Wednesday, June 30, 2010

Doom Looms over S&P

After Tuesday's terrible day in the markets, it is clear that a head and shoulders pattern is forming within the S&P 500. The head and shoulders pattern is a bearish technical pattern, and one that is usually followed by a solid market sell-off. The S&P closed way below it's 200-day MA on Tuesday. The 50-day MA is also extremely close to crossing below the 200 day, which would be another sign for the market to take step downward.

If the support of 1040 is broke, and I mean a solid closing below 1040, then I think the downside risk is huge. I am not offering an actual prediction for a bottom, but I'm willing to say we could be looking the S&P to bottom around 850-950 in the longer term. Friday's employment data will be market moving for sure, although we are expecting job losses due to firing of census workers. However, anything worse than expected will surely lead to a market sell off and thus give us the necessary close before 1040 to conclude that next leg down is in play.

The chart below gives some indication of why we feel the S&P will drop so much. The drop is considered finished, or bottomed, when the price declination is equal to the decline from the head to the neckline. This puts us in the 900s range. Its tough to offer an exact prediction of where it will finish, but surely things will not be pretty. Next week, there is limited economic data coming out, due to the shortened holiday week. However, in 2 week's time we get a slue of data, which will surely move markets. Can the bulls hold the 1040 line?

-(Chart created by Jeff)
My prediction is no. The coming data will be too weak. If there is a hint of European Growth slowing down, a faltering US recovery, or some kind of negative news from the G20 Summit, things will head south in a hurry.


Tuesday, June 29, 2010

Is The Economy Really Chugging Along?

There has been an awful lot of attention concerning the chances for a double dip, and even a third depression, the latter heavily promoted by Princeton University economist Dr. Paul Krugman. However, each theory relies heavily on differing stances of policies and deficits, all of which are difficult to quantify and examine. So in this article, we aim to break down a few simple indicators in an attempt to grasp the future prospects of slowing growth in the United States. We will start with rail loads, a statistic that is published weekly by the American Association of Railroads. The graph below depicts GDP and a quarterly average of rail loads. It is noticeable how strong this past quarter's average of rail loads (ending on June 30) was compared to other recent quarters.

A rebuttal here could be that I was using a quarterly average. Okay, so I'll use the sum of rail loads by quarter, which shows an even bleaker picture of growth.

Comparing this year's rail traffic thus far to the past 4 years, we are able to see how much weaker this year has been. The only bright spot is traffic is up from last year.

I've outlined in previous articles my strong opinions of how housing and employment contribute strongly to the growth of an economy. Well, currently in the US, we have neither. As you can see from the graph below new home sales and the monthly average for lumber in rail cars have a pretty strong correlation. Lets take this past months decline of 32% in new home sales, for example. The consensus was for new home sales to fall, but instead dropped off the face of the Earth. Were the monthly rail numbers telling us this all along? In May, the average amount of lumber being transported dropped almost 6%, the largest decline since October of 2009. During the period from September through the end of December, new home sales dropped by 12.10% and lumber loads dropped by 12.12%. (I do realize that the correlation between the two is nowhere near this strong, but you have to admit it's eerie). So lets take a stab at predicting new home sales from the month of June. Well so far, lumber loads have been horrendous and will mostly likely finish with one of the worst month over month declines in some time (further back that I care to calculate). So, I'm going to project we see a slight uptick, and I stress slight, however there is still downside risk.

If that graph wasn't enough to convince you, maybe the one below might. Right now, lumber inventories held by wholesalers, a number from the BLS site, are at 1 year high (they are subject to a 2 month lag, so that peak your seeing is April's number). Coincidently, lumber loads were at their highest levels since 2008 in April. Basically we are looking for a drop in lumber inventories to further solidify our case that the housing market continues to remain weak.

Looking at lumber prices and the generic 1st contract for lumber, LB1 for you Bloomberg users, we can see the huge decline in prices. Since the year began, prices are down 12%, but from the 2010 high, they are down over 40%. This is certainly disturbing. Comparing the price of lumber with rail loads of lumber, we can see the correlation has been pretty strong over the past year or so. Going by this assumption, we are likely to see a decline in lumber loads and subsequently a drop in new home sales, thus dragging GDP around the 2.0-2.6% range.

If we use lumber as an indicator for possible future growth, well, its pretty bleak. It is clear we are out of a recession, but will strong growth follow? Probably not. Lumber loads haven’t been rising enough for us to say that future looks good.

But enough with the talk of wood and trains, lets move on to employment. This Friday we get a monstrously crucial number, nonfarm payrolls. This will give an indication of job creation and growth for the month of June. Lately, census workers have artificially inflated job growth. This reading will drive the market either up or down. A sour reading would certainly help build the case for a slowdown in growth and maybe even the next stages of a bear market. As unemployment remains high, housing is also impacted. With banks imposing tight lending standards, it is tough for anyone to get credit to purchase a home, or even refinance to get out of a high rate. Once again, housing will suffer. The recent increase in home prices from Case Shiller was met with a drop in mortgage applications. The home price numbers are lagged from April so the increase in prices can, once again, be related to the homebuyer tax credit.

So where does one put their money? Well shorting Toll Brothers might be a nice place to start. Although the stock is at a recent low, and may be relatively cheap, its EPS is -4.1, according to Google finance.


Wednesday, June 23, 2010

Chipotle Mexican Grill: 1000 and Counting

Yesterday morning, Tuesday the 23rd, a friend asked me how I felt about Chipotle Mexican Grill (CMG), since I had advised him to get McDonald’s (MCD) at under $67 a few weeks ago as a defensive investment and he wanted something a bit riskier. I responded by saying I didn’t know too much about Chipotle, I’ve never even eaten at one, but that there would be a follow up email shortly. So I decided to do a little research. I had known that Cramer has been extremely bullish on it as a member of his CANDIES list of stocks that he thinks will continue to grow even if the market drops again. A few clicks into the Bloomberg later I saw just how much Chipotle has been thriving, up from $50 to $150 since its bottom in 2009. My follow up was that it currently looks a little inflated based on the dramatic rise in price and looking at their P/E of 33 as compared to McDonald’s (MCD) at 16, Yum! Brands (YUM) at 18, and Panera (PNRA) at 26. Chipotle also does not pay a dividend which was a concern at first glance since even lowly Wendy’s/Arby’s (WEN) can pull that off.

Later that day I decided I wanted to do some further research. Originally the plan had been to find a Chipotle to eat at so that I could get a feel for what all the hype’s about, but these efforts came up lame. Then I thought to myself, how much would it cost to franchise a Chipotle. Then I remembered my teenaged short stint in fast food and thought better of it; and also read that one would soon be coming to a town 10 minutes from my house. So the taste test will have to wait, but through extensive interviewing I have found that they are more of a Panera than they are a Taco Bell. By this I mean that they are that strange new-school mix of fast food and sit down hoping that a good customer experience will justify higher prices. In this thinking it becomes apparent that there has been little franchising in my area given the rise of local restaurants like Surf Taco ( and Fins ( which appear to be the same thing with a surf jive; quality Mexican inspired food, only the freshest ingredients, ambiance aplenty, high philanthropy, and green thinking.

Wednesday morning: heavy news on the CMG news feed, they’ve opened their 1000th restaurant. But for Chipotle, it ain’t nothing but a G thang, their market cap now has them behind only McDonald’s, Yum! Brands, and Darden (DRI) in the restaurant industry having passed Wendy’s/Arby’s, Panera, and Burger King (BKC) among others. At this point it’s begun to dawn on me that CMG may be fairly priced. Just look at the earnings since they have gone public. The 2nd and 3rd quarters have historically been their best and they have just had a monster 1st quarter with EPS of $1.21. This leaves the forward P/E at around 25 which I would consider within an acceptable range, but estimates for this coming quarter are just under $1.40. The past 3 years they saw jumps by at least 22 cents and that was during a recession when chicken burritos were a dollar at Taco Bell (now they are over $2.50, forcing me to officially shun them). Additionally, it is possible that Chipotle has been innovating some things; today I read that profit margins for Chipotle are still only around 50% of McDonald’s. Of course McDonald’s has had much more time to perfect the craft of reducing costs, and they have the option of using less fresh goods, but McDonald’s held a large stake in Chipotle until 2006 and perhaps some things rubbed off. Also, from 2008 to 2009 Chipotle’s total revenue rose approximately 200 million but cost of revenue fell roughly 100 million (~10%). Based on these few factors I do not think that it would be unreasonable for earnings to be greater than $1.40 in the second quarter and then have an even greater surprise in third as more of these new stores turn a profit.

Looking at the CMG balance sheet you would see that there has been a stock piling of cash realized in 2009 and a lack of long term debt. These both bode well fundamentally. And of course retained earnings and capital surplus are killing it as well. One thing that would worry me is insider transactions and the fact that all are selling. Personally I don’t have as much a problem with it as most considering the poor economy, but it would be more reassuring if they were buying it up.

Bloomberg has 24 listed analysts for CMG, 14 buys, 9 holds, and 0 sells. The average target price for the 14 that have entered one is at $154, not too much higher than the current price. And the relative strength index is only at 53, lending credence to the fairly priced notion. I would have to agree with this as well. Chipotle would have to have an amazing year to reach an EPS of say $5.50, which would blow away the 14% growth rate, but is extremely feasible (actually I’d say it’s likely). However, if you use the forward P/E multiple of 25 you have a price in the high $130s and if you use the current P/E of 33 you’d get a price in the $180s. I know that this is very lenient math-wise, but let’s just assume a P/E of 30 is acceptable and you would have a price of $165, rendering Chipotle roughly accurately priced.

But fear not Chipotle holders for there is hope. Chipotle just opened there first location outside of America, in London (Taco Bell has just done this as well so things could get very interesting in the coming years). And with only 1000 stores there’s obviously room for growth. That coupled with the fact that eventually the global economy will normalize should yields positive outlook for CMG. Looking at the graph above you’ll see that they are well above their 200 day moving average and are also in the middle of channel which could be turning into a triangle. But I wouldn’t give too much creditability to the technicals; over the last year or so CMG has had what Recognia called bearish signals only to blow right by them. So if you’re looking for a longer term pick that’s currently not paying a dividend you could give Chipotle a look, but definitely pick your entry points wisely, perhaps under $147 if available.


The DL on EPU - A look into Peru's Mining Exports

With all this talk about the Yuan being unpegged from almighty King Dollar, one may be wondering what type of impact this could have on export driving markets, especially emerging markets. Where should one look to invest that exploits this particular depegging? This article will focus on the wonderful country of Peru and a sneaky little ETF developed by IShares called All Peru Capped, trading under the ticker EPU. The following is a description of the fund and its objectives, copy and pasted from the Bloomberg terminal. “The Fund's objective seeks to provide investment results that correspond to the performance of the Peruvian market, as measured by the MSCI All Peru Capped Index. The Fund invests in a representative sample of index stocks using a "portfolio sampling" technique.” Now with this being said, one may ask why this fund? Why Peru for that matter? Well folks, this article will present a case for investing in the EPU ETF and the reasons why Peru will continue to grow in the coming years.

This past weekend, China decided to stop the Yuan’s peg to the US dollar. This sent stocks soaring at the open on Monday, however all gains would be lost as the day progressed. My thought on this was that people initially assumed it would do wonders for the global economy. However, as investors sat down and took a closer look at it, they realized that China hasn’t said anything to impressive. So this puts us back to square 1 of where to invest. Well my friends, the wonderful country of Peru and an ETF with a ticker EPU is the place to be.

It is theorized, and I stress that word, that the depegging of the Yuan will increase Chinese imports. It may be noted that China is considered one of the largest importers of metals. It can also be said that the major countries that currently provide goods to China will see an increase in demand for their goods, thus boosting exports, and subsequently GDP. Peru, being a large provider of exports, especially in the raw materials sector, is certainly a country that will benefit from the increased demand for raw materials by China. Peru is a large exporter of zinc, gold, copper, and other metals. According to a CIA report, China is involved with 15.2% of Peruvian exports, only second to the US of A. As the Yuan comes down in value, we expect to see this number rise. There has also been recent talk of Petrobras investing money in Peru, Mexico, and Africa. Inpex, a Japanese corporation, has also purchased a 25% stake in a Peruvian oil block. These recent developments of desired investment in Peru has added fuel to the proverbial fire that this is a solid country with strong economic growth potential.

Peru has seen constant strong economic growth for some time now. The central bank just increased its forecast to 6.6% by the end of the year. The graph below shows the growth of the economy, compared to that of the US. Now I realize this may be skewed and you can argue a thousand different things about why US GDP is less but save them. I understand and acknowledge that fact.

This growth in Peru has been largely lead (pun intended) by exports, as mention above. The graph below depicts exports from mining. Notice the constant rising.

Peru also has a low debt to GDP ratio, thus taking away worries of possible default and other financial threats.

Over the past few days, metal prices have increased take copper for example. As the price of copper rises, revenue to exporting countries will see a jump as well.

Now that we have presented a decent case for investing in Peru, the next step in our top down approach will be to examine the etf, EPU. For starters, the EPU etf is comprised of mostly mining companies and other industrial companies, which make up over 63% of the fund. This would naturally be the case, considering that Peru is an export driving country. There are 2 companies that make up over 30% of the fund, Cia de Minas Buenavent (BVN) and Southern Copper (SCCO). BVN has had solid dividend growth of the past couple of years and also has an electric power company and engineering plant. BVN is rising as we speak. Both securities have held up amid recent market turmoil.

All in all, it is clear how strong an investment the country of Peru and the subsequent EPU etf really is. We have presented a typical top down approach from overall macro economic conditions, to the specific country, to a specific industry, and then to a particular investment. Growth will persist in Peru for the coming years and one can certainly bet that EPU will experience similar prosperity.


Thursday, June 17, 2010

Can we say Adios to Spain?

What I found interesting over the past few days has been the transition from nervousness about Greece (from what used to be panic) to Spain pandemonium. One may ask, why are we seeing this? I will move forward with this article in a few directions hoping to express my opinion about why Spain has a danger flag hanging from its flag post, but that it's simply a danger flag, nothing more. We will explore some economic data, spreads, and yields, using all 3 in an attempt to draw a conclusion about what is really going on in Spain and what it's future prospects hold. We will conclude with a few reasons why concerns about Spain are greater than Greece, but serve only as smokescreens to the gem of Spanish debt buried beneath.

Let's being with some indicators. The graph below depicts the unemployment rate in Spain, on a quarterly basis, which is currently at 20.05%. I need not stress the absolutely ridiculousness of that number. For sustained growth to take place in a country, a low unemployment rate is a must, an obvious fact. With these rates rising in Spain, it will be extremely tough for them to rise out of this past recession and move forward with economic growth.

If we compare manzanas to manzanas, (manzanas are apples in Spanish), we can see the unemployment in Spain is much higher than the rest of the Eurozone. What's even more worrisome is that fact that both rates don't seem to have reached a ceiling yet.

Now granted having a housing bubble and subsequent burst can wreak havoc on an economy. Case and point, the country we all know and love, the US of A. However, what would a WORSE housing bubble and burst do to an economy? Well, for starters, growth will be sluggish, thus leaving a country more vulnerable to slipping back into a recession, as confidence among its citizens plunges. The graph below tells that story. 3.0% growth for the US (from the 2nd estimate of GDP) has been somewhat reflective of rising home prices. Spain is a different story. Housing prices in Spain just haven't seen the type of rebound experienced in the US. Side-note: I realize the housing market isn’t all fine and dandy, however things APPEAR to be turning in the right direction.

In my humbled opinion, the 2 indicators mentioned above are very important for growth. Of course, they are not the only ones but can be considered to be at the top of the list. Speaking of growth below is a chart of GDP in Spain on a quarterly basis dating back to 1996. That huge dip we see, well doesn’t seem to be improving. Yes, it is rising, but not at any sort of substantial rate. I guess one could classify it as less bad? Anyway, there will be another release at the end of June, which will surely shed some light on things.

Now that we have concluded that Spain needs an improvement in both employment and housing to improve economic growth, we will move into some other areas of concern. First off, the spread between Spanish 10-year notes and German 10-year notes was at an all time high, 220 bps at the time of this writing (it dipped Thursday morning to about 213 bps). Granted, this is nowhere near the level between Greek and German bonds, but for sufficient reasons. A few strong reasons for those high yields on Greek debt included fears they would default, destroy the Eurozone and Euro, and freeze up credit markets. This drove yields through the roof. However, over the past couple of weeks, this fear has waned and it appears that the market may have over exaggerated.

Looking at some of Greece's leading indicators, they are nowhere near as nerve-racking as Spain's. Spain is also one of the largest economies in the world. It is one of the largest havens for investments, meaning both companies that are based out of here, and investing done by this country. If Spain were to default and/or require some kind of assistance to help their debt-ridden country, the Eurozone would be in serious trouble. Being the 4th largest contributor to GDP, Spain's presence is extremely important in the Eurozone.

Let it be known that I DO NOT think that anything substantial will happen in the Eurozone, in regards to any collapse, break-up, or default. This article's purpose was so serve as a warning that Spain may be in trouble and a watchful eye should be kept on it. Like some previous articles I have written, I strongly support investing in the sovereign debt of these countries for both the yield and price appreciation. There will be no defaults and no breakups due to the fragile state of the global recovery. All these depressing indicators are simply a smoke screen meant to keep out weary investors. (That may be an exaggeration of sorts).

To cool the fuego de Espana (Spanish fire), the Bank of Spain has announced it will release stress tests performed on it's banks. Now, the US Treasury did this last year and it showed that some banks might be in trouble. The tests had different criticisms, most of which I don’t care to go into, but nonetheless, the stock market rallied and the stocks pertaining to these banks rose. Back to Spain, and the release of the results. My thinking is that these should be taken with a grain of salt, per say. Spain is releasing these results ahead of any other European this a good sign? Are Spanish banks well equipped to face a liquidity strain or worsening economic conditions? I think the results will come back positive. However, it should also be expected that some banks are going to be liquidity strains and some banks may be perceived to be in trouble, especially the smaller banks. All in all, I feel this is a step in the right direction, another reason why Spanish debt is certainly a market play.

Another side note, Spain sold debt on Thursday. The auctions went well, finishing with decent bid covers. This helped ease concerns about whether Spain will be able to pay upcoming debt in July. Spreads decreased and yields dipped on this news. All this news and awareness by the Spanish government will positively impact spreads and yields, so my advice, get in while the getting is good.


Monday, June 14, 2010

Up, Up and Away?

Greece was downgraded this afternoon by Moody's to a rating Ba1. This new rating is considered "junk" by their rating system. At the end of April, Standard and Poor's downgraded Greece to "junk" status, from a rating for BBB- to BB+. It appeared Moody's was a bit late to the party in terms of downgrading Greece's debt to "junk" status, but never the less, a lower rating arrived. The graph below depicts CDS spreads over the past couple months. As you can see, the downgrading of Greece has had significant impacts CDS rates. For instance, in subsequent days following Fitch's initial downgrades, CDS rates exploded. The same followed when Moody's downgrade was implemented at the end of April.

Looking at today's downgrade to junk status, CDS rates shot up from 733 bps, which was Friday's close, to about 800 bps. What will the longer-term impact be? Is Greece's debt really in danger of defaulting, or will another Eurozone bailout be needed save the ailing country? The dotted purple line gives a possible projection of rates based on past performance after a downgrade.


The 700LB Gorillas In South America

Over the past 2-3 months, Greece's distress has been atop the headlines. We have read about how they are going to default in due time because of their huge unsustainable debt to GDP ratio. Credit Default Swap (CDS) rates for Greece, and spreads for yields on bonds to that of Germany have widened substantially. Germany is considered the benchmark in the Eurozone. However, if we are considering CDS rates and yield spreads as 2 different points of reference, I think it may be worthwhile to look at other countries, such as Argentina and Venezuela, as well.

Below I have featured the CDS rates for Greece, Venezuela, and Argentina.
As you can see, both the South American countries' CDS rates have exploded recently. Greece's rate has come down after the bailout was passed, meaning expectations of default decreased. In case you are unfamiliar with a CDS I will give a brief description of an example. Basically a CDS is a financial instrument used to hedge a position against a company or in this case, country and the chance of default. For instance, say I enter into a CDS for $1 million for a pre-arranged "protection" time of 5-years with annual payments to Bank of Andrew. Lets also assume that I hold debt from a country called Risky. The rate of interest on the swap is shown below. The theory here is if a country is perceived to be risky and closer to default the rate will increase. This means that I pay, for Venezuela, 14.26% each year on the $1 million. If they do default, Bank A must pay me the notional amount. So for example if I were holding $750,000 in Venezuelan debt, I would have a net gain of $250,000 minus the annual interest payments. This is a simple explanation. The process is much more complex than I care to understand.

Most recently spreads have come in for Greece, due to the waning fears of default. However, no one seems to be paying attention to the South American countries of Venezuela and Argentina. Although both do have generally low debt to GDP ratios one may take this for granted and will thus be engulfed by a false sense of security. I do understand that Argentina has defaulted in the past thus making it a more risky investment.

The graph below compares those countries with the US and Russia. The graph speaks for itself.

Taking a peak at Venezuelan trade deficit, we can see the gap is the widening. This means they are importing more than they are exporting, which could a damper on GDP growth.

Looking at the yield on an issue of Argentinean debt, one must wonder why investors are requiring such a high yield. I do understand that there is global unrest but this yield is trading tremendously higher than Greece's, which is the so-called next country to default. And granted Argentina has defaulted in the past but they devalued their currency to boost exports and get their country out of debt.

All in all, it may be worthwhile to keep an eye on these 2 South American counties. Both are important, especially Argentina, to the global economy and any inherent possibility of default could potentially be harmful to the global recovery underway. This article attempts to serve as a point of view and is not in anyway a prediction future of either of these countries.


Sunday, June 13, 2010

Hershey’s: Overbought or the Price is Right?

The Hershey Company (HSY) 6/9/2010

Price - $51.54

52 Week - $33.70 - $51.54

EPS - $2.21

P/E – 23.11

Market Cap – 11.62 Bil

Today is June 9th and The Hershey Company has just recently (yesterday) surpassed the $50 mark and sustained, even built on these gains (today) even though the Dow was down 40 points at the close. As I am writing this I am sitting in a jury assembly room in Central New Jersey, more bored than I have ever been. But fulfilling my civil duty has allotted me the time to read Michael Lewis’s The Big Short, which like most of his works I fully endorse. I feel that through this and his last book, The Blind Side, he has done a terrific job of finding beaten and battered main characters and documenting their progress through their tumultuous lives. One could certainly argue that Michael Oher and Michael Burry were not all that different. One criticism would be that it was a bit short for the price the booksellers insisted on charging for it. But this gave me the time to analyze a few of my positions and judge their good standing.

In looking at Hershey’s I see a company who produced an awesome first quarter earnings report, (more on this later) that is expected to report a cyclically poor second quarter a few months from now. I will admit that I did listen to their live streaming conference earlier this year but was often put off by the numerous times different types of chocolate were discussed as opposed to sales figures and marketing plans. (This stance may have been shaped by my opposition of coconut flavored products and the analysts’ insistence on asking questions on the matter) Like other confectioners, Hershey’s boasts a starting line so to say including Hershey’s Kisses, Reese’s Cups, KitKats and York Peppermint Patties backed by an array of other choices, some of which do not get the attention they deserve (the competitor to M&M’s, the Kissables is the first that comes to mind; I cannot fathom how the public does not prefer the slightly thicker colored coating to that of the aforementioned M&M).

At looking at earnings the confectioners sector is indeed quite cyclical. In analyzing past data one will see that the 3rd quarter is the work horse followed by a slightly weaker 4th quarter. Over the last three years the first and second quarters have typically been 20-30% below the yearly average quarterly earnings. However what is extremely interesting is the fact that it is the first time in recent history that the Q1 earnings have exceeded that of the previous year’s Q4. This may suggest that thought the second quarter earnings may not excite anyone (they are predicted to be only 0.454 cents, a 19 cent drop since Q1) but if the second half of the year continues to have a significant measure on the first half than we could expect to see a massive 3rd quarter. Hopefully this made some sense, and yes I realize the logic is extremely sketchy.

On to the groupthink: Yahoo finance reports that there are 11 analysts following Hershey’s with a median target price of $48, the high being $55, and with a 3.1 rating on the 1-5 buy-sell scale. Hershey’s has a 52 week range of $33 to $51 and is currently trading at around 25% higher than the 200 day moving average. Additionally, they have a beta of 0.39 and a price to earnings multiple of roughly 23, which is difficult to directly compare to any one other company given Hershey’s diverse product line and the fact that Mars is private. So are we setting up for a significant drop in the near future? It is tough to say. Yesterday Hershey’s crossed a resistance level just over $49, which of course is bullish in the short term. They have not seen the sunnier side of $50 since 2007 and had highs in the mid $60’s in 2005. Personally I think the $55-$60 range is a bit farfetched since the steep increase in earnings seems to have been accounted for in the 25% increase in share price. I find it more likely that they will trade in the $48 to $52 range for some time, rendering their recently increased dividend less appealing (2.7%). It is somewhat reassuring to know that is unlikely for this dividend to be lowered and/or dropped based on historical yields and increasing cash on hand.

In conclusion, as anticlimactic as this may seem, Hershey’s is not necessarily a buy given most analysts use require a 15% increase in the next year to gain said designation and I am not sure if that would include the yields from dividends, though I don’t see why it would not. On the other hand, it is not a sell unless a poor 3rd quarter is announced in a few months, since Hershey’s is an extremely strong company with quality products. Also I believe that chocolate is not as effected as other goods from a sour economy and the price stood its ground during the Miserable May of 2010 (I’m not sure if this term has been used yet, but I’d like to take credit for it). Of course Hershey’s has non-food related products as well like an amusement park and a hockey team but neither has huge effects on revenue. It should be noted the Hershey Bears have made it to the American Hockey League finals lead by Mathieu Perreault, Karl Alzner, and Kyle Wilson, and have a very devoted following, so…GO BEARS.


Friday, June 11, 2010

The Case for Investing in Greek Bonds

I know the title may seem completely out there, and frankly, it is. But indulge me, if you will, and bear with me some thoughts that I will present to you. The current Greek 10-year bond was issued at €98.42, with a coupon rate of 6.25% paid annually.

However, things began to change for bonds across the globe as the Eurozone contagion crisis unfold. As the Euro zone crisis began to unravel, yields fell in bonds across the globe in a typical flight to safety fashion. However this was not the case for the Greek 10-year note. As expected, investors demanded a premium for the inherent risk of default, thus driving yields up.

Even though it may appear that Greece will default on its debt, in my humbled opinion, this will never happen. For starters, lets look at the last time a country defaulted on debt, Argentina. When Argentina defaulted, the aftermath was chaotic. The number of people who lived below the poverty line increased pretty significantly as did the number of people in extreme cases of poverty. This resulted in ruins from the time period 1999-2003 as GDP remained negative on a year-over-year basis. Countries devalue their currency when they are in default, with GDP getting crushed. To combat this, Argentina devalued the peso, thus boosting exports and with it, GDP. However Greece doesn’t have this option being tied to the Euro, thus presenting the case for more IMF and EU bailouts.

If Greece were to default and thus possibly leading to a monster decrease in GDP, the economy would quickly slip into a recession, and thus rendering it unable to pay its debts down. The problem with this is that Greece is attached to the Eurozone. Now if one country is experiencing incredible debt to GDP ratios, maybe other countries within it may experience similar situations and will be left helpless to pay back debt. This would create a domino effect, which is basically the definition of contagion.

Our political leaders are smart these days (that was extremely painful to say) and understand the consequences default would be to the global economy and the recovery underway. The recovery would be shattered, jobs would be lost, investor confidence would decrease, bank lending would dry up (credit lines are beginning to freeze as we speak), and stock markets around the world would tumble. A Bailout of Greece has already been put into play and more may be necessary. But I digress

Moving back to the case for investing in Greek debt leads us to a discussion on yields and returns. Below we have the S&P and Dow and their returns for the past 10 years. The Dow is down 11.64% and the S&P is down almost 30%. These are brutal returns, especially for someone looking to save. Now of course I'm a realist and do realize that their were stocks that performed magnificently during this period, but the average investor is typically limited to the performance of the overall market.

A Greek bond can be purchased at steep discounts these days, and the yield to maturity is above the coupon rate. Note here that the price for the bond was once trading at around €65, which is an absolute steal. This was a perfect buying opportunity for someone looking to scoop up a Greek bond and benefit from the price appreciation in addition to the monster yield it was providing. Does this mean that all opportunities are lost? No, not in the very least, in fact, I would suggest purchasing whatever sovereign debt one can get their hands on.

One rebuttal to my argument for purchasing such risky debt could be "Why not purchase US Treasuries since they are virtually free of default risk?" Well my friends, the answer lies below. Take a peak at yields here. As you can see, the generic 10-year Treasury note is offering around 3.2%, almost 3X less than the Greek note. One must also consider that 10-year notes serve as a safe haven trade, meaning when there is fear and speculation of a downward moving market, investors pour cash into this note, thus driving down yields and prices up. This is a highly unlikely scenario for Greek notes.

To surmise everything that was discussed here today, I will simply state that Greece will not default. Even if there is a strong "probability" that they will, the odds are highly unlikely. As we speak, the PM of Greece has stated, "Greece has tremendous growth potential." Now it may be naive to believe this whole heartily, but still one must ponder why he would be so strong and affirmative about Greece's future.


Tuesday, June 1, 2010

Skeptics and True Believers:

5/31/2010 – A look at Apple and a few of their bottom feeders

Apple (AAPL)

Cirrus Logic (CRUS)

Alcatel-Lucent (ALU)

Cause the times they are a changing

And who can predict what’s next

Hey! You lost control

Even though you might have thought you had it all

And hey, its just rock and roll

Penned by the now defunct, Central New Jersey pop-punk super group, Midtown, with the borrowed words of one Bob Dylan, these lyrics are now more pertinent than ever to the fast moving tech industry. As you probably know, this week was marked by a momentous occasion in Apple (AAPL) surpassing Microsoft (MSFT) in market capitalization.

Apple’s rise to dominance has been a long journey with obvious set backs but in the last decade they have been able to take over the world with their innovation of consumer electronics, that are in turn marketed to the most important demographics and are head and shoulders above all competition. To put it in ‘Buffettology’ terms, they have a clear durable advantage. Apple had a long standing cult following with Macintosh computers, and still does with about 20% of the market share, but this cannot compare to the market share that the 2003 3rd Generation iPod and 2004 4th Generation iPod would take hold of. Just a few years prior there had been a plethora of personal mp3 players but few came with such a user friendly transfer module (iTunes). Microsoft had their shot with the Zune, but I have never personally seen someone use this device. I know that it is in stores and probably works just fine but purchasing one would be like going to a single A baseball game with a major league park in the same parking lot at the same price and with free hot dogs (iTunes again).

2007 marked the introduction of the iPhone which quickly took over the smart phone market and of course Apple earnings rose in accordance. In the mean time, iPod sales continued to dominate all others and iTunes had become the preferred online music marketplace despite the increasing availability of free pirated music.

That brings us to January of 2010. In the last decade Apple has grown from the$3 - $5 range to the $240 - $260 range with a price to earnings multiple that is unfathomably low given its sector... In fact an interesting quip was made note of a few weeks back, mentioning the value of an investment if you were to have purchased shares of Apple in 2003 instead of your first iPod. Incase you’re wondering, it’s a lot more than the same iPod is worth now…And now the iPad has been officially released, both at home and abroad and in the wireless 4G version. With its somewhat limited release, demand is still at extremely high levels while more are being pushed out of the factories. (The most current figure is 2 million sold.) This has given time to the other companies now developing pad like handheld devices, most recently Google, which like the Zune and its counterparts will eventually bow down to its predecessor.

As one of the most talked about stocks during these turbulent times, Apple is generally perceived to be a lock to reach $300 and onwards after the next few earnings are reported. Judging by previous earnings data including the few quarters following the iPod and iPhone, substantial gains are to be expected and we could probably start thinking about $350 and even $400 in the next 12-16 months. This can be seen in the graph following the release of these two devices.

With all of that having been said, Apple is a very expensive stock for the home gamers albeit with a low risk level. So now we will focus on two much cheaper equities that feed off Apple’s gains. The first is Cirrus Logic (CRUS) which was made famous on May 7th by Jim Cramer, who noted that 30% of their total sales are from Apple. Cirrus makes the components that go inside the iPod, iPhone, and iPad, so as production rises, Cirrus revenue rises. Of course being featured on Mad Money can lead to some immediate over pricing and this was experienced the next few days. This preaching was following the May 6th ‘Flash Crash’ and some intense volatility that followed nearly erased all of the gains the stock had taken on May 10th. Since then the stock has performed very sporadically, but then again so has the S&P. Cirrus has a price to earnings multiple of 32, relatively low for tech stocks, and another positive quarter could turn skeptics into true believers. As the graph shows, Cirrus has moved almost in line with Apple over the past few years and with the international success of the iPad it is not unlikely that this $14 stock will break $20 in the near future. On June 1st Jim Cramer reiterated his feelings towards Cirrus. Below you will see a candle stick graph from the last month and a half. As you can see they have moved into a trading channel of sorts sticking around the $13-$14 range.

A more intriguing play is the French cell tower equipment supplier and IP data compiler, Alcatel-Lucent (ALU). After an unsuccessful quarter the price has fallen from the $3.25 - $3.50 range to in and around $2.50, which is in line with their low earnings and historical price to earnings. Last week, Alcatel overseas president Adolfo Hernandez, claimed they expect to see a “massive impact’ as a result of the release of the iPad. This however does not necessarily fall in accordance with their historical prices in comparison to Apple. In fact, looking at the graph there would appear to be almost no correlation at all between the two, But Alcatel plans on increased international business in expanding the wireless networks and all of the data that comes along with it. This also means that Alcatel is unlikely to falter if by some off chance an iPad competitor rises to the forefront. It is tough to gauge and predict the future earnings power of Alcatel, but as a shareholder I do hope it is positive since this position is currently sitting deep in the red. Going back to predictions, it is difficult to estimate when these “massive impacts” will be felt and a great deal of further evidence will be needed before one should consider purchasing ALU. With that being said, the potential is there if they are truly linked to the iPad’s success. In summation, it should be a very interesting 6-12 months for all three of these securities and increasing and hopefully sustainable price gains should be expected as the global economy begins to fall back to normalcy.