Sunday, December 27, 2009

Sunday Thinking

* A year ago when I started this blog, I commented on the insanely low long-term bond yields. The 30-year was at 2.6% or something, and now it is at 4.7%. Whether this is the bond vigilantes or the market simply frontrunning the expected maturity extension in the government's borrowing remains to be seen. I think this time is "for real" barring a major equity crash or an event with a similar impact. In 1981, the 30-year yield was (had been?) over 15%. We are in a worse shape now as 29 years of kicking the can down the road, growing spending and debt at unsustainable levels, and handing out unfunded promises make the matters much worse.

* Here's something else that makes no sense: California housing prices rose on a YoY basis by 6%, and there is anecdotal info that the flippers are back. California is like Greece, but the Greeks smelled the coffee while the Governator is asking for a bailout from the taxpayer. Who's the "girlie man," Arnold? California has outmigration of taxpayers and businesses, powerful public employee unions, a large underclass, highly business-unfriendly climate and dysfunctional politics. Official unemployment in the state is over 12%, and yet, housing prices- which never went down to proper income-based levels, are going up.

*2008-2009 were the years of the corporate bailouts (when the government decided that failure is not an integral part of capitalism), 2010 will be the year of the state bailout. CA is already asking the other states to fund its deficits, can NY, IL and MI be far behind? Newsflash for the states: if you can't cover your spending with taxes, then increase taxes or reduce spending. Surprisingly for me, NY's Gov. Patterson here has been a breath of fresh air coming from the Albany cesspool. He sounds like he gets it unlike most pols who still think it is politics as usual. The simple truth is that the government costs too much to run.

* I already wrote that one should be aware not only of the news as it comes out, but also the context of the news, such as the date and time the news was released. I pointed out that the House voted on the healthcare legislation on a Saturday at 11 pm, and interpreted it as a bad sign. The Senate voted on their version in the early morning on Christmas Eve. This, along with the partisan nature of the vote and the incremental cost of the last vote (the NE senator), is bad news. The other news that came out in the afternoon is that the Fannie and Freddie bailouts are now unlimited. This is correct: unlimited. And instead of having the past board and management of the companies in jail, and keeping the current management on an $1 salary while they wind down the portfolio, Little Tim is giving them $6 mm of your money.

* One can only speculate as to why the FNM and FRE news was released on a holiday afternoon. My thoughts are that they will be forced to grow again (which means credit losses) as the FHA is about to blow up. Because the bank bailout via housing market inflation sure ain't gonna get done by itself. But this is just me, a cynical guy sipping his coffee at home with the keyboard on my lap.

* In June, I declared that POTUS is a failure. By now BHO completely "owns" Iraq, Afghanistan, the economy, the twin deficits, Bernanke, Geithner and healthcare "reform". He has failed on the first six, and is about to fail on the last one.

* Keeping up with the political streak, if I were running against an incumbent in 2010, I would run on repealing most legislative initiatives (passed or proposed) by Pelosi, Reid and the like. Few incumbents are safe, and I am looking forward to possibly having more reasonable, thinking people in both chambers.

* Is the US going to "emerge stronger" the way "we've always done it"? In a word, no. To qualify, very likely "no." I recommend reviewing Taleb's story of the turkey (figure 1 in the essay). The "growth" has been funded by debt just like the turkey's weight gain has been funded by the farmer. The turkey is happy because, see, every day things move up. The farmer has other things in mind, of course.

So how likely is that the debt gets called one day? I don't know. If I knew, I would not be writing about it. Some of the signs will be rapid currency debasement (vs. hard assets) and rapidly rising interest rates on government bonds.

Speaking of turkeys, here is a nice clip of Idiocracy's poster girl, Sarah Palin, trying to use multisyllable words while some guy is beheading turkeys in the background.

Tuesday, December 22, 2009

Comments on Some News from Today

One of the topics I discuss on this blog is what I view as a permanent shift in US consumer preferences towards value/private label. There are several reasons for it, global wage arbitrage suppressing the living standards over the last 20-30 years, more recently, high unemployment, retailer consolidations, and others.

I have written about the private label growth in food several times: most recently here (discussing the top growing categories, BrandWeek declaring '09 the year of the private label and CVS consolidating its battery offering to PL and 1 brand), earlier here, (amazing expansion of the PL offerings at a number of retailers; very wide consumer acceptance) and, earliest here (some firm names and initial thoughts).

Nice to see that at least one branded food company does not have its head in the sand. Heinz (NYSE: HNZ) seems to be with the program. Here are some excerpts:

"[HNZ] sees a long-lasting consumer shift to thrift and must carefully balance its business strategy in response, the ketchup maker's chief executive said on Monday...Heinz Chairman and CEO William Johnson told Reuters in an interview the company will have to weigh its approach to promotional trade spending, such as coupons, and other types of marketing as consumers continue to focus on price even as the economy in the United States and Europe improves.

"To say that consumers will return to historic norms is disingenuous," he said...

"What we're seeing right now is an industry that in some cases is grasping for volume and, as a result, has ramped up trade spending," he said.

But Johnson said the maker of Heinz ketchup, Ore-Ida potatoes and Smart Ones frozen meals would not keep resorting to that one strategy to keep sales aloft."

So, to translate in English: we have a problem. We have been selling undifferentiated products at higher prices thinking we are protected by the brands we have. We were wrong. We are getting killed by private label. Since we have huge fixed costs, some in the industry have been lowering prices to keep the volumes. We have been doing the same thing but would like to signal to the industry that we think that it is time we stop, and come up with something else. We just don't know what yet but will signal once we figure it out. HNZ is not in the worst shape, in my view, from the food majors. No one else can make ketchup of the same taste, and (as far as I know) with the same margins. They also have a good variety of higher value add products.


Today two of my favorite staples companies were involved in deals today.

One, TreeHouse Foods (NYSE: THS) is acquiring a major player in private label hot cereal and drink mixes called Sturm Foods. I already complimented heavily TreeHouse's management in the articles above, and this deal is supportive of my viewpoint: accretive to EPS in less than a year! The market definitely liked it, and the stock was up 15-16% (mind you, this is a sleepy staple stock) following the deal announcement and increased guidance on top. Not a bad way to start Christmas week.

Two, Chattem (CHTT), a major player in OTC remedies and personal care products with a "drug" twist, is being acquired by Sanofi, a pharma major. CHTT has been a top performer in the staples area (the stock was at $3 in 2000, the deal is at $93.50/share). I already wrote in the last post that I see the possibility of a substantial drop-off in new blockbuster prescription drugs in the future. On the other hand, with healthcare becoming a worse mess by the day, one can see the argument for growth in self-medication (webMD is a pretty high traffic portal: it can't just be hypochondriacs, right?). It seems to me that Sanofi- again, a pharma major- is voting my way by acquiring CHTT and expanding their consumer OTC portfolio. If they were seeing a better future in R&D, they'd be spending that $2 bn someplace else. Though I wonder what the Parisiens think of Chattanooga, TN: "the birthplace of the tow truck, Chattanooga is the home of the International Towing and Recovery Hall of Fame and Museum" (from Wikipedia).

Friday, December 11, 2009

Thoughts on What Can Go Right Long-term

Most of this blog is about what can go wrong. Upsides generally take care of themselves. After spending some time on the bike this morning, the windchill got to me, so, quite uncharacteristically, I started thinking about what can go right long-term.

There will be big things that go right, for sure. I just don't know what they are so I can speculate: this blog is free to read which should give you a reasonable estimate of my ideas' real worth.

Things that will go right, almost by definition, are ones that are going to happen without requirements, directives, management or supervision by the government. Think about things like digital music, digital books, e-commerce, social networking, software, "brute" computing power or mobile communications: on average, great advancements that have succeeded in a large part because they are not heavily regulated, or regulated at all. The FTC does not require Intel to make faster chips. The market does. The competition does.

At a different level, Kuwait and Mali happen to be desert countries, and yet one is many times richer than the other (~35x on a GDP/capita PPP basis). Did it have anything to do with either government? Largely, no.

So, with that in mind, what are things that can go right?

(1) Shale gas is more commercially viable than previously thought. Gas replaces gasoline and diesel for fleet needs (similar to "The Pickens Plan"). This lowers petroleum prices for everyone else, resulting in a big tax cut effect. Compare this to government-hatched initiatives, such as ethanol or "clean" coal. Both are absolute malinvestments.

(2) Baby boomers do not retire as planned. The "not exactly greatest"(TM) generation does not exit the work force en masse for various reasons, including insufficient savings and fear of/actual inflation that makes it harder to live on fixed income. Higher middle class taxation also hinders savings. As the biggest chunk of the government obligations are future benefits, this works very well towards reduction as less people are eligible and more people continue to pay taxes.

(3) Baby boomers do downsize en masse, lowering housing costs for everyone (and shooting themselves in the foot, thus delaying the mass retirement even further). This is also a "tax cut" effect. Imagine the average household going from 33% of spending on housing to 27%.

(4) In many ways, "we" have already killed the pharma industry. As they reduce R&D spend, the drug pipeline dries up. This means that in a few years, all these expensive blockbuster drugs will become generics, and there won't be new expensive blockbuster drugs. While this is undesirable at one level, at another level, this should lower healthcare costs as say 90% of the drugs consumed are now priced as generics vs. a substantially lower percentage now.

(5) The population actually loses weight on average and smokes less on average, again lowering health care costs. Smoking rates, save for last year, have been on the decline for most of the decade. This is good news for healthcare costs (yes, I know there are estimates that smokers are "beneficial" in aggregate for tax purposes; I do not buy the argument for a few reasons). The obesity "epidemic" can also take care of itself: I have been reading reports that there has been an uptick in liposuctions as the job market has gotten more competitive. Is this a permanent change in the average views on obesity? I hope so.
Interestingly, the two states with a soda tax (W Va and Arkansas) also happen to have some of the highest obesity rates.

(6) Inflation lowers the real cost of government employees and retirees. Underreported inflation over a decade gradually lowers the real cost of government payrolls, and more importantly, the "guaranteed" pensions. Generally, private businesses can respond faster to inflationary pressures that the government can. Private businesses also have a better view on the "real" inflation as they have incentives to monitor their costs. Government managers have incentives to maximize their budgets and employees under supervision.

(7) EU, China and India gradually assume more "world policemen" roles. This lowers US defense spending thus alleviating the deficit. Defense is by far the largest expenditure in the federal budget, and the Ministry of War does a great job at ensuring that cash keeps flowing to it and its top management's future employers, the military industrial complex.

(8) "College education" stops being universally accepted as something of value to everyone, especially with costs going up, which makes the basic cost/benefit analysis more difficult. A reduction in the college-bound population leads to lower educational costs for everyone college-bound, less malinvestment by people who'd be better of not even trying, and less losses borne by the taxpayer on the student loan guarantees by the government.

As you can see, most of these require little to no action on the part of the government and require little to no inventions. These things can "just happen" without any scientific advancements or "public policy decisions", and nearly everyone would be better off.

Monday, December 7, 2009

Follow-up on Last Post (Trading Thoughts and Personality Brands)

This is too long to be a regular update to my last post, so it gets to be on its own.

Quick trade update on the ETF convergence that I described. It would have worked. The long GDX opened at $49.39, or a 2.56% drop. The short GDXJ opened at $26.25, or a 3.28% drop. In other words, as suggested, the long did better than the short. This was still true at 9:45 which was the last time I looked at it. Obviously, one needs to have pretty low transaction costs (this is 2 round-trips) and exceptional execution to win at this. One might also recommend doing it only with other people's money.

Another risk factor that came to mind about this trade is that since I do not know the exact composition of either ETF, the juniors might be more heavily weighted towards Canadian companies, which introduces a cross-currency dynamic.

On to the personality brands discussion.

One, I stated that I think the famous golf brand that has been in the news is safe. I retract this statement as more news of the less-flattering variety have emerged over the weekend. This has become the perfect illustration of one of my favorite theories in finance, the cockroach theory. There is always more than one (problem).

Two, this would make an excellent business school case. There are a lot of multi-disciplinary tracks that our "future business leaders" can discuss smugly. Marketing/branding is one. Then there is PR, media and entertainment angle: what kind of a story can sell more copies? The legal aspect: prenup with earn-outs, contracts with pay-outs, high-powered fixers.

I am just surprised that such prominent ambulance chasers like Jesse Jackson and Al Sharpton are not all over this, like they were around that white-gloved entertainer's funeral. The latter activist would be perfect to "define down deviance": he is quoted as telling the kids of the dead entertainer "wasn't nothing strange about your daddy." May be the brand tried to be post-racial just like the current presidential brand.

There is just too much money bet on this horse to let things be.

Three, let's look at payouts for the women.

The golfer is the productive asset here, and the re-distribution scheme is very logical. Basically, the key to getting a higher payout is a combination of exclusivity and access ("access" overlapping with being a threat by means of that access).

Highest payout: the wife. Legally exclusive relationship, full access to the asset; on top, she had access to the pro-circuit as hired help that got lucky. Payout: she and her kids are set for life

The payouts for the rest of the women in the story are also based on exclusivity and access. The story each one of them can tell is likely the same story, so being first REALLY mattered. It is rumored that the NYC woman got a huge sum, while the 1st cocktail waitress got $100k from the media, and now it sounds like the Perkins waitress gave her story for free. How much value is there to each subsequent story? Not the $1 mm the first one allegedly got, unless there is something even more scandalous.

So, ranking the payouts, Scandinavian model-wife>> NYC party girl >> Vegas cocktail waitress >> local Perkins waitress. It is almost too logical as it follows the likely lifetime earnings potential of each.

Perkins, for the benefit of the non-US readers, is a low-to-mid priced family restaurant chain in the US.

Four, the sponsors in this case were either incompetent, complicit or a combination of both. There should be brand managers fired over this. Where is the due diligence?

This reminds me of lobotomized pensions managers blindly accepting the AAA stamp on whatever they were buying. Everyone is doing it so we're really happy were able to get our hands on some of these nice, safe securities.

Here the sponsors got played a little bit too, in my view. Since the brand can only be linked to one company in most categories (i.e. apparel and equipment, autos, credit card), there is a sense of competition and urgency between the sponsors, who then went on to pour millions of dollars into brand building.

The biggest fallout should be with Nike. They really built their golfing business out of nowhere on the strength of this brand, much like they built the basketball business on Jordan and the soccer business on Brazil. GM, AmEx, TagHeuer and Accenture should not hurt too bad. The golf brand was not essential to them in my view.

Since Nike has the most to lose, chances are they will try to stick with their investment as much as possible. There is also the danger that the sponsors exit en masse. A bit of game theory, if one blinks, all stand to lose. Surely interesting to watch on the side.

Five, there is quite a bit of wisdom passed on from Ben Franklin, some of it R-rated. In this letter, he spells out some battle-tested advice on the choice of a mistress, if one absolutely must have one. Discretion is high on the list of qualities he lists, and for a good reason.

The golf brand should have approached other brands who have a lot to lose if the affair becomes public: top-brand athletes like Maria Sharapova, Gabrielle Reese or Mia Hamm would have been perfect, as it seems that the golf brand was not seeking emotional connections.

Six, and more philosophical. This whole story is one of false idol worship. So, to note that man-made idols are nothing new, I leave you with Percy Shelley's sonnet Ozymandias which describes even the physical fallibility of self-described, alleged and even actual "greatest's."

I met a traveller from an antique land
Who said: Two vast and trunkless legs of stone
Stand in the desert. Near them, on the sand,
Half sunk, a shatter'd visage lies, whose frown
And wrinkled lip, and sneer of cold command
Tell that its sculptor well those passions read
Which yet survive, stamp'd on these lifeless things,
The hand that mocked them and the heart that fed.
And on the pedestal these words appear:
"My name is Ozymandias, king of kings:
Look on my works, ye Mighty, and despair!"
Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare,
The lone and level sands stretch far away.

Saturday, December 5, 2009

Some Trading Thoughts (And Bit on "Personality" Brands)

Here are a couple of trading thoughts.

There was a big drop in gold on Friday. May be the yellow metal was taking a breather, may be it is starting to reverse, who knows? Certainly I do not. Knowledge of the future is highly valuable, as the Galleon case illustrates, and I do not have it with any certainty. At any rate, GLD was down 4.17%. The gold miners ETF, GDX, was down 5.31%, while the jr. miners ETF, GDXJ, was down 4.81%.

This might be a good ST conversion bet. Long GDX, short GDXJ in equal dollar amounts. GDXJ should move in any direction by more than GDX does, and GDX should move in any direction more than GLD does. Why is that? GLD is the physical metal, already mined and stored, less expenses. GDX is equity in miners, and miners, even if they are not financially leveraged, are operationally leveraged on the price of gold. Due to their high fixed operational costs, if the price of gold doubles, their earnings should more than double. GDXJ should be even more operationally leveraged: lower yielding mines, lower economies of scale, riskier governance, etc.

This is a risky trade for several reasons. One, precious metals got really volatile on Friday. A friend of mine who trades for a living, and who happens to be a big gold/silver bull, is out over the weekend just to see how it plays out. This means that the planned convergence may not happen. On top, even though the mean and median absolute daily performance of GDXJ is greater than that of GDX (which is consistent with the the operational leverage theory), GDXJ started trading relatively recently, so the number of observations is small.

Finally, of course, you can ask John William Meriwether how well big convergence bets work out.

Speaking of Meriwether, he is obviously a big believer that a third time is a charm, so he is launching a third fund doing, again, "relative value arbitrage" just like LTCM and JWM. A fool and his money are soon parted. But this is a nice lead in for the second thought. It shows that risk is back.

One place where you see this is the high yield market. The Distressed Debt Investing blog, a great blog BTW, reports: "In November of 2008, there was over $230B of corporate debt trading below 50% of par. Today there is less than $10B. As a percent of the market, 31.4% was distressed in November and now only approximately 1%." Emphasis mine.

In other words, someone (or a lot of someones) are throwing money in high yield. There is also anecdotal evidence of things getting too heated. Blockbuster did a deal in October. This is akin to a Trump-branded Dubai yacht harbor getting 3.50% fixed rate 30-year financing. Then last (?) week Pinnacle Foods, a Blackstone portfolio company, bought Birds Eye Foods, a Vestar portfolio company, with a $900 mm covenant-light ("covvie-lite") financing. Now, one, this is a huge deal relative to the recent HY deals, and it is cov light, and it is a sponsors flipping the company to another sponsor. Then there is the JohnsonDiversey deal, which has a PIK provision. These are all dear "relics" from the '05-'07 "boom."

How can one play this? Look at JNK, I think the most liquid high yield ETF. It has had a nice run along with equities since March, but it started leveling off. The run-up, as described in the quote from the debt blog, and the deteriorating quality of lender protections are signs that JNK might be going down. One can even short JNK and long LQD to bet that even if rates continue to go down, high grade will outperform on a relative basis.

Risks in this trade, again, are plenty. I am positive yields will be rising but as Howard Marks, the Oaktree Capital chairman writes, being too early is often indistinguishable from being wrong.

Now on to another recurring theme on this blog: brands. Again, as I have studied more marketing than the average consumer, I do not have "relationships" with any brands. But I do recognize and respect their power.

One of the big news this past week was the adversity that a certain golf brand experienced when it turned out that the person on whom the brand was based had been doing things that can be classified as "inappropriate." The brand protection machine went on full speed and it seems, at least to me, that the brand will be salvaged.

But the companies supporting this brand already have plenty of experience with risks like these and know how to manage publicity crises like that.

Michael Jordan has had well-publicized gambling problems and went through an ugly divorce, and yet the brand is doing fine.
Lance Armstrong also went through a divorce 2-3 kids later; moving on, he proposed to and then dumped Sheryl Crow; he has been through 2-3 high profile women since then, fathered another kid, etc. And, yet, the brand Livestrong is going on strong.
Kobe Bryant, another unfaithful husband who was also accused of rape, has rebounded quite nicely, even though he did change sponsors and does not have a product brand solely under his own name.
Martha Stewart went to jail, and came back nicely.

This highlights the risk of building a wholesome brand image based on a real person. It is almost easier if the brand is built based on being "real" (or even a "bad boy"). Someone like Charles Barkley is a good example. He does stupid things periodically (such as driving drunk or throwing someone through the window during a bar flight) but he "gets" it once sober, takes ownership of it, and moves on.

Sometimes overreliance on a personality brand can spell trouble for the entire enterprise. A recent example would be Steve and Barry's Chapter 11 and subsequent liquidation, and their reliance on Stephon Marbury//Starbury to drive sales. Turned out $9.99 shoes were not a great idea. Nether was relying on Marbury who showed all the caprices of a douche-star well-before achieving anything. Of course, taxpayer-backed GE Commercial Finance did the DIP loan after the Ch 11. I do not know what the recovery was.

So if there is a caveat related to investing here, look beyond the brands per se. As The Oracle of Omaha says, "I like Disney because the mouse does not have an agent. " Or something to this effect.