Opinions and observations expressed on this blog reflect the authors' individual experiences and should not be construed to be financial advice. None of the members of this blog are licensed financial advisors. Please consult your own licensed financial advisor if you wish to act on any recommendations here.

Monday, January 31, 2011

Oh the pain of a fragmented market

Generally, it would be fair to say that Android is doing well as a collective enterprise, but two articles put together make one realize what the challenges are for those attempting to make some money on the rise of the smartphone OS.



Reading the first article, you would say, "Motorola has two of the top five selling phones. They must be doing well." and reading the second you would say "...What gives?" I that that this highlights a problem for the Android phone makers in that the OS itself is prospering while the companies making the phones are not, or at least not as much as one would think.

Sunday, January 30, 2011

Geopolitical Instability and Oil Shocks

James Hamilton at Econbrowser has a post that's as good on this subject as I could hope to write: http://www.econbrowser.com/archives/2011/01/geopolitical_un.html

I suspect that the outcome in Egypt will not be one in which the country is run by a radical government that seeks to send the West a message by shutting down the Suez Canal, but the markets may be wise in slightly discounting that possibility.

Friday, January 21, 2011

Let the States Go Bankrupt?

As I work for my own state's budget office, this headline got my attention: http://www.msnbc.msn.com/id/41188877/ns/business-the_new_york_times/

I think that those pushing this have a hidden agenda and are not as "concerned" about the fiscal health of the states as one might think. At the end of the day, very few states are in what I would call real fiscal stress in that very few sit around and wonder on a regular basis whether or not they can pay their upcoming obligations. Illinois and California are probably the only two.

The argument is, mostly, predicated around the discussion of future pension and healthcare obligations. Some studies have greatly exaggerated the level of underfunding for pensions and this is something I was hoping to address in a post this weekend and I still might.  However, if you believe those studies, then you might say that we have to let the states have a mechanism to jettison these obligations.

I will address this in further detail this weekend. Understand that anything I say is not the official position of the State of Wisconsin, but rather my own view of the larger issues here.

Saturday, January 15, 2011

How do bubbles happen? (A mechanical demonstration)

A lot of skeptics over the existence of bubbles like to believe that just because a market is clearing at a given price that it means that price is an appropriate valuation for that asset. They said this about stocks and they said this about housing. After all, if the price got out of line with what it should be, more supplies would come on line and knock the price down.

Well, there's an issue with that. At the end of the day, demand and supply for assets is driven by what the buyers and sellers believe they can get for those assets. That expectation should be reasonably informed by the rational expectation of future earnings (with stocks it is profits and with real estate it is an equivalent level of rent), but as we know it often isn't. When the expectation about future prices becomes detached from rational expectations of underlying fundamentals, the demand and supply curves take on a life of their own.

Click on chart for bigger image
Like all microeconomics exercises, this is crude, but it gets the point out. Demand curves are denoted with "D" and supply curves with "S". The red lines show the market at the starting point. Then, for some reason that could well originally be related to real fundamentals, demand shifts out to D-2. This creates the expectation among holders of the asset that future prices will be higher than current prices and so the prices at which each holder of the asset is willing to part with it increase, shifting the curve in and prices rise further. Skipping ahead a few phases, demand for the asset again shifts out as buyers are trying to race in as their expectations of future prices get wildly out of hand and supply again shifts in as the owners of the asset have their expectations raised as well. 

The problem is that all the while the fundamentals of the pricing of that asset have not changed to support these expectations. At some point, this is realized and both demand and supply shift back to their original locations, causing a fairly huge drop in price.

Now, the exercise above also happens on the downside as well. It happened in March of 2009 in a big way. That was a huge "negative bubble" where expectations about the future prices of assets were irrationally pessimistic. This was partially informed by really bad information about likely future earnings just as the housing bubble was partially informed by, well, lies that the typical return on a house price was between mid-single digits and double digit percentages and that prices could never ever fall. This was so pervasive that it made its way into mathematical models for the pricing of mortgage backed assets.

The point of all of this is that bubbles will always take place in the context of what looks like a properly functioning market. Let's take housing for a moment. A great deal of research suggests that the only factor that really matters for determining the direction and magnitude of change in house prices is the inventory to sales ratio. Housing bulls in mid-2005 said that we couldn't possibly be in a bubble because the inventory to sales ratio was so low (sometimes less than 4 months supply). However, thinking about this in terms of the exercise above, the reason the supply was so low was because the market was withholding supply that would have otherwise been on the market because sellers were holding out for higher prices because their expectations had become similarly warped. The bubble deniers essentially thought that a bubble would only exist if prices were advancing 20%+ in the context of an inventory to sales ratio of 8 or more. Once homeowners and developers began to develop more rational expectations about what they could reasonably expect for their future prices, supplies picked up while demand dropped due to buyers' expectations coming down.

This is all useful to think about when we look at China's housing market and also gold. 

Thursday, January 13, 2011

Gasp! Citigroup almost failed in 2008!

I have to say that this is the least surprising article I've ever read in my life. http://www.huffingtonpost.com/2011/01/13/citigroup-was-on-the-verg_n_808721.html

The thing a lot of people who don't know much about the financial crisis don't realize is that from about August of 2007 (yes, I know that I wrote 2007) through when the crisis hit in full in the late summer of 2008, we were at all times on the verge of a major disaster. It was just a question of what the tipping point would be. There were about a half dozen major financial institutions including Merrill Lynch, AIG, Lehman, Bank of America, Citigroup, Wachovia and a few others that were all so imperiled by their massive write-offs of mortgage related assets and/or bad loans that they were all just sitting around, waiting for one or the other to fail. Whichever one went would take the rest with them.

71% of Americans Want a Crippling Financial Crisis


So, 71% of Americans don't want to raise the debt ceiling, but they also don't want meaningful spending cuts or tax increases. In that case, the only inevitable result is default. Luckily, Congress will likely ignore the will of the people, as it should, and do the right thing here. This was an issue that many demagogued on during the recent elections, but really is not a legitimate issue unless you have a meaningful way of reducing the budget deficit.

Oh well.

Illinois and the state of local government debt


I think that Illinois' dramatic tax increase (which is larger than I have ever seen a state do) is evidence that state and local governments that face insolvency have the willingness and the means necessary to address their problems. Among major state and municipal governments, I really haven't found any that have so overexerted themselves to the point that they cannot reasonably increase their tax burdens or decrease spending by enough to make up the gap. As such, Meredith Whitney's assertion that there will be between 50 and 100 major municipal defaults is a little questionable.

Tuesday, January 11, 2011

Supervalu: Certainly not

So, Supervalu (SVU) had a huge plunge today on a weak earnings report and weak earnings outlook. Frankly, the grocery store sector is a terrible business to begin with and one that should always be stayed away from on a routine basis.

Now, a brief caveat here is that on forward-looking earnings the stock trades at something around 6x earnings, which is cheap even if they had total stagnation ahead of them. However, I think it might be worse than that. The stock has a sickly chart that indicates strong market suspicion of worse things to come. So far, SVU continues to prove the pessimists right.

Oh for the love of God. Belgium, too?


Belgium has long had heroic levels of public debt and recently an ailing financial system, too. This isn't a surprise, but when you look at a situation where Greece, Ireland, Portugal, Spain, Belgium and possibly Italy are all on the cusp it certainly does make the entire Euro region appear as a fetid turd. Take this together with the fact that Germany is growing increasingly unwilling to engage in bail-outs and that the German public is wondering why they continue to subsidize the weak members of the Euro-zone, it is becoming quite plausible that the Euro area will split apart. For some countries, it's even advisable

Now, while I have not been in the camp that says a run on U.S. debt is imminent, I do think that Congress' bold assertion that we may continue to cut taxes in the midst of a mammoth deficit raises the prospect. As we have control over our own currency, our ability to deal with a potential run is a lot stronger than that of other countries. Clearly, there is no sign of trouble in our bond markets at the moment, but debt crises can set in awfully quickly. Fortunately, we have a Federal Reserve that is able and willing to intervene as needed. Theoretically, if the market really freezes up, they can intervene and stabilize any blips.

By the way, in case you had any curiosity about the outcome of the next Irish election, don't. It won't even be close: http://www.irishcentral.com/news/Latest-poll-shows-continued-drop-in-support-for-Fianna-Fail--113189849.html

Verizon iPhone... Meh

Despite shrill articles such as this one from Bloomberg, the market probably has the reaction just about right which is that none of the stocks in question moved a whole lot on this announcement. Apple (AAPL) ran up in the last couple of months in anticipation of this, but didn't do a whole lot today. Neither did Verizon (VZ), AT&T (T), Motorola (MMI) or anyone else for that matter. I think that's because frankly there isn't the iPhone frenzy there once was and that those with existing contracts won't be that willing, or able, to switch immediately.

The article's assertion that half of Verizon users will switch from Android to iPhone seems a little ridiculous. I think that this was a classic case of an analyst not knowing so they just made something up, and something not particularly plausible. The problem that iPhone has in the long run against Android is that the Android universe of phones offers customers features in whatever configuration they might want. Additionally, in terms of hardware capabilities, by the next iteration of iPhone Apple will have to be playing catch-up big time against the new vanguard of Android phones.

There will be switchers, sure, but I just don't get the sense that the bulk of Android users are just clamoring to switch. No doubt, many AT&T users will switch, but that's a different story.

Saturday, January 8, 2011

Retail Underperforms

I mentioned in a December 16, 2010 post that retail had probably seen its best days as a sector and that one would have to be selective. As it turns out, that was pretty much on the money. The chart above shows the S&P Retail Index (RLX) trailing the S&P 500 as a whole and badly trailing financials (shown here by XLF) over the past month.

I suspect that retail will continue to underperform for a little while here. I'm not sure that this indicates much other than retail's gains were a little overdone. Nearly every leading economic indicator in recent weeks is broadly positive. 

Motorola's Split: Is each better than the other?

Motorola (formerly MOT) split into two separate entities in a long-planned divestiture that was put off by the calamitous financial markets in 2008 and early 2009. The two new companies, Motorola Mobility (MMI) and Motorola Solutions (MSI) followed a fairly logical delineation where the cell phone and set-top boxes pieces will be with MMI and the enterprise and business equipment side including RFID scanners, emergency dispatch systems, and mobile radios will be with MSI.

Interestingly, before Motorola became the champion of all things Android in the past 18 months or so, I would have said the MSI piece looked a whole lot better. Motorola's cell phone business was absolutely hemorrhaging market share to its various rivals to the point it was scraping along at about 5% as of the end of 2009 in the conventional cell phone business:

Credit goes to MobileMentalism.com
 In 2009, sales in the mobile division were down a whopping 41% from a year earlier compared to 21% in their home network and set-top boxes segment and 13% in their enterprise segment. None of that was particularly much to celebrate, but business had clearly begun to stabilize in 2010 with third quarter results showing 20% sales growth in the mobile segment, 5% in the home segment and 9% in the enterprise segment.

Clearly, Android has good prospects going forward and Motorola's offerings in particular have a great deal to offer. I happen to have the original Droid myself so I am a little biased, but I'm a fairly big fan. Of course, Motorola's fortune's are not tied entirely to Android since other manufacturers, including HTC, can just take market share from Motorola and the others in the context of a growing Android pie. There's a good article in the Economist that expresses some skepticism on this point.

However, the profitability of the enterprise segment, which is now MSI, is on more solid footing at this point. The mobile division has been bleeding money, though at a slowing rate, for some time. With improved sales, that should reverse, but the current state of things is that the MSI segment is the more profitable one at the moment.

As a shareholder in Motorola, I now hold annoying amounts of both and have to decide what to do with the respective positions. When I originally bought Motorola, it was based on the idea that Android would help revive the fortunes of their cell phone division. This ended up not paying off as soon as I had hoped, but the indications are that they are really starting to hit their stride now. On this basis, I'll place the majority of my bets with MMI, though I have to round out the MSI position because it is a very irritating 12 shares right now.  I like what I see in both segments, but I'll continue to bet on the Motorola mobile turnaround. In some ways, though, each is better than the other. In case you are wondering where I got that from, watch this trailer for a Fist Full of Dollars and For a Few Dollars More double feature:

Wednesday, January 5, 2011

Family Dollar Miss


Steve messaged me about this right about the same time I was reading about it. I think what we saw here was more a function of a stock that had gotten ahead of itself and poorly managed expectations than any kind of clarion call of impending trouble either in the dollar store industry or for consumer spending. Generally, I think retail has mostly seen its best gains, but consumer spending will still rise gradually and at an increasing rate over the next year. However, most of these stocks have already anticipated that.

Family Dollar (FDO), for example, had risen from $29 a share to $49 a share between a year ago and yesterday. Not too shabby. Of course, Family Dollar actually benefits relative to other retailers in a bad economy. However, even they will feel the pinch as many states and local governments reduce social services. Also, even with the unemployment benefits extension, the maximum length of an individual remains 99 weeks, which means that a huge proportion of those laid off in this recession have seen their unemployment benefits expire. When these people have literally nothing to spend, even Family Dollar will suffer.

What will be interesting is if the luxury stores such as Nordstrom's (JWN) and Tiffany (TIF) put some distance between themselves and the dollar stores as well as the discounters. If that happens, and I suspect that it might, I'm not exactly sure what it will mean.