices of a given theoretical financial attribute as contained in different securities or derivatives.

This activity isn’t particularly new.  Harry Markowitz started the ball rolling in the early 1950s.

order execution A large money management institution deals in very large position sizes.  It has two basic choices in controlling its buying and selling.  It can deal in the traditional way, by developing a staff of highly-skilled (and highly compensated) professional human traders, or it can use computers.  I’ve only worked in firms that took the former strategy, so I can’t say from experience how the latter works.

There are two (maybe three) problems with using human traders:  the buying and selling process can be slow, and the firm’s intentions can easily leak into the market through the counterparty before the transaction is completed.

Firms using computers break large orders down into many small ones which they hope to execute quickly with a number of different counterparties and on various trading platforms.  So they hope to get the trading done before information about their intentions has spread, and therefore with limited market impact.  As I mentioned above, I have no idea whether this works well or not.

The third issue, which I haven’t seen discussed anywhere, is who pays for the trading.  A traditional buy-side trading staff can easily cost several million dollars a year, money that is paid by the management company out of its management fees.  My guess is that high speed automated trading systems get poorer executions but are much less expensive to run.  If so, the management company saves the traders’ salaries and the clients pay the economic cost of trading through higher buy prices and lower sell prices.   On the other hand, if the blitzkrieg approach gets better executions, everybody (except the displaced traders) wins.

returning to Trillium

According to the FINRA documents linked above, what Trillium did was this:

Let’s say the best (highest) bid for stock ABC was $50 and the best (lowest) offer for ABC was $50.25.

Trillium traders would decide they wanted to sell ABC.  They would place a limit order to sell just inside the best offer, say, at $50.24.  They would then rapidly place a bunch of orders to buy ABC at different prices just below the best bid.  These orders were “often in substantial size relative to a stock’s over all legitimate pending order volume.”

The Trillium traders never intended to buy ABC.  What they wanted to do was use the false impression of rapidly building buy volume to trick day traders into thinking a powerful upward movement was about to start.  They wanted short-term traders to rush in to buy the stock to ride the impending uptrend.  Of course, the first shares to be bought would be the ones Trillium had pre-placed in the market through their limit order.

As soon as the limit order was executed, the Trillium traders cancelled their phony buy orders.

This is a boiler room operator’s ploy that’s as old as the hills.  It’s the kind of market manipulation the syndicates of the 1920s-1930s did, though on a far larger scale than Trillium.  And it’s one of the abuses that Depression-era reform of the securities markets was intended to stamp out.

is this high-frequency trading?

What does this have to do with high-frequency trading, though?  Nothing that I can see.

Yes, the Trillium traders probably used computers to enter their orders, both real and fake.  And they worked this scam over 46,000 times during the three months FINRA cited in its disciplinary action.  That’s about once every 30 seconds while Wall Street was open for business.  Otherwise, what’s the connection?

More interesting, what would cause the Huffington Post, or the Financial Times, or Fortune to say there’s one?  I don’t know.  The Fortune Street Sweep blog does have a clue, though.   In its post on Trillium, it quotes FINRA’s Thomas Gira, who’s identified on the FINRA website as executive vp of the Market Regulation Department as saying (as I read it) that Trillium’s is a high-frequency trading abuse.

Maybe there is a dark side to high-frequency trading, but I don’t see Trillium as a case in point.  I don’t get why FINRA would say it is, other than the agency must be under pressure to do something.

the tablet war: dispatches from the front lines

September 14, 2010 By in Current Market Thoughts, Entertainment, Industry Analysis, internet, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , , , , , , , Leave a comment

In the past week or so, there have been two significant developments in the story of the development of the PC tablet:

–one is the outpouring of reports, both from the blogosphere and in newspapers, that the iPad is cannibalizing the notebook.

–the other is that AAPL has made up with ADBE, sort of.

details

the iPad

The many blogger stories about cannibalization seem to have been generated as the result of a well-marketed brokerage research reports by analysts covering AAPL at UBS and Barclays Capital.  The Financial Times recently had a more comprehensive comment in its Lex column.

Clearly, something is happening.  But I’m not sure the cannibalization numbers add up or that the overall story makes any sense.

We know from INTC that the back to school season has been weaker than had been expected as late as early July.  Last minute processor order cancellations/deferrals were big enough for INTC to make a downward revision to revenues on August 27th, pointing to “weaker than expected demand for consumer PCs in mature markets.”  This quantified the weakness that Taiwanese IT firms and US laptop makers like DELL had been talking about in the prior weeks.

In its press release, INTC revises its September quarter sales down by about $600 million, or 5%.  If we assume 5% is a good proxy for the unit demand shortfall (since the sectors showing weakness are less expensive computers, the 5% probably understates the unit decline), then the reduction in units to be sold in the Us and Europe (mature markets) is about 5 million.  That figure probably exceeds AAPL’s production, and worldwide sales, of the iPad during July-September.

Also, the laptop sales shortfall is reported to be predominantly in the netbook end of the market.  I suspect this is because low-end “regular” laptops have come down in price and now mimicked the features of netbooks.  As a result, for several quarters the latter’s unit sales have been flattish in a rising market.  Besides, I can’t imagine anyone who has used a netbook or an iPad would think they were close substitutes for one another.  You might just as easily argue that smartphones are cannibalizing PCs.

F or what it’s worth, my guess is that the slowdown in consumer PC sales in the US and Europe is a slowdown-in-the-economy phenomenon, not a cannibalization one.

Nevertheless, there is extremely high interest in tablets, even though most of those intending to buy one don’t really know what they are or where they fit in among their digital devices.  According to a Forrester blog post from last Friday 2.5 million US online consumers already own an iPad and 7.4 million more intend to buy one.  An additional 20 million say they’re going to buy a tablet of some sort–not necessarily an iPad–over the next 12 months.  (This 27 million total surpasses the number of Americans intending to buy an e-reader, the next most desired device, by about a third).

The one characteristic of tablets that should jump out for investors is that none will have INTC microprocessors and most will likely have linux-based software, not MSFT’s.

This explosion of interest, and the resulting scramble by AAPL to increase production capacity and by other manufacturers to get their tablet devices into the market, may explain the apparent urgency behind INTC’s moves to acquire McAfee and Infineon’s cellphone chip business.

AAPL and ADBE

Last Thursday, AAPL posted a release on its website about “App Store Review Guidelines.”   It seems innocuous…but it isn’t.  Back when the iPad was being introduced, AAPL said the device wouldn’t support Adobe Flash.  Why?  Steve Jobs eventually wrote his thoughts in an open letter.  Although AAPL and ADBE have a long relationship, he wrote, but Flash is unreliable, poor performing, and not secure.  The world has passed ADBE by, as well.  Ouch!

Two other problems.  Flash is designed for PCs and uses a lot of processing power and battery life.  Also, if you could download Flash onto your iPad you could use services like Hulu and bypass the AAPL apps store.

AAPL went a step further, too.  ADBE had developed a cross-platform compiler, that is, a software program that’s something like a translation device.  It converts a Flash-created app into one in a programming language that AAPL found acceptable.  But AAPL said developers couldn’t use the ADBE compiler, either.  The result was that many app developers had to hire two staffs, one to develop specifically for AAPL, another to develop for the rest of the world.

Last week’s press release is AAPL’s capitulation on app development.  AAPL still won’t allow any Flash code to be downloaded into the iPad, but it will accept programs that have been cross compiled from Flash in to an Apple-approved language.

Why did AAPL give in?  Some people say it was ADBE’s appeal to the government anti-trust authorities.  Maybe.  But I think the real issue is the stunningly fast development of the tablet market.  After all, the iPad is a limited device.  It’s been crafted to avoid any cannibalization of the iPhone (remember–if we look at profits, AAPL is a cellphone maker with a couple of lucrative sidelines, like MP3 players and computers).  Users are funneled to its app store to get  content to use.  If AAPL could get developers to write code that would be very expensive to adapt for most other tablet devices, its first-to-market advantage would be that much more overwhelming.

It’s this last thing that the bland note linked above is raising the white flag to.  To me, it’s a signal that AAPL sees competition coming for the iPad faster than it had thought.  This isn’t 100% bad for the company.  Its dominance of the tablet market will likely be less complete, but the market will likely be very much larger than it had dreamed.  It wasn’t that long ago (March or April) that analysts laughed at AAPL for arranging for production capacity of 1 million units a month.  It’s now churning out twice that and still scrambling to expand fast enough to keep up with demand.