Thursday, January 3, 2008

Morning Note...

From: Ben Batory
Sent: Thursday, January 03, 2008 9:07 AM
To: !Rockbay
Subject: Thurs Mkts + Good Read as Intro to 2008...

Futures up slightly on some decent jobs data, which comes as a welcome relief after yesterday’s focus on oil, commodities, slowing economic growth, and inflation.   ADP December private payroll report came in with an increase of 40,000 jobs.  Further, initial jobless claims fell 21,000 to 336,000 last week.  

Iowa caucus tonight kicks off the election season… Latest markets indicate Obama at 65% chance to win, followed by Hillary at 33%. On Republican side, Huckabee at 60% and Romney at 36%.  Intrade is particularly accurate with political elections.

IM upgraded at GSCO.  BTU downgraded at MLCO. URI upgraded at UBS.

Oil continues to push $100/barrel.  If it sustains $100, stops could be elected and high level of option activity is expected.

Also worth noting that a CNBC reporter – last night around 6pm on Fast Money – announced he had leaked information that MLCO would be announcing another $10B write-down in the near term.  

Announced Deals

Rockbay News: UBS maintains Buy rating and $81 tgt on NAVZ, DAI GY (as DaimlerChrysler) paid $30M in 2007 for violating govt fuel efficiency standards, dR reports PHH unable to find another suitor, QVT ups GCO stake to 10.3%, CITI cautious on SLM and cuts tgt to $21, BofA reiterates Buy rating for CVS ahead of Q4 results, CVS sss +1.8%,

Vito’s Trivia:  The answer to 111,111,111 x 111,111,111 is an interesting number.  Any guesses, without using a calculator?

Yesterday’s Answer:  We are currently at 5 minutes to Midnight on the Doomsday Clock…

BONUS – attached letter is a good intro to 2008…

Arlington econometrics -- January 1, 2008
Scotty C. George -- Senior Managing Director
Who’ll Stop The Rain?
Even the most successful hot streaks are due an inevitable rest. Thus, because of an extended bull market phase, the markets are showing signs of directionless fatigue.
Compared with years past, last year was the least successful for finding global opportunity and earnings accelerators. In fact, commodities price push erased nearly one half of one percent from global output. The data clearly shows, even if analysts are loathe to accept, that inflation in core costs, goods and services, and currency imbalances are beginning to show an impact upon spending patterns.
As inflation creeps, the impact upon industrial research and development, discretionary spending, food, healthcare, and fiscal policy resonates even stronger. Consumers are not keeping pace with the stealth tax effect of diminished spending power.
In turn, the financial markets are affected in two ways. Obviously, the first effect of cost creep is the viability of earnings power. Given that market timing and asset allocation are determined, in part, by profit potential, the diminution of earnings velocity adversely effects the momentum of stocks as well as the breadth of equities participating in such growth. But the second, and more complex to evaluate, factor which limits equity acceleration is the psychological impact of feeling “poorer”, of not feeling as if one is keeping pace with savings and capital gains expectations. In all facets of life, failure to meet one’s expectations for performance can be a serious obstacle to overcome, even if the perceptions are misguided.
Real or not, the perceptions which overlay today’s trading landscape are nefariously doing more harm than good.
In my opening commentary last year (Jan. 1, 2007) and throughout the balance of the year, I warned against the devolution of trends that many perceived as immutable strengths. For example, in addition to my early warnings about pricing pressure, I warned against the insidious valuation explosion in stocks and real estate, that was leverage (margin) inspired and built upon unsustainable hyperbole. The most obvious threat to capital gains expansion is always the manic velocity of the latter-stages of a secular bull cycle. Sure enough, just as a generation of enthusiasts discovered a decade ago, foolishness coupled with leverage can bring a trend to a screeching halt. This time, the erosion of fundamentals, and the discarding of prudent portfolio methodology brought down the real estate markets and took stocks (as well as most financial instruments) down with it.
One difference between this decade’s collapse and last, however, is that more “grey-hairs” got caught in this downdraft. Unlike the twenty year old “nerds and geeks” who postulated that the technological new paradigm was for real (in 1997), this latest mess was built upon the na├»vete and gullibility of pre-retirees and the nouveau-riche who had always thought that real estate was a “lay-up” investment. Many failed to remember the 1980’s, during which real estate values declined, causing similar pain.
The guilty also includes grey-hair culprits from the boardrooms of the globe’s financial services megaliths. Getting fat and wealthy off the backs of the uninformed is nothing new for Wall Street. This time, though, the composition of synthetically engineered products, highly leveraged and highly speculative, was too intricate even for the insiders. The golden goose was slain by its owners.
I also find fault with the custodians of fiscal and monetary policy. Politicians spent the previous decade with their eye on globalism, succeeding in principle to turn the global economy into a reality. However, at the risk of leveling the playing field, some of the “have-nots” became too emboldened, demanding their fair share at the table. In the process, equal access to capital eradicated territorial rights and borders, diminishing the impact of the superpowers.
Stewards of global monetary policy have been easing credit for years, setting the stage for ineffectual lending and the crisis which now surrounds us. Rather than anticipating third world demand, bankers found themselves responding to natural disasters, cyclical boom cycles, and legendary ego-driven capital expansion. Despite specific lessons of history, decentralized money supply accentuated the ideology of risk-based lending. Cheap money exacerbated the problem. To their credit, the French recently announced that they are going to forego micromanaging the spending/credit crisis and remain focused upon curbing the long term inflation impact of core cost price increases. We must respond to the crisis, yet our bankers are doing a very poor job sorting through the bubble’s collapse.
Caught, as we are, in the midst of this downdraft, the application of methodology becomes the most crucial element of achieving investment success going forward. I still believe that pockets of earnings acceleration exist. However, my recent findings conclude that the number of global equities which qualify using this primary screening process is diminishing, the numbers of sectors to be included is narrowing, and the cause of earnings expansion lies more in pricing power than unit volume growth.
Applying specific criteria to equity analysis should also require a discussion of humanistic factors. Quantitative analysts, like me for example, are usually mathematicians or engineers who apply strict scientific analysis to our data. We must also learn to think beyond the science and add theories of psychology and the humanities to our physics.
An advantage of scientific analysis is its objectivity. By filling volumes with strict review and processes we create efficient patterns of execution. We are able to identify and measure technical and numerical imbalances in the markets, and to provide strategies and solutions at a faster, more determined, pace.
On the other hand, the disadvantage of our science is the quantification of impact these imbalances might yield to the end-user, the client. Therefore, it is not uncommon to see negative history repeat itself as each generation of “nouveau-tycoon” feels that they are different this time, and somehow immune from the fatal flaws of ego, greed, and hyperbole.
In this coming year the markets need somehow to recalibrate, as if the excesses and pain never happened, to create an equilibrium starting point from which to render a new ideology about risk and reward, just as a golfer “shakes off” a bogey and proceeds to the next tee. Banks need to reconstitute their lending practices to avoid the expansion of credit risk. Similarly, global monetary boards must adjust their perspective from growth to inflation, and worry about the devastating effect of the depletion of natural resources upon the planet.
Into the first part of this year, I believe we will see an overhang of the downtrends that started last summer in the world’s financial markets. Obviously, the workout is quite complex. Its effects will resonate upon the rich, the poor, east and west.
Higher inflation and interest rates are unwitting cousins in the next decade. Emergence of global pockets of industrial, scientific, and economic strength can be the surprise player of next season. The gestation period for a new globalization is unknown. We do know, however, that fiscal policy as well as cultural influences will play the most significant impact upon the flow of capital and the profit potential for regional equities. Whomever demonstrates the qualities of building for the future will attract the most capital and the most political goodwill. In particular, the United States has a unique burden to rebuild a moribund moral dynasty that could be capable of sustaining a new humanism as a beacon for capital, talent, and expectations.
The markets can sense fear as surely as one fighter can sense the weakness of his competitor. Unfortunately, the markets don’t perform well in a negative vacuum. They stop lending, speculating and improving when there is no optimism. The bigger problems overwhelm everything during a psychological retreat.
My clients will note that our cash levels grew from the beginning of the year to the year-end, as we secured profits and rebalanced into strong leadership sectors. Performance on accounts was, in most cases, higher than the benchmark S&P, with significantly fewer dollars allocated to equity ownership in our models. Therefore our story this year is that we “did more with less: less risk, less equity exposure”.
My work indicates that opportunities exist for markets to accelerate in agriculture, energy and health issues, but with the imperative for leaders of the political and capital markets to coalesce to create policies whose effect is to promote the quality of life.
Indeed, in the short term, we must acknowledge slowdowns in wages, jobs creation, and earnings acceleration. But fear is not an option. Not every stock will struggle in 2008 nor will the economy “fail”. As with all cyclic phenomena, bottoms will become staging areas for an acceleration into new tops. Look for capital gains potential in agriculture, healthcare, energy, industrials, and internet technologies. Keep your cash handy because liquidity, not leverage, will prove to be the factor that jump starts the next upward cycle in the financial markets later in the year.
Asset Allocation:
Equity 38%/Fixed Income 30%/Cash 32%

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