2005-02-19 Report

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Bill's Portfolio:

This week I started a ‘Big Picture' thread on flash memory because digital electronics is driving demand for that technology. The future is video, which requires a different type of memory storage. And, the ‘big picture' stock plays I recommended are Kodak (EK), Sandisk (SNDK) and Lexar (LEXR).

As the cost of flash memory comes down, there is a broadening of technology applications underway, and a replacing of hard drive memory.

This week I recommended a put write on SNDK and closed it two days later for a gain of 37.5 percent. Then I recommended a switch from half the SNDK stock position into LEXR because of a current trial underway with Toshiba, which is interesting to the day traders, and that trade worked out well too.

Recently, I was recommending EK as well.

Now these are quite different size companies. EK has a $10 billion market cap, while SNDK is at $4 billion and LEXR at just $310 million. Other than point you in this direction I am going to stay out of a daily discussion.

A stock in the consumer electronic sector that is somewhat related is AAPL. Apple is a Steve Jobs promotion, and these days' people from Wall Street to Main Street are buying his lemonade. I'm not so enthused when I see a major part of a company (computers) going nowhere, but the whole company so highly regarded because of one part (iPod music player).

Apple (NDQ: AAPL) now has a market cap of $35.5 billion, and a PE of 70, which is perfectly priced. This company earned a net of just $276 million last year. The long-term chart looks like a reinvention of the 1999 Internet bubble.

AAPL is in a "melt-up". Therefore, as to risk/reward, I'm simply not interested.

Last week I wrote that what goes up, typically comes down, and in the case of AAPL, there is a serious mean reversion issue to consider. Then the stock went up another $5.60 (+6.90 percent), so what do I know?

The point is I do know. I know it's better not to be foolish with your capital, and I know that Apple needs to increase its earnings between five to eight times just to catch up to the current stock price.

My colleagues Tom Ott, Harry Jaloti, Ron Sen, Kaushik Gala, and Levi Bauer, were doing a group blog this weekend on AAPL, so it'll be interesting to hear their views.

They may not have posted their work yet, but they will this weekend.

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ETF:

These charts are for sectors 10 (energy: IYE), 15 (basic materials: IYM), 20 (industrial: IYJ), 25 (consumer discretionary: XLY), 30 (consumer staples: XLP), 35 (healthcare: IYH), 40 (financial: IYG), 45 (technology: IGM, IGV and IGW), 50 (telecom: IYZ) and 55 (utilities: IDU). They show -- to me at least -- that the market is toppy. That is not to say the equity market will collapse here; just that I believe that buy-and-hold investors will not do well in 2005 from a Dow perched at 10800.

In recent weeks, I recommended traders look for opportunities to accumulate quality stocks that are priced relatively low in healthcare (sector 35), telecom (sector 50), the tech semi-conductor sub-industry group (tech sector 45), and the goldminers and base metals (sector 15).

The semiconductor manufacturing sub-industry group (45301020) now looks extended on the upside, and I don't see the earnings growth needed to sustain such high prices.

This group suffered the biggest decline in its history over 2001-02, following the 2000 popping of the Internet bubble and the crash in the telecom sector. There was a modicum of recovery in 2003 and again in 2004, but buy-and-hold investors need to see a major improvement in global economic growth before the chip industry returns to health.

Unless I see the yield curve start to rise sharply, giving signs of economic growth, I only look to trade technical bounces off the price cycle bottom in this group, as I have been recommending.

I'd be looking for the Philadelphia Semiconductor Index ($SOX), presently at 427.73 to settle back about 4 percent to the 410 range. At that point, traders who are interested in making buy-to-hold purchases ought to watch the yield curve and other key signs of economic activity developments, such as new auto production before adding to positions.

The pharmaceuticals sub-industry group (35202010) had a big finish to the week with Merck and Pfizer receiving positive recommendations Friday from a Food and Drug Administration (FDA) advisory panel. The panel recommended Merck be allowed to resume sales of its Vioxx painkiller drug, which had been removed from the market last year because it increased patients' risk of cardiovascular problems. They also recommended allowing both of Pfizer's leading painkillers Celebrex and Bextra to remain on the market. These decisions will negatively impact the class action litigation that has been started against Merck and Pfizer, which removes a lot of downward pressure on the stock prices.

These developments are likely to bring significant capital flows back to the healthcare sector for the balance of this quarter.

The base metals are moving on major cash flow and earnings growth. During the week, I alerted you to Inco (TSE and NYSE: N), and the stock subsequently moved up quickly. Captain Ka-ching is just going to have to start putting ratings on his recommendations, as in Inco was a three-gong bell, or was it a four gonger?

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Bonds:

Lower bond prices, and higher yields, this week, reflect a change in investor outlook.

The yield spread dipped well under 200 basis points, which scared a few players into saying the "R" word " but Recession is unlikely. In fact, by the end of the week, bond prices had fallen so significantly across the board that investors were starting to use the big "I" word (inflation), but that too is unlikely " at least for several quarters.

From long-term charts of the U.S. Treasury debt market, you can see that all yields are moving north, which means that all U.S. treasury debt prices are now falling.

From the Fixed Income (Bonds) Yield Table at Yahoo Finance, you can see that the 30-year U.S. T-Bond is now yielding 4.67 percent, which is up from 4.475 the prior week.

Earlier this week, I warned that it was time to short the TLT. Was I right?

Well you tell me. Was that a three or four gong bell?

As rates began to reverse a week ago I wrote that: "The implications there of course are that stock prices for the interest-sensitive group like Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE), plus the home-builders, are likely headed south as the bullish bond price cycle has now peaked."

Let's see what happened to Fannie and Freddie this week?

Oh my! Gong, gong, gong! Isn't it beautiful when a plan comes together? But that's why you pay me so much for this excellent advice. :-)

Now let's see what happened to the homebuilders?

Well that's a mixed bag. Most were losers on the week, but Beazer Homes, KB Homes and Toll Brothers all had big gains. Amazing.

Over the years, I found that trying to pick a top in the homebuilders is a mugs game unless you actually work for one of these companies. I know, I have been repeatedly wrong.

Here is a table of fundamentals on the homebuilders (GICS sub-industry 25201030).

Note that except for TOL, which may be a little outside the range " on the high side " the others are all in the 9 to 11 PE's. That might seem low, and it would be for a manufacturing company or a tech company, of course, but homebuilding orders can dry up almost overnight, so there is not a high premium put on the group after it has enjoyed such a great run as it has in the last several years.

In any event, rising bond yields indicate higher interest rates on the way, which is not a positive environment for selling houses, particularly after the multi-years of record sales, and the associated personal debt that has accumulated. The homebuilders represent one sub-industry group I'd avoid.

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Commodities:

Commodity prices are indexed by the Commodities Research Bureau. The CRB index has done a turnabout a week ago Thursday, just as long bond yields took off to the upside. Then, this week the Producer Price Index (PPI) had its fastest growth spurt in several years.

The bottom line is that significant capital is flowing out of bonds and into the commodity-price beneficiaries because investors are starting to get concerned about the big "I" " inflation.

It doesn't take much to set the commodity prices running in one direction or the other. Just one mention of the big "I" however and basic materials sector 15 starts to move up.

I had perceived more weakness to come from the CRB index because oil prices had been falling. But this week saw crude oil up $1.85 (+3.9 percent) to $49.01, and Financial Entertainment Television started pointing you to $60.

I thought the interview on CNBC with T. Boone Pickens was hilarious. Do you really think a Texas oilman is going to tell you the price is going south?

Even at $49, the question still remains; when does the world see $35 oil (not $55 oil)? I say that because there are a lot of oil producers in the world; a lot of energy alternatives; a move afoot to promote energy efficient automobiles, and so forth. Because of that, I'm mindful of market risks in inflated oil-related share prices.

On this point, I note the politicization of capital markets, promoted by people like Larry Kudlow on his new CNBC TV program.

It seems to me that the U.S. energy lobby uses Kudlow as a chip in the game. When crude oil prices go north, there is Kudlow blowing his smoke, going on about the U.S. oil drilling contractors or owners of drilling rigs that contract their services for drilling wells (GICS sub-industry 10101010), or the manufacturers of drilling rigs and equipment, and providers of supplies and services to companies involved in the drilling, evaluation and completion of oil and gas wells (GICS sub-industry 10101020).

This group of charts shows just how fast moving these oil services stocks have been in the past six weeks.

The four biggest (Schlumberger SLB +1.59 percent, Halliburton HAL +1.68, Baker Hughes BHI +1.37 and Transocean RIG +2.06) were up in price last week on average 1.7 percent. But look at the PE's that nobody wants to talk about: SLB @ 43.25, HAL @48.84, BHI @34.47, and RIG @68.24.

With so many rigs out of service, I can only ask, ‘Where's the beef?'

Not being an expert in this sector, I merely wonder why, when the Integrated Oils are producing so much cash flow, they are not out drilling at a record pace for more reserves. Is this maybe a sign that there are plenty of reserves around today for several years in the future?

The Philadelphia Oil Service Index ($OSX), with all these stocks within 1 to 2 percent of multi-year highs, is now over-bought, in my view.

On the other hand there are very few base metals producers, and a longer cycle between discovery and production. In spite of a rather weak global economy, base metal prices have been very strong.

Copper set a 16-year high this week; nickel is strong, and accordingly the miners like Inco and BHP have excellent earnings, and rising share prices.

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Gold:

The goldminer stocks were slightly up on the week. I think investors were waiting to see the upshot of the Greenspan meetings with Congress. His typically boring performance didn't do a whole lot positive for the dollar; then the outrageously high Producer Price Index numbers came out, which portends a lower USD, and a higher gold price.

By now you know I have been taking bites out of the goldminers, here and there. I have been waiting for the EUR to USD cross-rate to move up through 132.50. Presently it sits at 130.24, but pointed in the right direction.

The Toronto Exchange listed goldminer ETF remains attractive. This is the iUnits S&P/TSX Capped Gold Index Fund, which trades under the ticker symbol TSE:XGD. You may wish to be taking fractional positions in XGD, saving most your ammunition for when the USD starts heading south again, crossing above the 132.50 rate with the Euro, which is when I believe that the gold stocks will really start to move up again.

The interactive chart of the goldminers that trade on the NYSE looks unremarkable, but that could change in a heartbeat.

I'd like to recommend writing two Goldcorp July 12.50 puts (GG=SV) @ $0.70, and simultaneously buying the April 12.50 calls (GG=DV) at $1.20 " if you can get those prices " for a net income of $0.20. Goldcorp GG closed Friday at $13.38, so my net premium on the call is 0.32.

The point to this trade is that I want the stock, but I also may just want to profit on the options trade.

If it moves up on me here, I'll take the $1.40 on the put writes, or the better part of it should I buy them back, and I'll exercise my 12.50 call, which would have cost me $1.20 less the profit I make on the put trades (probably about $1.20 if the stock moves up as I expect). So, I expect to buy the stock at about $12.50 instead of $13.38. You might think that's a small difference, but it's 7.0 percent.

You still might think that is a small percent, but if I earn it in a couple weeks and if I happen to sell the GG a couple weeks later, it's a relatively big percentage gain. Trading is all about making percentage gains.

Now if the price of gold bullion is rising rapidly, and the USD collapsing, I probably just buy GG calls, which is leveraging my capital, rather than the straight stock.

But I don't like to buy calls or puts too often, as precisely timing a fast market (up or down) is not easy and it's not often that markets move quickly " at least not as quickly as you'd like to see them go when you're leveraged to the hilt. :-)

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Forex:

This week, investors turned their attention back to the USD, and didn't know which way to go. $USD opened at 83.48 and closed the week at 83.52. No change.

Here's where your gut feel has to come into play. Mine says that the USD is ready to fall quickly again, starting next week.

You see, the long bonds (10-year and 30-year) in the U.S. fell too quickly, thereby showing that a lot of foreign money is not going to come into USD (typically to buy bonds). Commodities are moving up. PPI up. Slowdown expected in Y/Y earnings growth. What does that picture tell you?

Stagflation.

And what does stagflation do to equity prices? Pushes them down.

And what happens to foreign investors who smell stagflation and lower equity prices to come in the U.S.? They say, ‘Goodbye!' And, when they repatriate their wealth, they do so by selling USD.

At this point I think Larry Kudlow could stand on top of his CNBC desk with a megaphone and I don't think the Gnomes of Zurich are going to hear anything. They might laugh, but I think that, rather than get killed in the U.S. bond market, they'd rather have their size holdings in gold, or some other currency. Sorry Larry.

We'll see.

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International Equities:

As to the global stock markets, let's have a look at the past week's activity through a snapshot of the interactive charts at Investertech.com:
(Japan, Taiwan, Hong Kong, Singapore)
(U.K., Germany, France, Italy)
(Canada, Mexico, Brazil, Australia).

The commodity producing countries (Canada, Mexico, Brazil and Australia) all had another good week as evidenced by the country ETF.

In Canada this week, the energy and basic material sectors got a boost with higher commodity prices. I may be a hometown rooter, but I still think the natural resources-based Canadian economy (like Brazil and Australia) is perfectly positioned going forward.

Canadians are otherwise occupied today. Most are in church praying for the uncancelling of the NHL season.

Can you imagine Tom Brokaw or Dan Rather going onto a sports radio call-in show, as did CBC news anchor Peter Mansbridge yesterday, saying, "I miss hockey. Without it, I really don't know what to do on Saturday nights!"

Mind boggling.

The Economist this week has a strange view of Canada. It seems that Prime Minister Martin is referred to now as Mr. Blithers, and opposition politicians are having a field day.

I didn't vote for Martin, and I'm not a fan, but I hardly think Blithers is an appropriate monicker.

I feel the same about John Kerry. Had I the opportunity I would have voted Bush, but both persons, like Martin, are qualified in my view. In any event -- and this is the key point-- far, far too much focus is put on politicians, given that they don't create wealth, only destroy it, or transfer it to others.

BTW, shareholders of Stelco (TSE: STE.A) got good news Friday and the stock rocketed north, as it should. It's now on its way, I think.

What happened is that management and the Board, recognizing the extreme risk to class action for their questionable dealings in the past year, have finally come to their senses. They elected two new people to their Board. Now I don't know how companies can do that without calling a formal shareholders' meeting, but what's ever normal in this situation at Stelco.

The two new directors own about 20 percent of the common stock, so this is a concession to shareholders, and a statement that the five formal bids are going to be objectively reviewed and the best bid -- probably C$2 billion -- declared the winner, in the next couple weeks.

The stock could actually get to C$5.00, like my Dad told me last summer, when on his apparent death bed and unable to speak from a massive stroke, he had to write me a note: "Don't sell Stelco." It was C$0.50 at the time, and he believed it would go to C$5.00.

I never believed that, but then I was never much for the tooth fairy either, and for some silly unexplained reason, Dad promised to give me 1,000 shares and a car if and when Stelco hit his C$5 mark. A car!

After he could speak, and the price was north of C$2.00, he actually said to me, "I guess if it runs on four wheels, it's a car."

Some humor.

Back to Stelco, the Steelworker's union say they don't like the new director appointments announced Friday, which surprises me. They say the new directors, being capitalists, will just want the board to sell out to financiers on Toronto's Bay Street, instead of to a steel company like OAO Severstal of Russia, which has promised to keep all company operations going at full steam.

I'd like to see a steel company take over Stelco too, but not for a minute do I believe that these new directors, who are major stockholders, would sell out for anything less than the free market would bear.

The fact that the union is not impressed, just goes to show how bad this situation is. I forgive them because in forty years of watching these things, I can't remember such a situation where management ever deserved more to be turfed out on their ass. And then sued.

I have a friend who used to be in the executive management at GE's headquarters, who has a standard memo for people like that: "Screw you. More to come." Only, the word "screw" was actually put a little more forcefully.

The irritation on my part is of course how Stelco management tried to use a labor union pension fund liability against them in negotiations, and then tried to destroy the union when they wouldn't cave in.

The value of the equity in what is far and away the biggest integrated steel company in Canada then fell to a measly C$50 million at a time most halfway intelligent people knew it would be at least thirty times that. In the hands of competent managers, that is.

And when management made a self-declaration of bankruptcy, despite no formal demands by any creditor, it all backfired when the next two quarters saw record high earnings of C$100 million, even after management was putting their worst case forward to the bankruptcy court. And this quarter should be another all-time record earnings quarter too.

I still intend to show how many other public company peers to Stelco have under-funded pension liabilities far worse than Stelco; but you don't hear government here screaming about those companies as somebody put them up to last week in the case of Stelco -- even though the case was before the court and locked in multi-party buy-out negotiations. You also don't hear management in those other companies trying to squeeze or kill their labor unions.

When this episode is over, it's going to make my 2005 Dubious Feat Award, as it already did in 2004 by the Globe & Mail Report On Business, who gave it third prize. Being professional writers, they summed up the Stelco situation neatly.

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U.S. Equities:

Alcoa (NYSE: AA), which is a major player in the basic materials sector, had another good week (actually a great Wed-Thur).

General Motors (NYSE: GM) was up marginally on the week, but was up strongly Wed-Thur along with AA.

Longer-term, I still like GM. The Fiat situation is out of the way, and new car sales on the lots have started to pick up. Higher interest rates will cause higher costs to finance, so that prospect will move many buyers into an earlier purchase.

In mid-December I wrote the GM March 37.50 put (GM=OU) @ $1.55, and closed it (i.e., bought back my short) at $0.80, for a two-month gain of $0.75 (+94 percent).

Now I'm waiting for weakness in the stock in the next couple weeks, where I would be interested in writing the GM=UG September 35 puts at something between $2 and $3 (presently $1.70 last and offered, but just $1.55 bid).

Last week, while mobile, I just didn't have the resources available to publish the Dow 30 price performance table. Here it is:

You can do this table yourself by copying the following list of the Dow 30 stocks and entering them in the window for "Summaries" at Investertech.com.
AA AIG AXP BA C CAT DD DIS GE GM HD HON HPQ IBM INTC JNJ JPM KO MCD MMM MO MRK MSFT PFE PG SBC UTX VZ WMT XOM

After you bring up the list, click on the Performance tab. To sort for the relative price performance for any recent period, you just need to click on the column header of the period that interests you.

Here is the table, and following that are the Dow charts from Investertech.com that I broke into groups of ten, which you can add technical indicators for as well.

(list one) (list two) (list three)

For each of the individual Dow 30 component issues, using Investertech.com, you can look at the different time frames from intra-day to monthly data charts, and see the technical indicators at the points where trends and cycles reverse.

AA

AIG

AXP

BA

C

CAT

DD

DIS

GE

GM

HD

HON

HPQ

IBM

INTC

JNJ

JPM

KO

MCD

MMM

MO

MRK

MSFT

PFE

PG

SBC

UTX

VZ

WMT

XOM

Here too is a 30-minute data chart of the Dow, S&P 500, Nasdaq Composite, and Russell 2000 (small cap) indexes. I like to look at them all on one page to get a sense of the broad U.S. equity market strength or weakness, including technical support or resistance lines.

Last week I asked: "Is the Dow soon to hit 11,000 and higher? I can't say, but I do think with all the hype from Wall Street these days (GOOG, AAPL, MSO) at a time the Fed is tightening, and the yield curve is flattening, and the VIX and VXN are over the moon, that 10,800 is in nose-bleed territory, and caution should be the order of the day."

If MRK and PFE were not up like a rocket on Friday due to the positive review by the FDA panel, the Dow would have closed down on the day, and, like Nasdaq, down almost 1 percent on the week.

Speaking to Congress this week, I didn't see Greenspan doing his Fred Astaire dancing act. Investors, I feel, remain unimpressed that Congress can get their spending habit under control. Greenspan told them he would continue to tighten money supply, which will put the brakes on rising U.S. equity prices in 2005.

Your first concern going forward ought to be to preserve capital.

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Enjoy your weekend.

BCara@BillCara.com

ps, writing the story about my Dad and the car reminded me of something else funny he said this week. My Mom is receiving the best possible care in her final days, but I wanted her to look her best so I brought along my beard trimmer to cut away some rather long chin whiskers she's grown in the past couple months (probably brought on by the medication she's receiving).

Just after I started, Dad called across from his bed on the other side of the nursing home room they share, "Give her a goatee!"

Straight out of "Everybody Loves Raymond", and this from a man who my Mom told me at the beginning of December would not see Christmas. In fact it was last summer she nodded to me that she thought we had that moment lost him, and I thought so too.

Well this week, his 99 percent paralyzed left arm came back to life. He showed me he could raise it to where he could touch his nose, which is less than 60 days from when he first did that with his "good" right hand. So, you never know how these things are going to go.

But the nursing home is really something. How the staff can keep going with smiling faces after having 14 of 140 patients die of the flu in a two-week period this month. That resolve is simply amazing. The patients, too, deserve accolades. I came across a woman I know walking in the hall on Thursday, and all she did was raise her arm to me with crossed fingers. A picture really speaks a thousand words.

There is always hope.