Boo!!!

Party like its 1999

This week, Barron's did a piece on the Sky high valuation on Chinese stocks. What amazes me is the similarities to the Chinese market and the Tech run up we had back in 1999. Does anyone remember that one? Apparently everyone's ulcers have healed and they are ready for another "this time it is different" market environment. Don't get me wrong, bubbles are fun, except for the popping part, but maybe that won't happen in this new Chinese economy. They have this huge booming middle class that needs as much stuff as the world can provide, right? Well, yes, but not at a growth rate consistently over 10%. Anyone remember how much fiber optic cable we needed last decade? Not near as much as we got. I believe we will see the same outcome in the Chinese market that we saw in the US tech run up in the late nineties. When will it come? That is a much more difficult question. I expect the current run up to last through the 2008 Olympics, however, I play these positions very cautiously. If I can take 20% of a move I am fine with that. I have to have the risk to reward ratio in my favor. Therefore, I only buy these Chinese/Emerging Market type securities on pull backs into support levels. Be warned, we will overshoot the valuations significantly in these securities and the US markets will feel it.......

For Andrew Barry's take in this weeks Barron's...

IT'S TOUGH TO SAY WHEN THE CURRENT mania for Chinese stocks will end, but the potential for a significant decline is growing. China's benchmark index has shot up 109% this year, and major Chinese companies now are valued at steep premiums to their U.S. counterparts.

Warren Buffett urged investors last week to be "cautious" on Chinese stocks, adding that "we never buy stocks when we see prices soaring." Buffett recently sold Berkshire Hathaway's (ticker: BRK/A) 1.3% stake in PetroChina (PTR), China's largest company, based on its sharply rising share price. PetroChina is valued at about $440 billion, nearly double its midsummer capitalization.

The world's No. 2 company based on market value, it rapidly is closing in on ExxonMobil's (XOM) $508 billion valuation. PetroChina trades for more than 20 times estimated 2007 profits, or twice its historic price/earnings multiple, versus Exxon's P/E of 13 and P/Es of about 10 for other Western oil companies such as Chevron (CVX) and ConocoPhillips (COP). Some analysts and investors think the Chinese oil company deserves no premium to its Western peers, and is overvalued by 50% or more.......

For the complete text: China's Sky-High Valuations Don't Compute, Barron's, October 29, 2007

The subconscience release

I want to try and bring in occasionally some reference to my athletics. While my day (and sometimes evening and night) job is to navigate through the oft troubled financial markets, I do spend much of my free time running or riding my bicycle. Boulder is a fantastic place for both. I find that while trail running in particular (perhaps due to the diversion of oxygen to my screaming lungs and failing to make its way to my brain) I develop some of my best money management/ investing strategies.

For instance, yesterday, while running my pooches on the Mesa Trail, I came up with the idea of, in one certain instance, selling a new position (that was entered as a momentum play that failed to keep running) for a very small loss with the anticipation of buying the same position more closely to support. This little idea was brought out by my subconscience and can now be further developed in my conscience mind.

I find that while physically exerting myself I allow myself to open up my subconscience mind. This is akin to great thinkers coming up with ideas under the influence of ....(you fill in the blank). The point is to find that place where you are receptive to letting yourself go and allowing your subconscience mind communicate with your conscience mind. Always have a way to write or digitally capture your thoughts; you never know when one of your ideas will lead to something profound.

A bounce in New Home Sales? Look closer...

My favorite, no BS, no spin, economics blogger, Barry Ritholtz, consistently does a fantastic job of pulling apart the BLS (Bureau of Labor and Statistics) economic numbers. This government organization makes the reporters job much easier since most of them don't really understand statistics and typically pull a headline out and forget to double check and see if what the information they relay is truly valid. Barry points out that the new home sales number released today was up 4.8%, or an annual rate of 770,000. Nice headline but the margin of error is +/-10% which makes the number irrelevant (not much of a headline). However, looking at the 23% drop year over year with a statistical error of 8% is statistically significant. Bottom line is that the reported number has to be larger than the error or the number doesn't mean a thing. Good thing most people don't understand the magical powers of statistics. Remember the saying lies, damn lies, and statistics?

Visit Barry's site regularly, it will make you a much more informed person.
TheBigPicture

No, New Homes Sales DID NOT Rise . . .

Thursday, October 25, 2007 | 10:12 AM

in Data Analysis | Real Estate

Look, we have to stop meeting this way.

Some half-assed piece of data comes out, the markets spasm, then you want to understand what the data really means.

OK, let's look at New Home Sales.

U.S. Census Bureau and the Department of Housing and Urban Development releases New Home Sales each month. The data contains three elements that contextualize what they mean, and how much significance they have, beyond the headline number.

First, we see the headline number. This month, September 2007 sales of new one-family houses were up 4.8%, at annual rate of 770,000 (SA).

Second, we look at the year-over-year data, which in this case was 23.3% below the September
2006 estimate of 1,004,000.

Third, we look at margin of error. The monthly gain of 4.8% was within the "estimated average relative standard errors" of ±10.3%. This means the data point was "statistically insignificant."

The year over year number however, at 23.3% -- ±8.0% -- is greater than the margin of error, and therefore is statistically significant.

Note: These aren't my opinions; these are simple mathematical facts that the Commerce Dept. notes in the footnotes of its release.

Next, we look at the revisions: For the month of August 2007, the original sales report was for 795,000 new homes built (annual rate). This was adjusted downwards this month to 735,000. An apples-to-apples comparison (original release to original release) shows a decrease, not an increase in new homes sales. Comparing the original (but soon to be revised) September data to the revised August data presents a misleading picture.

Lastly, we need to consider Cancellations. The Census Bureau does not make adjustments to the new home sales figures to account for cancellations of sales contracts. As we have seen, the Cancellation rates of Home Builders have been huge:

Firm . . . Cancellation rate for Quarter
Centex (CTX) 35%
MDC Holdings (MDC) 57%
KB Homes (KBH), 50%
Lennar Homes (LEN) 32%
D.R. Horton (DHI) 48%
Beazer Homes (BZH) 68%
NVR (27%)

So, you can further discount the reported data by some amount relative to the above cancellation rates . . .

Thanks for trying to keep us honest....

A subprime outlook for the global economy

I try and read the bi-weekly postings; "Thoughts from the Frontline" and "Outside the Box", both from John Mauldin. I always find his articles insightfully written and will always make your brain smoke as you try and understand the context. This week I found the article especially enlightening. The article written by Stephen Roach, ex-Chief Economist for Morgan Stanley and current Chairman of Morgan Stanley Asia, outlines many of my concerns going forward. A portion of the text is below, for the full text follow the link at the bottom of this post.

A Subprime Outlook for the Global Economy
By Stephen S. Roach


After nearly five fat years, the global economy is headed for trouble. This will come as a surprise to policy makers and investors, alike-most of who were counting on boom times to continue.

At work is yet another post-bubble adjustment in the world's largest economy - this time, the bursting of America's massive property bubble. The subprime fiasco is the tip of a much larger iceberg - an asset-dependent American consumer who has gone on the biggest spending binge in the modern history of the global economy. Seven years ago, the bursting of the dot-com bubble triggered a collapse in business capital spending that took the US and global economy into a mild recession. This time, post-bubble adjustments seem likely to hit US consumption, which at 72% of GDP, is more than five times the share the capital spending sector was seven years ago. This is a much bigger problem - one that could have grave consequences for the US and the rest of the world......

Don't Count on Global Decoupling

A capitulation of the American consumer spells considerable difficulty for the global economy. This conclusion is, of course, very much at odds with notion of "global decoupling" - an increasingly popular belief that depicts a world economy that has finally weaned itself from the ups and downs of the US economy.....

A Subprime Dollar

This constellation of forces could prove especially vexing for the US dollar. Currencies are, first and foremost, relative prices - in essence, measures of the intrinsic value of one economy versus another. On that basis, the world has had no compunction in writing down the value of the United States over the past several years. A broad dollar index, which measures the US currency relative to those of most of America's trading partners, is off about 20% from its early 2002 peak......

The Failure of Central Banking

The recent chain of events is not an isolated development. In fact, for the second time in seven years, the bursting of a major asset bubble has inflicted great damage on world financial markets. In both cases - the equity bubble in 2000 and the credit bubble in 2007 - central banks were asleep at the switch. The lack of monetary discipline has become a hallmark of an unfettered globalization. Central banks have failed to provide a stable underpinning to world financial markets and to an increasingly asset-dependent global economy....

For the complete text, which I highly recommend

A subprime outlook for the global economy
courtesy of Investor Insight and John Mauldin

So Cal Fires

Our thoughts and prayers are with you all. Google has an amazing overlay to their map program that helps up keep up to date on the changing events in this area of California.

View Larger Map

For information on helping out go to.
CNN's Impact your world

Oct 19, 1987

Very cool interactive chart from the WSJ of the terrible ride the Dow took on Black Monday and Terrible Tuesday, October 19-20, 1987.

Real effects of inflation

Why does the Federal Reserve focus on core inflation (that is real inflation less anything volatile like food and energy)? They claim it paints a more realistic picture of the direction of inflation. That model would work well if the groups they point to as volatile were actually volatile and not trending ( 1,5,2,7,1,-2,6,1 is volatile, 1,3,4,2,5,4,7 is trending higher). The fact is the groups they exclude (food and energy) are trending higher over time which is inflationary. The result of this yields a higher cost of living. In the graph below core and headline inflation are not running parallel (which would indicate that measuring a less volatile number would prove fairly accurate over time). Headline is actually increasing at a faster rate (over time) vs. core inflation. Inflation remains in check as long as you exclude the inflationary items.
James Picerno, Seeking Alpha, writes a good piece on the disconnect between headline and core inflation in:

Don't Write Inflation's Obituary, Just Yet

What are the actual effects of focusing on an inflationary gauge that fails to measure the actual, how does this effect my life, measure of inflation? For one, adjustments to Social Security checks are tied to core inflation measures.


The Washington Post reports this morning that
Social Security Checks to Rise 2.3%

Payments to Social Security recipients and most federal retirees will increase 2.3 percent in January. It is the smallest cost-of-living adjustment since 2003, reflecting a lower rate of inflation.

Are you diversified?

All of you have seen Jim Cramer's, Mad Money, in particular the segment when a caller call in and tells Jim the stocks in his/her portfolio and Jim goes on about how well concentrated or diversified he/she is. While the intentions are good the reality is that in general a given stock's movement is largely described by the overall movement in the broad indexes (s&P 500, DJ-30, etc.). Throw in some volatility or beta, and your position is just collateral from the general buying or selling fever of the day. In my opinion, diversification in the traditional sense is a devise created by brokers to cover their ass and ensure their clients will preform just as mediocre as everyone else and will provide you roughly what the general markets gives. Investopedia provides a good article on the danger of over diversification. This article suggests an optimum number of stocks to own to ensure diversification is about 20. I agree with some reservation. Based on the Modern Portfolio Theory, holding 20 positions will eliminate unsystematic risk, or the risk associated with holding an individual position. The theory goes on to state that systematic risk can not be diversified away. Therefore, if you are in the stock market and it crashes your positions will crash as well. This gets very close to smelling like on a risk adjusted level you will have a difficult time "beating" the averages.

This brings me to the real point of this story. Maybe the new model should be based on something like the Harvard Endowment which has handedly beat the market for years. The model used by Harvard is to diversify across asset classes (domestic and international stocks, bonds, real estate, private equity, hedge funds, commodities, etc.). I would suspect this approach has not gained much traction for the general population because of the lack of vehicles available to invest in, that is until recently. Money Magazine's article on Ivy League investing sheds some light on what makes these endowments tick.

These graphs demonstrate a new frontier of diversification and how the individual investor can emulate the big boys portfolio.

***Before taking on any new or otherwise investment strategy talk to your financial adivsor to discuss your particular risks and objectives.***

The Unhappy Anniversary

All the other media outlets are making a big deal out of this anniversary so I feel I should mention it, but in a different light. The resounding question being asked is if we could endure a failure like we witnessed on this date in 1987. I can't imagine the pain that that crash caused. I do know the pain feel from "little" dips, pullbacks, etc. As a swing trade/investor these one day to a few day events hurt. What I would like to address in light of the market crash talk is planning. As a professional money manager the most important decision I make is when to take a position off the table. The actual position is not near as important as the management of that position. Before I decide to add any position, I make my goals very clear. I want to know the level at which my position no longer gives me a favorable risk/reward outcome. That level can be after a position makes a great run in a short time or it can be after a position pulls back to a level that the odds no longer favor a continued move higher. The main point for me is to know typical action of each position and come up with a strategy for any direction it takes. I do this from a technical perspective (support, resistance, average true range, dollar loss, percent gain, etc). Each position is different and requires a strategy unique to itself.

U. S. Trade Deficit Falls to lowest in 3 years

One of the positive aspects of our falling dollar is the narrowing of our trade deficit.

A surprise drop in the U.S. trade deficit highlights two key economic trends: uncertain demand at home and stronger growth abroad.
Rousing gains for U.S. exports helped narrow the August trade deficit by 2.4% to $57.6 billion from $59 billion in July, the Commerce Department said Thursday. Wall Street expected little change.
U.S. exports grew 0.4% to $138.34 billion, while imports fell 0.4% to $195.92 billion.
Year over year, exports surged 12.8% thanks to healthy growth abroad and extra buying power courtesy of a weaker dollar.
A sluggish U.S. economy, meanwhile, kept year-over-year import growth at 3%. That’s the smallest such gain since June 2002 — excluding January, when oil prices bottomed.

Rising exports are undoubtedly a bonus, but economists say much of the rise comes from the shaky greenback. ....Investor's Business Daily via CNN Money

Read More

Dear Mr. Poole, you left the money spigot turned on

Just the other day I mentioned that the St. Louis Fed president, William Poole, did not see a weakening dollar as a precursor to inflation. Assuming we can agree on the definition of inflation as a relative increase in money supply, leading to a general increase in prices/decrease in purchasing power, then the continual increase in the rate of Repurchase Agreements should mean something to the tune of increasing the money supply. This measure was recorded in M3 money supply level. The government decided this statistic was not worth paying the people to update it. Very convenient, as that has been the major method to inject money into the system. Still can't fool the traders as witnessed by currency and commodity traders.




SFO Straight Talk:

Fed Injects Large Repo Of $16B
The Federal Reserve injected a very large $16 billion into the financial system Wednesday morning, as the central bank battled to get the federal funds rate back to its target level.

The Fed carried out a $16 billion overnight repurchase agreement, or repo. That was much larger than the $5 billion baseline estimate of Wrightson ICAP.

"The very large RPs of the past two sessions are the result of the Fed's decision to undersupply reserves last week," said Wrightson analysts said on the company's Web site. "Short-term efforts to prevent softness in overnight rates before the weekend have led to imbalances in the other direction in the final two days of the maintenance period."

In total, there was $59.25 billion submitted. Of the $16 billion accepted, $11.5 billion of it was in tranche two, which are loans made against collateral including Treasurys and agency debt.

Easy credit contiues to wreck havoc

Another one of my favorite topics over the last year or so has been the Sub-prime (let's generalize and call it easy credit) mess that our Federal Reserve created as a response to the tech bubble in the late nineties. The Fed's interest rate lowering program had the immediate effect delivering one of the mildest recessions in our history. The pending question remains did we prolong a deeper correction? Economists across the board need two boards to disseminate their 180 degrees of perspective. I think we have not felt the full force of the easy credit issues but global growth will help absorb some of our pain. The Wall Street Journal has a nice little interactive map showing just how widespread the easy credit situation has become.



I see many opportunities in the next year or so to help our house flipping brother take a burden off his shoulders. Real Estate, like the stock market, has and will continue to appreciate over the long term. The question is can you maintain cash flow in the short term?

See also:

Foreclosure Filings Nearly Double

Working families need help to afford the basics

Poole on the dollar

I certainly don't have the credentials that William Poole, St. Louis Fed president, has but come on. You can't pitch straight down the middle and call it a ball. While all eyes are on the Fed today, Mr. Poole took the opportunity to comment on housing and the current credit landscape. The take away was that the sea is choppy. Not exactly breaking news. What was interesting was his take on the current US dollar. Quote, "Weaker dollar is not fueling major inflation concerns". Easing credit conditions did not raise any concern either, until it was a problem. I am a technical analyst by trade. I get drug into the fundamental world on occasion but by and large I believe that the charts show what IS, and not what we are told. Market actions are based on current beliefs and when people put their money down they believe that it will net even more money. Therefore, when I look at price action of gold, oil, food type stocks, interest rates, and currency I can't help but believe there is still some inflation concern. At least there is still a whole lot of money betting that the dollar's slide is going to continue to drive commodities higher.

Barchart.com - Charts - DXY0 U.S. DOLLAR INDEX Cash FINEX

Barchart.com - Charts - GLD STREETTRACKS GOLD TR NYSE

With the dollar reaching all time lows against its trade weighted average of international currencies, you at least have to pause and ask yourself is this really what we want to do?

Sept Fed Minutes

The Sept Fed minutes are out and the stand out message to the markets are that the doors are ajar for further cuts going forward. The unanimous decision by all voting members indicate to me they see real trouble on the horizon and are acting preemptively. The 50 bp cut we saw last month took me by surprise given the past clues into the Fed's thinking. We were told time and again they would be vigilant on inflation, would not bail out those who made poor investment choices, and any decisons would be data dependent. Despite what we heard what we saw is what IS, that is what is important. What is is a level in which the Greenspan put has been replaced by the Bernake put. I suspect that the 180 degree turn on inflation outlook is that a soft economy (2007 and 2008 growth has been revised down) will act in a manner to cool inflation (soft economy will lead to decreased demand). I know in my own experience that I do tend to eat less, drive less, use less health services, and generally don't feel the need to educate my self any more. Oh, wait the Fed doesn't look at these things when looking at inflation, so they must not count. It does look at ORE (Owner's Rent Equivalents) maybe the answer lies there somewhere. As housing prices decrease, rents should increase, leading to inflation. No that doesn't work either. Maybe lowering interest rates to beat down our currency. No that works just like printing money which is inflationary. Maybe lowering rates to make sure the economy remains propped up through the 2008 presidential election. That smells closer but the Fed is independent right, it is right?

Greenspan on The Daily Show

I just got wind of this. We could all feel it was true but now Easy Al "tells it like it is". The Cliff Notes go something like this.....
1) The Fed is in place to tell us how much money there is and too much of it causes inflation.
2) By the way we do not have a free market, the Fed gets to "Regulate" it.
3) The Fed's perception is the Market's reality
4) I (Greenspan) have been in the forecasting business for more than 50 years and I am no better today than I ever was and neither is anyone else.
5) Human nature never changes it is still all about fear and greed






I can't wait for the Sept Fed minutes due out tomorrow. I am sure it will drum up some lively commentary.

Colorado Trail trail running

Aside from the miserable performance by our beloved Denver Broncos, we had a beautiful fall Sunday. We spent the morning out trail running on part of the Colorado Trail, beginning from the trail crossing at FR550, just down the road from Hwy 126. With very little actual elevation change and miles and miles of singletrack (for those mountain bike purists) and beautiful scenery, his trail is one of the best for all levels of runners. This section is one of my all time favorite for those long runs in preparation for an up coming marathon.

The Making of a Financial Portfolio Manager

Welcome to my blog. For this first posting I will give you a little of my background via some quick life highlights. I was raised in Midland, Tx (yep, 180 degrees away from Boulder, CO). I grabbed my High School Diploma on the way out the door to Colorado, where my real adventure begins.

By the time I had moved to Colorado I had already climbed Mt. Whitney in California, and Mt. Rainier and Mt. Baker in Washington, learned to ice climb (on the local Midland, Tx., trees), and dove off the coast of Kauai.

Once in Colorado I spent my first few years really climbing both rock, ice, and some big peaks. Oh, and I spent some time on the University of Colorado campus with the aspirations of becoming a doctor. My advisor took some issue with that notion as I was not "Med School material". Turns out he was correct, but for different reasons. I did manage to finish up my undergraduate work at the University of Colorado with duel degrees in Biochemistry and Molecular Biology. Turns out that I really didn't have a passion for the sciences but the undergraduate work did wonders to develop my analytical side which plays a major role in my current work.

By my senior year I had worked my way onto the University of Colorado Triathlon Team (to meet girls of course). Well, I didn't meet any girls but did mange to find a skill set that I maintain to this day. I fell in love (for lack of better words) with the sport and immediately took it to the highest level. I began training for the iron distance triathlons (I am too slow for the short stuff). By November of 2000 I completed my first full length iron distance triathlon, The Great Floridian.

By the end of November, that same year, I found my self in the Vail Hospital with two broken ankles. I took a pretty substantial fall ice climbing. I was picked to lead the very sketchy climb because I was the only one with insurance at the time. After being CAT scanned from head to toe (with special interest in my heart; they wanted to make sure it was still attached to my aorta), and having my ankles bolted back together, I was left to deal with the pain and realization that I might never properly walk again. This hurt much more than the mess below my tibiae. Months and months later I did finally take my first run of 100 ft. A year later I would go on to run my first marathon. I did return and returned with a vengeance. If anyone is interested I can make a few posts on that experience.

During the days of crawling on the floor with my busted bones I decided to head into the business world and work towards an MBA. As it turned out my MBA (student loans) helped to finance my professional amateur triathlon career. By 2004 I was qualified to compete in the Ironman Triathlon World Championships in Kona, Hawaii. Yep, the big one. Life is a compilation of each of our past experiences. Ironman training, while not providing me with direct career experience, helped me to develop dedication.

I completed this and began selling Microscopes, and other high end imaging equipment and accompanying software out of Salt Lake City. This lasted about a year and a half. My heart was with the stock market not the sciences. During this time I had also managed to obtain a Master's degree in Finance. My path was now set. I loved the stock market.

My focus was now on my career. I was still athletic but not what I was. Again, a topic for another post. The transition from peak performer to an "also ran" is more difficult than is advertised. I suspect this is why many professional athletes come out of retirement. I did manage to qualify for the Xterra off-road World Championships in Maui, HI but another injury derailed that experience. I would now be starting over at the very bottom of the heaps of people trying to jockey a successful career. I would draw on my years as an athlete to carry me.

Deciding to pursue a financial oriented career, I landed a position back in Boulder, CO, with a stock advisory firm (Winning on Wall Street) where I would take phone calls and tell our members what I thought of their stock ideas. I also was able to spend some time co hosting the associated radio program.

With my new found knowledge of stock analysis, risk management, economics, and my desire to be a professional portfolio manager I started Keystone Capital Management. This is where we will start this blog. I want to share the trials of being forged by fire into a professional polished money manger. This has been the most difficult venture I have ever undertaken. The street level learning and psychology of dealing with other people's trust and future is more than I ever could have imagined. It has been a fascinating journey that I hope you will enjoy and participate in.