The inflationary pressures felt by the consumer have been created by the Federal Reserve. Producer prices, as measured by the Producer Pricing Index (PPI), rose another 0.8% in January. The most important take away from these numbers is that the core prices increased 0.5%, well above the 0.2% expected by the market. Amazingly one headline I read stated; "Spike In Core PPI is Not a Sign of Future Inflation Pressures." What is it then? The article then went on to explain that all of the increase was due to a spike in pharmaceutical prices and that this will not lead to inflation. For those of you on medication I am sure you will disagree! Whatever you do do not get sick as it is going to cost you a bundle.
This report was followed up with price increases to the consumer in the Consumer Pricing Index (CPI). These increased another 0.4% in January. I am no mathematical genius but 0.4% multiplied by 12 gives me an annual rate of 4.8% and this is high and rising. Core prices, those tracked by the Federal Reserve, increased to 0.2%, double what was expected. This was also pushed aside as just a normal spike during an "expansionary" cycle. Now don't get me wrong, these numbers are not out of control yet, but the problem is that they are being swept under the rug by the same people that are creating the inflation to begin with, the Federal Reserve. Furthermore I would argue that with high unemployment and a poor housing market we have anything but a truly "expansionary" economy right now.
The Federal Reserve is currently buying an average of $110 billion a month in Treasury paper with money that is being created out of thin air. They have therefore monetized most of the United States' deficit to June. In fact they have purchased so much Treasury paper that they are now the largest holder of U.S. Treasury securities, surpassing the Chinese and the Japanese the two largest independent holders. At this speed, by June they will own more than those two nations combined! Foreigners are no longer funding our excesses, we are gorging on our own budget deficits and in doing so we are exporting inflation to ourselves and the rest of the world.
While this printing is going on and as long as the rest of the world does not lose complete confidence in the U.S. stock prices, food prices, energy prices and precious metal prices will continue to inflate. At some point this party has to end and there are only two ways it can happen. The happy ending is that the U.S. economy grows at a rapid clip on its own steam rather than being pushed along by the Federal Reserve. The government becomes austere and the load of Treasury debt held by the Federal Reserve is slowly unwound without issuing new debt. I put the probability of this happening at less than 10% in large part due to high unemployment, increasing costs of insurance, medical expenses and taxes and weakness in the housing market. As I have explained in previous blogs, there is a bifurcation occurring in the market which will result in the second option occurring.
The second way out is that the world finally loses faith in the U.S. and its economic policies and the result is a rapidly falling dollar leading to rapid inflation followed by a collapse in all markets. This outcome can be delayed (as the Federal Reserve is doing) but it cannot be avoided unless the policies of the government change to that of austerity rather than the current policy of increasing the level of debt. Either way pain will be felt but with a $3.4 trillion budget announced by the Obama administration, austerity is not in their vocabulary and hence my disdain for the markets. Enjoy the ride, but be prepared for the inevitable.
Friday, February 18, 2011
Wednesday, February 16, 2011
Innovation
As mentioned in my last blog there appears to be a bifurcated recovery underway. Inflation is starting to take hold and this is filling the purses of the bankers, the farmers and the miners. Small business in America is not so lucky. In my discussions with many small business owners it is a real struggle. Capital is scarce and where capital is scarce, growth slows. Layoffs are common place and in some cases the owners themselves are doing all the day to day chores that they used to hire people to do just so they can survive a little while longer. This does not translate into a lot of confidence for the future and this is reflected in the consumer confidence index.
Outside of these groups there is a burgeoning group of innovators and entrepreneurs that are starting new ventures that potentially could put business on its head in the coming years. In the 1930's there were plenty of "new" companies that burgeoned in the poor markets of the great depression. United Technologies ($54B in revenues), Tyson Foods ($24B), Fischer-Price, Duracell, Texas Instruments, Starwood Hotels, Unilever and Fortune Magazine, just to name a few. All of these companies started at the absolute "worst" time in economic history and all have prospered.
This spirit has not died. In fact I believe that it is even more prevalent than ever before. During the last year I have assisted two start ups with financing. Both of them are growing in leaps and bounds. The first is in the business of providing assistance to agents and homeowners by negotiating the sale of the property through short sales. The company can be found at www.lotusrealtygroup.com. To date they have closed more than 50 transactions and have a pipeline of just under 100 properties. They are helping to unlock the gridlock between the banks and the homeowners while profiting in a poor real estate market.
The second company is a network of 15,000 freelance writers and editors that can create content for everything from white papers to web content for a fraction of what it costs to hire in house expertise. Furthermore they can crowd source ideas providing advertising campaigns with a huge boost. Why choose from a handful of options when you can have 500? They can be found at www.ecopywriters.com. This freelance network of writers and editors is rapidly replacing the brick and mortar offices and allowing people to work on their own time where ever they are while still providing a wonderful product to the clients at an unbeatable price.
Other ideas that have been presented to me recently is a novel way to advertise on the caps of fountain drinks that are found in fast food restaurants and take-out places. There was a novel way to track advertising through mobile devices. Real estate groups that are providing their agents more than just the tools necessary to sell a house but also to help the owners of the house with access to free tax and legal advice. A way to earn a rate of return on your CD style investment of 2.50% rather than nothing at the banks. Designs for cars, bandages that heal wounds, medical devices that light up the back of the patients throat so that emergency crews can save them. The list goes on and on. Considering that I run a relatively small fund the fact that these people are coming to me rather than the big houses says a lot about the illiquidity of the market, but the good news is that a lot of these companies will prosper and will provide employment in these bad times and it is these companies that will provide a great future for those that work there and for my investors alike.
If you would like any more information on the two listed companies or the short term investment opportunity let me know and I can forward your details to the relevant party.
Outside of these groups there is a burgeoning group of innovators and entrepreneurs that are starting new ventures that potentially could put business on its head in the coming years. In the 1930's there were plenty of "new" companies that burgeoned in the poor markets of the great depression. United Technologies ($54B in revenues), Tyson Foods ($24B), Fischer-Price, Duracell, Texas Instruments, Starwood Hotels, Unilever and Fortune Magazine, just to name a few. All of these companies started at the absolute "worst" time in economic history and all have prospered.
This spirit has not died. In fact I believe that it is even more prevalent than ever before. During the last year I have assisted two start ups with financing. Both of them are growing in leaps and bounds. The first is in the business of providing assistance to agents and homeowners by negotiating the sale of the property through short sales. The company can be found at www.lotusrealtygroup.com. To date they have closed more than 50 transactions and have a pipeline of just under 100 properties. They are helping to unlock the gridlock between the banks and the homeowners while profiting in a poor real estate market.
The second company is a network of 15,000 freelance writers and editors that can create content for everything from white papers to web content for a fraction of what it costs to hire in house expertise. Furthermore they can crowd source ideas providing advertising campaigns with a huge boost. Why choose from a handful of options when you can have 500? They can be found at www.ecopywriters.com. This freelance network of writers and editors is rapidly replacing the brick and mortar offices and allowing people to work on their own time where ever they are while still providing a wonderful product to the clients at an unbeatable price.
Other ideas that have been presented to me recently is a novel way to advertise on the caps of fountain drinks that are found in fast food restaurants and take-out places. There was a novel way to track advertising through mobile devices. Real estate groups that are providing their agents more than just the tools necessary to sell a house but also to help the owners of the house with access to free tax and legal advice. A way to earn a rate of return on your CD style investment of 2.50% rather than nothing at the banks. Designs for cars, bandages that heal wounds, medical devices that light up the back of the patients throat so that emergency crews can save them. The list goes on and on. Considering that I run a relatively small fund the fact that these people are coming to me rather than the big houses says a lot about the illiquidity of the market, but the good news is that a lot of these companies will prosper and will provide employment in these bad times and it is these companies that will provide a great future for those that work there and for my investors alike.
If you would like any more information on the two listed companies or the short term investment opportunity let me know and I can forward your details to the relevant party.
Thursday, February 10, 2011
A Bifurcated Market
The Federal Reserve believes that the printing of money will result in a return to a "normal" economy. Their view is that printing money will stimulate the economy. Using Bernanke's own words; "Lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion." Out of this jobs are created and all is back to "normal".
Well let's delve into this for a moment. Lower mortgage rates have not happened. In fact the mortgage rates are following the 10-year treasuries higher. The 10-year treasury has recently broke down and the yield has increased and this has fed into mortgage rates that have increased from 4.2% in October to 5.0%. This rate increase has quelled any form of a recovery in housing and some people are even calling for a second leg down in housing. As housing normally leads the economic recovery this is a bad omen and certainly is not what Bernanke expected to happen or what he is saying is happening.
Job creation has not happened. While the unemployment rate has recently fallen to 9.0% from just under 10.0% it is more a factor of people falling off the government unemployment list rather than people actually finding jobs. If you include discouraged and part-time workers then the rate jumps to 16.1%. Certainly not a number that shows success.
So where is all the "success" that Bernanke and company are telegraphing? It all boils down to one leg of the stool and that is the stock market. The stock market is on a one way tear and is showing no signs of turning back. So long as the Federal Reserve continues to print money that new money has to go somewhere and right now it is being piled into the stock market.
So who benefits from this stock appreciation? The main beneficiaries are the wealthy and the investment bankers. Most of America does not own a stock. Housing is their main asset. As housing prices are down they are feeling the pain. Furthermore I am not sure why an executive has to hire people because his stock price has gone up but according to Bernanke this is what will happen. Certainly among a small sector of the economy there is a massive benefit to the money printing. Those involved in the stock market and investment banking are making a lot of money. However if you refer to the Austrian economist Mises you will see that inflation always benefits a few lucky individuals at the expense of the bulk of the population.
Right now food and gas prices are spiralling higher squeezing the average Joe. Out of work and with no sign of a recovery in housing the cost of this money printing is higher prices and a loss of value in the one asset that would get him to retirement. Meanwhile the investment bankers are paying out massive bonuses and buying bigger houses. Sales at Tiffany's and Nordstrom's are growing while Walmart sales slow. This bifurcation of the market cannot continue forever but it looks like it will continue as long as Bernanke prints money and he has stated that there is much work to still be done and by that I am sure he is referring to tree cutting and money printing.
There are other repercussions that seem to escape our fearless leaders. High food prices are causing social unrest in Tunisia, Algeria, Jordan, Yemen and now Egypt. Countries trying to fight inflation are raising interest rates. Recently Brazil, India, South Korea, Thailand, Malaysia, Poland, Peru and more have all raised interest rates. So this bifurcation is not just limited to the United States but, just like the housing boom, the United States is exporting these problems to the rest of the world.
How will this all end? Well as a follower of this blog you will know that I believe it will all end badly. Once the printing stops, and it will, the stock market bubble will collapse and will create another wave of unemployment and another drop in the price of housing and this time there will be no money printing available to the Federal Reserve to "save" us. The pain will be enormous but hopefully this time around the market will be left to clean the slate so that we can rebuild on a solid foundation.
Well let's delve into this for a moment. Lower mortgage rates have not happened. In fact the mortgage rates are following the 10-year treasuries higher. The 10-year treasury has recently broke down and the yield has increased and this has fed into mortgage rates that have increased from 4.2% in October to 5.0%. This rate increase has quelled any form of a recovery in housing and some people are even calling for a second leg down in housing. As housing normally leads the economic recovery this is a bad omen and certainly is not what Bernanke expected to happen or what he is saying is happening.
Job creation has not happened. While the unemployment rate has recently fallen to 9.0% from just under 10.0% it is more a factor of people falling off the government unemployment list rather than people actually finding jobs. If you include discouraged and part-time workers then the rate jumps to 16.1%. Certainly not a number that shows success.
So where is all the "success" that Bernanke and company are telegraphing? It all boils down to one leg of the stool and that is the stock market. The stock market is on a one way tear and is showing no signs of turning back. So long as the Federal Reserve continues to print money that new money has to go somewhere and right now it is being piled into the stock market.
So who benefits from this stock appreciation? The main beneficiaries are the wealthy and the investment bankers. Most of America does not own a stock. Housing is their main asset. As housing prices are down they are feeling the pain. Furthermore I am not sure why an executive has to hire people because his stock price has gone up but according to Bernanke this is what will happen. Certainly among a small sector of the economy there is a massive benefit to the money printing. Those involved in the stock market and investment banking are making a lot of money. However if you refer to the Austrian economist Mises you will see that inflation always benefits a few lucky individuals at the expense of the bulk of the population.
Right now food and gas prices are spiralling higher squeezing the average Joe. Out of work and with no sign of a recovery in housing the cost of this money printing is higher prices and a loss of value in the one asset that would get him to retirement. Meanwhile the investment bankers are paying out massive bonuses and buying bigger houses. Sales at Tiffany's and Nordstrom's are growing while Walmart sales slow. This bifurcation of the market cannot continue forever but it looks like it will continue as long as Bernanke prints money and he has stated that there is much work to still be done and by that I am sure he is referring to tree cutting and money printing.
There are other repercussions that seem to escape our fearless leaders. High food prices are causing social unrest in Tunisia, Algeria, Jordan, Yemen and now Egypt. Countries trying to fight inflation are raising interest rates. Recently Brazil, India, South Korea, Thailand, Malaysia, Poland, Peru and more have all raised interest rates. So this bifurcation is not just limited to the United States but, just like the housing boom, the United States is exporting these problems to the rest of the world.
How will this all end? Well as a follower of this blog you will know that I believe it will all end badly. Once the printing stops, and it will, the stock market bubble will collapse and will create another wave of unemployment and another drop in the price of housing and this time there will be no money printing available to the Federal Reserve to "save" us. The pain will be enormous but hopefully this time around the market will be left to clean the slate so that we can rebuild on a solid foundation.
Tuesday, February 8, 2011
Cyber Smear
There are two kinds of Chinese stocks that trade on US markets - those that are listed through an IPO (initial public offering) and those that are listed through a reverse merger.
The companies that are listed through an IPO have the support of institutions and therefore enjoy great analyst coverage and support from the market. These stocks trade at earnings multiples in the double digits and some of them have reached the lofty heights north of 50 such as China Unicom. A stock with a price to earnings ratio north of 50 is a high flying momentum stock that has double to triple digit growth rates and are coveted by the analysts and the press. US examples would be Apple, Salesforce.com or Vmware. All are high fliers and all are trading at high multiples with Salesforce and Vmware at multiples in the 100's.
As a brief education a stock that trades at a price to earnings ratio of say 100 means that if earnings do not grow that it will take the company 100 years to produce earnings that match the stock price. Obviously the market does not believe that earnings will remain static. The large ratio is due to the market's expectations that earnings will grow at a rapid pace to bring that multiple down to a more reasonable number of say 15. Stocks with multiples like this are prone to big swings and if the company misses an earnings number the stock price typically will get cut in half.
On the other side of the scale are the companies that come to the US markets via way of a reverse merger. A reverse merger is a cheap way to go public. Essentially a company buys a "shell" company (one that has traded on the US market previously but has since ceased to exist) and then slowly works its way from the bulletin board to the big board. These companies come at very cheap multiples to earnings and can be found with exceptionally high growth rates. Some examples are China Education and China Media Express just to name a couple (both of which I hold a long position). Both of these stocks trade at seriously low multiples and, in the case of China Education, trade below cash value. How is this possible?
Well it comes down to trust. Both of these companies have recently been hammered with cyber smear. Cyber smear campaigns can occur at any moment. All they require is for someone to post a negative article about a company that is picked up by the investors and down goes the stock. Now this is where support from a big investment bank is critical. If the support is there, cyber smears are rare. Why? The chance of a cyber smear working on a stock that has a large analyst following is minimal as the smear campaign will garner little attention as investors trust that the Goldman's or Merrill analysts have done their homework and that this is a poor attempt by the shorts to drive a stock lower. Not so with a thinly traded stock. One negative report can drive a stock below cash value (as with China Education), or can cut it in half (as with China Media Express). Attempts by companies to quell investor concerns are normally met with skepticism and give the shorts ample time to exit their position.
To me this is part and parcel of investing in these types of Chinese stocks. As long as there is the inherent distrust in the numbers that are being presented by Chinese companies there will always be an opportunity for a short seller to profit from a random smear campaign. It is not if it will happen but more like when it will happen.
Investors in these stocks can do a number of things to profit from these stock movements. The first is to wait patiently for the smear campaign to happen and then buy once the dust settles. The second is to place protective put options on stocks that you own but this is expensive. The third and far more aggressive way is to sell put options with a strike price at or below the price that you would happily buy the stock. If that price is never met then you pocket the premium. Alternatively when the smear happens you then own the stock at the lower price. There are obviously a multiple of other ways to go, but the point is that there are ways to profit handsomely from these wild swings.
Before you blaze a trail into these bloody waters you had better do your homework. There have been a number of Chinese stocks that have turned out to be nothing more than a hoax, so make sure that the company has a reputable auditor. Furthermore you should make sure that the company exists. Check with reputable analysts and, if you still are unsure but love the stock, get on a plane and go and see for yourself. Finally try to find a company with a management team that protects shareholder value. This is tough as there certainly is a cultural difference. I am still waiting for China Education to eradicate the negative sentiment of the recent smear campaign. Until they prove their cash reserves this stock could languish for a while, but my research shows that the smear campaign is just that, but until the doubts are removed it could be a while for this to recover.
Be patient, do your homework and enjoy the ride!
The companies that are listed through an IPO have the support of institutions and therefore enjoy great analyst coverage and support from the market. These stocks trade at earnings multiples in the double digits and some of them have reached the lofty heights north of 50 such as China Unicom. A stock with a price to earnings ratio north of 50 is a high flying momentum stock that has double to triple digit growth rates and are coveted by the analysts and the press. US examples would be Apple, Salesforce.com or Vmware. All are high fliers and all are trading at high multiples with Salesforce and Vmware at multiples in the 100's.
As a brief education a stock that trades at a price to earnings ratio of say 100 means that if earnings do not grow that it will take the company 100 years to produce earnings that match the stock price. Obviously the market does not believe that earnings will remain static. The large ratio is due to the market's expectations that earnings will grow at a rapid pace to bring that multiple down to a more reasonable number of say 15. Stocks with multiples like this are prone to big swings and if the company misses an earnings number the stock price typically will get cut in half.
On the other side of the scale are the companies that come to the US markets via way of a reverse merger. A reverse merger is a cheap way to go public. Essentially a company buys a "shell" company (one that has traded on the US market previously but has since ceased to exist) and then slowly works its way from the bulletin board to the big board. These companies come at very cheap multiples to earnings and can be found with exceptionally high growth rates. Some examples are China Education and China Media Express just to name a couple (both of which I hold a long position). Both of these stocks trade at seriously low multiples and, in the case of China Education, trade below cash value. How is this possible?
Well it comes down to trust. Both of these companies have recently been hammered with cyber smear. Cyber smear campaigns can occur at any moment. All they require is for someone to post a negative article about a company that is picked up by the investors and down goes the stock. Now this is where support from a big investment bank is critical. If the support is there, cyber smears are rare. Why? The chance of a cyber smear working on a stock that has a large analyst following is minimal as the smear campaign will garner little attention as investors trust that the Goldman's or Merrill analysts have done their homework and that this is a poor attempt by the shorts to drive a stock lower. Not so with a thinly traded stock. One negative report can drive a stock below cash value (as with China Education), or can cut it in half (as with China Media Express). Attempts by companies to quell investor concerns are normally met with skepticism and give the shorts ample time to exit their position.
To me this is part and parcel of investing in these types of Chinese stocks. As long as there is the inherent distrust in the numbers that are being presented by Chinese companies there will always be an opportunity for a short seller to profit from a random smear campaign. It is not if it will happen but more like when it will happen.
Investors in these stocks can do a number of things to profit from these stock movements. The first is to wait patiently for the smear campaign to happen and then buy once the dust settles. The second is to place protective put options on stocks that you own but this is expensive. The third and far more aggressive way is to sell put options with a strike price at or below the price that you would happily buy the stock. If that price is never met then you pocket the premium. Alternatively when the smear happens you then own the stock at the lower price. There are obviously a multiple of other ways to go, but the point is that there are ways to profit handsomely from these wild swings.
Before you blaze a trail into these bloody waters you had better do your homework. There have been a number of Chinese stocks that have turned out to be nothing more than a hoax, so make sure that the company has a reputable auditor. Furthermore you should make sure that the company exists. Check with reputable analysts and, if you still are unsure but love the stock, get on a plane and go and see for yourself. Finally try to find a company with a management team that protects shareholder value. This is tough as there certainly is a cultural difference. I am still waiting for China Education to eradicate the negative sentiment of the recent smear campaign. Until they prove their cash reserves this stock could languish for a while, but my research shows that the smear campaign is just that, but until the doubts are removed it could be a while for this to recover.
Be patient, do your homework and enjoy the ride!
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