But an earlier March event,  in its own way no less mad than the basketball tourney,  the Academy Awards did give us a David prevailing over Goliath triumph when The Hurt Locker soundly trumped both Avatar and Up in the Air– the prognosticators favorites heading into the event. Similar to the Duke/Butler comparison, The Hurt Locker cost $15 million  to make which  sadly remains its gross even after the Awards. This number probably approximated the catering bill for Avatar which did garner a few Oscars,  so the real loser at the Academy Awards was definitely Up in the Air, a movie with the  mega-star George Clooney playing a  likeable road warrior who spends his time flying around the country terminating management level employees. Quite a timely subject and ten years ago it would be hard to imagine this movie seeing the light of day, but desparate times call for desparate measures and the title of the movie aptly describes where we stand in the investment cycle in both literal and figurative terms.  After the stock market’s breathtaking ascent in the second half of 2009, we had a continuation in the first quarter of 2010 with the Standard and Poor 500 increasing  5.3%. Yet the road was bumpy with averages falling over 5%  during February on worries about a China slowdown and then a Greece meltdown. Interest rates except in Greece and other similar entities reamined largely in check and the Barclay’s Aggregate Bond Index (formerly known as the Lehman Index) rose 1.7%.  Yet despite increasing optimism about corporate profits, recently increased consumer spending,  and some interesting merger activity, it is hard to be unabashedly sanguine going forward.  While the stock market may soon approach it’s pre-Lehman levels,  housing and commercial property prices will  likely take a far longer time to retrace theirs.  A well placed real estate attorney told me that most of downtown San Francisco is effectively in foreclosure since eye popping loan to value disparities will need to be confronted as many loans are due to be renegotiated in the next few years. Indeed the Wall Street Journal’s HEARD ON THE STREET recently discussed the issue with reference to banks such as Wells Fargo , whose stocks have soared, but who have a  high number of such loans on their books:  “Even seemingly healthy loans where payments are up to date can end up hurting banks. Key Bank recently sold a repossessed Illinois mall for about 65% of the face value of the $37 million of debt against the property, even though it is nearly fully occupied.” (April 12, 2010).

Still there is enough good news on the corporate front both macro and company specific that has trumped such concerns for the time being.  The closely watched ISM (Institute for Supply Management) Index, a monthly survey of over 400 US companies in 20 industries, registered a significant upside surprise in March.  This is madness we all welcome since the latest numbers indicate GDP growth of 5-6% going forward.  Normally  GDP growth leads to domestic job growth although in our current predicament this logical expectation may not be a slam dunk.  One of the reasons is that many doubt that the US Dept of Labor unemployment figure, hovering at just under 10%, reflects the reality of the job market since many people have stopped looking or have taken part-time work and do not show up on the monthly reports.  The ranks of “consultants” have swelled and as the old joke goes, a consultant is a guy who knows how to make love a hundred different ways but lacks a girlfriend.  The real unemployment number is likely closer to 15% and some commentators  even worry that the encouraging news from the ISM  will bring many of the under-employed back to seeking full time work which could even increase the the 10% number.   Yet after the debacle of the financial meltdown and the ensuing recession,  seeing likely GDP growth of 5%+ less than a year later is something to be welcomed by all.

Anton Chekov, the Russian physician turned dramatist, once noted that a revolver placed on the mantle in the first act must go off in the third.  So what we will be waiting to find out is which of the revolvers on the mantle will be the one to go off and have the most lasting resonance.  Will it be the recovery we are now beginning to see spurred by the ISM numbers and merger activity, or will it be a continuing downward spiral in housing,  commercial real estate and real employment and the reckoning that results from our government continuing to kick the can down the road. As we wait for the ending of the play with Chekov’s warning in mind we should remember that most plays (including his) have four acts. So there will be more to follow after we hear our revolver and in the meantime we will remain Up in the Air.   This is not an argument to run to the sidelines or take an ostrich approach.  Rather it is a recognition that in an uncertain investing environment it makes good sense to be cautious, hedged, agnostic and above all, opportunistic.

12/15/09

Yesterday President Obama held a meeting with the “too big to fail” CEO’s where he admonished the bankers who received TARP funds to start lending their dough “in the national interest.” Both sides of the aisle have weighed in on this issue-the left decrying the TARP recipients paying their profitable trading desks bonuses built on back of taxpayer money while the right saying that the bailout reeked of socialism and that the banks should manage their own affairs for better or worse.

But let us say you are running one of these banks and you look at the landscape.  Banks are in the business of buying and selling money, and like anyone else they want to buy low and sell high. Banks are getting (i.e. buying) money at pretty close to zero given the current level of short term rates via the Federal Reserve.  So they should do well lending that money to small businesses and real estate buyers -all of whom agree that getting a loan is about as easy as running a marathon with your legs tied together.  If you are paying close to zero for your money and can lend to a business or real estate buyer at 5 times that or better, isn’t that a favorable risk/reward-even if some of the loans don’t work out as planned?  That is true, but the banks have a greater carrot dangling in front of them and that is the yield curve. The math is far from complicated.  Here they can pick up 4.3% buying a 30 year Treasury or make a 30 year mortgage loan to a homeowner at around the same rate with a questionable asset the bank may end owning. Since there is a lot of that stuff in house already, there is not a whole lot of incentive to increase the inventory. They can hire loan officers and appraisers to determine the credit worthiness of the borrower and the asset-something which will generate positive press,   or have their fixed income traders click boxes on their Bloomberg screens and make loans to the US Treasury. Yes and these traders may get a year-end bonus for doing their jobs profitably which involves using leverage and derivatives. And if Obama says you guys have to start lending, the bankers can say, “Guess what, Mr. Prez-we’re lending to you.”  So as long as the yield curve looks the way it does at present, and the Fed and the Treasury Dept have not indicated otherwise, there is not a great incentive for the banks to lend, except to avoid a deluge of real estate bankruptcies through workouts and debt for equity swaps—that is the elephant in the room.

There is of course, a long history of US President’s spanking fat cat bankers. In the early years of the 20^th Century, President Teddy Roosevelt often railed against the “corporate malefactors of great wealth,” although after 1907 Financial Panic he had no problems when the malefactor in chief—JP Morgan used his leverage with his fellow fat cats to rescue the US financial system from imminent collapse. That famous meeting at the Morgan mansion led to the formation of the Federal Reserve. The next Roosevelt made similar statements but kept mum when the bankers were doing what the current Goldman Sachs CEO called “God’s work.”  Like President Obama, TR certainly would have said he did not “run for office to be helping out a bunch of fat cat bankers on Wall Street.”  But the rest is and will be history.

I’m wild again, beguiled again, A simpering, whimpering child again,   Bewitched, bothered and bewildered—am I.   

In the musical, Vera Simpson, a wealthy, bored and married socialite falls for the charming heel Joey Evans, who seduces her, separates her from her money,  then dumps her.  Sound familiar! There is not much transference required to see how the song works as a corollary for most people’s investing experience over the past eighteen months.  After a year which for many investors resulted in both major losses and a high degree of shell shock, the first half of 2009 has shown some improvement with the S&P 500 being in the black by 3%. But it took a 30% plus rally in the second quarter to achieve this.   

Although conditions both in the market and the overall economy have improved somewhat in the past few months, there is still a fair amount to be bewitched, bothered and bewildered about.  For the past two decades we the investing public were  happily “bewitched” by the equity culture with encouragement and cheer-leading from the likes of legendary fund manager Peter Lynch, (One Up on Wall Street) who told us that we could all find the proverbial 10-bagger if we kept our eyes and ears open, and Wharton Finance Professor Jeremy Siegel (Stocks for the Long Run),  who still strongly advocates staying fully invested in  stocks and ignoring whatever the market is doing in the short run—i.e., less than 100 years.  Those are fine sentiments when investing is less of a blood sport than it has been for the past 18 months. Yet for many, this time it was different:  having experienced a  severe decline which for many people eradicated their gains of the past decade, there is much trauma, blame and bother to go around. That brings us to the current state of bewilderment— fretting about whether our budding green shoots will blossom or turn to yellow weeds. There are compelling arguments for both.  The US economy has moved past Point A  (”A” perhaps standing for Armageddon) but how to get to Point B is less clear.  The last quarter and July have produced encouraging upside surprises in company earnings reports as well as some economic indicators.  But unemployment numbers are discouraging and according to commentators such as Morton Zuckerman and Roger Lowenstein, the statistics do not accurately mirror the worsening reality.  Despite the improvement in business inventories, consumers are still not spending and home prices remain in the dumps.  How lagging these indicators prove to be is the $64 question. 

Remaining agnostic about the stastical barrage may prove to be the best course. This will likely result in seeking out sensible opportunities but using risk management strategies to guard against a reversal.   Besides the song from Pal Joey we can also gain some perspective from a popular play that premiered two years later in 1942, Thornton Wilder’s The Skin of Our Teeth, in which the heroine tells us:  “Don’t forget that a few years ago we came through the depression by the skin of our teeth!  One more tight squeeze like that and where will we be?  My nerves can’t stand it.”  Maybe it is deja vu all over again, but as in Wilder’s play, the capacity for survival and renewal appears to be trumping our most dire predictions.

Since the last half of 2007, the global equity markets have exhibited the kind of volatility which recalls the “Panics” of the early 20th century. This was discussed in a previous posting entitled Your Great Grandfather’s Stock Market.  So what is a prudent way to invest in this environment?  Many have headed for the mattresses, making risk aversion the new bubble.  Others have been like deer frozen in the headlights with fingers and toes crossed.   Neither approach will bear much fruit going forward and while a passive investment style suits a market whose general trend is clearly up (cf. Jeremy Segal Stocks for the Long Run) there is now a strong case for hands-on active management complete with hedging and downside protection.

To illustrate and lead by example, here are some real examples of investment strategies used in accounts managed at JMR Capital Management.

CASH FLOW IS KING

In the last quarter of 2008 we initiated some positions in exchange traded funds with high cash yields which could be added to by writing (i.e. selling) covered call options.  

HYG.  IShares IBox High Yield ETF. This security replicates a well known high yield bond index which contains the most liquid and tradable US dollar denominated high yield corporate bonds.  The top ten holdings comprise 22% of  $2.7 billion of total assets.

10/30/08      BUY  500 SHARES  @ 71.84     $35920

Since November we have received 7 monthly dividends totaling $2390.5 or $4.78 per share.  In addition we added to the cash flow by selling the following call options:

10/30/08     Sold 5 March 09 $76 calls @ 1.60             $800

Since the price of the stock was below the strike price (76) on the option expiration date, we sold another call.

4/14/09      Sold   5 June  09 $72 calls @ 1.85        $925

Our total from selling the call options  is $1725, which when added to the dividends received since November brings the grand cash flow total to $4115.50 or $8.23 per share.  This gives us a return of 11.5% so far.  To protect the downside we also have a stop loss order at $70.

KMP.   Kinder Morgan Energy Partners.  The company owns and manages energy transportation through approximately 8300 miles of pipelines for oil, natural gas and CO2.  It has paid and increased its quarterly dividend every year since 1992. 

10/14/08     Buy 400 shares @  50.978     $20,048

12/30/08    Buy 400 shares  @  45.216      $18095

Our total investment for this particular account is $38143 or $47.68 per share

Dividends receveid through the end of April have totaled $2088.  To this we have added to the cash flow by selling the following call option.

1/23/09      Sell June 09 52.20        $1180

Our total cash flow is now $3268 or $4.08 per share.  If the June call is exercised at 52.50 our total return from dividends, call premium and appreciation will be $7123 or 18.6%.  We have placed a stop loss order at 45 to protect our return.

More examples to follow—please stay tuned and let us know what you think.

Is Yale really not that interested in the stock market?  Apparently so.

A look the university’s most recent data on asset -allocation shows just how

differently the smart money [emphasis mine] looks at prospects in the market.

Julian Robertson at Tiger Management (the yen-carry trade), George Soros at the Quantum Fund (macro currency plays) and David Swenson at Yale (see above) all seemed to posses the holy grail in the form of unusual allocations combined with  exotic trading strategies. Unfortunately as we now know, they spawned far too many imitators chasing the same strategies. Through all of this Sturm und Drang, legendary Graham and Dodd value investors, Warren Buffett and Wilbur Ross made immense fortunes sticking to their knitting.

But during 2008, the smart money vanished and has yet to reappear.  The mighty are still falling all over the place. Jim Simons, the highest paid hedge fund manager in the world is taking a major hit as his highly secretive fund for institutional investors, Renaissance Capital,  is reportedly underperforming the S&P by 19% in 2009.  In the meantime, hedge funds are under attack from all sides: Congress, State Attorney Generals, President Obama, the investing public and even some hedge fund insiders.   The  former CFO of one of the largest hedge funds which had not experienced a losing year prior to 2008 told me: “We are supposed to do three things:  invest in strategies which are not correlated to the stock market,  preserve capital and provide some liquidity.  We are 0 for 3.”  Ten-bagger-plus venture capital and new technology returns will have to wait for a return of a vibrant IPO market, which could be populated by companies developing green technologies, electric cars and the fruits of stem cell research.  But as former investment banker Frank Quattrone has pointed out, the Wall Street banking and research system that enabled the likes of Apple Computer and Cisco Systems has effectively ceased to exist.  Nevertheless, Mr. Quattrone who had the resources and staying power to reverse a guilty verdict following a draconian Dept of Justice prosecution has set up shop again as an investment banker focused on mergers and acquisitions. He is also a major donor to the Innocence Project. Peter Lynch is quietly hiding out as a consultant to his former employer, Fidelity Investments.  Warren Buffett proudly announced in an October 2008 New York Times Op-Ed article that “I’ve been buying American stocks.  This is in my personal account in which I previously owned nothing but United States government bonds.  My non-Berkshire net worth will soon be 100 percent in United States equities.”

Between October 2008 and March 2009 the S&P 500 dropped 30%, and while admitting that his call was pre-mature, Mr. Buffett can be seen fairly regularly doing lengthy interviews for CNBC, a division of NBC, whose parent company is GE, one of Berkshire Hathaway’s largest holdings. In 2008 Mr. Buffett lent the company $3 billion via a preferred stock investment with a 10% yield plus warrants.  Through all of this including his rather downbeat Berkshire annual meeting, Mr. Buffett is as cuddly and charming as ever, driving a succession of female CNBC reporters around Omaha in his Cadillac, waving to his longtime neighbors, stopping at the Berkshire owned DQ for a burger and telling us that he wishes he was 25 so he could be around for the most powerful recovery of all time.  But is he or anyone else still the smart money??

This kind of volatility in the financial markets has characterized periods of extreme economic unrest such as the Great Depression of the 1930’s and the Panics of 1907 and 1870’s. Those  debacles supposedly resulted in some financial market reforms that were designed to mitigate such extremes.  The NYSE,AMEX and NASDAQ all tell us that their specialists and dealers are charged with maintaining a “fair and orderly market.” In prior periods of extreme volatility such as 1907 and 1930, there was no such expectation.  There was no  Federal Reserve regulation, margin requirements did not exist, corners on stocks and underlying  commodities were frequent,  and large moves were the rule, not the exception.   We, however, are supposed to be in a brave new world with state of the art trading systems on the exchanges which maintain a “fair and orderly market,” automatic circuit breakers which close the NYSE in the event of a 10% swing and wise men such as Richard Grasso and Bernard Madoff who have served as the respective heads of the NYSE and NASDAQ boards. 

We hear many cries for more regulation, more transparency in derivatives such as credit default swaps and House Financial Services Chair Barney Frank saying that the uptick rule for short sales should be reinstated. These are excellent ideas and perhaps such measures will help.  But our markets reflect the ultimate global democratization of capital and as New York Times columnist Tom Friedman has said a world made flat through technology.  Our world is jittery, on edge and in a manic depressive state.  Our markets will reflect that with or without additional regulation.

This brings us to the recent comments of the auto analyst at Deutsche Bank who reduced his rating on General Motors to sell and set a price target of zero. As several readers of the Wall Street Journal opined, thanks for the helpful comment.  We might want to alter the last word of the often quoted line from Shakespeare’s Henry VI, Part II: “The first thing we do. Let’s kill all the lawyers.” GM is now back to its 1946 price level and the question at present is whether or not a government backed bailout would help enough.  Many Wall Street and armchair analysts think GM is more than a lost cause.  Perhaps so, but before tossing in the all the towels, we should take a hard look at a relevant precedent in the very unexpected and stunning turnaround of Nissan/ Renault.

Nissan Motors, in 1998 had been given up for dead. The Japanese economy was in a prolonged recession and Nissan was suffering more than its competitors Toyota and Honda whose global franchises were thriving . Nissan had an enormous amount of debt for its capital structure, a crumbling stock price and a lack of profitable models. Sound familiar? Into the fray stepped Carlos Ghosn, a Brazilian born Lebanese citizen of France to take the helm the third largest Japanese auto manufacturer.  Brought in as the Chief Operating Officer as a result of the merger with Renault, Ghosn became the CEO and orchestrated an improbable and spectacular turnaround under very difficult economic and cultural conditions. Ghson focused the merged company on the leverage that could be gained through a few profitable models. Japanese corporate culture was viewed as impenetrable by an outsider and Nissan, like Ford was for many years run by the founding family. Being an outsider proved to be an advantage since part of the turnaround of Nissan involved layoffs and plant closings—steps a Japanese corporate insider would have been hard pressed to execute. When responding to questions about how he was able to do this, Ghosn very diplomatically speaks about how he was able to connect with Nissan employees and get them to buy into his vision for change.  Ghosn also put his own body on the line saying he would resign if he did not return Nissan to profitability after one year and eliminate their debt after 6 years. Ghosn is still at Nissan and recently placed the company in the forefront of electric car development through his partnership with Project Better Place.  The ultimate cultural seal of approval came for Ghosn was when his life was turned into a Japanese comic book series.

Can GM be saved along the lines of Nissan?  A couple of years ago, Kirk Kerkorian thought it could and became the largest individual shareholder of GM. His plan was to have Ghosn run GM, but he could get nowhere with the GM board. Kerkorian sold his stock and CEO Rick Waggoner still occupies the head seat. Would Ghosn be interested in taking on the largest challenge in the history of the auto industry?  Perhaps he is content to stay where he is, but two things are clear: it is crunch time and a version of the Nissan template needs to be tried in Detroit. If the respective managements cannot see the light then Detroit’s new partner, the US taxpayer and their new CEO need to apply the necessary pressure to the car makers to clean house and to Michigan legislators who have prevented this by protecting the Big Three from fuel efficiency standards and modifying union and legacy contracts.  So we are more than ever back to the original saying about GM and the nation and there is the potential for a great success story or a missed opportunity. In either scenario (hopefully the first), there will be far reaching consequences for the economy and financial markets.