December 2011


This post describes the methodology [as far as the signal] and position management on the purely ‘swing’ element of the newsletter methodology.

The signal is a weekly call, not a call that is based purely on price, particularly not the ‘last price’. This way of trading is apt and applicable to ‘daytraders’ but very few to none of everyone else.

Focusing on “Change on Day” is like focusing on the score of any one quarter of a football game(innings in baseball, periods in basketball/hockey/soccer, pick your poison); ridiculous even for a bettor. Yet the default scoring method from quote providers and the media is the distance traveled since 4pm yesterday. I care about price change since a major pivot, over the last 5-10 days, over a rolling quarter. Since yesterday? Not so much. Just like a sporting event, yes, a significant quarter or inning could make the difference in the game but there are better measures that indicate shifts without noting an endless stream of false indications. The default way in which I first receive price data, to me, amplifies the potential for distraction.

The second report will be put out over the weekend. It will be free again this weekend, partly while I get the various bits & bobs sorted out, partly also while I finalise the format, and lastly, just to let everyone have a look.

The ‘numbers’ are toxic. Rarely do you see, except in the biotech’s such risk.

On the ability to create value, measured through a return on equity, the returns have been falling over the 4 yrs of statements to the current [-30.91%] The stock currently is creating no wealth, it is destroying it.

Cashflows are all negative, pushed even further into the red by capital spending requirements. This makes the stock totally dependent on outside financing, either debt, or new equity raising via additional shares, or some other method: grants, subsidies, etc.

This makes the liquidity risk enormous. The chance for bankruptcy is ever present. For all intents and purposes, it is bankrupt, so dependent on additional capital is the operation.

Not included in the numbers is the ‘what if”? What if it actually delivers the product that it is researching/developing? Diagnostics are not as sexy as ‘cures’ or rather treatments. Obviously this won’t necessarily impact revenues, but it may impact the multiple assigned to those earnings.

This is either a home-run, or bankruptcy.

The so called ‘golden cross’ probably works as often as anything else.

Of course, the requisite Ducati

A Kawasaki

Gixer

The MV designed by the chap that originally designed the Ducati

China will withdraw its support for foreign capital in the country’s auto-manufacturing sector in an effort to build up its domestic industry, state media reported late Thursday.

The report from the state-run Xinhua news agency didn’t disclose additional details, and it was unclear whether it would impact existing operations by foreign auto makers. U.S. and European auto makers, including General Motors Co. and Volkswagen AG, and Japanese auto makers like Toyota Motor Corp. and Honda Motor Co. have long produced cars in the country through joint ventures with local partners.

Expect this ‘type’ of sanction to increase into 2012

The last time we heard from Codexis, we took a look at the firm’s financials, which all kept pace with estimates. Codexis offers an interesting business model in that the firm focuses solely on developing custom yeasts and other biocatalysts. Currently Codexis is paying the bills by producing high-dollar petrochemicals for the pharmaceutical industry, but has been actively trying to enter the biofuel market by developing yeasts that break biomass down into sugar as part of a research agreement with Royal Dutch Shell.

That research has paid off in Codexis’ newly announced CodeXyme cellulase enzyme product line. The new enzymes are designed to produce sugar from cheap, local feedstock sources. A cheap sugar supply is key for Codexis, whose other biocatalyst work is focused on producing high-value, sugar-alcohol-based industrial petrochemicals.

It also means a potential new source of revenue for Codexis’ customers. Codexis has a partnership with Raizen, Brazil’s largest sugar producer and a massive ethanol producer. With Codexis’ new enzymes, Raizen will be able to convert leftover biomass from sugar production into ethanol, freeing up more of its sucrose to sell in the sugar market. According to Biofuels Digest, Codexis CEO Alan Shaw has priced the leftover biomass from traditional sugar production at $50 a ton, or as low as $10 in Raizen’s case, which, in his eyes, is like “making gold from dirt.”

This is the one to watch. The technology is just about there. With Congress failing to renew the corn ethanol subsidies, that competition is gone, leaving the door wide open to CDXS and its competitors, which aren’t that many.

With the backing of Royal Dutch Shell, capital is not an issue, nor is the risk of bankruptcy, failure to raise working capital etc. This one is fast reaching its time.

The annual stab at predicting. Always fraught with problems, always fun to try.

You cannot step twice into the same river, for other waters are continually flowing in

Heraclitus, Fragments.

INFLATION:
Inflation through money creation, via the Federal Reserve, will continue unabated. Bernanke has said as much already, and the effects of raising rates in a Presidential cycle, simply will not happen. The real question with inflation is what will the ‘demand for money’ look like, and what effects will it have?

The demand for money will remain high. Credit destruction will ameliorate the credit creation, thus keep the rate of CPI inflation somewhat constrained. CPI inflation will rise, driven largely through oil prices that keep energy costs and transport costs high through the CPI that includes these prices. The smoothed version will show lower increases. The inflation through the PPI however is a different story altogether. Here rising prices will continue to hurt the higher cost producers, which largely are the smaller capitalization stocks and private businesses.

EARNINGS:
S&P500 earnings increased 17% YoY to November 2011. This was due to what? Certainly there will be an inflation gain in there, particularly when you consider the relative weights of the capitalizations that make up the index.

Energy and Healthcare keep increasing their prices due to inflationary pressures created by the Central Banks. With regard to healthcare, these price increases are engendered through subsidy or oligopoly pricing enabled by the government. This type of inflation will continue in any industry that is the recipient of government subsidies.

The takeaway however is that ‘earnings’ will continue to increase in the S&P500 index. Earnings have benefited from the ability of businesses to cut employment. How much fat is left on this bone is debatable, but, increased earnings, in a still lowish inflation environment, could well drive a P/E expansion, which is just another way of saying expect the market [as an index] to rise beyond expectations of the consensus.

Therefore, the stockmarket, the index, will enter a trending volatile period. With sentiment low, decreasing institutional participation, the market will climb the proverbial wall of worry, in part on an improving and inflated earnings growth.

DEFICITS:
Will continue to grow. This obviously is another driver of the inflationary pressure that will continue to exert an influence. Industries that continue to hold government contracts and influence can and will increase their prices to government who are not price sensitive, that is to say they will pay higher prices that could not normally be passed onto the individual without reducing volume units supplied.

We saw one debt ceiling crisis last year, I’m sure Obama, and other candidates, would like to avoid another, their credibility, competence and morality were severely questioned due to the last debacle, in a Presidential cycle, they will want to avoid a repeat performance: thus debt ceiling restrictions will prove no barrier to further expanding the deficits.

BONDS:
Will due to the deficits continue to be sold. Sold to whom? There will be the usual support from the big shops like PIMCO who got badly burned this year on a ‘short’ call on US Treasuries. Various Pension Funds and Insurance Companies, but after that the primary buyer will again be the Federal Reserve, essentially monetizing the debt. As Bernanke is willing and able to create ever increasing fiat money, at least for the moment, interest rates will remain low. They will not be allowed to express a ‘market rate’ which would trigger in very short order another plunge into deep recession. Avoid Bonds like the plague. The returns are virtually nil. They will however provide a tailwind for equities.

PRESIDENTIAL CYCLE:

Year 1: The Post-Election Year
The first year of a presidency is characterized by relatively weak performance in the stock market. Of the four years in a presidential cycle, the first-year performance of the stock market, on average, is the worst.

Year 2: The Midterm Election Year
The second year, although better than the first, is also is noted for below-average performance. Bear market bottoms occur in the second year more often than in any other year. The “Stock Traders Almanac” (2005), by Jeffrey A. and Yale Hirsch, Hirsch notes that “wars, recessions and bear markets tend to start or occur in the first half of the term.”

Year 3: The Pre-Presidential Election Year
The third year or the year preceding the election year is the strongest on average of the four years.

Year 4: The Election Year
In the fourth year of the presidential term and the election year, the stock market’s performance tends to be above average.

In his study “Presidential Election and Stock Market Cycles,” Marshall Nickels of Pepperdine University analyzed stock market bottoms in relation to the presidential cycle. In the period from 1942 to 2006, there were 16 presidential terms and 16 market lows corresponding to those terms.

Three of the lows occurred in the first year of the presidential term, 12 in year two, one in year three and none in year four. Of the 16 bottoms, 15 occurred in the first half of the term and only one in the second half of the term.

2012 is a Presidential election year. The election will take place in November. It is another one of those seasonal trends that stockmarkets love. The underpinning economic theory however is one of loose monetary and fiscal policy. We already have that, we may get increased inflationary stimulus, we most certainly won’t get less.

The winner? Romney. Obama will join the other ‘loser’ 1 term Presidents.

HEALTHCARE:
Demographics are not the only driver of rising health care costs in the U.S. When passed in March 2010, the Patient Protection and Affordable Care Act—popularly called “Obamacare”—was intended to lower spending on medical care over time. The question is: would it?

After months of debate, several lawsuits, and multiple competing federal court rulings, the Affordable Care Act will have its day in court. That day will determine the nature of freedom in America. the US Supreme Court agreed to examine the constitutionality of the health-care law sometimes known as Obamacare. The main question is its “individual mandate,” specifically whether the federal government has constitutional authority to require citizens to purchase health insurance. For that justification, supporters have looked to the Commerce Clause in the Constitution, which gives Congress the power “to regulate commerce with foreign nations, and among the several states, and with the Indian tribes.”

But for the Commerce Clause to provide sufficient authority to the federal government to mandate that everyone buy health insurance, choosing not to buy health insurance has to be regarded as “activity.” Thus, under the Constitution, and the Commerce Clause, is this possible or likely?

If the Supreme Court does not clarify the question of whether the Commerce Clause applies to inactivity, the individual mandate in the Affordable Care Act may become the precedent upon which future activists justify even further expansion of government power.

The Supreme Court has in its history widened, and narrowed the definition of ‘commerce’. The case that may pertain in this instance took place in the Lochner era of 1905 to 1937. Here the Supreme Court decision struck down a law that limited the number of permissible hours of working in bakeries. The majority of the Court held that the state law [New York] violated the freedom of contract. That the freedom of contract was an integral part of the liberty provided under the 14′th Amendment protecting the due process clause.

I think therefore that the abomination that is Obamacare, will in possibility be struck down by the Supreme Court. US medical costs are seriously out of control.

The thing with Obamacare is this: the law has not been in effect long enough for the effects to be seen. The medical costs have been rising for different reasons. They rise mostly due to the influence the large pharmaceutical companies have upon government. So while the repeal of Obamacare is a good thing from the point of view for the Constitution, it will have little or no effect on medical inflation. For serious inroads here, a game changing innovation is required, possibly from gene therapy.

Healthcare costs will continue to drive medical inflation, and hence earnings. Earnings that will contribute to the aggregate earnings of the S&P500, as will the energy sector.

UNEMPLOYMENT:
Unemployment is a lagging indicator. It lags at the turns. As a stockmarket indicator, not too much attention should be allocated. The economic policies that are required to improve employment are however an issue for employment. The cost of employment at the margin, or the ‘discounted marginal value product’ [DMVP] of employment is the variable that creates or destroys jobs.

Unemployment was also driven by businesses cutting jobs to maintain profitability. How much further this could run is questionable. If there is more fat on the bone, unemployment could well rise as ‘costs’ cannot be passed forward to the consumer. This would suggest that the consumer goods stocks might come under some pressure to cut employment to maintain profitability. Consumers do not have much, if any slack, for increasing discretionary consumption: rising energy costs will further erode purchasing power. As utilities operate more or less as small local monopolies, these costs can be passed forward to a degree.

EUROPE:
Remains a mess. It however limps forward under a mixture of austerity and inflation. This mixed policy bag cannot be good for the majority, and even Germany will feel the effects. The effect, relatively speaking, is a positive for the US.

CURRENCY DEVALUATIONS
With all trying via currency devaluation to capture exports, something has to give: all cannot devalue at the same time. The result will be an increasing atmosphere of tariffs and protectionism, which inevitably raises international tensions, which under the law of monopoly increases the actual number of wars.

WAR:
That the US finally pulled out of Iraq, the question is for how long can they avoid becoming embroiled in yet another war? Already Iran is claiming, due to trade sanctions, to seek control of the oil transport water lanes. The sanctions were put in place due to Iran seeking nuclear weapons. Israel is particularly aggressive in this geographical region, and has strong influence on US foreign policy, which remains Imperialistic. Therefore while the US has ended one war, they will soon be embroiled in another. The Welfare-Warfare-State cannot have it any other way. Again, either US military based stocks and/or major energy producers.

ENERGY:
Oil prices will continue to rise on the back of world-wide inflation. To such an extent that many economies will not be able to afford the prices. Coal will make a comeback, certainly in Chinese consumption of energy needs. In the absence of any real viable alternatives, coal consumption and production will pick-up. The ETF KOL [which I hold] will likely see some price appreciation and provide some diversification via holdings of Chinese coal producers.

GOLD:
Is the ‘bull’ run in gold over? I really don’t know. Gold and Silver tend to appreciate in value under conditions of uncertainty and inflation. We’ll have inflation, we’ll have uncertainty, but I’m not sure that we’ll see gold gaining new highs, at least not immediately. To me gold looks to be heading towards $1300.00oz. At this area, or even a little lower, then, possibly, the gold bull might resume. If gold is your thing, then avoid gold mining stocks, which are just destructive of value, stay with the actual metal itself.

BLACK SWANS:
Will be white. The biggest shock to investors will be the rise in the market, against all expectations, against the news-flow, against the direst of predictions.

SUMMARY:
You want to be in the market, against all better judgments. The two markets that are viable are the market for common stocks, and the commodities markets.

I predict I will lose a great deal of money in DECK today, thanks to seemingly warm weather.

Apparently, we’ve all become Barney Rubbles, walking barefoot throughout the wilderness. The stock is down another $4.5 on no news.

It’s not that flippe-floppe-flye buys or recommends stocks that underperform, it’s that he has absolutely no idea or plan on how to manage the trade.

But, the bull, when he arrives, will again be a monster.

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