Tuesday, July 28, 2009

Bernanke Recovery, Updated Trickle Down Economics - 7 / 29 / 09

The real question is why the markets are moving up. And the answers are telling. It's my view that cheap capital does not create opportunities for businesses to borrow or obtain growth financing, the type of 9,10, or 11% money that allows them to compete in new markets, or compete better in old markets. Standard loans of that nature are offered by Banks to their most stable, near risk free customers. Asset backed 9% money is excellent business for the top tier banks. These banks, who have been made custodians of our economy by the US government do not know how to lend or take risks on businesses the way they used to.

Financial institutions newly fattened on tax payer funds have no intention of using government provided funds to extend new loans to their existing or new customers. But these are the loans traditionally needed to jump start the economy. Instead they loan money to private equity managers and private lenders who have huge amounts of cash on the books, and permit the banks to hypothecate the risk to these private funds that seek to earn 20% annually. These private funds can't afford to lend at a few percent above what they are borrowing at. They charge 14% interest plus 20% of the loans value in equity. That's what a growth loan looks like these days in a best case scenario. What companies can afford to pay that?

Here's an anecdotal conversation I have recently had with a Tier 1 bank middle market lending officer (who happens to be a close friend of mine) that explains how the Bernanke / Geithner stimulus package really works.

Me - "We just acquired a company that needs some growth capital. It's a 15 year old business with revenues of $22.0 million, and $4.5 million in EBITDA. Currently it has a $5.0 million note on the books from a tier 2 bank. They have assets recently valued at $30.0 million. Shareholder equity is greater than $9.0 million. They would like to borrow an additional 3 million and refinance the $5.0 million into a single $8.0 million note."

Banker - "Well, I don't think its for us. Too risky. I but I could introduce you to 3 private lenders who would definitely give you a proposal."

Me - "How do you know these lenders?"

Banker - "We lent the money to them."

Now I understand that this conversation was held with a single bank, but I have received a similar response from at least one other top tier bank (Wells Fargo) and 2 mid tier banks. Banks don't want to take lending risk. They want to make easy money.

One way they do this is to acquire or build a good trading floor. This trading floor uses a portion of the capital on the banks books to trade / invest in equity, commodities, and secondary debt to generate profits for the shareholders. In good years they pull in 30% on the money - that's a great business. Margins on this type of business are terrific, even after paying high salaries. In a bad year the trading floor covers its costs. Rarely do they lose money. They have access to prime brokerage products. Prime Brokerage products rarely lose value. So why would banks do anything more than proprietary investments and lending to other lenders?

Given this model, for the Bernanke / Geithner stimulous package to work banks need to have enough cheap capital that they are inclined to trade a portion of it and in so doing put money into the capital markets creating buying and upside. This is what has caused the equity markets to rise, not value building in the economy. The real hope here is that the equity markets rise enough and remain at new highs long enough to entice IPO and secondary investors to return to the equity markets. Equity investments are the only reasonable money available to growing companies. And I believe that Bernanke and Geithner know this to be the case. Which is why the US government makes whatever announcements it can make to sustain or improve the equity market's performance. And it is also why the stimulus package will take a very long time to work.

Build Value Every Day

Bradford van Siclen

Monday, July 27, 2009

Perspective 2009 - 7 /26 / 2009

Its an interesting time for market pundits. On the one hand we are in the midst of a terrific market rally. But on the other hand there is really not much to base this rally on. It is the opinion of at least one pundit that the low of this market in March represented the gamblers / speculators worst case US economy valuation, and that recent highs represent these same gamblers / speculators view of a perfect year end US economy value. What we do not have is the rush of value based institutions and I wonder, do any still exist?

More troubling, A few months back we witnessed consistent "surprise" earnings to the upside, and a resulting market surge. Talking heads stated "The economy is showing signs of improvement", "Green shoots" and other knee jerk responses. But the truth is a bit more mundane.

In March and April the earnings surprises were based upon 2 key items:

1) the standard inability for industry and market analysts to accurately predict anything at all and instead heading their statements with negativity - "It's better to miss low than miss high". This concession to their fallibility combines with their refusal to recognize that CFO's of Fortune 500's are far superior to them in managing their businesses for the benefit of market valuation, and

2) the Fed had given all banks the opportunity to operate with virtually no cost of capital. Meanwhile the failed financial sector heavily infused with low cost government capital declined to lend to any new emerging businesses, or even new divisions of established businesses in favor of refinancings to businesses which did not need the assistance and the calling of loans from companies who did. That equates to some profitability gains for established companies as interest payment go down. But no growth capital for companies or divisions that need it - more on this later.

The Fortune 500 responded to this environment through the only methods available, by cutting costs (firing hoards of folks and eliminating expansion investing) then delaying the payment of current costs (increasing payables for example) and the results nearly across the board were lower revenues but higher earnings. Of course the esteemed analysts somehow did not anticipate the bottom line results. Thus the "surprise".

However we recognized this well ahead of the pack, and began looking at the companies who use these practices as a daily business method and were thus among the first to "surprise" to the upside. Our bellwether value companies - Dell, GE - both purged themselves of costs and balance sheet losses during the market's slide, leaving themselves with only one way to go, up, based upon fully disclosed and real value. I expect many of you disagree with my position on Dell and GE citing the continued negative press that seems to circle these two giants. But amid all the negativity take a look at their trend lines since March. Why does that trend line exist? Its called value. Sure there are companies whose shares have fared better on a percentage basis. But DELL and GE are our true value players. Limited volatility, tons of liquidity, tons of cashflow and assets, and excellent financial officers and management. They are big and mature.

I'll add one opinion on GE, I do not believe that the dreaded real estate investment write down that prevents its shares from breaking out will have impact on this company's share value at its current position. And once GE has inched its way above $15.00 there will be a rebound in another GE division which will offset the effects of a writedown of real estate assets. And then while no one is looking, GE will readjust its real estate valuation to proper (lower) levels and no one but the best analysts will catch it. More importantly, no one will care.

That's how its done in the big leagues value investors. And to me it is the most important reason to be a value investor. The mature value building companies can really do have magic bullets, cash, diversification of revenues, assets, and very agile financial departments who understand how to protect the value of their equity.

Which leads us to the recent earnings reports. More "better than expected earnings". It's my belief that any Fortune 500's (save those operated by risk loving CEO's) has at least 18 months worth of stored profits or losses "hidden" in their balance sheets that can be deployed at any time to react in the best proper way to the equity markets. [PLEASE RE READ THAT LAST SENTENCE] If the S & P had been down for the recent 4 weeks instead of up, these same companies would be producing earnings that would be at estimates or occasionally below estimates citing one time charges or a lack luster quarter. Think of it this way, anyone surprise to the downside over the last 5 months - Nope. Shocking given the economic environment. But not shocking given the equity market's run.

Build Value Every Day

Bradford van Siclen

Wednesday, July 15, 2009

There and Back Again - 7 / 15 / 2009

Times like these give a new definition to the term trading range. Here, the past 2 weeks Dow Jones Index closing prices:

7/1 8542
7/2 8280
7/6 8324
7/7 8163
7/8 8178
7/9 8183
7/10 8146
7/13 8331
7/14 8349
7/15 8519 -> at 10:30am

That is a 500 point or 5% swing over 2 weeks. The Financial media loves to scream market up 100+, market down 100+. But this simple table shows the real story, traders control this market and game other traders up and down based upon questionable government financial statistics and surprise earnings or revenues from Fortune 100's.

Meanwhile instead of investigating the reasons why unemployment, housing starts, bank lending seems to improve month by month, while the previous month's numbers are revised down to worse than previously reported virtually every time, CNBC has decided to focus on the new genius at Goldman Sachs (Blankfien), the marijuana and porn industries. One day we may see Lloyd Blankfien and Jamie Dimon speaking at the CNBC Porn / Marijuana conference.

Seriously, these matters leave me wondering whether the investment markets will return. And contemplating the recent Dow Jones price action, my thought is, it has returned. Investors are the support in the market, traders are the noise. Shut out the noise and focus on the 6 month trend of your favorite issues.

Select them because they are trading at real, conservative, multiples to earnings or enterprise value, and also because they have enough cash (or short term securities) to fake their earnings if they need to. Yes I meant to say that. Don't kid yourself. The biggest, best companies manage their earnings, storing them on the balance sheets when the market dynamics won't give their stock price a decent multiple for their full value, and pulling them off the balance sheet and flowing them through the income statement when times are tough.

Earnings, even for the biggest companies are lumpy. Somehow, unless there is a crisis or a one time event, they are not lumpy. This makes virtually no sense unless the company is a utility. But still GE, DELL, AXP, MSFT, XON, they all have consistent, managed, growth or earnings.

Occasionally I come across a writer from a major financial paper, in this case the Wall Street Journal, who some how sneaks through the Editor in Chief's cheer leading requirements and puts out out a quality piece of analysis. Rather than summarize it, I attach it below in full text (as you may imagine, I agree with him entirely):


The Bernanke Market

We won't get real growth until Congress and Treasury get policy right.


I remember once buying the stock of a small company and I couldn't believe my luck. Every time my fund bought more shares the stock would go up. So we bought even more and the stock kept climbing. When we finally built our full position and stopped buying the stock started dropping, ending up at a price below where we started buying it. We were the market.

Just about every policy move to right the U.S. economy after the subprime sinking of the banking system has been a bust. We saved Bear Stearns. We let Lehman Brothers go. We forced Merrill Lynch, Wachovia and Washington Mutual into the hands of others. We took control of Fannie and Freddie and AIG and even own a few car companies, pumping them with high-test transfusions. None of this really helped.

We have a zero interest-rate policy. We guaranteed bank debt. We set up the Troubled Asset Relief Program (TARP) to buy toxic mortgage assets off bank balance sheets. But when banks refused to sell at fire sale prices, we just gave them the money instead. Dumb move. So we set up the Public-Private Investment Program to get private investors to buy these same toxic assets with government leverage, and still there are few sellers. Meanwhile, the $1 trillion federal deficit is crowding out private investment and the porky $787 billion stimulus hasn't translated into growth.

At the end of the day, only one thing has worked -- flooding the market with dollars. By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn't put money directly into the stock market but he didn't have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear. Stock and bond funds saw net inflows of close to $150 billion since January. The dollars he cranked out didn't go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market.

The good news is that Mr. Bernanke got the major banks, except for Citigroup, recapitalized and with public money. June retail sales rose 0.6%. Housing starts jumped 17% month to month in May and will likely be flat for June. Second quarter GDP may be slightly up. And he was successful in spreading a "green shoots" psychology throughout the media. But the real question is, now what? Government interventions are only meant to light a fire under the real economy and unleash what John Maynard Keynes called our "animal spirits." But government dollars can't sustain growth.

Like it or not, the stock market is bigger than the Federal Reserve and the U.S. Treasury. The stock market anticipates only future profits and prosperity, not government-funded starter fluid. You can only fool it for so long. Unless there are real corporate profits from sustainable economic growth, the stock market is not going to play along. It's the ultimate Enforcer.

In mid-May, Mr. Bernanke's outlook seemed to change. Maybe he didn't approve of the sharp housing rebound -- like we need more houses! Maybe he saw inflation in commodity prices -- oil popping to $72 from $35. Or, more likely, he finally realized that he was the market and took his foot off the money accelerator, as evidenced in the contracting monetary base (see nearby chart). Sure enough, things rolled over -- the market dropped 7.5% from its peak, oil prices dropped almost 17%, and even gold has lost some of its luster. But in July, the Fed started buying again and the market rallied.

Can the U.S. economy stand on its own two feet without Mr. Bernanke's magic dollar dust? Eventually, but apparently not yet. Unemployment stubbornly hit 9.5% in June, according to the Bureau of Labor Statistics. Housing prices are still dropping, albeit at a slower pace, and foreclosures are still rampant.

But I think what really bothers the market is that the structural problems that got us into trouble in the first place still exist. We took the easy way out and, with the help of Treasury Secretary Tim Geithner's loose "stress tests," swept banking problems under the carpet. We waved off mark-to-market accounting and juiced bank stock prices to help them recapitalize, but all those toxic mortgage assets on bank balance sheets are still there as anchors on lending. All the pump priming and stock market flows didn't get rid of them.

Hats off to Mr. Bernanke for getting the worst behind us. He'll be pressured politically to keep pumping out dollars, but he should resist the urge. The stock market will ignore his dollars if it doesn't believe they'll turn into real profits. Green jobs and government health-care clerks do not make a productive, sustainable economy. That can only come from innovative companies with access to growth capital. The stock market won't turn bullish until it sees that type of economy.

Again, when it's clear that you are the market you have to stop buying and begin tackling the hard stuff. By not restructuring banks, by not getting bad loans off bank balance sheets, by not standing up to the massive increases in government debt crowding out private capital, the Fed and Treasury are holding back real economic growth. [END]

Thanks Mr, Kessler, real investors applaud you.

Build Value Every Day

Bradford van Siclen

Friday, July 10, 2009

When Will We Begin To Improve? 7 / 10 / 2009

The Stock Markets - what's up there? Frankly nothing. The government's bail out program of banks has not restored confidence. It has merely created a back stop. Value investors then grabbed onto the recent bottom created by the bail out and propelled by the "green shoots" commentary from Bernanke. And the market moved from its march lows of 6500 to June highs of 8800.

But I think he made a classic mistake, and spoke optimistically, not factually. Facts are valuable to investors. Optimism is valuable to speculators. The program he engineered with the Treasury has done only one thing - back stopped a financial markets slide into 1996 levels (5000).

This economy is still in clean up mode - this is anything but a recovery mode. And the equity markets are telling us precisely that. These markets are jumpy but will not advance until they can comfortably project growth.

The drag is big, its the biggest anchor the financial world has ever seen. Its a combination of a surplus of the asset that America once coveted (real estate)and a surplus in the basis of its value (US Dollars), topped off with more leverage than even PIMCO cares to guess at.

On that subject, ask yourself why PIMCO is making positive statements about the economy and the performance of high grade debt instruments every day? Because if they step out of line, the debt market and their portfolio will tank. They are compromised and begging for a recovery that can support interest payments. You think California is in bad shape now? In technical if not actual default? Who do you think holds the biggest slug of California Debt? (PIMCO). What conversations do you think they are having with Geithner?

Ask yourself, why is it that employment and consumer price indexes meet or beat (positively) expectations every month only to be revised negatively the following month..Because if speculators and investors both knew the truth - that the economy is still in decline - the capital markets would slide back to the March lows very very quickly.

I agree that the problem created was so large that only the government could have stopped the process of a reset in values that may have wiped the last 12 years of growth and value off the world's balance sheets. I agree that this government was heroic in its efforts to stop or stall this decline. But their job is not done by a long shot. The same characters who were in charge of this fiasco are still, for the most part, in charge. And they are now afraid to make further mistakes, afraid to take any risk because the government is watching them very carefully. All of a sudden their business models which propelled their stock prices to 2006 - 2007 highs are not functional in a regulatory enviornment with real oversight.

Our economic system depends on the ability of our best (in general) and brightest (in general) entrepreneurs and business men getting together and compelling lenders to give them a chance to develop their business.

Now, unfortunately these methods have been forgotten. The people who were competent in lending to growing businesses have been removed, down sized. Middle Market banks and local business lenders are still reducing their loans outstanding to businesses and the loans they are extending are refinancings of performing loans. Worse, the equity markets are languishing. So equity investors are very cautious about putting money into growing companies. In the past, tough lending markets led to accelerating private equity markets as investors searched for a return. Those days will return, but given the current economic enviornment, companies need to be cleaned up first.

They still have a long way to go. At this rate, November seems a likely economic turn around estimate -

Build Value Every Day

Brad van Siclen

Wednesday, July 1, 2009

7 / 1 / 2009

No changes in this market yet. The Dow Jones is still in the the grips of wealthy hedge fund managers who, lacking any real desire to evaluate discrete issues or sectors they view as momentum plays, are now satisfied moving large sums back and forth along the Dow Jones Index. Everyday these professionals show up and say "You have to be in this market and trade it.", referring to the myriad equity index trading instruments. They don't know when a turn up or down is coming, and so they are left protecting principal and speculating on daily moves. Clearly lacking in this market is position trading and investing.

One subject I happen to watch closely, but avoid spending too much time on is Gold. To me, gold is simply a hedge against loss of value in your currency of choice. Do you think the government is printing too much money? Do you think that the money supply is increasing? Do you think that interest rates are too low? Any one of these is a reason to own gold. But own it, do not trade it. Gold seems to be second to oil, the most manipulated commodity, in volatility on a week to week basis.

Lately the trading of this commodity is giving me great concern. Gold's action is a great indicator of future economic condition. And its action suggests great uncertainty in our economic near future with a very strong negative long term bias.

Beginning with a look at the 5 year gold chart an amateur can see we are still in the first leg of a Bull market in gold. That's bad for the economy. It says that investment professionals don't trust the future of the world and US economy to create value. As a market analyst with an investment banking back ground I learned early on that the only thing protecting an equity issue in the public market is its underlying value by fundamental standards. After the honeymoon and the speculation surge of an IPO, unless the company can produce stable earnings results, the value must ultimately go down. Gold is like the post IPO perspective on the world and US economy. Except that it rises inversely to prosperity. It speaks for itself in its value against the US dollar / US economy - here's a link to the 10 year chart against the dollar. If you are looking for expert perspective on the US economy, click on it or copy it into your browser window.


Financial writers have it easy. We have 360 days a year and myriad statistics to include or exclude in making our ultimate argument. I could very easily argue that the rise in gold is due to a dynamic industrial world that, driven by greater numbers of participants, primarily China and India, a gold shortage exists that production has yet to catch up with. And the supply and demand imbalance has created Gold's 10 year climb.

But that's not how I see it. What I see is the result of the US economy growing by virtue of financial leverage and cost cutting measures that have created little additional value since 2005 but at the same time created huge amounts of leverage.
Industrial production, which creates real value, continues to be imported by the US in exchange for US currency. US currency value continues to erode because its value is based upon the US economy's overall ability to repay the government's debt. That amount owed is offset by the US government's ability to repay loans through intl. treasury auctions that raise money to repay old loans and interest owed. Each time this occurs, money being borrowed to repay borrowed loans in conjunction with an economy that is creating less value during that time period the value of the dollar is dilluted and the US economy takes on more real leverage.

I have read that the value of an ounce of gold will eventually cross the value of the Dow Jones Index. I have heard ranges between 2500 and 6500. Either way its Armageddon if it occurs, and I for one do not agree that it will ever happen. My optimistic view is that ultimately the dollar will weaken to the point that manufacturing and industrial production increase in the US so value can be created which suggests more than a recession recovery. That will be a valuation overhaul and ultimately the restructuring of the US economy we desperately need.

Build Value Every Day

Brad van Siclen

Thursday, June 25, 2009

Bernanke Under Attack - 6 / 25 / 2009

Finally it would appear that Congress is beginning to wake up. Is this because its constituents, the American People, are finally catching up with the detail of the Fed/Treasury/Executive Branch's gross over stepping of financial powers? Have the American people finally realized that we have simply repeated the same mistakes of the past that brought us to this financial precipice? This government, in combination with investment and commercial banks that brought the American Real Estate, Industrial, and Financial systems to the brink of destruction, has now used leverage yet again to solve ALL problems.

Mr. Benanke is a bunch smarter than me, and he certainly speaks more clearly than Greenspan and, pleasantly is not at all sneaky like Greenspan was. So why would he be knowingly adding leverage in historic proportions to the largest pile of leverage ever created? The simple answer is that the problem is really so big that only the world's faith in US government could keep the US and therefor the world's economies from imploding (and entering a dark age of finance). Perhaps that is a bit dramatic. But this is the argument the US government would have us all believe.

But my fear is that there are darker forces at work here. CEOs of the world's financial corporations that are not only smart like Bernanke, but are exceedingly more street smart. You don't rise to the top of these institutions without being very smart, very expert, and very good at understanding and using pressure points on your employees, bosses, and regulators. And in the case of our recent financial crisis, these players who gamed the system with leverage to create fat returns for themselves, were able to compel Benanke and earlier on Paulson to save their firms..all of them but for a few sacrificial lambs - Lehman and Bear Sterns

Unfortunately for these CEOs, Bernanke is no dummy either. He has quickly caught up and has begun revealing the reality of the past bail out events. And what do the Financial CEO's do when they fear more dark secrets will be disclosed to the public at large? They do what they do best and use pressure points to redirect Bernanke's over all efforts. Somehow, miraculously, right at the moment Bernanke is requesting that Bail Out money not be returned by banks yet, his entire leverage package which has saved all of their jobs, and most of the banks they ran into the ground only 6 months ago - the CEO's are no questioning the merits of their career saving bail out packages.

Queue the anti- Bernanke debate. Drag him out in front of the congressional panel and begin knocking holes in the processes he funded. Remember though, he did not create these payment / bailout solutions - the Treasury did. The Fed's only job is to use economic data to determine the prime interest rate. The Fed can then use its balance sheet to prepare for the needed liquidity or contraction of the money supply as may be required by the regional Fed banks to support the financial markets requirements that a change in the prime interest rate creates.

Now, given the fact that the President uses any opportunity to give a speech (he's already given more televised speeches than Ronald Regan and George Bush I combined), why isn't Obama stepping up and giving a speech or a press conference in support of Bernanke? I am not certain. But I do not like it. It suggests that this engineered solution of the financial crisis is in serious question among the world's financial powers, that regardless of the stock market performance since hitting its March low, there are real concerns about the effectiveness of the financial rescue package. And the Executive Branch knows this well. So being politically astute they have used bi-partisan committees to put hard questions to both the Treasury and the Fed. Whoever cracks first will be the scapegoat should this bailout prove to have limited effectiveness.

So this market, and the near term value of the US economy as a whole remains uncertain. We have created liquid, efficient markets and added to it instant top level information. We have yet to determine the bottom of this market. It may have been in March 2009 - but its a long summer ahead. I still believe that the stock market will bet at 10,000 before the end of the year. But it won't be on fundamentals, it will be on speculation, better than expected dollar strength, a weak pound sterling, and a series of positve government and commercial bank performance releases. If we can't build value we will certainly speculate on its eventual return.

Build Value Every Day

Bradford van Siclen

Tuesday, June 23, 2009

Vaule Based Reality Bites - 6 / 23 / 2009

Yes, I have been silent for a period of time. I have done a bunch of thinking over the last few days. Here are my conclusions.

1) As an investor in equities, you are taking great risk in these markets.

2) There may not be any actual support levels in the markets, and there may never be again by traditional, technical standards.

3) On the other hand, there will be value and fundamental based support levels for discrete issues.

4) Investors can not ever be long term holders of single funds or stocks again.

5) Cost averaging works only with stop loss positions on each entry point. Averaging down means you have made a mistake and now are compounding that mistake.

6) Experts making daily or weekly market direction calls are not only fooling themselves, but they are also fooling investors.

7) The economy has not turned around, nor has it bottomed.

8) The dollar has begun, likely 2 years ago, its inevitable slide to 70% of its 2005 - 2006 values. World currencies are performing similarly.

9) Cash Flow remains and will always be King.

10) Gold is not an investment, it is a hedge.

11) Oil is a manipulated commodity, by governments, by traders, by producers. And because of this, the dollar is a manipulated currency as well.

12) It is not possible to be a long term investor in any traditional asset - real estate, commodities, currencies, equities, or bonds - given the lack of investment and financial experience at the US government Treasury, Fed, Executive, or Congressional levels. Without an expert and consistent theme from the US government, there will be no stability.

Watch your step very carefully.

Build Value Every Day,

Bradford van Siclen