Recently I have had rebalancing trades, selling a little Dorel Indsutries and Sappi. Also, I swapped Sonic Automotive for Group 1 Automotive early on Tuesday. I was able to enjoy two unexpected sell-side upgrades. It’s not supposed to work this well, but it is nice when it does.

On another note, from a piece by Lloyd Byrne of Morgan Stanley, in 2006 only 73% of oil production was replaced by new reserves for companies that they follow. This is just another reason why I am overweight energy. The replacement ratio has fallen for the last four years.

Finally, if you subscribe to RealMoney, be sure to read Jim Griffin’s post, Fed-Watchers Have Blinders On. I have been contending that the housing lending crisis is serious but will not derail the economy on is own. With the decline in the dollar, it is no surprise that our exporters are seeing some growth. Funny that few notice that. I guess we are used to being importers only….

Full disclosure: long GPI DIIB SPP

I must admit to being unimpressed with Sam Zell’s bid for Tribune. I can’t remember the last time someone put up so little money for so great an asset, aside for when I was the juniormost member of the AIG team considering whether to take over The Equitable. (AXA walked away with it, and the untold story is how AIG botched the whole thing.)

The skinny is this: Tribune the company borrows money, and gives it to the ESOP [employee stock ownership plan] to buy up the shares of Tribune. Sam Zell provides a small amount of subordinated financing ($325 million) to Tribune to help make this happen, and receives a warrant to purchase 40% of the company for $500 million. If the true value of the company is $8 billion, this is one sweet deal for Zell. Imagine getting interests in a company worth $3.2 billion, and only having to put up $825 million for that right.

Now, Tribune in its soon to be levered state might not be worth that much, to Zell, or to the employees. This deal presumes a lot in terms of the future profitability of Tribune. Will they be able to carry the debt load?Those that have read me for a while (at RealMoney) know that I am a bear on the newspapers, and most non-internet media businesses. The internet is destroying the margins that support newspapers in three ways:

  • Classified ads are more effective over the web
  • Advertising on the web is more targeted
  • Why subscribe to a paper, when the data is freely available online?

Now in each area a newspaper is still useful, but enough erosion occurs to ruin the economics. I doubt you can turn around a newspaper; perhaps you can create ancillary businesses off of proprietary content, but try to get people to pay for it, or stream a ton of traffic to get ad revenue.

As for the use of the ESOP to finance the takeover, it puts a gun to the heads of employees, who can only vaguely affect firm performance. Any value that they had built up in the ESOP is now at greater risk. If they succeed, they could make quite a bit (while Sam Zell makes proportionately more. If Tribune fails, the ESOP will be worthless, for any who were relying on it. (I realize some older workers can diversify some, but that’s not enough.) Sam Zell would lose his investment, but he can afford that easily. The proportionate impact to workers whose largest asset might be the ESOP would be much worse.

If I were a Tribune worker, I would urge the ESOP to vote down the deal. The downside is more significant than the upside.

Around the world, broad measures of money are moving higher as goods price inflation moves higher.  China and India come to mind here.  Economic liberalization has brought benefits for both the nations that liberalized, and those that trade with them.

As such, tightening measures by developing country central banks are to be expected.  As an example consider this article by Andy Mukherjee of Bloomberg.  There’s a lot of excess credit out there, and central banks are half-heartedly trying to extinguish it.

Goods price inflation is moving higher globally, and global short rates are rising as a result.  When do we hit the tipping point, and what nations/sectors will have the worst of it once deflation or stagflation takes hold?  I’m not sure, but those that are running a current account surplus should do better.

I should mention that Assurant has been added to the S&P 500. Could not happen to a more deserving company; they are truly innovators in the insurance industry.

And now, more on indicators, bullish, bearish, and otherwise:


  1. Low quality stocks outperformed in the first quarter, according to Merrill Lynch. That’s bullish in the short run, but not the intermediate term.
  2. LBO volume and private equity volume continue unabated.


  1. Economy feels like stagflation-lite. Low positive growth, and rising inflation.
  2. Inflation is rising globally, particularly in India and China.
  3. Mortgage interest payments in the US are a record high (since 1989) compared to Disposable Personal Income.
  4. Corporate credit metrics are deteriorating for both junk and high grade corporate debt, but are not critical yet.
  5. Equity REITs seem to be rolling over.

That’s all for now. Tomorrow is another day.
Full Disclosure: long AIZ

Usually I look at my indicators at the beginning of a month. If I look at them more frequently, the changes are too small, and I don’t get the signal. In no particular order, here are my thoughts, both Bullish and Bearish:


  1. Contrary to what the bear in Barron’s said this weekend, the chart for the Merger Fund is bullish. They paid a dividend at year end, and the current chart shows that arbs are making money, which is bullish.
  2. ECRI’s indicators are forecasting growth up, and inflation down.
  3. Both emerging market stocks an bonds have bounced back well.
  4. Earnings yields are still high relative to Treasuries, though if profit margins mean-revert, this argument is hooey.
  5. ISI Group’s broadline retailer’s survey is showing some life.
  6. Securitization of subprime loans, and CDOs containing tranches of subprime deals rated less than AA, are not getting done. These assets are getting sold to financial intermediaries that have adequate balance sheets to fund them.


  1. From Alan Abelson’s column in Barron’s this weekend, Henry Kauffman uses a concept akin to my “bicycle stability versus table stability” to discuss liquidity. The former is access to credit, while the latter is excess high quality assets that are readily salable.
  2. Imposing tariffs on China is a real dumbkopf move. Eventually that will bite into the capital flow that keeps our interest rates so low, in addition to decreasing the benefits from the global division of labor.
  3. M3 is falling, and significantly. The banks are pulling back from landing, and credit availability is shrinking. My M3 proxy is the total liabilities of the banking system. Works very well.
  4. Fed funds continues to miss on the high side, since the FOMC meeting. The monetary base has gone flat, and there has been only one permanent open market operation this year, on 2/26.
  5. Financial stocks are lagging the market.
  6. The yield curve is still flat.
  7. Equity REITs don’t yield enough relative to Treasuries.
  8. Housing prices are falling nationwide.
  9. Asset price changes are increasingly in two camps: safe and risky. Correlations within the two camps are high and positive. Correlations of the two camps are very negative.
  10. Inflation remains high over the Fed’s comfort zone.

Neutral, or You Call It

  1. Implied volatilities have bounced up, but are still low.
  2. Corporate bond spreads have bounced up, but are still low.
  3. Implied 5 year inflation, five years forward, has been in a channel between 2.2% and 2.8% for the last four years.
  4. TED spreads are higher, but still low.
  5. The swap curve gained slope after the recent mini-crisis.
  6. The FOMC tightened less this time relative to prior times, if the measure is inflation versus the Fed funds rate.

That’s all for now. The two biggest bits of news are the tariffs on Chinese goods, and the decline in my M3 proxy. Bearish items both.

I’m still looking for a way to document my performance to readers, but let me simply say that the broad market portfolio beat the S&P by a few percent. What worked?

  • Fresh Del Monte
  • Grupo Casa Saba
  • Valero Energy
  • Helmerich & Payne
  • ABN Amro (sold too soon) 😉
  • Dorel Industries (wish they hadn’t delisted)
  • Lyondell Chemicals
  • Dow Chemicals, and
  • SPX Corp

You see any commonalities there? Energy, especially refining. Chemicals. Aside from that, I don’t see anything really correlated.

What didn’t work?

  • St. Joe
  • Barclays plc
  • Japan Smaller Capitalization Fund
  • Nam Tai Electronics
  • Cemex
  • Lithia Motors
  • Conoco Phillips
  • Magna International
  • Jones Apparel
  • Deerfield Triarc, and
  • Allstate (ouch)

Commonalities? Autos, maybe? Away from that, it seems eclectic to me.

In my balanced mandates, my foreign bonds and floating rate securities worked. High quality paid off as volatility rose. Really didn’t have any problems with my bonds.

Now I just have to do as well next quarter. 🙂


I had a two-part series that was published at RealMoney, and at the free site,, that further explains a series of posts that I did here on my recent portfolio reshaping. Here are the links:

Getting Your Portfolio in Better Shape

Getting Your Portfolio in Better Shape, Part 2

It’s relatively unusual for my articles to be out on the free site, so enjoy the boon from The

  1. There were two articles on reinsurers this morning suggesting that there should be a lot of consolidation via M&A. I’m not so sure. First, most players there want to acquire, not be acquired. Second, most of them don’t trust the underwriting and reserving of their competitors to the degree that they trust their own. To the extent that current players want to diversify, it is cheaper to do it organically than by acquisition. With the high degree of ease of entry into the market, the franchise value of a reinsurer is low. Now, maybe the property-centric reinsurers want to diversify (a smart idea, but they are stubborn), or the new reinsurers want to buy in a reverse merger one of the class of 2001 to eliminate the capital haircut from the ratings agencies (but they don’t have the cash for it). Those ideas make sense, but scale isn’t that much of a virtue here, and with P&C reinsurers the reserving is opaque as mud. I can see a deal or two getting done, but not a lot of them.
  2. With all the hand-wringing in the Wall Street Journal this morning on free trade, just watch, we impose some series of tariffs or restrictions that reduce the current account deficit, only to see the capital account surplus shrink also, leading to higher interest rates and a lower dollar, breaking the current cycle giving the US cheap imported goods in exchange for dollar denominated bonds.
  3. Throw a rock, hit a commentator who says that the Bank of China (or other major central bank with large dollar holdings) would never sell their positions because it would work against their interests, driving the value of the dollar down. That’s a half truth at best. Here’s why: the central bank will eventually focus on the future, realizing that sunk costs are sunk. Just because you have a big dollar position, does that mean you have to add to it to preserve its current value. Ignore the past, and let the dollar denominated securities mature. Use fresh cash and maturity proceeds to buy assets in the currencies that you like. It won’t cause a panic, but the dollar will still adjust down. Recognize from the start that the dollar assets are worth less than current exchange rates, and maximize value from there. (Large holders of any asset under pressure have to think this way to maximize value.)
  4. Buyer Beware. Or maybe, it should be borrower beware. People are generally less competent at making rational choices when they are borrowing rather than paying cash. So it is no surprise that when Beazer finances homes that they sold, buyers might have gotten less than an optimal deal. This is true with many financial transactions. In general, the more moving parts in a transaction, the worse off the average person is in evaluating a deal. Better to line up your financing separate from the decision to purchase an asset, or you could end up up with a bop on your beezer, figuratively speaking.
  5. So FASB might have a tighter leash on its neck from the SEC? Not sure whether that is good or bad. Neither organization gets high marks in my book. FASB desperately needs a more coherent overarching approach to accounting, rather than the piecemeal addjustments that they are doing. The SEC, if anything, is more beholden to political pressure, and the idiocy that that brings into accounting.
  6. Then there’s Texas, basically invalidating the GASB on reporting the liability for long term government employee benefits. You might remember my piece at RealMoney, Pensions: Things Can Always Be Worse. Well, this is an example of that, and it is not limited to Texas. Though the Texas argument may have merits, governments all over the country are finding that they have to finally recognize the present value of the pension promises that they have made, and disclose it to the citizenry. It will be a mess, because a large amount of these promises are totally unfunded, much like Social Security, Medicare, and most other programs of our Federal Government.
  7. It takes a week, but finally the market comes around to my view of the FOMC, though it takes Bernanke before Congress to correct the view of the markets. Inflation is not on hold, but the FOMC is, for now.

A bicycle has to keep on moving to stay upright. A table does not have to move to stay upright, and only a severe event will upend a large table.

I developed this analogy back when I was a corporate bond manager, because there were some companies that would only stay afloat if they kept moving, i.e., if operating cash flow continued at its projected pace. That is bicycle stability; they have to keep pedaling. There were other companies that could survive a setback in earnings, and even lose money for a time, and the debt would still be good. That is table stability.

Need I mention that in a crisis, the equity of companies with table stability typically fall less than those with bicycle stability?

I think that it is incumbent on every portfolio manager to look over his portfolio, and ask what companies that they own would not be able to survive if they were not able to raise capital for two years.

My current main economic concern is that inflation in the developing world, particularly China and India, will lead to their central banks to overshoot on policy, and cause a drop in global aggregate demand. Inflation is accelerating, and money supply is not slowing. The excess liquidity is not finding its way into goods prices as much as into asset prices.

This portfolio review will not protect you from loss, but it will protect you in relative terms in a crisis. You won’t be hurt as much.