February 7, 2010

Forbes cover story: Global Debt Bomb

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The 2/8 Forbes cover story is well written and quite compelling.  Here is the link along with some of my notes.

http://www.forbes.com/global/2010/0208/investing-credit-auditing-leverage-global-debt-bomb.html

[Bass] If 2008 was the year of the subprime meltdown, 2010, he thinks, will be the year entire nations start going broke.
…Reinhart has found that a 90% ratio of government debt to GDP is a tipping point in economic growth… The U.S. government-debt-to-GDP ratio is 84%…
The CDS market is priced to imply a 3.1% chance of default over five years on Treasury debt.
To buy insurance against a default in Greece over the next five years costs 3.4% a year.
[Bass] His biggest potential score is in Japan. Government debt has soared to 190% of GDP from 50% in the mid-1990s, hitting an estimated $10 trillion in 2009… …Kanno in Tokyo says that Japanese bonds are in a bubble that could pop in the next three to five years, as savings rates drop.

 

February 3, 2010

Bought FRE puts 20100203

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I purchased 12 put contracts on Freddie Mac (FRE), with a strike price of $1 and expiration of July, for $0.16 each.

The thesis was brought to my attention by John Hussman in his November 16 weekly column where he quotes Freddie Mac’s quarterly report:

“In June 2009, the Financial Accounting Standards Board issued an amendment to the accounting standards for transfers of financial assets (SFAS 166) and an amendment to the accounting standards on consolidation of variable interest entities (SFAS 167). Both amendments are effective and will be applied prospectively by the company on January 1, 2010 … Under these accounting standards, the company will record the underlying mortgage loans in these single-family PC trusts and some of its Structured Transactions on its balance sheet. These mortgage loans have an outstanding unpaid principal balance of approximately $1.8 trillion as of September 30, 2009… While Freddie Mac continues to evaluate the impacts of adoption, the company expects that the adoption could have a significant negative impact on its net worth.”

Fundamentally, I still believe that this economy has problems ahead.  Moreover, even if the economy was in decent shape, the market is still overvalued.  With a probable second round of foreclosures upcoming, the FASB amendment could be a nice catalyst for a larger trend, at least for FRE.  As for the execution, I’m well willing to risk $200 on this.

 

February 2, 2010

The AM broker call: covered CYN; put SSO

Posted by n_cavallaro under All Commentary, CYN, Stock purchases, bought to cover, Trade History, Trade highlights | Tags: , |
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I know who it is before I even answer the phone.  At 9:40AM, the market has just opened, and I already know that at least one of my short positions has been covered…

“Hello?”

“Hi… this is [broker] calling to inform you that there was an SEC mandated forced buy of 1 share of CYN from you account…”

Seriously!  Seriously?  1 share?  You’re going to pawn me off one share so that my position is now 49 shares?  Who will want me to buy 49 shares from them?  Yuck.

So my 1 share was bought at $49.85.  I decided to cover the entire position later in the day at $49.55.  Seeing my thesis erode, I would liked to have covered in the high $40s, perhaps a dollar or so lower.  In review, the FDIC-Imperial deal to CYN was clearly a blow to my short position; the deal was instantly accretive to City National’s book value.  Further, I now recognize that I may not have had the right stock for the play–I wanted to profit from a fall in California banks, thinking all would suffer (which still might happen).  However, even though CYN is in a losing region, it is probably the best of a bad lot.  Whether or not this thesis eventually plays out is no longer worth my coin.  At this point, I take the loss and move on.

From a portfolio perspective, I wanted to keep a similar amount of negative exposure to replace the covering of CYN.  So, I purchased two put options on SSO (the double levered S&P500 ETF).  These were the June $44 contracts, at $8.00 each.

Even in a loss, I still keep score:

3-Aug CYN short 40 40.66  $   1,619.35
18-Nov CYN dividend 40 0.1  $        (4.00)
20-Nov CYN bought to cover 40 37.45  $  (1,505.00)
18-Dec CYN short 50 41.22  $   2,053.94
2-Feb CYN bought to cover 1  49.85  $       (56.85)
2-Feb CYN bought to cover 49  49.55  $  (2,434.98)
           $     (327.54)
 

February 1, 2010

Hussman article 20100201

Posted by n_cavallaro under All Commentary, Hussman Commentary
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An interesting graph from Hussman Econometrics:

“…the ability of companies to increase book value over time has been a critical determinant of long-term earnings growth…”

“…Investors now rely on the renewed attainment of bubble valuations in order to achieve acceptable returns…”

http://www.hussmanfunds.com/

 

January 25, 2010

Bought Exelon 20100125

Posted by n_cavallaro under All Commentary, Stock purchases, bought to cover, Trade History | Tags: |
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 I initiated a new long position today: 30 shares of Exelon Corporation (EXC) at $46.14.  Exelon is (I believe) America’s largest utility company; it’s primary markets are Chicago (ComEd) and Philadelphia (PECO).  Being a utility company, some of you may view this as a rather bland play, and to some degree, it is.  However I see this as an appropriate tactical maneuver in a strategy that allows for an open minded approach to investment success.

This story begins late last year.  In December, Bill Gross (of PIMCO) opined in favor of purchasing utility stocks.  His argument is that over the next several years, “Diminished growth, deleveraging, and increased government involvement will temper profits and their eventual distribution to investors.”  In such an environment, utility stocks will adequately perform.  I agree.

In last week’s issue of Forbes, Exelon was named one of America’s Best Companies (only three were highlighted).  The article mentioned that Exelon runs 17 nuclear reactors, “by far the largest nuclear fleet in the nation and the third biggest in the world.”  With its nuclear advantage, Exelon can produce low cost, carbon free energy, something that other utilities cannot do.  “Exelon’s nukes turn out 130 billion kilowatt-hours of electricity every year and not a single metric ton of carbon dioxide.”  In my view, Exelon is a company that will be able to generate solid returns without having to worry about competition.

Since I belive that Exelon will be an overachiever for years, all I needed was a reasonable entry point for the stock.  Since Gross’s article was published, utility stocks and the market have been slightly positive, whereas Exelon has fallen about 4%.  I’m happier to buy the dip now, than to have chased earlier only to watch the stock fall.

The remaining question is, why has Exelon underperformed recently?  Perhaps an unlikely passage of a cap-and-trade bill hurt the stock.  Such legislation would have hindered carbon producing utilities, but not Exelon.  Another explanation could be that investors and analysts were disappointed with Exelon’s earnings on Friday.  To me, this can be disregarded since the fundamental earnings power of Exelon are unchanged over the upcoming years.

Pricecheck!

In contrast to some other utility companies’ price metrics (as I calculate), Exelon’s metrics look fairly consistent and stable.  Cash return, return on invested capital, and earnings’ returns all tell similar stories even though they use different inputs.  A juicy dividend every quarter is also reassuring.

Stock Div% Cash return ROIC Earn% EBIT%
EXC 4.6% 8.7% 7.1% 8.3% 11.1%
           
WR 5.6% -4.3% 4.4% 8.0% 7.1%
NGG 5.6% 3.8% 9.4% 8.2% 10.3%
SO 5.3% -2.6% 5.3% 7.4% 7.4%
NST 4.5% 6.9% 6.1% 7.0% 9.0%
           
NRG 0.0% 12.1% 8.7% 12.3% 36.0%
AYE 2.7% -4.9% 5.4% 12.5% 9.4%
MIR 0.0% 1.1% 24.5% 11.5% 28.4%
ETR 3.8% 8.7% 4.9% 8.7% 8.3%
PEG 4.2% 1.4% 8.4% 10.2% 13.4%
AEP 4.6% -3.1% 5.2% 8.6% 8.6%
 

January 19, 2010

Sold CHK, bought DBC

Posted by n_cavallaro under All Commentary, CHK, Stock purchases, bought to cover, Stock sales, short sales, Trade History | Tags: , |
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I sold my position of Chesapeake Natural Gas (CHK) today.  My orignal thesis is no longer valid, and the stock is probably fairly valued.  The main fear is that the supply of natural gas will become (or already is) excessive relative to the demand for natural gas.  This would move the price of natural gas lower, which would hamper producers like CHK.

Previously, I had written a call option (covered call position) that expired last Friday, and I considered writing another call.  However, I view the risk of principal loss as too great and am happy to walk away with a profit.  Further, since I held this position for a year, this gain is taxed at a long term capital gains rate.

Having sold CHK, I still desire a broad exposure to commodities.  Even though commodities have risen, and are likely to pull back, I purchased the Deutsche Bank Commodity Index (DBC), 50 shares at $24.50.    This purchase uses less than half of my funds from CHK, and I intend to increase my allocation to commodities on price weakness.

Taking the two trades together, I am now less exposed to natural gas and more broadly exposed to commodities.  I have less money on the table and am in position to increase my stake on price weakness.

Here is my history for CHK.  As you can see, I stumbled out of the gate on this, but catching the bottom and writing two covered call positions turned out to be great tactical manuevers.

9/15/2008 CHK bought 40 39.45 -1585
10/15/2008 CHK dividend 40 0.075 3
1/15/2009 CHK dividend 40 0.075 3
1/15/2009 CHK bought 60 14.38 -869.8
4/15/2009 CHK dividend 100 0.075 7.5
5/4/2009 CHK write call July $25 1 1.1 101.74
7/15/2009 CHK dividend 100 0.075 7.5
9/10/2009 CHK write call Jan $28 1 1.5 141.74
10/15/2009 CHK dividend 100 0.075 7.5
1/15/2010 CHK dividend 100 0.075 7.5
1/19/2010 CHK sold 100 28.20 2812.96
          637.64
 

January 13, 2010

Bought ITB put, bearish on housing

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I have been bearish on housing for about a year now.  Evidence of this can be seen here, when I first shorted ITB (betting against US Homebuilders) back on Feb 6, 2009.  I remain bearish on homebuilder stocks because I am skeptical of an economic recovery, question the supply/demand of the market, and believe valuations are expensive.  Let’s take these one at a time.

I hesisitate to believe a bounce-back economy is upon us.  The all-inclusive unemployment is 17.3%.  Even worse, manufacturing jobs are slipping while service jobs, like government positions are holding steady.  Further, with the decline in credit, I can’t imagine many companies are expanding their capacity to produce (via more factories/machines).  With fewer manufacturing jobs and without investments in production capabilities, how can an economy produce more to enable a recovery?  I have read that even if the data somehow shows a recovery, it will be not only a jobless recovery, but a job-loss recovery.

To get a sense on how unemployment affects the housing outlook, consider this from Mark Zandi, chief economist at Moody’s Economy.com:

A soft job market, especially one this soft, means potential buyers don’t have money to pour into new homes or the confidence that they’ll be able to hang on to their jobs and pay the mortgage on their existing home.

Combine the weak consumer with massive mortgage rate resets (most of which are unlikely to have been modified), and it’s easy to see that supply is likely to outstrip demand.  Reasonably thinking, if consumers are unable and unwilling to purchase houses, homebuilders will have difficulty profiting from not selling houses.

To further strengthen my argument, Pending Home Sales increased in response to the government’s tax credit for first time homebuyers through October.  Then, when the tax credit was originally set to expire in November, Pending Home Sales dropped.  Now that the tax credit has been extended to April, prices have again mitigated.  This means that the deciding factor in home sales has been the tax credit.  All this is doing is pulling forward demand.  May I kindly remind the audience what happened to car sales following the end of the cash-for-clunkers program:  demand dropped to below where it had been before the program started.  I believe that since the tax credit has existed for a longer duration, the drop in home sales will be more severe.

CashForClunkersGraph

On to valuation… Yahoo shows the P/E of ITB at 23.7; given my thoughts above, I think this is absurdly high.  Perhaps earnings are depressed, which could warrant a high multiple.  However,  I argue that earnings will continue to be depressed, at least through the first half of 2010.

As far as execution goes, I would have liked to have shorted an additional 100 shares of ITB, but there were none left to borrow at my brokerage.  So, I purchased 3 put contracts at the July $17.50 strike, for $4.70 each.  Considering ITB is trading at about $13 per share, I am quite content with a $12.80 break-even price.  I’m hardly paying a premium–only paying $0.20 for six months of time decay.  (For the options gurus, the volatility was 30, which is what I consider an inexpensive option contract).

A final note…  One of the neat things about trading options that are deep-in-the-money is that sometimes you can see your volume.  If you look up the .ITBSW option, you can see three contracts traded today; those would be mine.  I have displayed this below in the red circle.  To the left of it, you can also see the $4.70 that I paid for each of them.

 

January 11, 2010

Welcome New Visitors

Posted by n_cavallaro under All Commentary
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Since there has been a large increase in visitors this week, here is a 10 second table-of-contents:

1>  To read my most recent article, click here.  For the article that made a name for myself, click here.

2>  For my portfolio performance in 2009, click here.  For my 4th quarter performance in 2009, click here.

3>  I publish all of my stock trades; to view them, click here.

 

January 4, 2010

Hussman article 20100104

Posted by n_cavallaro under All Commentary, Hussman Commentary
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Hussman’s article is a little lengthy, but a good refresher.  Reading his point of view continually strengthens my confidence in the ‘open minded approach’ perspective.  Here are a few highlights:

“The best way to destroy the capitalist system is to debauch the currency.”

Vladimir Lenin, leader of the 1917 Russian Revolution

“My impression is that investors underestimate the risk of assuming that those problems are solved because we are riding a wave of deceptively “costless” government bailouts.”

http://www.hussmanfunds.com/wmc/wmc100104.htm

…I will have 4Q09 Performance data up on the site soon!

 

December 19, 2009

Recycling the CYN trade

Posted by n_cavallaro under All Commentary, CYN, Stock sales, short sales, Trade History | Tags: |
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Recycling the CYN trade

On Friday afternoon, I shorted 50 shares of CYN at $41.22.  This is a recycled trade from August, but the investment thesis has slightly changed.

This is not financial health story.  I am not shorting CYN based on capital ratios, a speculated dividend cut, or anything to do with management.  I have no gripes in any of these areas.

Shorting CYN is a valuation story.  This is a California economy story.  This is a creditworthiness story.  This is a market is overvalued and going to harm CYN on its way down story.

From the August article, three arguments remain sound.

  • The market is overvalued at 1,100.  CYN is defenseless against a market decline.
  • Credit problems will hamper earnings.  Oncoming mortgage reset rates (Option-ARM & Alt-A) will be problematic and of lengthy duration.  When loans fail to be repaid, CYN will suffer.
  • California is of the four worst states to conduct business (the other three being New York, New Jersey, and Illinois).  The state has severe fiscal woes and rising unemployment.  Last week’s edition of The Economist publicized this in an article, stating that California has unfunded liabilities for retirement programs exceeding $100 billion through the next six years.  An unhealthy economy is sour news for banks operating within it.

Further, on a personal level, I am trying to increase my short exposure to better align myself with my portfolio allocation goals (which I am hoping to publish in early January).

One concern I am aware of is that 24.7% of float is short.  So, there is the potential that other short sellers simultaneously exit their positions, which would temporarily increase the stock price.

Other Reasonably Thinking news:

I still presume my option on SDS will be put to me.  (Though, this is not yet reflected in my account).

Also, I’m drafting an end of year page which should be up in early January.  Stay tuned!

 

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