Monthly Archives: May 2011

the April 2011 Employment Situation report

May 8, 2011 By in Current Market Thoughts, economics, Employment Situation report, Strategy Tags: , , , , , Leave a comment

the report

On Friday May 6th, the Bureau of Labor Statistics released its April 2011 Employment Situation report.  According to the BLS, the economy added 244,000 jobs last month, bettering economists’ estimates of an increase of 185,000 positions.  Private industry gained 268,000 jobs; as has been the case recently while states and municipalities seek to balance their budgets, governments shed 24,000.

Strength came from a variety of sectors–manufacturing, retail, healthcare and leisure and hospitality.

revisions

The official unemployment numbers come from the larger of two surveys the BLS conducts monthly.  Called “Establishment” data, it is compiled from reports from organizations representing about a third of the employees in the US.  Not all the information comes in on time, so the Establishment data are revised twice before being declared final, once in each of the two months following the initial release.  These revisions are themselves a good indicator of the strength of the economy, since they are typically positive in a healthy labor market and negative in a bad one.

The February job additions were initially reported as a gain of 192,000 positions.  That number was revised up to 194,000 in March and 235,000 in April.  The March job gains were initially reported as +216,000.  In the April report, the figure was upped by 5,000 to 221,000.  We’ve seen the same positive pattern for a while.  So far, so good.

the unemployment rate

“discouraged” workers

The April unemployment rate was determined to be 9% of the workforce, up from 8.8% in March.  One might think that this is evidence of a well-known quirk in unemployment statistics that makes itself evident when the job situation is improving.  It’s what the statistics do with “discouraged” workers, that is, unemployed people who are so downcast from repeated failure to find a job that they see no point in continuing to seek work and simply stop looking.

People in this situation are not considered to be unemployed.  They’re classified as not being in the workforce.  As a result, when the discouraged drop out of the ranks of job seekers, they decrease the workforce and thereby make the unemployment rate lower.  In other words, in bad times the unemployment situation is actually worse than the official statistics show. 

Conversely, as the job situation improves, the discouraged take heart and begin looking for work again.  This makes the unemployment rate go up.

Although this is what usually happens, the April figures don’t show discouraged workers reentering the workforce.  Instead, it shows 190,000 fewer workers employed than in March and 205,000 more unemployed in a workforce that’s virtually unchanged in size.

“Household” data and sample size

The unemployment rate isn’t derived from the Establishment data, which are forms companies send in telling about how many people they employ.  The unemployment rate comes from the “Household” data, information gathered from monthly interviews with 60,000 randomly selected households.

This is a much smaller sample size.  In fact, the BLS statisticians calculate that the smallest movement in the month-to-month figures from the Establishment survey that’s statistically meaningful (and not just statistical noise) is 100,000.  For the Household survey, the number is 400,000.  This means that the .2% increase in the unemployment rate may simply be a random variation in the data collected.

investment conclusions

April is the latest in a series of months of strong employment gains for the US economy.  There’s no evidence in the report (compiled around mid-April) of any slowdown in hiring activity due to rising commodity prices.  But even though the data show a significant strengthening of the labor market to well over double the rate needed to absorb new entrants to the workforce, it will still take several years at this higher level of job gains for the economy to reach full employment again.




INTC’s new “3-D” tri-gate microprocessor technology

May 6, 2011 By in Current Market Thoughts, Industry Analysis, Stock ideas, Technology, Uncategorized Tags: , , , , , , , , , , Leave a comment

INTC’s May 4th announcement:  tri-gate

During its most recent quarterly earnings conference call, INTC alluded to a “revolutionary” announcement it would be making on May 4th about its next-generation microprocessor-making technology.  We already knew that the company was going to shrink the distance between elements of the patterns it creates on silicon from 32 nanometers (1 billion nanometers = 1 meter) to 22 nm this year.  But it hinted that there was more to come.

The “more” at a press conference on May 4th.  The company intends to manufacture its 22nm chips using a new technology that it has been developing for almost a decade–a 3-D process it calls tri-gate.

what it is

Up until now, INTC–like everyone else–has been placing chip circuits on a flat silicon substrate.  For 22nm, INTC intends to make the substrate three-dimensional by raising a series of fins up from the substrate, on and around which it will wrap the chip circuits.  If the conventional chip design looks like strands of spaghetti laid side by side, the new one looks more like Rice Chex.

what it does

The the new 3-D “tri-gate” chips cost only 2%-3% more to make than conventional ones.  Just by being 22nm (vs. competitors’ 32 mm offerings), they’re smaller, faster and use less power.  That speed and power advantage is about 15% (I’m eyeballing an INTC chart).  However, the new process allows the chips to be tuned, so that they do much, much more:

–they will use less than half the power of competitors’ chips in high speeds, or

–they will run 37% faster in low-power applications, like smartphones and tablets.

Assuming the adoption of the new process goes according to plan and works as INTC expects, tri-gate will put the company several years ahead of other chip makers.  And it will underscore dramatically the value of INTC having ownership of its own fabrication plants.

when it arrives

Volume production is slated for the second half of 2011.  INTC seems to be putting particular emphasis on shifting its Atom chip–targeted at markets ARMH presently dominates–to the new process.

the big question

The big question for tri-gate, as with any new technology, is whether it will work as expected.  INTC has close to ten years’ experience with the process–and does not seem to me to be the kind of company to announce a development without great confidence in it.  The rest of the semiconductor manufacturing industry is planning to adopt some version of the technology, just not right away.  Still, until we actually see INTC churning out large numbers of tri-gate chips, we won’t know for sure.  We also don’t know whether, even if the chips perform as advertised, that INTC will be able to displace ARMH in new smartphones or tablets.

investment implications

INTC shares are about flat since the announcement.  They’re trading at under 10x earnings and yielding over 3%.  To me, no good news, and a lot of bad, is already factored into the stock price.  On the other hand, merely applying a market multiple to the stock would imply a price of over $30 (see my analysis of INTC’s 1Q11 earnings).  So the risk-reward relationship seems very favorable to me. What I also find interesting is that besides the case made for a value investor, there’s one to be made to a growth investor as well.  It’s the prospect of much better earnings growth than the market expects, for longer than the market thinks.

About ARMH: it’s trading at 90+ times earnings, on the idea that it is the virtual monopoly provider for microprocessors to smartphone and tablet manufacturers.  INTC success doesn’t necessarily translate into ARMH failure; a lot depends on how fast the market is growing.  But while the company may do well, to my mind the ultra-high multiple represents a significant risk in the stock.

will Hong Kong break its currency peg with the US$?–probably

May 5, 2011 By in Asian economic development, economics, emerging markets, Hong Kong, Japanese development, Strategy Tags: , , , , , , , , Leave a comment

the HK$-US$ peg

There has been increasing speculation recently that Hong Kong will abandon the policy, in place for almost thirty years, of tying the HK$ to the US$ at a fixed exchange rate.  Given the tenacity with which the former British colony defended the peg during the Asian financial crisis of the late 1990s (against speculators who seem to have had no clue about Hong Kong), this may seem strange.  But I think the peg has served its purpose and may now be more trouble than it’s worth.  My guess is the peg will go–and in the near future.  In stock market terms, this would be good for domestic firms that use US$ inputs and bad for exporters.

why the peg exists (much more detail in this post)

In the initial post-WWII period, the Hong Kong dollar was pegged for economic reasons, first to sterling and later to the US dollar. In 1974, however, the Hong Kong government decided to let the currency float.

Pegging your currency to that of your largest trade customer makes a lot of sense  for an emerging economy ( the granddaddy of post-WWII pegging successes is Japan), since it ensures that you retain the labor cost advantage that’s your greatest development asset. Doing so has a number of costs, however. One of the most significant is that you give up control of your domestic money policy. You can’t tighten when the other party is loosening, even though that might be the right move for your economy. Why not?  Your interest rates go up; the other country’s go down.  The higher interest rate differential means arbitrageurs short the other currency and use the proceeds to buy yours.  This produces immediate upward pressure on your currency and downward pressure on the other party’s.  So you’d be shooting yourself in the foot.

Therefore, you’re stuck mimicking the money policy moves of your key trading partner. Unless the developing economy is extremely vigilant and conducts a restrictive fiscal policy, the consequences can be disastrous. The most recent example of calamity can be seen in the current situation of Ireland and Spain, which imported a vastly over-stimulative monetary policy through the euro—where interest rates were set with an eye to the needs of much less dynamic members like France and Germany.  Ouch!

unpegging in 1974

In the mid-Seventies, the US was beginning a policy of too much monetary stimulus that would spawn a late-decade inflationary spiral—and the subsequent Volcker medicine (sky-high interest rates and deep recession) of the early Eighties.

Rather than be dragged along down the same path, Hong Kong unpegged.

repegging–why?

In October 1983, however, Hong Kong repegged to the dollar. This had nothing to do with the now more orthodox money path of the US. The key reason was political.  The mainland refused to renew the lease the UK held over Hong Kong, meaning that the British colony would revert to Chinese rule when the then-current lease ended, in 1997.

At first, Hong Kong citizens weren’t thrilled. They had witnessed the ill effects of the Great Leap Forward and the Cultural Revolution, and surmised that they might well be the recipients of extensive “reeducation” to purge them of their capitalist views. Given that the state and the Communist Party owned all the capital, they might forfeit all their personal wealth, as well.  And the UK wasn’t appearing overly worried about the future safety of colony residents (Parliament would eventually deny UK citizenship to the mostly ethnic Chinese Hong Kong citizens, saying they would find the climate of the British Isles inhospitable).

Given this situation, Hong Kong citizens had two priorities:

–find another country willing to make them citizens and give them passports, and

–get as much accumulated wealth as possible out of Hong Kong and out of Hong Kong dollars (which might not exist after 1997).

when to move?

When should you remove you money from Hong Kong? Assume your HK$ would have no value after the handover. Your first thought might be to take your money out of Hong Kong a few months before the fact, to avoid the terminal collapse of the currency.  But everybody is going to be thinking the same thing.  So the date when the currency begins its swoon may not be in 1997 but maybe in 1996. But everyone is probably working that out, as well. So the currency will exhibit terminal weakness even earlier.  Who knows how many iterations of this backing-off process there will be.  The only sure thing is that the penalty for waiting too long will be severe.  Maybe the safest course, then, is to start to move money out of Hong Kong immediately.

To forestall a currency crisis that was already starting to ignite, the Hong Kong government decided to repeg. It though–correctly–that if citizens were guaranteed that their currency would not lose value vs. some internatinoal standard during the runup to the handover, capital flight would be minimized.  The penalty in imported inflation might be high.  But the political necessity overrode this.

the present

The pegging policy worked.

We’re now almost thirty years later. Hong Kong has survived the continual inflationary problems that the peg to the US$ have caused. Citizens have long since realized that the luckiest day of their economic lives was the one when China decided not to renew the UK lease.

So there’s no real reason in today’s post-colonial world to keep the peg.  All it brings is inflation–especially now, when the US is maintaining super-low interest rates as it tries to recover from the near-meltdown of the financial system. And Hong Kong citizens would by and large prefer to hold currency tied to the renminbi than to the US$ anyway.

My guess is that the rumors we’re hearing are a testing of the waters as prelude to replacing the peg.

investment implications

In all likelihood, the HK$ will rise vs the US$ if the peg is removed.  If so, the implications are straightforward.  Any firm with revenues in HK$ and/or costs in US$ will benefit.  Any firm in the opposite situation will lose.

from growth to value: a life cycle progression

May 4, 2011 By in from growth to value: the life cycle, growth vs value, Industry Analysis, Stock ideas, Technology Tags: , , , , , , , , , , Leave a comment

going ex-growth

What happens when a growth stock goes ex-growth.  Nothing good.

Owners of a stock like this face two issues:

–the share is doubtless trading at a very high relative price-earnings multiple, based on Wall Street expectations that its superior track record of profit expansion will continue.  Not only that, growth stocks often experience a kind of buying frenzy at the peak of their popularity that pushes the multiple way above the level the stock would deserve, even if investor expectations could be met.

–growth investors lose interest, leaving value investors as the only possible buyers.  But, as we saw yesterday, value investors are attracted only to issues that have been all beaten up and tossed onto Wall Street’s scrap heap.  Like famous relief pitcher Sparky Lyle, former growth stocks must go “from Cy Young to sayonara” –or from living in the penthouse to sleeping in a doorway in the alley–before they attract much investor support.

This process of price earnings multiple “compression” or “derating” normally takes a very long time.  I don’t understand why.  Maybe it’s confirmation bias–that people see only what they want to see.  In any event, it happens.  The first half of the 1970s, before I entered the market, were characterized by the rise of a small number of stocks, like Xerox, Polaroid or (my favorite) National Lead, that were believed to be able to grow at high rates forever.  They were called “one decision” stocks–no need to sell ever.  Many of these issues traded at 90x-100x earnings in an overall market that was selling at around 12x.

In the case of the “Nifty Fifty”, it took from 1975 to 1984 for the excesses to be wrung out of the majority of these stocks.  Of course, we need only to look at the aftermath of the Internet bubble of a decade ago to see the same process play out again, although this time it “only” took 2 1/2 years.

INTC and MSFT–APPL, too

…which brings us to the topic of INTC and MSFT, two titans of the personal computer era, and how to evaluate them today.  I’m tossing in AAPL, as well, although that firm was doomed by a series of strategic missteps by a younger Steve Jobs, to remain a bit player in the PC world.

the performance record

All three stocks hit a peak in early 2000.  From April of that year to now, their stock performance is as follows:

S&P 500          +.5%

MSFT          -41.8%

INTC          -66.2%

AAPL          +963%

From the market bottom in early 2003:

S&P 500          +55.9%

MSFT          +23.8%

INTC          +36.6%

AAPL          +2007%

From the market bottom in March 2009:

S&P 500          +98.5%

MSFT          +68.9%

INTC          87.2%  (including a 15% rise in the past couple of weeks)

AAPL          +308%.

valuations:  2000 vs. now

At the top in 2000, the S&P 500 traded at 27x earnings of $56.18; now it is trading at 13x earnings of $100.  eps growth, 2000-2011 = 78%.

At the top in 2000, INTC traded at 36x earnings of 1.53;  now it is trading at 9x earnings of $2.50.  eps growth = 63%.

At the top in 2000, MSFT traded at 68x earnings of $.85;  now it is trading at 10x earnings of $2.50.  eps growth = 194%.

At the top in 2000, AAPL traded at 30x earnings of $.85; now it is trading at 14x earnings of $25.  eps growth = 28x.

Looking at MSFT and INTC shares:

MSFT:  the obvious factor is that the stock’s relative PE has been crushed.  During much of the 1990s, the company was growing earnings at a 50% annual clip.  During the past decade, it has barely managed to get into double digits.  That’s better than the overall US economy and the S&P did over the same period, but still represents a sharp departure from the past.  One might also argue that MSFT’s numbers are flattered by the recent launches of Windows 7 and Office 2010, which together have added about $1 a share to eps.  What comes next?

INTC:  it took INTC until 2010 to surpass its earnings peak of 2000.  Yes, the PE has been flattened and the company trades at at about 2/3 of the market multiple, but earnings growth has been sub-par until recently.  The big change for INTC, to my mind, is new management that is focused on building what customers want rather than on what its engineers can create.

which to buy?

Here’s where ideology comes in.

On a PE basis, INTC is a little cheaper.

But, to my mind, MSFT has a far superior operating model.  Relative earnings growth vs. INTC over any time period shows this.  MSFT has had a stranglehold on the personal computer operating system and productivity program businesses for over two decades.  There are few signs of this changing, since so many corporate IT systems are built on MSFT products.  Unlike INTC, MSFT has little need for capital.  And, again to my mind, because AAPL’s Office-like products are so bad, MSFT faces less competition in this arena than INTC does vs. AMD.

On the other hand, MSFT appears rudderless.  It hasn’t had a new product success in at least a decade.  And I see no signs MSFT is wiling to adapt itself to a changing environment.

INTC, in contrast, faces serious competition from ARMH.  But INTC seems to me to understand the need to recast the way it operates and is changing itself as quickly as it can.

If I could choose one of the two to own 100% of myself, there’s no question I’d pick MSFT.   So it seems to me that if I were a “no catalyst” value investor, that’s the stock I’d choose.

But, as it turns out, I’m a catalyst-for-change kind of guy.   I own INTC and not MSFT.  Why?  It isn’t the lower PE.  It’s the catalyst that I see in the current INTC management and that I don’t detect with MSFT.

a footnote on AAPL

How does AAPL fit into this discussion?  In a sense, it doesn’t, because AAPL is clearly a growth stock.  Over the past two years, however, the AAPL PE has contracted from about 30 to the current 14.  In fact, if you subtract AAPL’s $50+ billion in cash from the market capitalization, AAPL is trading at a sub-market multiple of under 12.  The stock is being priced almost as if the company had already gone ex-growth, which it clearly has not.  I can’t recall ever having seen a true growth stock act this way.

the two (possibly three) flavors of value: with and without a catalyst for change

May 3, 2011 By in book value, cash flow/share vs. earnings/share, growth vs value, two flavors of value Tags: , , , , , , , , , , , 1 Comment

As you know if you’ve been reading this blog for a while, I’m a growth investor.  But I started out my career as a value investor and spent over half my working years in shops that had either a value orientation or a substantial value presence.  For an outsider, then, I think I have a reasonable grasp of what value investors think and do.  I’m also laying the groundwork in this post for writing tomorrow about the titans of the personal computer industry, AAPL, INTC and MSFT.

how all value investors operate

Value investors like to invest in companies whose stocks are trading at very low ratios of price to book value (shareholders’ equity), price to cash flow, price to earnings and/or price to assets.  Many times such companies have gotten to low valuations because their managements have made strategic missteps.  Sometimes, though, the environment in which they work is highly cyclical and the cycle has turned against them.  Or it may just be that the industry in which the company operates is boring and seldom catches investors’ eyes.

In their pursuit of very cheap companies, value investors hold to two ground-level beliefs, namely:

–you can’t fall off the floor, and

–everything reverts to the mean, sooner or later (but mostly sooner).

The first dictum suggests that if a company’s stock is already all beaten up, at some point it just won’t go any lower.  So if buyers can locate and act at around this level, they have limited downside risk.

The second idea is that the company will eventually overcome the mistakes it has made–either with present management, new leadership, or as a division of a larger company.  In any of these events, the stock will go up …or the business cycle will turn in the company’s favor …or investors may just spontaneously wake up one morning and find the company’s industry much more fascinating (maybe as the first market entrant is taken over).

In any of these cases, the severe negative market emotion that has driven the stock to extremely low levels will dissipate and the stock will return to a more normal valuation–that is, one more in line with its past trading and with what companies with similar financial characteristics in other industries sell at.

All value investors believe this.

What sets them apart from one another?

For one thing, different investors may use somewhat different metrics.  One may be deeply convinced that he should only pay attention to price/book.  Another may be equally committed to price/cash flow.  A third may want to have another company in the same industry that’s very well run, whose (higher) margins may give a strong clue as to how good things might one day get.

In the final analysis, however, I don’t think these differences mean all that much.  Where I see the big divide for value practitioners is between those who want to see some catalyst that will encourage/force favorable change in the firm being analyzed before they’ll buy it, and those who don’t.

no catalyst

I understand the argument that the “no catalyst needed” camp makes.  They say that when things start to go bad for a company, investors can (and usually do) have a violent negative reaction that far exceeds anything that the (deteriorating) fundamentals justify.  The stock gets battered in a way it never will again, once the sellers are able regain a bit of their self-control.  Therefore, by buying when the blood is flowing the thickest in the streets, you get by far the best prices. You’re more than compensated for the risk early buying entails.

I understand the argument, but temperamentally I could never just look at the price/book (or whatever other metric) screens and jump in.  What if the stock turned out to be GM, or Enron, or Global Crossing?  As a result, I’ve never tried to investigate whether the approach works.  Unfortunately, I have seen it fail, though.

catalyst required, please

The second camp of value investors are those who insist on being able to see some sign, or catalyst, that convinces them that change for the better is under way.  It may not have to be much.  The retirement of a CEO and the appointment of a more capable successor might be enough   …or an activist investor approaching another laggard in the same industry   …or indications that the business cycle is changing in the company’s favor.  Although I’m not that interested in a regular diet of value names, I’m much more comfortable with this second approach.  But that’s just me.

where does GARP stand?

There is a third style that stands on the border between growth and value.  It’s called Growth at a Reasonable Price, or GARP.  I’ve often had colleagues describe me as a GARP investor, mostly, I think, because I don’t see a compelling reason to live exclusively on the bleeding edge of growth (with emphasis on bleeding).  But I’m not a GARP investor in the way value players would understand it.

As growth, GARP means having a forward PE that’s equal to or lower than the forward growth rate.  As value, in contrast, being a GARP investor means that you determine a forward PE level, say, 15x, above which you refuse to make a purchase, no matter what you think the forward growth rate will likely be.

For example, I have no problem paying 22x earnings for a company that will grow earnings at a 28% annual rate for at least the next few years.  In fact, I’d consider myself lucky to have discovered the stock before the PE rose further. I’d also be happy to pay 40x for a company that could grow at a 50% rate.

A value-oriented GARP investor, in contrast, would have drawn a line in the sign in the sand, probably between 15x-20x–certainly no higher, and would refuse to buy either.

That’s it for today.  Tomorrow, let’s apply this to INTC and MSFT.