The Fearful Investor

Low Revenues, High Margins... Not A Sustainable Path

I know I don't publish here as often as I should, but I've got a day job managing money, and don't have the time to get here as often as I'd like -- and I usually don't have important things to say... But, I think I've got something now....

We've got Stagflation on our hands... Stag is for stagnant, the economy isn't growing.. 'Flation is for inflation, prices are going up. 

In this most recent earnings season, we've seen a lot of companies report better than expected earnings on lower than expected revenue. Fewer people are consuming products/services but those who are, are paying more for it! Look no further than the NYC mass transit system -- higher fares, less service... 

• Disney reported last night that at its parks, attendance was down by 3%, but increases in rates more than offset the decline.
• Republic Services, a waste management firm, has seen core volume decline year-over-year each quarter since the beginning of 2008. But, they've also raised prices in 7 out of those 10 quarters.
• VCA Antech, owner of close to 500 animal hospitals across the country, saw number of requisitions drop 2.8% compared to the same quarter last year, but the price of those requisitions rose 2.3%.

So, the "haves" are paying more (read: inflation) for the same service to make up for the fact that there are fewer "haves". And, to make matters worse, Deutsche Bank believes that food and energy prices are headed up, too!

Is this trend of higher prices and super low income and economic growth sustainable? Methinks, not.

Investment-wise, here's my 2c:

- Interest rates stay low
- Only the stocks that can count on selling their goods are investable (energy, consumer staples, utilities)
- watch out on discretionary plays, esp the ones that have been making up in price what they've been losing in volume...

Suffocating Yourself To Health

The UK is instituting austerity measures to bring its budget deficit under control:

1. L30B of spending cuts
2. Freeze on public worker pay
3. Increasing VAT to 20% from 17.5%
4. Bank tax on assets
5. Drop corporate tax from 28% to 24% over 4 years
6. Raise capital gain tax from 18% to 28%

I get the spending cuts, as the government can't spend what it doesn't have. But raising taxes? Economic growth and job creation does not emanate from higher taxes... Listen to a Harvard professor about what works....

"There have been mountains of evidence in which cutting government spending has been associated with increases in growth, but people still don't quite get it." -Alberto Alesina, Harvard University Professor

Politicians don't appear to have the... gumption to make the hard decisions to cut costs... Yes, it will mean job losses, but it seems we can't afford:

1. two wars at once
2. union contracts that call for annual pay increases (tax revenues are going down, not up)
3. universal health coverage without more stringent cost controls
4. not to have a pension cap per year to cut off the public servants retiring on $150k or more in annual pension

Perhaps the most likely economic path from here is sluggish growth and few new jobs for years. I'm just worried that if the U.S. continues to pursue fiscal strategies like the UK, we'll suffocate what little growth we have.

Seeing The Future... In The Newspaper

I've always thought that the US economy will resemble Europe's over time... Lower growth, higher taxes, higher entitlements, lower standard of living, generally...

We're creeping that way and it seems that our next import from Europe will be financial austerity as the government can't afford all of it's planned obligations. On Page A12 of last Friday's WSJ, our future is laid out in two articles about Europe: Spain Tightens Reins On Budgets, Banks and U.K. Budget Will Target Welfare Payouts.

Ratings For Yahoo! Are Up

Our thesis for Yahoo! is predicated on two things (from the highest level):

1) Staying relevant/growing market share online

2) Growing margins, cash flow, etc.

It seems that Comscore and Experian data seems to be confirming that (1) is quite attainable. See the link below from E-Week - very positive for Yahoo!

E-Week Yahoo/Bing Post

Yahoo For Yahoo!

Here's a quick write-up I wrote for my quarterly newsletter that was sent out yesterday...

Yahoo! is perceived by many to be in the same bucket as AOL -- yesterday's internet companies, quickly leaving the scene to the 'real innovators' like Google, Facebook and Twitter. While AOL is, in fact, a declining business thanks to it's legacy as a dial-up portal, Yahoo! is a media aggregator with #1 sites in:

• homepages (ahead of Google and Facebook),
• e-mail (bigger than Gmail and Hotmail combined),
• finance,
• news (ahead of NY Times and CNN.com), and,
• sports (ahead of ESPN).  

We think new management is right to re-position company as an online media company focused on providing advertising solutions for Global 2000 companies. When the market realizes that the competition is other advertising outlets in all channels beyond Google and the internet (billboard, radio, TV, etc.), and that online media companies are gaining share and can be quite profitable, Yahoo's valuation should benefit. In order for the re-positioning plan to work, Yahoo! must:

• Have compelling content and link to compelling content, which will enable stable to growing market share,
• Provide targeted and successful advertising options - the pinpoint demographics for Sony to advertise their 3D HDTVs before football season or for Pfizer to advertise Lipitor, and,
• Keep up with innovation by providing mobile solutions that maintain and build usage of Yahoo! sites and services

Yahoo! currently trades at a trailing free cash flow yield of about 9%, when adjusting for the cash and publicly traded assets. With the current recovery in advertising spending and the ongoing migration of ad spending from offline to online, we think that the investment should do OK in a bad economy and quite well in a good one.

In a longer write-up, I'd add:

1. Yahoo's Chinese assets, through their ownership in Alibaba have potential for growth should fast-growing Taobao or Alipay go public. Yahoo! spiked when Alibaba.com went public, and I'd expect the same out of another Alibaba group IPO.
2. Yahoo! management is holding their 2nd analyst day in 7 months in May. I'd expect the path to higher margins and cash flow should be clearer to all then.
3. Most media companies are leveraged (see News Corp., CBS, all the Liberty companies, et. al.). Yahoo, with $3/share in cash, is anything but leveraged. Over time, I think you'll see leverage here...
   

Inflation & Deflation

Gold, copper, stock prices are up -- USA average hourly wages are down

The rich get richer, as investors make $ to keep up with inflation, and the poor get poorer, as incomes stagnate and the value of pay diminishes...

Regardless of your politics, this can't be good for a long-term investing environment...

Stay tuned for more volatility (good & bad).

Positioned For Growth! (What Growth?)

The chorus on Q3 earnings calls across many industries was: revenues are up compared to Q2 and "right-sizing" (read: lots of layoffs and mothballed production) is complete. Everyone is "positioned for growth" and expects to record better than expected margins in a recovery.

To which, I meekly raise my hand, "What recovery?"

WalMart just gave guidance yesterday indicating that they expect no sales growth at domestic existing stores in Nov09 - Jan10 period as compared to the same period last year. As you may recall, there wasn't a whole lot of spending going on in here in late 2008. So, while companies are positioned for growth, my receptionist just buzzed me and said that Mr. Growth called and that he will be late for his appointment.

Now all you tech investors will point towards Microsoft, Intel, EMC, etc. I'll grant there's some growth there. But not much. (I and my clients own Microsoft).

I guess, at the end of the day, it'll still be all about the stimulus here and abroad. Most economies that haven't done much in the way of stimulus (such as Europe/Canada) aren't growing much at all...

Failing The Smell Test

I just read Annaly Capital's latest monthly commentary. These guys invest in mortgage-backed securities and have a great record doing it. Here's my favorite quote re the recent positive GDP report:

"GDP gains driven by personal consumption while incomes are falling, joblessness is rising, and credit availability is shrinking, just don‟t pass the common sense test (see Friday‟s 10.2% unemployment rate and the ghastly consumer credit figure, down $14.8 billion from last month and $125.8 billion from the peak in mid 2008). It‟s impossible to deny that the GDP data from this quarter are better, at least relative to how bad things were earlier in the year. Without the multiplier effect of the stimulus kicking in, however, we believe the third quarter 2009 GDP data could look like an accounting extraordinary item, a one-time event that quality-of-earnings analysts would disregard."

Now, I'm all for a rallying stock market, as a rising tide lifts all boats, including my defensive one, but it's hard to see how less income to the economy and less investing by corporations can make forward prospects look good for companies in which I'd like to invest. Sure, things are getting better, but Intel's 3rd quarter, while better than their 2nd quarter, wasn't as good as last year.  Now, easier comps will help going forward, but the growth has got to come from somewhere....

Avoiding Losses Can Be A Winning Strategy

WSJ features an article (subscription required) about diversified equity funds that are doing well over 2008-2009 combined.

Message basically is: If you are up a lot this year and still are down for the past two years, it means you lost too much last year and should think about using low-volatility managers going forward. If you did not lose much last year, you do not need to make so much back this year, to get to break even....

Our strategy has always been to stay conservative and only invest in a diversified set of hi-confidence ideas. See about us and relevant disclosures....

A Story About Jim, Or Why This Market Scares Me

Jim's a (fictitious) friend of mine.

Used to be a hard worker, but somehow lost his mojo and now just lazes around. He halfheartedly looks for work from time-to-time, but since he got laid off from a cushy Wall St. job, he doesn't see the benefit of taking lesser compensation for a 'lesser' job.

He basically has lived off some money left to him by a grandparent and the good name of his family. 

Well, last year, as his stock account was getting blasted, Jim began to cut back on his lifestyle. Fewer parties, restaurant visits, trips, etc. He even cut out dry cleaning and his maid, resorting to wearing jeans and t-shirts to all but the most formal of events.

This year, though, things have changed. It seems another inheritance has arrived and Jim's back to living the high-life. No new job, just more money.

If Jim were a stock, he wouldn't be investable. He's generates no cash, and builds no value with the money he spends. Yet, here we are, jacking up all the stocks for companies that Jim supports.
The Gap (GPS), Nordstrom's (JWN), Cheesecake Factory (CAKE) and Starwood Hotels have all doubled from the lows. Ford's (F) a triple from March.

Now, we can quibble about whether it's government stimulus (the new inheritance) or people feeling better that is driving less-bad results from consumer stocks, but we can all agree that there's less income out there to consume retail products. 

I hope I'm wrong, because life is more fun when the stock market goes up, but I fear I'm not.