Finally Something I Can Agree With Obama On- I like The Dog In The Picture

The title and the picture have nothing to do with this posting. I just liked the dog since it looks like our Gertie. Gertie, by the way, is proving to be smarter than our President as she has no dilusions about who she is, or what she wants. She doesn't confuse herself with Hugo Chavez' dog while Barrack does seem to be channeling Hugo in his quest to turn the USA into a South American economy. Enough about dogs. As far as Obama, he may not be the cause of the market sell off, but his rhetoric and posturing sure are not helping the situation.

A brief review of my last several posts makes me look pretty prescient. While I said start getting ready for another slide, I didn't really expect it to occur immediately. Any brilliance I possessed is luck. I was confident in the direction and very lucky on the timing. Happily I took my own advise and haven't been beaten up.

The big question is how long and how deep will the sell off be? Wish I knew. I listened to an hour presentation yesterday by Bob Doll, Chief Investment Officer of Blackrock, who was coherent and logical, as he always is, and made a good case for 2010 being a positive year for equities. I can't fault his logic, but my stomach thinks otherwise. He gets paid better than me, has better data at his disposal, and has spent more time thinking through various scenarios, but if he is right, it will be one helluva roller coaster ride getting there. He named all the headwinds that we will face, but thought that massive stimulus and inventory rebuilding will lead stocks higher. It could happen, but I don't think it will.

In a nutshell, you don't need inventory if people don't buy. Sales tax receipts say the consumer isn't buying. Business won't replenish inventory, again, unless the consumer starts to step up and feel better. That won't happen without a much more robust job market. That appears years away. All of the bailouts,stimulus and jobs spending has spooked the public and ultimately it will spook the bond market. Visions of the future are presented daily from Greece, Iceland, Ireland, Portugal, and Spain. These evolving problems will translate into higher US interest rates and compete with equities. Higher bond yields mean that equities will need higher earnings yields, the inverse of the P/E, and earnings will not grow enough to compensate for declining P/Es.

I have no confidence in Obama being a positive in our recovery. He's ideologically opposed to being business friendly. Therefore, I don't think the consumer, nor business, is going to start gaining confidence and our economy will remain weak. China and Brazil will not grow at levels to ignite our economy. The only potential bright spot for 2010 is the same one i identified last year and that is M&A as solvent companies need to grow somehow and when organic growth isn't available, you do acquisitions. Lazard remains the purest play in M&A and is huge in restructurings which we will see lots of as the world sputters.

Mr. President, for popularity purposes, you need to be seen more with dogs. I like dogs, especially little white dogs.

What Will Monday Bring?

After three days of misery, caused by a combination of potential Chinese fiscal restraint and Obama political expediency regarding bank and Fed bashing, investors are recooperating and wondering what Monday will bring. I believe we will see more selling as everyone knew stock prices were too high, but were playing a game of musical chairs as they wanted to continue to make money while momentum was pushing equities upward. Everyone thought they could exit before the downdraft.

Just as Massachusetts changed the political landscape, the past three days have reinforced what investors knew, but didn't want to accept. Stock valuations had been too high and everything was not improving. We aren't in for a quick bounce back. Gains should be protected and speculations reduced. Selling will continue, causing a significant sell off until prices reflect a more reasonable multiple of earnings growth.

As I laid out a few days ago, my positions have been lightened with only about 25 percent in stocks. The remaining 25 percent still hurts. I feel lousy. Recently opened short positions in DFS and COF have paid handsomely. A large long position in K-12 has been reduced to only 5000 shares as I wanted to capture the gain and I felt the company would tread water till next September when school districts and parents decide on internet education decisions. Luckily LRN hasn't gone down in the downdraft and I've been able to sell at good gains. My remaining positions are largely concentrated in emerging markets and international companies. I haven't decided what to do with those.

While the past three days have been painful, the percentage decrease has been minimal. I'll look for more vulnerable companies over the weekend and sell them on Monday. Some up days will present themselves, but the tide has changed and investors are starting to treasure capital which means selling. My suggestion is to lessen long positions and add negative positions. As Charles Barkley says " I could be wrong, but I doubt it."

Sales Tax Receipts Reveal A False Recovery

The concensus view is that the Recession is over and the economy will grow at a 2-3% pace in 2010. All prognosticators hedge their bets by reminding the public that the recovery may not feel good and employment may not grow robustly, but GDP will be increasing so we are on the way to prosperity again.

I haven't joined that camp. You cannot solve a debt crisis by simply swapping the obligor of the debt. Instead of over-extended consumers and real estate developers, we now have the US government, ultimately the taxpayer, on the hook. The big question is how long before we must face the music.

The stock market's current game of musical chairs is about to end. Everyone, including myself, thinks they will be able to find an available chair as the music stops. That's not reality. A significant test is coming soon. While 4th quarter earning reports are likely to look good when compared to a vile 4th quarter in 2008, that will only mask the state of the economy. The Liscio Report has noted recently that preliminary sales tax receipts for the current period are down dramatically. They have not been bouncing back as the job losses shrink, the GDP rises, and the stock market flourishes. Real money that the states receive, from consumers, is shrinking. Hence, the market has gotten ahead of itself. This will be an eye opener for all playing the musical chairs game.

My ultimate goal, as a retiree, has been to transition from a heavy dose of equities to a more conventional fixed income strategy. That hasn't been easy as yields have been so low on bonds and the government's spending ultimately will cause current holdings to lose value as rates rise. And rise they will. While I've admitted to playing the musical chairs game, I've started to lessen positions as of last Friday. When it becomes well known that sales tax revenues, about the only calculation available that isn't an estimate, are not improving, the stock market "should" pull back. Timing is difficult, if not impossible, so if the music plays for much longer I will rue my decision. But, I'll be well rested and still have my principal and rates have been rising. Even if you are old life is a journey.

So Cold I Might As Well Write

The nipples on my man-boobs are hard, but you can't tell as I'm wearing three layers of clothes and have a fire in the fireplace. As a "snowbird", I'm in Florida for six months and it shouldn't be this cold. I know I won't receive any consolation back home in Nebraska, so I might as well gripe to readers. The weather sucks so lets talk investments.

I'm having trouble concentrating on my typing as I'm powerfully drawn to the set of real tatas to my left. Unfortunately, of late, you won't see any of those either in Florida as they too are clothed in three or four layers. What does this have to do with investing money? Not a thing.

Everyone that is in the stock market has ben enjoying themselves. retirees and those that are sitting out the rally are miserable and going broke. Those straddling the fence need to be nimble as the game of musical chairs is in full swing. How long will the music continue to play? Warren Buffett once said that you can go broke waiting to be right and he's not only the guru, he's correct. This party could go on for quite awhile with the Fed's cheap money and support. But the rest of the world's central banks aren't as accomodative.

The wheels are starting to fall off in Europe and a German led bailout doesn't seem imminent, so the weak sisters will have to pay higher interest rates to roll over their debt. That thought process will be catchy and investors will look askance at other countries that are spiralling out of control besides Greece, Ireland, Iceland, Italy, and Dubai. U.S. rates are going up and they will continue to march upward much to Obama's chagrin and the retirees glee. At some point in the process the stock market starts to look not as attractive as we still have all of our economic problems and, finally, an alternative investment. Remain nimble with equity investments as problems lie ahead. I just don't know when the tipping point will occur. One thing I do know is that it is easier to concentrate with the nipple image at the top of the page and out of sight!

My portolio is about 50% invested in equities at present. I wish it was fully invested, but I like sleeping at night and as an oldster, I don't have the ability to rebound over a long period of years. I continue to write covered calls and gather dividends during the march of the music. Those types of stocks will decrease less and at a slower pace than the market in general, but even conservative stocks will go down when the market swoons.

Watch bond yields and lighten up as they rise. Ten year yields have been on a march and should continue to increase, but concentrate on the shorter maturities. As they move, exit or lessen your equity positions unless you have long time horizons and no need for cash.

Cabela's Remains Inexpensive

I opened a position in Cabela's about two weeks ago at $12.00. At the time it was selling for about 3.5Xebitda and less than book value. I didn't catch the bottom, but CAB has moved up about $2.50 quickly.

Besides being a retailer, CAB has a large credit card bank, World's Foremost Bank, that not only confuses the numbers, but scares investors. Cabela's runs a conservative book of credit and has experienced better deliquencies and charge-offs than it's industry peers. It also securitizes asset backed bonds and, like other banks, faces the prospect of putting those assets back on their balance sheet and having capital available for support. There was a dilution worry.

The company addressed the new accounting issue that causes the securitizations to come back on the balance sheet by increasing their line of credit and making allowances to contribute enough capital to its subsidiary, WFB, so there won't be any dilution. At 4Xebitda[ttm] CAB sells at a discount to competitor DKS and most other retailers. Earnings have been decent even during the past year so, with the credit card concerns waning, the stock could march upward to 6Xcashflow which would be $20. It hasn't been at that price in the past several years, but I'm hoping.

Since I was becoming light headed and buying retailers, I also bought PSMT. It is the reincarnation of Price Club. When Price Club sold out to Costco, the owners opened up a Central American operation that now has 25 warehouse clubs. I've convinced myself that this is an international diversification investment, not another retailer.

I'm attempting to stay nimble as I still do not see a lot of sustainable signs of prosperity.

Waiting For The Next Shoe To Drop

Everyone feels better after the market's spectacular rally in 2009. Almost everyone is leery of the sustainability of such a rapid rebound. The investment world continues to play financial musical chairs even though they collectively know better. The Fed's zero interest rate policy has taken safer investments off the table and the Government's spending will ensure future inflation that will harm bond holdings. So, equities continue to march upward. But, for how much longer?

At some point, even the brave and foolish will become fearful. Since everyone is playing the same game, investing in stocks since there isn't an alternative, the rush out the door, when the time comes, will be crowded and painful. What might cause that panic? Here are some guesses.

So far Australia has raised rates twice lately and a Scandinavian country also increased short term rates and has signaled that they were starting to take stimulus funds out of the system. Other countries are starting to talk the talk. A rate increase trend could signal that the U.S. won't be too far behind.

Iran's latest announcement, that they will build another ten enrichment facilities, was not the news that Israel and Obama peacemakers had hoped for. The deadline nears. When the Israelis attack, Iran will retaliate somehow. The markets won't like it and prices will tumble during the panic stage.

Soft demand has held oil prices down. Middle East turmoil would accelerate price spiking and have an immediate, negative impact on the economy. Even without war, the declining dollar and flight to commodities may drive oil higher with the same result.

A failed Treasury auction where buyers demand significantly higher yields than anticipated, would signal to the world that the world views the U.S. as a weakened credit and not worthy of cheap interest rates.

Dubai's debacle is being softened by the UAE's potential willingness to help. Greece, Ireland, Spain, Italy and a few other Euro zone countries are also having significant problems with their sovereign debt chewing up a high percentage of GDP. Will the Germans come to their aid? A major country default or restructuring would not be pretty.

Jobs, jobs,jobs are on everyones mind. We've all heard that job growth is a lagging indicator and that we will start to see job creation in 2010 as the recession has officially ended. A stubborn jobs number; one that continues to stay negative well into 2010, could ruin any rebound in confidence and affect the market.

After passage of a healthcare bill, immediate work on Cap & Trade could cause further concern as the impact on the economy from both of those gigantic, negative pieces of legislation will tax both business and the consumer.

Finally, maybe we'll wake up and realize that the "new normal' doesn't justify current stock prices. My bet is that won't happen, but one of the other scenarios, or one I didn't anticipate, I've listed will cause stocks to find a lower level. Cash will feel comfortable, even if it earns little, if the market tumbles during the first half of 2010.

Archipelago Learning Off To a Fast Start

The marketcap lines may soon intersect and with the upstart becoming more valueable. K12 has revenues of $350MMish and a marketcap of $523MM this morning. Archipelago, in its first day after its IPO debut, has convinced investors that its $40MM of revenue is worth $469MM. Shares are up about 13 percent since yesterday's IPO.

I'm hopeful that some of the luster associated with ARCL will rub off on LRN, a similiar story and, I believe, a better investment.

More Bank Dilution Looms

Investors in financial shares have fared well this year as almost all are significantly higher than their March lows. Those that bought shares near the lows have obviously fared better than the original owners. But the time has come to be wary. Dilution looms, again, on the horizon.

Banks have had ready access to capital this year as they attempt to work through their myriad mistakes. First, the Government provided needed support, then hungry investors started lining up to buy financial secondary offerings. The result was the same: loans were written off, capital depleted, new capital acquired, and original investors diluted. Painful only for the original owners.

While mortgage and credit card loan delinquencies are still at record levels, commercial real estate lending was poorly underwritten and is now showing serious weakness, another capital consuming issue is raising its head. On January 1, 2010, FAS167 will take effect unless delayed. The effect will be that banks must set aside additional capital to support off balance sheet credit card receivables and other securitizations. Whether or not the assets are brought back on the balance sheet or not, more capital must be found to support the potential risk of implied recourse. The big credit card issurers, JPM,C,WFC,BAC,COF, to varing degrees, will be affected. Since current capital isn't plentiful, they will sell more shares and dilute the current base.

Several days ago, First National Nebraska, a moderate sized regional bank with a large credit card operation, filed to sell $250 million of new common and preferred securities. The major reason given for the decision was the need to support off balance sheet credit card securitizations. The decision to sell new shares was a difficult one for First National as it is owned, almost exclusively, by one family. They felt the need, and pressure, to dilute themselves to comply with FAS167. What do you think the professional, non-owner, managers will do? Yes, sell new shares to whom ever will buy them, Government or public.

Setting aside concerns about the remaining potential loan losses and adequacy of loan loss reserves, capital raising is coming again to the banks courtesy of the accountants and transparency. Bank shares will be worth less in 2010.

I'm Rooting For The Oprah Effect

This past week has been an excellent news period for Smart Balance. The price of a share of its stock reflects the improved news flow. What's new? Here are the announcements:

1. A new credit agreement with relaxed covenants. The company stated they still expect to comply with the old covenant thresholds, but they don't have to. they now have added flexibility to grow. Moody's upgrades to stable.

2. The national roll out of their new milk product. After test marketing in Florida and the Northeast this year, SMBL will go nationwide in 2010. The milk business is considerably larger than the spreads market and provides the opportunity to grow sales, market share in the dairy isle, and profits.

3.Today the company announced an agreement with Bob Greene, Oprah's health and fitness guru, to develop and market Bestlife products. These healthy foods and drinks will carry the endorsement of Greene and, implicitly Oprah. Smart Balance will remain the premium products, with Bestlife a more affordable product line.

4. Steve Hughes, SMBL CEO purchased several thousand shares in the open market. A few days earlier a director did likewise.

All this news is nice and may move the stock upward, which makes me feel good, but Smart Balance is a five year play. If you have patience, I think we'll earn multiples of our investment when Hughes sells his then billion dollar company to a major food company for a considerable sum. I'm willing to wait.

Archipelago Learning's IPO Valuation Favors K12

Archipelago goes public on Thursday. The company intends to raise $100 Million, with shares coming approximately one-half from the company and the remainder from selling private equity companies. At the mid point of the anticipated offering, ARCL will be valued at $400 Million.

Providence Equity Partners bought the company in January, 2007 for approximately $85 million and owns 77 percent. Founded in 2000, the company had sales of $42 Million over the past 12 months. Earnings for the nine months ended September 30 were $6.9 Million while the net profit for the prior year was $1 million. ARCL has been growing their student enrollment and has recently enterd the high school market. Their business is basically internet based test preparation.

At $42 Million of revenue, and a market capitaization of $400 Million, the company is being valued at 10 times sales! The P/E of last year's earnings is 400! Interim results are up considerably, however I haven't delved into the makeup of the improved earnings.

K12 is a similar internet based marketer of lessons and test prep. Its market cap is a mere $550 Million and has trailing 12 month revenue of $330 Million or a P/S of 1.6, not 10. LRN trades at a forward P/E of 24, high but not the 400 or 40, depending on the time period, of ARCL. Both feature the cost savings of the internet, face state education cost pressures, but appear to be able to outgrow the reimbursement reductions. K12 projects earnings growth of 20 percent for 2010.

Today, after the ARCL IPO announcement, K12 increased $.71. I believe it will continue to move upward as investors compare the two companies. An investment in LRN garners a company that has more scale than Archipelago and excellent growth opportunities for a lesser, comparable valuation.

William Kabourek owns shares of K12