Wednesday, July 4, 2012

Cyclical Slowdown

There is a lot of worry about a cyclical slowdown in the global economy for the second half of 2012.

Weak economic data out of the US, Europe and China have equity investors very worried.
S&P 500 earning estimates are coming down and the cyclically sensitive sectors such as financials, tech and energy have dropped in response.  The US 10 year treasury interest rate has dropped to the lowest level in decades.  All of this worry seems very well discounted.

However, the analysts as still worried about further deterioration.  Goldman Sachs came out with a widely publicized "short the market" call - which they have since been stopped out of.  All of the big banks are issuing bearish calls on tech stocks.  In particular, I can cite stories about JPM cutting estimates of 18 different hardware vendors including AAPL.  Goldman Sachs is advocating buying September $22 puts on INTC.

What is going on here?
  1. Europe looks weak due to the numerous issues that they have there with sovereign debt.
  2. China looks weak.  This has a cascade effect on all of the beneficiaries of Chinese growth such as the energy and materials sector.
  3. Manufacturing looks weak across the board.
Despite all of this bad news, the economy could be more resilient than is generally believed.  As Bill McBride has pointed out, the housing market is looking very healthy.  There are a number of forces at work here.
  1. Inventories are low.  
  2. Investors are removing REO supply since the cashflows from rent far exceed the carrying cost of buying the homes.  Thank you Ben Bernanke for ZIRP.
  3. Population continues to grow and housing starts are at generational lows
As Bill points out, housing is a leading indicator of economic growth.  The housing data has just been great recently for all metrics including inventory, pricing and builder confidence.  This could provide a reasonably good offset to the loss of overseas growth drivers in Europe and China.

On this 4th of July, it seems like the the domestic US economy is poised to be the engine of growth for the world.

This provides plenty of opportunity to invest in names that have large US earnings exposure but have been sold off on these ancillary concerns.

Sunday, June 24, 2012

Investing in the Philippines

The Philippines seems to be breaking out of its dependence on remittance checks.

The population is largely English speaking and highly educated.  It used to be that the only way to prosper was to go abroad and return money back home due to the dismal lack of economic opportunity.  The main cause of this was an inept and corrupt government.  The instability of the government also lead to higher higher costs of capital to compensate for the additional risks.  The problem became so acute that the largest contributor to GDP was remittance checks.

Today, things are changing.  The Filipino command of English is much better than most non-English speakers.  They tend to have a neutral accent and they understand Western idioms which customers prefer.  This has lead to a boom in call centers sprouting up all over the country.  They have been so successful that this new business represents 5% of GDP with a trend to surpass 10% in 2016.  They are taking business away from India where accents are difficult to change.  Interestingly, they are not winning business by under-cutting  wages.  On the contrary, the better form of English demands a premium.

In addition to just call center duties, the Philippines is looking to move up the value chain in back office work.  Things like auditing accounts and other similar processes are being tested out by big firms such as JPMorgan.

All of this seems to be working as the Philippine economy is booming by outperforming their Asian neighbors.  The strength of the Peso against the dollar is also encouraging.

To get exposure to the Philippine market, I would start by researching the following ETF EPHE
If this new back-office economy takes off, the growth rates in the country would be enviable as the educated working class now has a direct means of income for which to kick-start a virtuous growth cycle.

For more adventurous traders there's always the PHP/USD currency trade or you may want to look into real estate in Manila.

The risk here is that the government devolves into yet another corrupt state of affairs.  Such is life in the Philippines.   However, the rewards this time around may out-weigh the risks.

Limits of Exponential Growth

If you haven't read this excellent dialog between a physicist and an economist, it's well worth your time.

Here the physicist argues that exponential growth (assumed by many economists) cannot last forever.  This is sort of obvious to mathematicians and physicists but not so obvious to others.

Of particular interest is the long term growth rate of energy use.  It's been a fairly constant 3% for hundreds of years and energy use correlates very well to economic growth. This makes intuitive sense as the more "stuff" you create, the more energy that you require.  Thermodynamic limits put a cap on this growth at some time in the future.  How much time do we reasonably have?

Well, if we continue with a 2.3% growth rate (chosen for a 10x increase every century), in 400 years the ground atmospheric temperature of the earth would reach the boiling point of water.

If you assume some very conservative parameters even taking into account alternative energies and dramatically increasing the efficiency of our energy use, you'd still come out to only another century or so left of this kind of growth.

What does this imply for investors?  Energy will become more scarce at a rate faster than the market is predicting.  This is especially true for liquid fuels.

You want to have some energy exposure in your portfolios.  Oil in particular is going to appreciate far faster than is generally predicted.

This all sounds very Malthusian, but he was actually correct - if only a bit early in his predictions.
Some of the very smart long term investors, such as Jeremy Grantham,  have picked up on this.

Saturday, June 23, 2012

Innovator's Dilemma Stocks

My theme here is to short companies that have their technologies obsoleted by competitors.  They are my innovator's dilemma stocks.  I am focusing on technology companies here because that is my area of expertise.  Certainly, this phenomena is not restricted to technology.

Here are some "obvious" names.  They are obvious in the sense that the market is aware of their problems and their stocks are depressed.  However, Jim Chanos says that valuation is the least important factor when considering shorts.
  • NOK
    • Losing symbian business faster than Windows phone can compensate.  
    • Shut out of WP8.  
    • Windows phone ecosystem is much weaker vs. Android and iPhone
  • RIMM
    • No one is developing for the new platform.
    • Not enough value prop vs. Android and iPhone
  • GME
    • Online game distribution threatens brick an mortar business
    • Existing stores face competition from larger players like Walmart and Amazon
  • GRMN
    • Core business is threatened by smartphone GPS software
Less obvious names can be the source of higher profits.  These are names where the valuations looks reasonable and the core businesses are still generating healthy profits.

  • NVDA
    • Their core business is split into 3 segments - discrete GPU, workstation and mobile
    • Discrete GPU
      • Competition from integrated GPUs from Intel and AMD are putting significant pressure on this business.  Both Intel and AMD are developing high performance integrated GPUs which should reduce component costs and offer a better price/thermal/performance value to notebook and desktop computers.
      • In the workstation space, Nvidia sells the Tesla product.  Look for Intel to enter this market with Xeon Phi which offer a better programming model.  Look for margins to compress with the entrance of another credible competitor.
      • The mobile space is where Nvidia hopes to get design wins for phones and tablets.  In the phone space, the lack of an integrated LTE solution will limit their market.  Their Tegra processors are also not as competitive as those from Samsung (Exynos) and Qualcomm (Krait).  In the tablet space, Nvidia should do fairly well with Windows RT.  The reason for this is that their software team is very experienced with writing Windows graphics drivers.  Expect the competition to lag here.  The risk with Nvidia is similar to the risk with Nokia.  Can they generate enough Tegra business to cover the inevitable losses in the other two businesses?
  • INTC
    • This one might be very controversial.  Their business can be broadly segmented into two parts - clients and servers.  Yes, they do have a software business with McAfee, but the core profit engine comes from their chips.
    • In the server space, I don't expect any credible competition here.  The competitors from ARM have to enter an ecosystem where Intel has dominated for at least 15 years.  Software inertia alone is enough to keep Intel in business here for a very long time.  Furthermore, their core CPUs are far superior in performance/watt relative to the competition despite their rather ambitious claims.  Intel is not standing still and has offered Xeon Centerton as a way to fend of the ARM camp.  This sever segment represents about 30% of the business
    • The client space is 70% of the business.  This is where Intel faces serious issues.
      • ARM is moving up the value stack with tablets.  Increasingly, people are using tablets to do things that they used to do with notebook computers.  The current data shows that they are not "cannibalizing" notebooks yet.  However, they are delaying the upgrades of current notebooks which is effectively a cannibalization.
      • Looking towards the future, ARM has ambitions to improve the performance of their chips to the point where they can run office software in Windows RT for example.  The advantage of ARM here is that they offer a much better price.  Tegra 3 is $25 vs a $150 CPU from Intel.   If the Tegra chip can provide a user experience that is comparable to an Intel chip, Intel will have a big problem.
      • The ARM software ecosystem is growing "up-the-stack" as well.
      • It doesn't take a rocket scientist to see that you could build a notebook with ARM processors much more cheaply.  This could cut off PC growth for Intel in emerging markets where the customers there are very price sensitive.  

Tuesday, June 14, 2011

Three Bears and Goldilocks

These three bears have been performing well of late as the market takes a turn away from risk assets.

Albert Edwards -
David Rosenberg -
Gary Shilling -

They are fascinating in that they go against the general bullish bias of Wall Street.

Here is a Goldilocks scenario:

The consensus is that the soft-patch in the economy is mostly due to transient effects such as an oil shock and a supply disruption due to the Japanese tsunami.  If this is the case, the equity markets should rally once the transient effects go away.  This would be a time to buy stocks and sell bonds.

Saturday, June 11, 2011

RIMM is taking a beating

RIMM is suffering from numerous analyst downgrades recently.

Here are a few analyst comments on the stock.

Susquehana - We believe RIM faces mounting risks to its market share and margins
UBS - we await clarity on how RIMM intends to fend off mounting competitive pressure 
ThinkEquity -Despite the 35% pullback in the stock ... we maintain our Hold rating
MKM Partners -We are lowering our 2011 estimates on product delays
RBC Capital -“soft” outlook for Q3
Goldman Sachs -rapidly deteriorating business
Morgan Stanley - launch of the remaining 4 BB7 devices may not occur until November

The one lone bull on the stock has this to say:

Sanford Bernstein - the worst case scenario is very unlikely to materialise in the next 2 years

Wednesday, June 8, 2011

Analyst Language

I ran the text of our analyst comment database through a word-cloud to come up with the picture below.  It's pretty interesting to see the language of Wall Street presented in this way.  They're all about 'targets' and 'estimates'.  It's a good thing we're keeping tabs on how they're doing.