Net-Net's and More

The famed value investor Ben Graham used to regularly be able to dig up what he referred to as "net net" investments - companies whose current assets (adjusted by a discount factor) less their total liabilities exceeded their market caps and therefore had potential for significant stock price appreciation.

Motley Fool describes net nets like this:

http://www.fool.com/investing/small-cap/2007/03/30/net-nets-a-classic-special-situation.aspx

There is usually some sort of reason that a company's stock is trading so cheaply - like huge debt or an obsolete product, etc. With the dissemination of information so ultra efficient today, there are not a lot of these types of investments around today.

One that I have come across recently is Nautilus Inc. (ticker: NLS), maker of all manner of gym equipment and owner of Schwinn bikes. It does not fit the strict definition as outlined by Motley Fool. However, its current assets less total liabilities exceeds the current market cap by almost 50%. Essentially what the market is saying is that NLS's inventory and/or receivables are worth a lot less than what's noted on the balance sheet. That is clearly possible, but it could be worth looking at NLS as a Long position, and potentially a profitable investment if you can determine that the market is undervaluing the inventory and/or accounts receivable.

I am not putting NLS on the interest list because more homework needs to be done on the viability of its assets. But I wanted to demonstrate the concept of a (near) net net and ask you whether you know of any others worth looking into? There are tons of opportunities in the micro-cap companies for individual (retail) investors out there today.

Another name that I cannot put on the Short Interest List until someone confirms whether individuals can borrow it (a couple of months one could not) is Under Armour Inc. (ticker: UA). It had run up from its lows recently and looks expensive. At year end, there was $138 million in purchase commitments listed in the notes to the 10-k that was not there last year and amounts to 76% of total inventory on the balance sheet. The Company shed no light on it. At the same time, the Company faces a tough rollout of footwear and the management seems to have lost a bit of its well known confidence in the last couple of weeks. Let me know if this is shortable at your broker (online or otherwise).

Finally, another Short Interest List candidate, that I know has been tough to short either at work or as an individual is Green Mountain Coffee Roasters Inc. (ticker: GMCR). It is valued like it is going to the moon and it has been noted in outside Wall Street research that it changed its revenue recognition policy in the last 10-K filed with the SEC to suggest that it is booking some revenue on shipment now, rather than just delivery. Wall Street Analysts do not really know if this change added to the Company's positive 1Q09 surprise, but management is not shedding any light on things. Again, if you are able to short it in your personal account, let me know, and I would add it to the Short Interest List. From a professional standpoint, there are no shares available for my company to borrow (and then short sell).

Happy hunting!

-2outof4

Does Mr. Geithner Read 2outof4?

There is not much detail here, but doesn't it sound as though Mr. Geithner is reading 2outof4?:
http://online.wsj.com/article/SB123799575291939189.html

"Resolution Authority" sounds on the surface like winding down these unsavory institutions with the least burden on taxpayers and unsuspecting customers, rather than propping up these institutions with pass throughs straight from the taxpayers.

Maybe Mr. Geithner does not like being called Timmy.

-2outof4

Morning Sunshine

After battling with a number of glum Post drafts last night and then waking up to no power this morning, this made me smile when I finally made it into work:
http://www.ibtimes.com/articles/20090325/fedex-threatens-to-cancel-boeing-jet-orders-report.htm
I've heard plenty of negative anecdotes re Mr. Smith's formative years, but I cannot disagree with Barron's assessment over the weekend that he is a top 30 Global CEO.

I still have not heard a clear explanation from ANYONE on how the Card Check legislation benefits the laborer.

-2outof4

Credit Question

This is Treasury Secretary, Timothy Geithner's, plan to reestablish the flow of credit to the American consumer:

http://online.wsj.com/article/SB123776536222709061.html

It is written in plain English and not super long.

Basically, he says that he wants to bring mortgage rates down and get consumer and small business lending going again.

My thoughts are a) aren't the "near historic" low rates what got us where we are today? b) I hope the securities backed by SBA loans bought by the Fed were priced correctly (the SBA has proven incompetent at funding legitimate businesses in the past) c) we may have seen a rise in refi's this month, but I know two people, a coworker and a coworker's friend who refied just because it made sense, not because it was saving them from financial distress d) I think the securitization number was so high because Timmy gave a signal that at least in this program he would not completely screw private investors (b/c he needed them), so of course there is a market for AAA rated debt paper e) I don't see how the Public-Private Investment program will work for old assets because banks still will not want to sell for the prices that the PPIP should be willing to pay f) is credit really constrained to working families and businesses?

The last point is what I am most interested in. I know some of you own small businesses. Has anyone out there had his or her personal or small business access to credit lessened in the last several months? This is similar to my question regarding foreclosures in mature neighborhoods. With the credit question, I do think I will receive some "yes" responses, but I believe on a much lower scale than the pols and media would have us think.

All Tim needed to say to get securitizations going again (and loosen up credit, which is what all the back patting in DC seems to be about) was to incentivize, temporarily, investors to take the risk they were afraid to take. It is a fact that securitization markets have been closed since Fall of 2007. But if some of the same private investors that Timmy brags about in this op ed were given a tax break on gains from securitization for X amount of time, I am sure they would have come out of the woodwork sooner to buy AAA paper without the Fed needing to make any loans (take any risk itself). Private investment capital has and is afraid of getting burned by government's bumbling - see the clean energy industry - and that needs to change.

-2outof4

February Skepticism Returns

That deep skepticism I felt in February over the recovery bill, TARP, TALF, et al. has wooshed back with a vengeance this week.

Not that this is a surprise to me, but it seems like too many powerful interests have their hands in the cookie jar - the cookie jar that you and I pay into and will be paying into a lot more in the future.

The debacle with AIG and with what seems like taxpayers making AIG's counterparties (read Goldman Sachs and the like) whole on its varied Credit Default Swaps (CDS) is an outrage.

Meanwhile, that cheek clencher is being obfuscated by Barney and the blowhards dressing down AIG's CEO, Edward Liddy (a former Board member of Goldman by the way), over $165 million in retention bonuses.

Bare in mind that these bonuses were being contractually paid to people like this: http://www.nytimes.com/2009/03/25/opinion/25desantis.html?_r=1 The witch hunt is a complete joke.

I was criticized earlier for saying the involved parties needed to be forced to the table and work something out. Even if the counterparties settled for five cents on the dollar and some went out of business, that would be fine. The government could have just facilitated the orderly workout of AIG's other assets and liabilities, and sounder entities should have taken over custody of said assets and liabilities.

The notion that an orderly end to AIG would create financial Armageddon needs explaining to me. For example, if I have a life policy at AIG and AIG is going to fail, why couldn't the associated asset and liability on AIG's balance sheet for that policy be moved to another insurer that wants it? We could go policy by policy through AIG's book protecting the taxpayer and unsuspecting customer. Granted, the consumer may not be made completely whole, but wouldn't this be better than the mound of debt and reward for bad behavior that is being created currently?

Then there is this: http://online.wsj.com/article/SB123776518094909023.html

Spending layered on top of permanent spending increases is not the way we want to go. It just becomes increasingly clearer that government cannot seem to establish targeted programs in a time of economic crisis, instead it is using the crisis to put its programs (for better or worse) into place without a way to pay for it.

On top of that, it seems like we may just skirt the usual democratic process and use something called Reconciliation to pass everything that the administration wants: http://news.yahoo.com/s/bloomberg/20090318/pl_bloomberg/ai5mx_2yfz7s_1 I cannot make this up.

I know the ranting about spending and the like gets old (I'm the one pounding my head into the desk), but at this point of potential pivotal change, we need real work done to solve these problems - not just try to appease as many political agendas as possible because in the end it just weakens our position in the globabl market place. I am still looking for the person or entity that can provide the assist!

-2outof4

Nutter Likes to Read, but Doesn't Seem Very Innovative

Back in February I proposed this solution http://2outof4.blogspot.com/2009/02/hey-mayor-nutter-likes-libraries-too.html to Philadelphia Mayor, Michael Nutter's, problem of keeping the cities' libraries open.

It turns out he blew an opportunity to innovatively save money, jobs, and libraries while not further burdening citizens and potentially moving more residents out to the 'burbs:

http://online.wsj.com/article/SB123747958958985749.html

Is there any thinking outside the box in big government?

-2outof4

New Book Recommendation

The following book is a must read in my opinion, and I urge you all to sit down with it.

'Hot, Flat and Crowded' by Thomas L. Friedman is a book about the lack of a global sustainable energy system, the impediments and possibilities for developing one, the economic benefits of doing so, and how America can lead a revolution of intelligent design and revolution - once again asserting itself as a technological and manufacturing global leader. More than that though, it is a vision for our children's' future - which at its root exposes the inadequacy of our government's policy and action status quo.

From the book: "We are living at a hinge of history that is going to determine just which way this Energy-Climate Era will swing. If we are going to manage what is already unavoidable and avoid what will be truly unmanageable, we need to make sure everything we do from here on helps to build a real, sustainable, scalable solution. The clear and easy paths are closed. All that matters now is how we walk through the fire."

http://www.abebooks.com/servlet/BookDetailsPL?bi=1290189772&searchurl=an%3Dthomas%2Bfriedman%26kn%3Dflat%2Bhot%2Band%2Bcrowded%26x%3D0%26y%3D0

-2outof4

Tackle from the Blind Side

One of my favorite authors is Michael Lewis. Besides his great books he publishes a number of articles at places like Vanity Fair and Bloomberg News. I've been advised to read his VF article on Iceland's collapse over the weekend.

But for now, I'll give you this gem:
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_lewis&sid=atlHxXH7FweQ

It superbly covers the misplaced blame that politicians like to assign without delving into and fixing the problems at hand. It also emphasizes something that I try and emphasize here - the correct framing of numbers as support to an argument.

Happy Friday!

-2outof4

Technical Blog Question

Hi. You were very helpful on my last question. If I have a draft in the Edit Posts section of Blogger, how do I move it up so it becomes the most recently published post once I post it? Right now, I have had to post some old drafts that then get lost in the previously dated posts.

Thanks!

-2outof4

Optimism Around Ingenuity?

This is dated from 2/10/09, and although I do not agree with everything and have to consider the source, I love the tone and help ourselves attitude. There are a lot of great ideas as well.

Fred Smith, President and CEO of FedEx:

http://news.van.fedex.com/node/12752/print

-2outof4

Interesting Charts and Questions

I get a lot of stuff sent to me throughout the week. Here was an interesting economic graph and table from this week. They give an interesting global framing of the numbers we often hear in the news. Is the US in a position of relative strength or just less worse than everyone else?

-2outof4

Stock Interest List Update

MW - reported 4Q08 results last week and surprised analysts on the back of margin strength from cost containment and more stable than expected sales declines. It appears the promotions that MW is running (2-for-1 suits) are driving traffic more than expected. So although the product margin is low, the volume and the general cost reductions are supporting earnings. It is not surprising to have a huge stock reaction in a company's share price that was as beaten down as MW. The shares are up 51% from the time I left for vacation on 3/6. That is the problem with shorting very "cheap" stocks - little margin for error especially if the Company is doing "less worse" than expected. However, at today's valuation and in the current environment, I would still keep it on the Short interest list.

WFMI - Whole Foods Market, Inc. is a name which a lot of readers probably know. Based on the recent run back up in share price following 1Q09 earnings, FTC clarification on the Wild Oats litigation, and Yucaipa (an investment company) increasing its stake, I think the risk/reward of a WFMI short makes sense. I tweaked two Wall Street firms' earnings models a bit, essentially extrapolating SSS and Identical Store Sales trends as well as 1Q09 gross margin, and pretty easily calculate 62-63c for FY09 compared to consensus of 70c.

The key issue in my mind is Same Store Sales (SSS). SSS deteriorated at WFMI for the first time in history during 1Q09. The cadence got a bit better in January, but then trailed off again the first four weeks of 2Q09 at (4.5%) and ID sales at (5.4%), including currency. The numbers for 2Q08 were 6.7% and 5.1%, the numbers for 3Q08 were 2.6% and 1.9%, and the numbers for 4Q08 were 0.4% and (0.5%). The Street seems to tout the idea of slowing growth leading to increasing profitability, but in that case I don’t understand the growth multiple the Company receives.

In conclusion, it seems as though besides the general market run-up, there has been a lot of positive news that has recently been baked into WFMI’s share price. Given the environment and the desire of the consumer to trade down, I view this as an attractive entry point for a short. However, I do note that WFMI has traded at crazy multiples in the recent past – including 55x earnings and 28x EV/EBITDA, which must be taken into account in order to have real interest in the name.

HBI - Hanesbrands Inc is another name almost all readers will know. The Company makes the eponymous t-shirts, as well as many other wearable products. The reason this Company is on the Long interest list is because the management assures it will generate $300 million in Free Cash Flow (FCF) this year and continue to drive down its debt load, while maintaining enviable market position in categories that are almost consumer staple rather than consumer discretionary.

The catch though is that investors have driven down the share price because HBI still has a ton of historic debt from when it was spun out of Sara Lee in 2006. In fact its net debt level is almost 3x its stock market capitalization. But HBI was recently able to push out one of its debt covenant changes for two years, therefore getting rid of some of the risk surrounding the Company's debt covenants.

If HBI can battle through its recent sales declines and keep its price increases, which have been taken in February, and benefit from supplier cost structure improving, there is a chance that HBI can meet Wall Street estimates for the year. If the Company also delivers on its net debt reduction target of $300 million and keeps up that level of FCF generation, this is a clear Buy.

If the stock price drops down to between $6 and $7/share like it did recently, it should really be interesting. There was quite a bit of insider buying at these levels and certain management members were very proud of such well timed purchases.

SHOO - As a follow-up to a prior post, SHOO still looks of interest on the Long side. The Company posted free cash flow (FCF) in its 10K filing with the SEC of $33.5 million. Even though there was a 13% uptick in inventory levels (on a days sales basis), that kind of free cash generation is at least supportive of the current stock valuation, even if FCF declines meaningfully over the next couple of years (i.e. there seems to be a decent built in margin of safety).

-2outof4

Another Wild Week

It has taken me a while to get back into the swing of things this week after vacation. What seems pretty clear is that the government is hell bent on inflating the economy out of the current mess.

The Fed announced yesterday that rates would remain flat but that it was going to buy up a few hundred billion more of treasury bonds. It also announced that it was going to expand the type of collateral that could be used under the TALF program.

What does all the gubalty goop mean? Well here's an article in plain English explaining the former:
http://online.wsj.com/article/SB123749350368087807.html
Essentially the Fed wants to lower interest rates on mortgages, which is working because anecdotely a coworker just refied over the phone at 4.6%. The Fed accomplishes this by going into the market and buying the bonds, whose price and interest rate has an inverse relation. So, as prices rise (because the government is demand/buying so many), interest rates end up dropping.

The latter is somewhat explained here:
http://online.wsj.com/article/SB123748950250187103.html?mod=rss_topics_obama
TALF is what the government has decided to use to get lending going again. Previously, someone like a Carmax had sold a bunch of cars on credit and then sold those loans to an entity that would in turn create a security out of a bunch of pooled loans making an Asset Backed Security (ABS). This was done with all kinds of loans from car to school to home. The creator of the ABS would then sell them on as investments to other people. Part of the reason that most of our fine financial institutions are currently near insolvency is that although they moved a bunch of the ABS on to other people, a lot of the worst/lowest rated (and I use that term loosely) was left on their books - and now its gone bad or looks like it will not be paid down.

So where does this leave us? It is hard to argue that some sort of stimulation to the economy would not be welcome. As you probably know by now, I'm just not in favor of trying to do that by having a Part II of the last six years. (I think there is a lot of really creative stuff that could be done with sustainable energy sources to create jobs and reestablish America's strength in the world economy, but that's another topic.) Inflation is an obvious concern too. At some point rates will have to go up in order to control what is almost unavoidable inflation. This is the primary reason I advise not to lock yourself into any kind of interest rate on an investment product for more than 12 months at a time today. In 18 months rates could be 8% and I wouldn't want you in a 60 month 5% product.

One vehicle to play a rise in rates is the ETF, ticker TBT. It is the inverse of the Lehman Brothers 20+ Year Treasury Index. So, its price goes up when the Lehman Brothers 20+ Year Treasury Index goes down (or interest rates go up b/c remember bond prices move inversely to interest rates). That's a lot of inverses! This is one of the few stock tips I would go on record with friends and family. At some point I guarantee that it is going to go up - a lot! I just don't know when. I bought a little in my IRA in mid December and sold on the above news this week. I will get back into it at some point. Please note, this is one of those leveraged ETF's so it trades at two times the inverse of teh Lehman Brothers 20+ Year Treasury Index.

As for the TALF, I suppose I understand the need to get high grade debt paper circulating in order to lend more money, etc., but I also want to stick to the fact that I think America just needs to deleverage and that the process will be painful. This kind of program to me delays that deleveraging as much as anything. For example, the numbers for a company like Carmax were explained to me like this earlier in the week:
Carmax used to make a loan with a 10% interest rate, their loss rate would be 2%, they would sell the loan off at a 4 percentage point cut to the buyer of the loan and Carmax would end up with 4 percentage points of the interest on the loan, and supposedly this interest income accounted for a large percentage of earnings. (All numbers used are examples only.) This explains why Carmax's stock was crushed last Fall when the ABS markets, or ability to sell on ones' loans completely seized up. The problem is that the above numbers today look more like this:
Carmax makes a loan with 10% interest rate, their loss rate is now 6%, they sell the loan off at a 4 percentage point cut to the buyer and Carmax ends up with no profit on the loan business. Therefore, it kind of makes Carmax (ticker: KMX) of interest on the short side because a huge portion of its earnings will likely not repeat in this environment.

The point is that the TALF is being implemented and will likely be used to securitize loans from places like Carmax, but ultimately these loans are not profitable to the Company, and could be a negative to earnings in an inflationary environment where they have to offer the buyer a higher rate because rates in general are higher. In a sense, in this example, TALF just allows the consumer to buy that car at an artificially low rate and allows the car sellers to move volume. Does anyone see the need for the government to prop up volumes in that and similar markets?

It doesn't really get us on any stronger financial ground as a country in the long run. It just perpetuates business as usual, which I thought we just voted to change.

-2outof4

Carolina Blues

It looks like the Prez and I have the same NCAA tournament winner:
http://games.espn.go.com/tcmen/entry?entryID=2813746
It doesn't look like he has any major upsets, but I think his body man may have a little too much influence. But hey, what's wrong with a little ACC bias.

-2outof4

Mama Said There Would be Weeks Like This

Whoa-a! Up 10.7% on the S&P in a week to 757. Now that's a bear market rally if I have ever seen one.

A leaked internal memo from Citi and some decent retail numbers (I'll take a look at the MW numbers from the interest list), given the expectations, all lead to a major money making opportunity.

The only problem is that the average person, and hedge fund for that matter, was probably on the side line in most cash given the fear of the last several months. It looks like an excellent example of even though things may go lower still, one needs to have some money invested, or risk being left out of the party altogether.

Stocks can get "too cheap". And when they do, we need to start investing a little bit, knowing that things could still go down, but that there will also be opportunities like last week. A lot of companies in consumer land, for example, were up 30+%!

I look forward to getting back at it, as well as hearing from you! Vacay is over.

-2outof4

Anyone Know an Orthopedist?

I'm back! And in order to show you that I'm not only interested in "nerdy" things, I'll give you a glimpse of the more action packed side of "SB '09" (the moniker given to our little vacation by a fun loving gal from Dallas).

For anyone interested in mountain sports, I highly recommend heading out to the "I-70 Corridor" resorts and vistas in beautiful Colorado. Not only is the economy bringing down the prices of condo rentals and everything else, it means the slopes are uncrowded during the week.

Our first day out was a time to get our feet under ourselves and loosened up for more action later in the week, or so I thought. When my friend, DB, wanted to venture into the terrain park almost immediately, I thought he was crazy. However, I went along with him anyway, which explains past pictures of me wrapped around trees and in creek beds. You see, he is a budding Warren Miller, and is always after the action shot!

This video is of the first jump, the first time in the park at A-Basin:

Prior to that, two kids with baggy pants and fluorescent bandannas skied up next to us. So, I couldn't look chicken! The video doesn't really do the ramp, height or distance justice. It was freakin scary!

Is it an optical illusion?:

They're so cute at this age:

DB gets all the right angles:

I should have known by the shaking in my legs from all the adrenaline that the next move was not a smart one. Always listen to your body! But with a combination of DB chiding me for more action shots and the size of the kicker being considerably smaller than the first, I went ahead:

Ouch! Big mistake. As you can see, I got rotated a little too far backward and just crumpled to the ground, bending my left knee unnaturally backward, while twisting severely and rolling over my equipment! Better go see ski patrol:

Nurse 2outof4 to the rescue! Ski patrol didn't really know anything except that there was no bone sticking out of my ski pants. So, it was off to the ER. The MRI machine is not run on Sundays in Frisco, CO, so the Doc just tugged and pulled my knee around. Final diagnosis: didn't think there was any serious ligament damage, but maybe something wrong with my meniscus, definitely a bad sprain, wear a hinged don-joy brace, and lots of R.I.C.E. The departure nurse said that I would not ski again, and then quickly restated to say not that week.

Probably the worst part of the injury besides not being myself on skis, was it came with a strangely coincidental stomach virus that kept me up all night heaving and emitting sounds that none of my housemates could identify as human! Needless to say, I was on my back on the couch on Monday.

But Tuesday we had 10 to 12 inches of fresh snow at Vail. Two legs be damned!

This is not a bad shot by DB, considering for all intents and purposes I am skiing on one leg and unable to turn to the right:

Nope, definitely not an ambi-turner, but the snow and scenery in Shangri-La at Vail were amazing:

With so much snow, the flat run-outs often led to treks back to steeper terrain:

But alas, not being able to turn right in the bums and deep stuff, due to a bum knee, left me one more day off, followed by a couple of sunny and relaxing days with Mrs./Nurse 2outof4 on the cruisers! Meanwhile, DB found another partner to ski the "Minturn Mile", an out of bounds run down to the village of Minturn, west of Vail, on our last day:

All in all, a great vacation, despite the obvious, with friends and family. And to paraphrase the great Warren Miller, go ahead and move to ski country. If you don't, you'll be one year older when you do.

-2outof4

Two Investment Insights

1) It is almost never good when a company comes out and says that it is going to make its earnings announcement earlier than originally scheduled. See Exhibit A, Gymboree Corporation (ticker: GYMB) http://finance.yahoo.com/q?s=gymb (click the five day chart).
The crazy thing is that the news of the pre-announcement came out on Wednesday morning before the opening bell. One had all day Wednesday to short the stock before the Company announced disaster after the bell that day.

2) In speaking with a housebuilding exec this week, the obvious question came up. If I could, where should I buy real estate today? He said that he only really likes central and northern Florida, specifically Orlando, Tampa and Jacksonville. Paraphrasing the exec, "at least that's the bet I'm making!"

-2outof4

2outof4 on Vacation

That's right. I am escaping the Internet for a whole week! Seriously, I hope to be on the web as little as possible, and will not be posting until I return.

Starting Saturday and concluding the following weekend, I hope to be making some additional videos and photos, so that you are not quite as bored when you come to the site.

Hopefully, we don't hit 550 on the S&P while I'm gone!

-2outof4

Who Knew?

A while back I was frequently mocked by some former colleagues for participating in something they deemed "Yoga Pilates". Yoga Pilates was actually a class at Gold's Gym called BodyFlow - kind of a Yoga and meditation mix. Not only was the class a good stretch for my not-so-limber body, but I found myself very relaxed by the end of the class.

Well, here is another one. This time it can be done in the comfort and seclusion of your own home. I mocked it before I tried it. But I have found "08 Minute Pilates" to be an excellent source of core strengthening - something us desk jockeys can appreciate. Plus, Mrs. 2outof4 says that I am standing straighter. (I think its that she didn't like the beer gut.)

The video is led by Andrea Bernard and her henchwomen - Edna and Angie. Don't knock it before you try it!

-2outof4

State of Manufacturing in the US

I receive many great emails throughout the day with fantastic economic data and indicators. A friend in the northwest of the US sent me this from his own daily email flow:


"I was putting some data together from the BLS website. This is the number of manufacturing jobs in the US over time. They changed the way they presented the data in 2003 and I think moved some jobs that used to be called manufacturing to somewhere else. So there is a weird drop then. But still, the trend is amazing as the economy and population has grown a ton over this time. A lot of this is the big 3 auto companies, but still. Manufacturing used to employ like 7% of the US population and now it is 3% or something like that. It has gone from 14% of jobs to 8% of jobs. Anyway, I thought you would think this was interesting data. Easy to see why cities in the Midwest are hurting so badly. Population keeps leaving as the jobs leave. Or cities like Detroit just get destroyed with unemployment, crime, etc. Interesting to think what will happen. Will it go to zero? Will this reverse if we get rid of unions? This just cant be good for the US economy."





(You should just be able to click on the graph to see it more clearly.)


I'll take this post to also add a book to the book list. "Running Money: Hedge Fund Honchos, Monster Markets and my Hunt for the Big Score" by Andy Kessler (http://www.amazon.com/Running-Money-Honchos-Monster-Markets/dp/0060740655/ref=pd_bbs_3?ie=UTF8&s=books&qid=1236314094&sr=8-3) is a tale of Mr. Kessler's day to day challenges starting and running an investment firm, but also of his views on technology, product cycles, and the economy in general. It is easy to read and I recommend it.

The reason I bring this book up in reference to the above email and clear deterioration in manufacturing jobs in the US, is because Mr. Kessler spends time outling his thoughts on where those jobs have gone. I believe his answer would be somewhere along the lines of who cares?

He essentially believes that the US has outsourced a lot of the low margin heavy lifting, i.e. manufacturing. However, the US makes up for that by earning higher margins on the "intellectual property" (IP) that goes into the products that then come back into the US. The US consumer benefits due to increased efficiency and product income, as well as income redistribution through the stock market to things like retirement savings, etc.

In other words, some computer scientists in the States develop a microprocessor for which a Chinese computer manufacturer will pay $100 each (note these figures are just for illustrative purposes). There is no export from the US because the US company will license the technology. So for every $100 microprocessor the computer manufacturer pays the US company to license the US company earns 80%, or $80. The Chinese company integrates the microprocessor into the computer and exports the computer to the US for say $1,000 and earns a 5% margin, or $50.

In this transaction the American trade deficit is either $900 or $1,000 depending, I assume, on repatriation. However, the American company has earned 60% more on the transaction, and not only that but the American public is either directly or indirectly (through retirement plans) invested in the microprocessor company, so as it grows profits, Americans are in theory becoming more wealthy.

So does it make sense manufacturing jobs are being pushed offshore? Yes it does. Does it matter? It matters if Americans as a whole cannot innovate and grow businesses the way they have throughout America's brief history. Do I worry about the fact in itself that manufacturing jobs are decreasing? No, because I agree and have witnessed the above thought process in practice. It is also interesting to note the authors' numbers - 7% to 3%. Big percentage difference, relatively small on an absolute basis.

-2outof4

Different Angle on Higher Education Concerns

This article from the Consumer Digest takes another angle on the post from February entitled "Why Does College Cost So Much?":

http://news.prnewswire.com/DisplayReleaseContent.aspx?ACCT=104&STORY=/www/story/03-03-2009/0004981738&EDATE

They seem like very reasonable points, and just further reasons why the federal government should not allow these companies to bilk it for 20% net income margins.

-2outof4

Fair Tax - Do You Think It is Fair?

Hello! I have had some great suggestions and questions from a number of you. Today someone asked me about the "FairTax". I have to admit I knew very few of the details, but it sounds interesting.
http://en.wikipedia.org/wiki/FairTax

Essentially the FairTax abolishes Federal income tax and payroll tax. The only Federal tax that we are left with is a sales tax, proposed to be 23%. There seem to be lots of pros and cons.

Included in the pros are that this tax captures the entire US tax base from less wealthy to mega wealthy and from illegals to under reporters. There are vast numbers of anecdotes suggesting that a high percentage of able US workers either do not pay at all or under pay their taxes.

Opposition includes, similar to the Flat Tax, that the FairTax is a "regressive" tax because it taxes the lower and middle class at a greater percentage of their income than the wealthy. It is also said that the FairTax would not capture as much revenue as the current system.

The last point I think is reasonable. This suggests that Federal tax revenue in 2007 amounted to $2.6 trillion:
http://www.heritage.org/Research/features/budgetchartbook/fed-rev-spend-2008-boc-C1-Federal-Spending-Is-Growing.html
This suggests that consumption (granted, do not know the exact parameters of this definition) is about 60-65% of GDP:
http://www.bloggingstocks.com/2009/02/04/will-the-u-s-economys-focus-shift-from-consumption-to-producti/
This suggests that 2008 GDP amounted to $14.3 trillion:
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)
Therefore, if the US government taxed consumption (65% of GDP) at a 23% tax level, the revenue raised would equal $2.1 trillion, or half a trillion shy of 2007 levels.

It is true too that the FairTax seems to only tax end consumption and only "new" goods, so I presume it is not fair to include the full 65% of GDP. Nonetheless, it makes sense to me to look at plans like this. For one, it is glaringly more simple than the current tax code and the implementation difficulties that I could foresee are easily overcome. Don't forget, the current IRS budget is for approximately $11 billion annually. If a piece of that was offered to some private enterprise, I am sure it could come up with a way to solve the implementation glitches.

I understand that people will come down on the FairTax as regressive. But how can one argue that illegal immigrants and Joe the Plumber, who have either not reported taxes or significantly under reported taxes, should pay less that Joe the Garbage Collector or Jane the Software Engineer, who have dutifully paid tax through payroll their whole lives? Similarly, I do not really buy the argument that because wealthy people make more money, a greater percentage of it should be taxed. Plus, the FairTax is progressive in terms of consumption. The sales tax on a new Porsche is going to be a lot higher than a new Hyundai.

This does bring me to a a few questions. Does the FairTax stymie new product development? Isn't one incented to buy slightly used and use for longer? Whereas, that is arguably better for the planet in the long-run, it certainly would lower the government's income?

There seem to be many interesting angles and questions with regards to the FairTax, and I am curious to hear some other view points! Just because I did not get the math to work on my quick calculation, does not mean the tax is not a decent idea. After all, one can balance a budget through both the revenue and expense line items.

-2outof4

S&P Shocker

Several people have asked me for a view on where the S&P trades to this year. Well, sitting at just about 700 currently, I have no idea where we will end the year. However, I would not be surprised at all if we saw 550 at some point this year. That's 21% lower than where we are today.

That possibility presents a major challenge for professional money mangers. Their overriding fear is missing the "bounce" to a level of 900 or greater. The bounce may well happen as a result of further government stimulus, or some other unforeseen boost to the economy, or for no good reason at all. So money managers risk not being invested at the time of this bounce. The problem for the pros is that the move to 550 may come first!

The above situation is the cause of much of the deer-in-headlight expressions seen up and down Wall Street. So, in terms of stock investing, my fundamental view is that company earnings will in general get worse, but you will be able to find companies that are out performing or whose stock has just been bid so low that it rallies with any kind of slightly positive company-specific data point (see February's UEIC post). So, in sum, this market favor's the cliched "stockpicker".

This viewpoint begs the question, why are there not more actively managed (defined by me as a product where the manager is attempting to make positive returns in all kinds of market conditions, and has the leeway to do so) products available out there for the average investor to include in his or her portfolio? Where is the hedge fund for the common person?

-2outof4

Feel Good

It should be pretty clear that the current state of the Union has me a bit down. But similar to a jammed rest stop on I-95 brightening my day, a good Aria doesn't hurt either.

This is Paul Potts singing a number, which I was fortunate enough to see live last week, on Britain's equivalent of Idol. Enjoy!

http://www.youtube.com/watch?v=1k08yxu57NA

-2outof4