Durable Goods Orders

The Commerce Department reported that Durable Goods Orders rose less than forecast in November, posting a .1% gain. Analysts had forecast a rise of 2%, nonetheless this was the first gain in 4 months and followed a revised .4% decline in October. Excluding transportation orders demand was down .7% versus an expected increase of .5%. Orders for military gear fell 24% led by a drop in aircraft demand. Orders for non-defense capital goods excluding aircraft, a proxy for future business investment, fell .4% after a 2.9% gain in October. Initial Jobless Claims rose 1,000 to 349,000 while continuing claims increased 75,000 to 2,713,000. Weekly mortgage data reported by the Mortgage Banker’s Association showed declines of 6.5-8.5% in its applications, purchase and refinance indices. At 9:00am CST we will get the final read on December Consumer Confidence.

'Tis the Season to Remember

I hope you enjoyed your Christmas / Holiday and are taking some time off to rest and relax.

As this year comes to a close, I hope it’s been a profitable one for you. And, as you all reflect on the past year and plan for the New Year, please take a short break from the busy world of finance, to view this brief, but important public announcement. Hopefully, it will give you a better appreciation for how good you have it, and a brighter outlook for 2008.

The following is one of the hottest things on the internet and has been featured on Fox News recently. Lizzie Palmer who put this YouTube program together is 15 years old. There have been over 3,000,000 hits on this. In case you missed it, here it is.
http://www.youtube.com/v/ervaMPt4Ha0&autoplay=1

Wishing you all a prosperous New Year!

UPDATE: As for me, I plan to coast into the New Year 72% in cash as the “hammer of death” smashes the market, Thor style.

Bearish

Time to take profits and sit on the sidelines in cash until it looks like a bottom is confirmed.

No New Positions

I'm not seeing any specific entry points for any of the sector ETFs. Still waiting for good set ups to appear.

Holding off on any new positions. Taking a defensive stance right now and staying on the sidelines, I remain bearish.

More on RIG

RIG, the leader in deepwater drilling has been languishing as of late. They had announced an $8.5B financing, which included $6B in converts and $2.5B in senior notes. The downward pressure on the stock is most likely due to selling by the Arbs on the convert. You also have to question why the company would pursue a convert issue just days after a massive recapitalization and $15B buyback through the GSF merger.

While management could have provided more disclosure and transparency on this move, the converts seem to be prudent. This is due to the low coupon rates of 1.5% to 1.625%, and no near-term dilution.

Dilution won’t hit until the stock gets to $168.61, which is the equivalent of a 32.5% converson premium. RIG is obligated to settle the converts for cash up to the principal amount of the notes upon conversion, and in common stock above the conversion price. If the stock gets above $168.81, RIG is then obligated to issue shares at the conversion ratio. If it gets to $185, the converts are about 1% dilutive without factoring in lower interest expense from the coupon rates.

I wouldn’t worry about this issue. RIG is still a buy long term and should outperform others drillers.

Sub-Prime Explained

Btw, if you're still wondering, and have a few minutes, here's an eight minute summary that explains (in no uncertain terms) the sub-prime mess.

The Soda Pop Kid

Interesting news out on Jones Soda (JSDA). Founder and CEO, Peter van Stolk has just announced his resignation.

Board members Scott Bedbury and Steve Jones will assume the chairman and CEO roles, respectively, until a replacement is found. Bedbury is better know for his “Just Do It” campaign slogan at Nike in the late 80’s and his repositioning of Starbucks stores as destination coffee shops in the 90’s. His next challenge will involve the expansion of the Jones Soda brand from niche to mainstream.

This change comes as a result of the mismanagement of JSDA, by van Stolk. The company failed to move into the larger canned soda market earlier this year.

JDSA is currently up over 7% today.

Flow International (FLOW)

Here's something for the "low-priced stock" affectionado:

Flow manufactures Ultra High Pressure waterjet cutting systems and related products. These products are used to cut materials in different industries such as aerospace, automotive, disposable products, food, glass, job shop, metal cutting, marble, tile and other stone cutting and paper industries.

Flow is in negotiations to acquire its main competitor Omax Corporation, signing an option to acquire the company for $109m rising to $135m after 2 years subject to performance. Any merger will be subject to Hart-Scott-Rodino clearance. Flow currently has $33m in cash and minimal debt. Additional funding will be required, likely with an equity element. Omax is based a half mile from Flow’s headquarters, and like Flow has its roots in technology developed by Boeing (BA)engineers. Integration would be relatively easy from a cultural and logistical standpoint.

Omak has some technology that Flow does not, and also has unique overseas distribution channels. Omak would also benefit from Flow’s internet-based order fulfillment strength. Another advantage of the acquisition is that it will settle the outstanding patent litigation that has been ongoing for several years between Flow and Omak.

Further details will be available during Flow’s 2Q08 conference call to be held tomorrow. The stock has been beaten up since the retirement of the turn-around CEO, Stephen Light, but is up nicely this morning. It’s not too late to get in now, as I estimate a target of $12—but patience should be exercised, something that many of you may be lacking in spades.

EPS:
2007A $0.10 P/E: 74x
2008E $0.43 P/E: 17x
2009E $0.63 P/E: 12x

(Fiscal Years ending in April)

Is a Recession Priced Into Stocks?

Is a recession already priced into stocks? Well, that depends. There are certain sectors that have already discounted a recession and there are some that have not. The haves and have nots. Additionally, within each sector, there are specific industries that are attuned to economic developments and some that are not.

Without getting too detailed, let me summarize and then expound on a specific example.

Industries that have largely embedded a recession scenario: Hardlines Retail, Apparel, Transportation, Steel, PVC Chemicals, and Telecom.

Industries that have little, if any, recession risk embedded: Electrical equipment, regional banks, softlines retail, airlines.

If you haven’t figured it out, list number two is the one to avoid, if you think we will experience a recession.

Here is a list of stocks, primarily cyclicals, that should do well if we have a “soft landing” scenario: ACN, AEO, ASH, BA, CAKE, CIT, FCX, LEH, LOW, MAN, MRO, MU, JWN, OMX, OSK, PRU, STX, RIG, X.

On the other hand, here is a list of stocks that are currently discounting little recession risk, that could underperform if we do get a recession: C, DIS, WLP, S, AMZN, PCP, EOG, TXT, WM, WY, AMP, HOG, NTAP, BEAS, ACI, CENX, TMA, YRCW.

And here are your defensive plays that should do relatively well, even in a downturn: APD, AA, APC, CELG, CNP, CL, CEG, CVS, XOM, FPL, GOOG, HPQ, HNZ, INTC, JCI, LMT, MCD, MCK, NWS, NKE, PEP, QCOM, LUV, SPLS, UPS, TEVA, UTX, UNH, VZ, WMT, WYE.

Not Your Father’s Shit

Now, let us turn to the important matter of Fertilizer stocks, as an example. These stocks are not pricing in a recession. They are too busy banking coin and pricing in a boom. Driven primarily by Asian demand, and to a lesser extent, alternative energy, industry growth has dramatically overshadowed the normal cyclical nature and the high energy costs.

Historically, the correlation between GDP growth and domestic fertilizer consumption is not high to begin with. The global relationship, while stronger, is not overwhelming either. I would also argue that the global correlation is rapidly declining due to emerging market development. As markets develop, their demand becomes less GDP sensitive and more correlated to population growth and other factors.

If we look back to the past two recessions, we see mixed messages regarding consumption of fertilizer in North America. Nitrogen consumption increased in 1990-91, but declined in 2001. Phosphoric acid consumption declined in 1990-91, but gained modestly in 2001. And the third major category of fertilizer, potash, declined in 1990-91 and consumption was flat in 2001. But what should matter most to investors is whether domestic producers benefit from consumption trends, which makes looking at North American operating rates more relevant.

Moreover, the fertilizer industry has undergone some significant structural changes which have served to dampen the cyclical nature relative to historical trends. Declining economics in nitrogen and phosphates has led to meaningful capacity rationalization, while improving dietary trends in third world regions has been a boon for potash demand. Additionally, corn-based ethanol demand has benefitted domestic producers.

Much of these trends appear to be relatively insulated from a decline in U.S. GDP. What should not be overlooked, however, is the highly global nature of the fertilizer industry, and the potentially more relevant threats associated with economic weakness in third world economies. These risks are somewhat modest since GDP only sets in motion the underlying drivers of new demand above and beyond population growth. And, the impact those drivers have on food demand unwinds only slowly. The picture isn’t so bleak. Odd, no?

But where could we be wrong? Where is the downside? Regardless of the U.S. economic trends, fertilizer consumption and operating costs should remain fairly constant. But, a modest decline in pricing power is possible if the economy creates a situation where farmers become more cost sensitive. Presently, they are driving brand new pickups and drinking rich man’s whiskey. If that is your concern, take a look at Mosiac (MOS), which has lower exposure to U.S. and Canadian demand.

MOS gets only about 40% of its revenue from North America, while Potash (POT), Agrium (AGU) and CF Industries (CF) get roughly 70%, 85% and 90%, respectively.

Should we be concerned about valuations? Currently, valuations are well above any historical norm because strength in the market is weakly correlated to economic activity. Potash and phosphorous producers are in a relatively good position to cut back on supply if markets begin to get sloppy.

Know this: a U.S. recession is not a substantial risk to fertilizer stocks. However, a reversal in economic growth in China and India is. But even then, the risk of a sharp drop in consumption is limited because grain supply worldwide is so low and shifts in the workforce of those countries makes changes in demand less likely to slacken.

In summary, buy that shit.

Turkey Telephones....TKC

TKC. This is the Turkish mobile phone company that get a 15% monthly fee, paid by the Turkish government on the gross revenue of the company.

The chart looks really nice. Just what you would expect to see from a non-US based investment.

It Helps to Watch the Bond Market

Treasury prices are climbing higher in early trading with the benchmark 10yr up almost a half of a point to yield 3.88 percent while the 30yr bond is roughly a full point higher to lower its yield to 4.32 percent. Highlighting the pronounced degree of volatility currently embedded within the financial sector, investors should expected further consternation in the general direction of interest rates given the release of the employment data at the end of the week and the next FOMC meeting eight days away. Despite all the uncertainty, however, the broader economy remains poised to outperform the financial sector as indicated by the corresponding slopes of the Treasury yield curves.

With a difference of 60 basis points, the spread between the 2yr/30yr curve and the 3mo/10yr curve is particularly low given historical norms. Due to the abnormal amount of productivity accumulated over the course of the prior decades and mostly underutilized to this point, the economy will have relatively easier time acting with a greater degree of efficiency than that of the financial sector as investors un-extrapolate growth prospects already “priced-into” a number of investment vehicles.

As far as interest rates are concerned, nominal levels have a strong tendency to go lower overall (not, however, in a straight line dynamic) as the current environment is decidedly non-inflationary in nature. With the output gap (the difference between realized and potential rates of GDP) continuing to widen, the strength of long-term disinflationary pressures are poised to easily overcome that of any transitory inflationary dynamics that flare up in the interim. One such risk would be the reversal of the current trade environment.


According to last quarter’s GDP data, exports growth topped 18 percent for the period, extremely high for a service-dominated economy. The uncharacteristic performance of exports, subsequently, owes much of its near-term success to the general weakness in the trade-weighted dollar. The performance of the dollar reflects the health of trade at any given time which means that should trade revert to more efficient fundamentals; the dollar should begin to regain its value over a protracted timeframe. Domestic good-production, therefore, will need to be monitored closely for any signs of such a change, a major reason why today’s ISM data is so important.

According to the Institute of Supply Management (ISM), the monthly diffusion index for November came in at 50.8, mostly in line with consensus estimates. The lowest realized level since January, activity was about the same it was in October (50.9) showing signs of slowing manufacturing growth quarter-to-date. Much like the headline data, new orders grew at a similar pace they did in October (52.6 vs. 52.5), decidedly below the six month average of 55.3. Hiring, meanwhile, fell to below contractionary sub-50 levels for the first time since March. New export orders, however, was strong again last month while imports fell for the second consecutive month. Taken altogether, although overall export orders remain strong, the overall sustainability of continued strength remains very much in question given the lack of further investment within the manufacturing sector.

Recession?

It’s very possible that the US and global economy will avoid a “hard landing”. Why do I think that?

1.) monetary conditions are lax, viz. a vis low interest rates and a weak dollar

2.) net exports are stronger, due to domestic growth within Asia

3.) inventories do not look excessive, viz., steel industry, as an example

4.) corporations are not over-leveraged or over-invested relative to cash flow generation

5.) outside of the housing market, there has been little labor hoarding ahead of this downturn. With high relative margins and limited pricing power in the labor markets, there is less need for lay-offs.

The global economy should avoid a recession because:

1.) China should grow at 10%. This is after economists have reduced estimates.

2.) China doesn’t have a non-food inflation problem—therefore, fiscal policy can be flexible

3.) worldwide, labor has limited pricing power, viz wage growth is actually shrinking

4.) given the economic environment, central banks can respond to weak/slow growth with rate cuts

5.) internationally based corporations are under-invested.

Look for the Fed to get aggressive with rate cuts. We could see the “Greenspan days” where rates are back down to 2.50% - 3.00%.

But, if we do have a recession, historically, the Fed has cut rates an average of 6% (obviously it won’t happen now). Know this interesting tidbit: the biggest rate cut was from July 1981 to November 1982, where the Fed cut rates 1100 bps, from 19% to 8%! That started a secular Bull Market from 1982 - 2000.

Morning Notes

Although the economic news released yesterday was weak, stock prices soared after the Federal Reserve hinted that it may lower interest rates again. Assuming the market continues to rally: Prudent Investors may want to buy stocks at this time. Aggressive Investors and Traders should play the market to the upside.

Citrix Systems (CTXS) : Desktop Virtualization

Desktop virtualization involves separating the physical location where the PC desktop resides from where the user is accessing the PC. A remotely accessed PC is typically either located at home, at the office or in a data center. The user is located elsewhere, perhaps traveling, in a hotel room, at an airport or in a different city. The desktop virtualization approach can be contrasted with a traditional local PC, where the user directly accesses the desktop operating system and all of its peripherals physically (using the local keyboard, mouse and video monitor hardware directly).

When a desktop is virtualized, its keyboard, mouse and video display (among other things) are typically redirected across a network via a desktop remoting protocol (such as RDP, ICA, VNC, etc). The network connection carrying this virtualized desktop information is known as a “desktop access session”.

The data center is the desktop. Wall Street has underappreciated this area because they are focusing more on the growth of server virtualization. This creates an opportunity for the average Joe investor.

It is expected that the desktop virtualization software market should grow from current levels (small usage) to over $1.5 billion by 2011. In the same time-frame, it is also estimated by savvy investors and people in the know, like me, to grow to over 25 million end users, representing only about 6% of the corporate desktop PC installed base.

Any IT organization worth it’s pound of flesh is constantly looking for ways to reduce the cost of maintaining existing IT systems. The corporate desktop sucks more dollars out of a cost structure than IT managers care to put up with. Hardware and software costs typically account for 20%-30% of the total cost of the corporate desktop, with the remaining 70%-80% of the cost consisting of IT maintenance. Desktop virtualization would lower the annual cost of ownership of computing by 40%-50%, versus high-cost workstations. There is also a potential 5%-10% reduction in cost for low-end PCs.

Currently, it appears that desktop virtualization technology has developed to the point where it can be applied to the corporate desktop environment, thus improving performance, increased flexibility, personalization, and reducing operating expenses.

One way to play this area is Citrix Systems (CTXS). Both CTXS and VMW are seeking to leverage dominant positions in each of their core virtualization markets to enter into the desktop virtualization market. However, CTXS appears to be better positioned to capitalize on the opportunity at hand. The reason is based on the breadth and depth of it’s product portfolio, as well as a large installed based of over 70 million end users.

CTXS is the most leveraged play on desktop virtualization. The company will soon release it’s Citrix XenDesktop solution, which has the most feature-rich desktop virtualization software on the market.

I realize that many of you are excited about VMW. This is also a good choice, but not as attractive as CTXS, in my opinion.

Note: If you buy CTXS based on this post, beware that investing involves risk, and you might lose money.

Wells Fargo (WFC)...Future Buy?

Wells Fargo disclosed that it will further tighten its home equity lending standards and record a special fourth quarter 2007 provision of $1.4 bln (pre-tax), largely from certain indirect channels through which it is no longer accepting business. The company will continue to provide home equity financing directly to its customers, but has decided to stop originating or acquiring new home equity loans through certain indirect channels. It's too early to buy the stock, but it deserves to be on the watchlist for signs of improvement or a technical breakout.

Transocean (RIG). Odd, no?

RIG has printed $139.50 this morning.

Yesterday, Fitch downgraded RIG’s senior unsecured bank facility to BBB from BBB+. Yet the stock was up almost 5% with oil down and closed at $135.75. Odd, no?

Maybe it’s because of the trend for the increase in day rates on deepwater drilling projects. Or maybe its because of the merger with Global Santa Fe (GSF), creating a $53 billion revenue generating monsta driller. (Btw, I like GSF because it has “Santa” in it). Or, could it be that RIG has no sub-prime or overly tanned CEO’s?

Like it or not, Green-turds, the world needs oil to run and offshore is a vastly untapped area. However, due to political asshattery in countries like Venezuela, Nigeria, and other third world countries, I would expect most of the offshore drilling to focus off North American and European shores.

FYI… RIG just inked a deal for a 4-month contract at a day rate of $600,000 on their Pathfinder rig to start in June 2009. As I mentioned in a previous PG post, they have a backlog of $33 billion and it is growing. IMO, there will be more of these deals to come as the cost of finding and recovering oil is getting harder and more expensive. Oil will go well over $100 in the coming year.

Note: Under the terms of the merger, RIG shareholders will get $33 cash per share plus 0.6996 share of the new company (”RIG”) for each share they currently own. GSF shareholders will get $22.46 in cash plus 0.4757 share of the new company. The combined company will have 318 million shares outstanding (322 million fully diluted). For tax purposes, the cash distributions will be treated as stock redemptions, meaning that shareholders will treat them as partly return of capital and partly gain or loss on sale.

By the way, insiders have been buying the stock.

Citigroup (C)

A $7.5 billion cash infusion from Abu Dhabi into Citigroup sparked a broad rally on Wall Street today. Although we still have a down/bearish situation, the market could easily move up tomorrow. With that in mind:

Investors should get their shopping lists ready.

Aggressive Investors and Traders should play the market up or down as it develops. Citigroup is a stock to put on for a potential trade

American Eagle Outfitters (AEO)

AEO - American Eagle reported Q3 earnings of $0.45 per share, in-line with the First Call consensus of $0.45; revenues rose 6.9% year/year to $744.4 mln in-line with the company's pre-announcement. Company issues in-line guidance for Q4.

Update: AEO was down $0.15 with the market up 215. Apparently AEO investors didn't take the pic seriously.

American Eagle Outfitters (AEO), $21.77

They report earnings tomorrow before the open. Expect to see $0.45 for the quarter. They have already reported that same store sales were up 2% and revenue up 13% from last year at this time.

Store traffice was good this past weekend. They should earn $.70 for Q4.

Within the next few months, expect them to announce details about their fourth concept and an aggressive share repurchase program.

One of the best values in retail stocks out there. Don't forget that their customer base is the younger crowd who exercise little or no restraint when it comes to buying clothes.
Disclaimer: Investing involves risk. You should be willing to potentially lose some or all of your investment. I am not recommending that you buy this stock. Your situation, objectives and risk tolerance should be considered before purchasing any stock highlighted on this blog.

Euro Overvalued?

Gavekal Capital has come out recently with their view on the Euro. They're thinking that in a couple of years, the Euro could be trading at $1.05 - $1.10. For the most part currency rates are determined by relative rates of return on capital. They cite slower growth, as Europe has an aging population. Also the "Islamic-ization" of Europe could impact the EU negatively. Wealth generation is higher in the U.S., as is productivity, capacity utilization and technological innovation.

Their view on the Euro is not the consensus view, but is noteworthy.

Transocean (RIG), $126.28

Credit Suisse/First Boston has come out with an upgrade on the stock with a target price of $158.

RIG currently has a backlog of over $33 billion and is expected to earn $17.25 in 2010 vs. current estimate of $8.05 for FY:2007. That is a CAGR of over 29% on earnings. The 2008 earnings estimate is $13.75, up from $11.25, and 2009 is $16.75, up from $13.58.

This also is a core holding for many mutual fund managers in the large cap growth area. I bought more shares today.

Disclaimer: Investing involves risk. You should be willing to potentially lose some or all of your investment. I am not recommending that you buy this stock. Your situation, objectives and risk tolerance should be considered before purchasing any stock highlighted on this blog.