April 2008


I haven’t had a technical Goldman update for a little while, so here we are;

GS has been in a pretty sharp uptrend, and I believe this uptrend is safe for the near future. Corrections have been just recently through time, rather than price. Therefore we may well see further upside over the next couple of days.

Should GS rollover, plenty of warning should be given, with the opportunity to position short. This possibility, driven by the 200MA, is of course on a technical basis valid. What then remains to be seen is how price interacts with the 50MA

It would seem, unfortunately that the solution to one problem, that of returning vital nutrients to the soil [nitrogen] via fertlizer, creates another problem. In this case, the growth of algae that threaten the ocean eco-systems.

China and India are massive users. China already has an environmental crisis through various forms of pollution. It would seem that by creating the soil damage via pollution, they need to create further environmental damage to offset the former.

Inflation is the driver of both Equity and Bond yields. As inflation rises, so must the respective yields to compensate the loss of purchasing power.

Equity valuations are complicated by the fact that their coupons [dividends] are not fixed, and second, that their capital appreciation is in theory unlimited. Hence, we will in individual common stocks at almost all times, and within the index under rare occasions, decouple from the inflation anchor.

Start…………..End……………Duration……………Unemployment/Rate…………..Change/GDP
8/1929………..3/1933………….43………………………..24.9%……………………….[-28%]
4/1960………..2/1961………….10………………………..6.7%…………………………+2.3%
12/1969………11/1970………..11…………………………5.9%…………………………+0.1%
11/1973………3/1975………….16………………………..8.5%………………………….+1.1%
1/1980……….11/1982…………6………………………….7.6%…………………………[-0.3%]
6/1981……….11/1982………..16…………………………9.7%…………………………[-2.1%]
6/1990……….3/1991………….8………………………….7.5%…………………………[-0.9%]
3/2001……….11/2001………..8………………………….6.0%…………………………..+0.5%

The duration, and contraction of a recession is very much dependant upon the level of unemployment, which is due to consumer spending contributing some 70% of GDP. Thus, to get an idea of how deep the recession may be, examining unemployment will shed light on the subject.

Typically recessions originate within a “shock”…unexpected bad events, the prototypical Black Swan event that then morphs into the economy. We have had in the past, oil crisis, terrorist attacks, natural disasters etc.

The shock, that has triggered this recession will most likely be attributed to housing, sub-prime, and financial system melt-down.

The duration, depth and damage that a recession can cause are all tied to the ability of prices to adjust. If prices can adjust quickly, the recession will be shallow, if they cannot adjust, or adjust very slowly, the recession picks up momentum.

This is why stockmarkets tend to lead the economy, both up….and down. The pricing mechanism in financial markets is very transparent, the liquidity generally, is high, thus prices can, and do adjust very quickly.

House prices, by comparison, are less transparent, less liquid, and adjust by comparison, very slowly. Having said that, housing prices are adjusting very quickly to the downside. While people are certainly not happy about this, particularly if they purchased near the top, as far as housing remaining a recessionary driver, this is a very positive outcome that will shorten the recession.

Employment has very sticky prices, which is why unemployment becomes such a factor. Businesses that experience falling demand for product inventory, will, to sell the inventory, drop prices. Future inventory, to remain profitable, must cost less to produce. Cost of Goods, the line entry on Financial Statements accounts for usually some 70% of costs, much of this falls under wages.

Will workers accept pay cuts?

No, they tend not to…thus, rather than cutting wages, management cut workers, thus unemployment increases.

The second factor that affects product pricing are the inputs, raw materials. Currently, these are suffering high inflation, oil, foodstuffs, etc. Thus, again, to make a profit, producers cannot drop prices below their costs, due to high commodity costs.

Therefore, due to the stickyness of commodity prices, unemployment must rise, to allow inventory prices to fall. This outcome will be politically unpopular, and unacceptable, thus, once the financial crisis within the banks has been solved, which is underway, the next order of business will be once again to tackle inflation.

Commodities are responding to the below natural rate, interest rates, lowered due to the “shock” applied to the financial system. Only when rates again return to the natural rate, or slightly above, will we see a return to supply/demand equilibrium within the commodity markets.

With todays FOMC meeting, I suspect the reduction in rates will end, and signals will be sent that the future direction of rates will be upwards…thus we can expect in that scenario, sector rotations that will reflect the price of money.

This will need to be done carefully, as rising rates, will trigger a sell-off in the Bond market, as investors close out profitable positions. This sell-off will raise yields, making by comparison, stockmarket yields less attractive.

Thus, the Fed will need to maintain a delicate balance, as falling equity prices could re-threaten the banks and their capital ratio’s [again] if there is a particularly violent sell-off in equity markets. Volatility is not going to disappear just yet.

I’ve been looking at some of the auto-makers, General Motors, Ford, Toyota for a possible position, as the economy comes out of recession, but the fundamentals are pretty scary.

Auto dealerships, in particular, upper-end car dealerships. This particular stock, might have potential, in addition, it sports a 5.6% dividend.

VALUATION MEASURES

Market Cap (intraday)5: 552.67M
Enterprise Value (30-Apr-08)3: 1.66B
Trailing P/E (ttm, intraday): 9.35
Forward P/E (fye 31-Dec-09) 1: 8.32
PEG Ratio (5 yr expected): 0.98
Price/Sales (ttm): 0.10
Price/Book (mrq): 0.92
Enterprise Value/Revenue (ttm)3: 0.30
Enterprise Value/EBITDA (ttm)3: 7.919

From Brett Steenbarger;

A deadly pattern among some of the best traders is to channel achievement motivation into trading *more*.

The best traders do have a strong achievement motivation and work quite hard at their craft. That achievement drive makes them hate losing. Their impulse is to go for the jugular; they want to not only achieve, but achieve *more*.

This drive can be a trader’s greatest weakness, however. It can lead to stubborness in taking losses, leading to outsized losses. It can also lead to overtrading, as the driven trader attempts to *make* things happen. That is a particular recipe for disaster on slow, narrow days such as yesterday, when it’s easy to get chopped up jumping aboard seeming trending moves.

The net result is that *pressing* to achieve can take the trader out of his or her game. It subverts risk management by leading the trader to trade too large, without careful attention to stop loss points. It also interferes with decision-making by leading the trader to take trades without an objective edge.

A good analogy is the fighter who goes for the knockout on every punch, leaving himself wide open to jabs and punches from the opponent. When the boxer is *too* aggressive, defensive skills go out the window. So it is with the trader.

Another analogy is the soldier in the battlefield. Too hyped up and too aggressive, he may charge out of his foxhole and make himself an easy target for the enemy. Sometimes the best strategy is to maintain control and pick off the enemy sniper-style.

How can you know if this is a problem for you? If you keep metrics of your trading results, you’ll see that the average size of your losing trades exceeds the average size of the winners. You’ll see that your biggest losing days are ones in which you trade most often and with largest size, particularly when the market was showing no special opportunity. You’ll also know by your state of mind: traders who *press* to win typically experience high degrees of frustration when the profits don’t come quickly.

If these are concerns for you, self-control strategies such as meditation and biofeedback can be tremendously helpful. How to use such strategies will be the focus of my next post.

Since the St. Patrick’s Day inflection point, spreads on high yield corporate bonds are down over 20% from their high of 862 basis points (bps) versus US Treasuries (based on the Merrill Lynch Index of high yield debt). As long as spreads can continue to come in, the environment for equities should remain positive, but at a level of 685 bps, spreads remain over 180% off their lows last June

The spread twixt Treasury paper and Corporate paper, while on one hand a barometre of the risk the market is willing to assume, also has implications for corporate treasuries that need to raise financing. When the credit crisis was at it’s worst, even solvent corporations were potentially in trouble, should they have required finance for working capital.

Thus, with the easing, the outlook for equities [possibly excluding financial stocks, who might find capital ratio’s under threat again], at least from default and solvency issues, is definitely on the mend, which was the purpose of the emergency measures put in place by the Fed.

I am actually in the camp of “no cuts” with a signal of interest rate hikes in the future. Here is a supporting opinion;

In what may be the last great act of his presidency, George Bush is sending many Americans tax rebates. The checks began going out this week. Some households may get as much as $1,200.

What is not clear is how many citizens will go out and buy a new washer-dryer set and how many will simply stuff the money into their mattresses. One would cause inflation, while the other would only serve to hoard money as many families are beginning to hoard food.

The Fed has several reasons not to cut rates again.

First among those may be that inflation is rising much faster than government figures would show, at least for the goods and services that count most. Gas will probably hit $4 this summer. A bagel could cost $10. The price of corn is up 23% this year.

The governors at the central bank have also become concerned, quite rightly, that banks are passing none of the Fed’s cuts on to consumers or businesses. Mortgages are only given to the most credit-worthy. Financial institution would rather keep cheap money to help build reserves against the next set of write-downs which are likely to come in Q2. Many soothsayers claim that banks are out of the woods. Their stock prices and the worsening housing crisis would portend otherwise.

The cost of money for the man in the street is high and may go higher.

There are almost no reasons for the Fed to cut rates again now and plenty of reasons for it to stand pat. If Bush and Congress are right, they have done something to stimulate the economy. Doing two things at once as the price of everything from Cheerios to bug spray is going up does not increase the chance of inflation.

Inflation is already here. Fighting it has become the new priority

Douglas A. McIntyre

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