Paradox?

How can the housing market be the worst in 35 years, the trade deficit at record levels, GDP growing at a stagnant 1.6%, and consumer sentiment at a 14 month high?

First of all, I believe that the high trade deficit signals strong consumer spending. Second, I believe that inflation is 3.5% lower than it should be. The answer is in how GDP is calculated. I think that GDP is under-reported by a wide margin.

I will research this and post an update later.

GDP news...

I don't think theres anything unexpected or new here. Housing construction fell 17%, taking 1.12% off GDP. Inflation took off maybe 3.4% (although that's not reported here).

Forex news. My new strategy of playing the dollar according to the Moore Inflation Predictor (see Inflationdata.com) is working better. I didn't take any profits on the first position, but I did change it before taking any losses. Today I picked up 67 bips on the Pound.

Maybe the low GDP numbers caught some people off guard after all. I guess it's time to say what I see coming up (possibly). I see at least two more quarters of bad housing data. I also see worse numbers for next quarter's GDP, because inflation will come back. However, the continued high trade deficit and high consumer confidence tell me that the consumer has shrugged off the housing collapse.

However, I hope that things look worse next quarter because that will create a great buying opportunity. In the meantime, keep riding the market up.

they're hiding data.

I smell something fishy. This article has every bit of relevant data, except how much production increased, year over year.

I will need to do some digging to uncover this...

But here's a guess: 17%. (Remember Hurricane Katrina a year ago this quarter?)

analysis of AMD

Today's headline aquisition of ATI by AMD highlights the significance of strong internal fundamentals for a company's performance. Here are the specifics from AMD's press release:
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Under the terms of the transaction, AMD acquired all of the outstanding common shares of ATI for a combination of approximately $4.3 billion in cash and 58 million shares of AMD common stock, based on the number of shares of ATI common stock outstanding on October 24, 2006. All outstanding options and restricted stock units (RSUs) of ATI were assumed. The value of the ATI acquisition of approximately $5.4 billion is based upon the closing stock price of AMD common stock on October 24, 2006 of $20.32 per share and excludes the value of assumed equity awards.

AMD financed the cash portion of the transaction with a combination of cash and new debt. AMD obtained a $2.5 billion term loan from Morgan Stanley Senior Funding, Inc., which, together with combined existing cash, cash equivalents, and marketable securities balances of approximately $1.8 billion, provided full funding for the transaction.
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AMD saved $290 million (over 5%) on the aquisition. Anyone who bought AMD after its crash last week should benefit. This story highlights the good things that can happen to a company when it has good fundamentals that are overlooked.

PDC and Natural Gas futures

From now through December 2008, natural gas futures are over $7.50. Maybe they should be at $4.00. PDC should do well even with future drop in prices. Their business depends on being able to lease drilling rigs that they purchase or build in such a way as to get back their out of pocket investment in the rig with the first 2-3 year contract. Those contracts will keep coming as long as drillers can hedge their sales against a future drop in prices, in order to cover their lease with future production. If the natural gas market holds up, PDC will be able to command a huge premium for the rigs that are coming off their contracts from 2-3 years ago.

PDC is at $13.29. They have $1.73/share in cash and no debt. Their operating cash flow is $2.40. Their P/E is at 10.3. But that's not the true story. They reinvested $128 million in the company last year. That's 19% of market cap or $2.56/share. Their price times cash flow is 4.8, which gives an internal rate of return of 21%.

Thoughts on Saturday's Barron's

I predict that the market takes off for the rest of the year. Barron's had about a dozen reminders of the pessimism in the market despite it's pretty good year, and recent new highs. Here are some gems:

"the higher the market goes, the further it could fall"

"the NASDAQ is still at 2342"

"it will take the Dow 168 years to reach 36,000"

These statements of fear make me very confident in jumping into sectors and stocks that up til now I was very reluctant to. Take the tech sector. I almost considered Yahoo! (YHOO) after it dropped 20% earlier this year. It's come back since. Microsoft (MSFT) was another consideration at $24.00. It's now at $28.00

Today's pick is AMD. After subtracting cash from the share price, AMD is trading at 4.5 times cash flow. That's a 22% internal rate of return.

right on the money

Fintrend's Moore Inflation Predictor is right on the money again. Bloomberg reported that core inflation was still up 0.2%, but overall inflation was down (see yesterday's post for explanation).

Here's the MIP chart from last month:

Here is the new chart, updated for September inflation:

The new chart clearly predicts lower inflation over the next year than the August chart. It still shows a bounce in November and December, and then a downtrend for the next 10 months. However, the range is very different. Instead of a 3-5% range, the new chart predicts a 2.5-4.5% range.

I think this chart's value is mostly in the directional predictions, rather than quantitative. As seen by today's CPI, the chart predicted the correct direction of inflation, but was off by a considerable order of magnitude. The last chart predicted a 1% drop, but the drop was actually 2%.

what is seen, and what is not

Why is core PPI higher than regular PPI? Bloomberg reports that PPI was -1.3%, while core PPI was +0.6%. Easy answer. Inflation is trending down. A year ago, core inflation was lower than inflation because higher energy prices were still leading prices of finished goods, and secondary products. Now energy has dropped 25%, but that drop still hasn't found its way into manufactured goods.

$30 oil!

Well, now that I wrote the ridiculous headline, I'll tell you why. First of all, MSN Money is always wrong. Don't get me wrong, I like Jim Jubak. However, I never trust what MSN puts on their front page. Also, I don't think Jim is taking his own advice.
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I don't think that the oil-production quota cut of 1 million barrels a day recently floated by the Organization of the Petroleum Exporting Countries (OPEC) will be enough to stabilize oil prices near $60 a barrel -- too many producers who need to cheat and pump above quota in order to keep their own economies afloat.
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This jogged my memory of an article that I read a few days ago about Venezuela. The article said that Chavez has led his country to record fiscal deficits.

My prediction is that the lower oil goes, the more oil countries run by greedy megalomaniacs like Chavez will pump.

missed the boat on this one...

The Financial Times reported "the lowest level of wheat stockpiles in 25 years" today. On September 14th, I predicted that El Nino would lead to "rising crop prices and lower oil and gas prices." Too bad I didn't buy wheat futures at the time. They've gone from 450 to a current 528'4. I should have seen the signs: federal ethanol subsidies giving a greater incentive to plant corn, El Nino causing drought in southeast Asia and Australia, and high energy costs being passed along to consumers.

Well, maybe its time to look at cattle futures again.

apartment REIT's

The thought came to me: How do you profit from the housing slowdown without shorting the home-builders? Well, when people stop buying houses, more people stay in apartments. It was a good idea -- a year ago! I looked at half a dozen residential apartment REIT's. The conclusion that I drew was that most of them took off about a year ago, just when housing started to slow last fall, and shortly after the home builders hit their peaks.

airline news...

Airbus is out of the picture, and in the news. This is probably the fifth or sixth story about Airbus's woes that I've seen and it begs the question, "how can an investor profit from this?" Well, since most of Boeing's capacity is already consumed by orders from foreign airlines, this bodes well for airlines. It also bodes well for Boeing (BA), but that is already priced in by the market (Boeing's P/E is 33). Domestic Airlines, however, will benefit from a smaller supply of new planes.

Vive la France!

"The French economy grew by 1.1% in the second quarter, its strongest growth in 20 years, while German output expanded 0.9%, the best performance in five years." This was reported by BBC. Unfortunately, Socialism is a self-perpetuating disease.

This gives me an idea to think about: if global forces drive inflation, then shouldn't Europe, with its much slower GDP growth forecast inflation before the U.S.?

I'll have to think about it.

full circle

My thoughts have come full circle. Just to keep myself honest, I have decided to re-examine my long-held (about a year) working assumption that globalization and Chinese imports were inflationary, not deflationary. However, an ever more efficient and freer trade organization should be deflationary, at least on the labor end. On the other side of the equation are raw material costs. Due to the global rise of earth worship, the worldwide regulation of miners, drillers, and explorers has put emormous pressure on existing supply. These two pressures have to be considered, along with others. Other considerations that may or may not have a meaningful impact on global inflation/deflation are the rate of technological advancement, global stability and popular freedom, the policy of central banks, and others we may not have considered.

rethinking and thinking...

What will housing do to the economy? That is the question which will determine all the other answers in the next few months.

Let's revisit some recent history. After the stock markets lost $7 trillion, why was the 2001 recession so mild? Because interest rates were lowered to record lows. That lowering of rates dropped the dollar against the Euro by 25%. A weak dollar has fueled China's growth. I am starting to rethink my overall position.

This article caught my eye, and jogged my memory. First of all, it reminded me of a Merrill Lynch presentation where Richard Bernstein said that the government only counts 401(k)'s and IRA's as retirement savings. If Joe Smith buys 100 shares of his company's stock because he likes working there, that counts as spending, not saving. Richard estimated that the real savings rate was 8%, not 0%. This article tells me that there is $6.4 trillion doing nothing. That's a lot of money that won't be going into housing, or commodities if they slide. If rates are lowered, that money won't go back into CD's or bonds. That money will go into the market.

The second thing this article reminded me of was a sentence in the Zeal report a couple of weeks ago. I guess it's been bugging me in the back of my mind. The report said that the technical data from the chart suggested that the fundamentals were strong. I don't know why this article reminded me of this, but in remembering it, I immediately realized that the reasoning is backwards. Technical analysis should be used after a fundamental valuation is taken, in order to determine the timing of the trade, or the price to look for. In other words, fundamental analysis answers the question "what?" and technical analysis answers the question "when, or where?" This realization has made me more skeptical of the Zeal's idea of a continuing commodity run.

Back to our question: "What will housing do to the economy?" Well, housing is directly tied to the consumer, so let's see how much housing will really hurt the consumer. Now, the money on housing is already spent, so to speak, so the most painful thing will be ARM payments going up. Let's have some fun with numbers. $1 trillion in ARM's adjusts next year. The average loan is $150 thousand. That makes for 6.67 million mortgages. Let's guess that the average monthly payment goes up $200/month or $2400/year. That's only $16 billion. That seems a very small number.

What if the housing market slowing will turn the consumer from housing spending to other spending since wages are finally growing?

What will housing cause? If housing gets bad enough to cause a recession, what will happen? First of all, a mild recession like the one we had in 2001 would not be the end of the world. A little bigger one like 1997 would hurt a little, but we'll come through fine. Bottom line: I think housing will have a long slow slide, and the stock market will have a couple of bumps before it takes off.

I think commodities will continue will give up most of their gains for the last year or two on recession concerns plentiful supply.

This supply needs to be watched carefully to determine which industries can keep up with demand and which ones can't. I think that oil has the most oversupply of any of the major commodities. Since may, Saudi Arabia has been cutting back on production. Just today, it was announced that Nigeria is cutting back production 5% and Venezuela has already cut back by 22%. I am hoping to see a price war when greedy egomaniacs like Chavez realize that they can't stop the slide in prices by cutting back on production.

My bet: oil at $30 a barrel. Well, that's for the shock value. I think a more reasonable target is $39 (half of the peak).

How do we cash in on this bet? United Airlines (UAUA). Their profitability is leveraged to the price of oil. If oil declines, their 0.40% profit margins may pick up a point or two. Each point is worth 60% of current market value, and fuel costs are about 1/3 of total costs.

Also, gold stocks keep looking better and better. Gold is back over $600, but most large gold stocks are sitting near their yearly lows. I think the best bet is the Gold Miners index ETF (GDX). The ETF combines the relative safety of the larger gold companies, along with the smaller takeover target companies.