Biz Dev in NYC by Rob Tsai

Friday was my last day at Rapt, a software and services company focused on helping online publishers improve their yield through better pricing, inventory forecasting and analytics. I had spent two years there as a Sales Consultant, working with customers to assess the right solutions for them and building the business case and ROI analysis to quantify the revenue uplift from working together. We were fortunate to be acquired by Microsoft in March of this year.

I was privileged to work with some very bright and talented colleagues, as well as clients such as the New York Times, USA Today, Reuters and MTV Networks.

My plan is to take the summer off, read, trade my personal account, play tennis and golf and soccer, visit friends, and then to look for a job in investment management in the fall.

With only the agriculture and energy complexes appearing to work, and with the financials continuing to trade down, I’m continuing to position myself for a sideways or bearish market for the rest of the summer.

As we come close to retesting the March lows of the DJIA and SPX, I felt that last Friday’s sell-off was nowhere near as brutal as the March sell-off surrounding the panic that was Bear Stearns. Only this time, the story was contagion. First the money seller banks sell off, then the regionals follow. Investors have kept trying to call the bottom in financials - only to see more downside. Each bounce is being sold.

On the commodity side, I’m still bullish agriculture and natural gas and iron ore (over crude and gold). Bunge’s sell-off after its acquisition of Corn Products is a little troubling, but Potash and Mosaic both held up ok, and Corn Products is less of a pure play on agricultre - and more of a processor of grain products (like Archer Daniels). I’d say it’s a less attractive part of the value chain, especially as raw input costs rise, the ability to pass on the costs and maintain margin is difficult. Who is to say that sugar refineries won’t get their margins compressed similar to the crack spread compression faced by the oil refineries like TSO and VLO. Plus, Bunge paid a big premium, so it wasn’t surprising that the buyer’s stock sold off on the news.

I still feel Potash and Mosaic need to get bought on any pullback. Actually, I feel like Mosaic is getting close (would buy in the low 140s).

And Deere looks interesting at these prices, too.

Here’s what I traded today:

Shorts -

Shorted Conagra ahead of Thursday’s earnings. All food stocks have been feeling the pressure of rising inputs - pork (Smithfield), poultry (Pilgrim’s Pride), Jams (JM Smuckers) - so I think Conagra will have a hard time this earnings period and offering guidance moving forward.

Shorted Big Lots - retailer has had a big run, lots of insider selling. The only retailers I’d own today are Walmart or Costco.

Shorted Hanes Brands - cotton prices are running, commodity product, high debt

Shorted Oracle - bearish on enterprise IT spending, with financials continuing to break down, retailers in pain. The countervailing trend is international demand (IBM posted good numbers last quarter), but I’m still on the bear side here.

Shorted Ryder - transports performance diverging from the indices is a little strange here. Transport theory suggests that the market will turn when the transports are performing (as volumes precede the economic turn). Still, I feel this is a head fake. High oil prices definitely squeeze the margin of trucking. I’d rather own the rails. Though they are impacted by fuel prices, it’s a more efficient mode of travel. And trucks are more levered to shipping consumer stuff in declining demand (apparel, electronics) while rails ship the stuff that world needs (grains, coal).

Buys -

Still buying industrials, energy and metals - Gardner Denver, EOG Resources, Cabot Oil and Gas (Secondary priced and stock is still trading higher), Companhia Siderurgica Nacional, Precision Castparts

Bought an ultrashort on the Lehman 7-10 year treasury index. Fed meeting this week, and fed is in a bind. 4.15% yield on the 10-year to me is a joke, with spiraling costs in oil, gas, food. The ECB has been uber-hawkish on rates, trying to defend against inflation, while the Fed has been uber-accomodating in an effort to rescue the domestic markets and the economy. Seems to me a bad situation - as we continue to need to print paper to fund our war in Iraq, our broken health care system and our insatiable demand for driving SUVs (actually - this may possibly wane with $4 gas), and yet we want creditors to fund all this with 4.15% paper. Seriously?

I was recently interviewed by Covestor for their weekly member interview series.

Here’s a link to the PDF of the interview.

Thanks to Perry, Paul and Blair for the opportunity to be featured.

It has been one year to this day, since the passing of my father Ding Joe.

We miss him greatly and will love him always.

On days like this, it’s helpful to remember that you can actually MAKE money too on other days.

I meant to update my 2007 performance, using Cake’s charts, since they roll over once per month.   I think my long portfolio was up 42% in 2007 - but I’m definitely feeling the pain today.

I read Mish’s posting on Minyanville yesterday, which paints a pretty tough picture heading into 2008:

• I have received many emails recently in regards to yield and inflation adjusted returns. The most common complaint goes something like this: “Prices are rising at x%, the CPI is a crock, so if I get less return than x% then I am losing money.”
• Yes, that is likely true. It has also fueled bubbles in many equity markets (and perhaps even commodity markets) by those looking to do something about it.
• However, no one is entitled to positive returns. It is entirely possible that for a period of time the best thing one can do is minimize “real” (CPI adjusted) losses.

Mish goes on to press his case for a continued “assymetric unwind of the credit bubble”, based on the following assumptions:

• Housing is going to continue to be weak
• Commercial real estate is going to be weak
• Capital impairments at banks will be an issue
• Unemployment is going to rise
• Consumer spending will be weak
• Credit card defaults will rise
• Foreclosures will rise
• Corporate earnings will be weak
• The Yen carry trade will unwind

The question arises whether it’s too late to make money being short the homebuilders, commercial REITs, financials, consumer discretionary (restaurants, retail), or long the Japanese Yen (FXY).   I personally think there’s still room in these trades, and I have a few positions that reflect these themes.

Mish concludes:

• The credit conditions that fostered those so called “profits” are not returning no matter what the Fed does. S&P earnings are now estimated at 23 not 16. A PE of 23 is not cheap. In fact it is more closely associated with market peaks. If more writedowns than expected come, even 23 will be too low an estimate.
• Please remember that for the last few years nearly every investment class rose in union. It is entirely possible if indeed not likely, that the reverse happens for a few years. What was correlated on the way up can certainly remain correlated on the way down, even if there is an asymmetrical skew to the unwind.
• In a muddle through economy with weak corporate earnings, mistakes will be punished quickly and severely. Thus safety should be the primary concern. Furthermore, risk in equities and risk in the economy are both heavily skewed to the downside.
• Long-short strategies that can play relative strength within sectors and or stronger sectors vs. weaker sectors may be the best equity strategy going forward. Otherwise there is simply nothing wrong with building a CD or treasury ladder while one waits for better opportunities down the road.

Last night on Fast Money, Guy Adami was recommending a long position in Intel, after the stock got crushed on a Bank Of America analyst’s downgrade.  SeekingAlpha has a good posting supporting this pullback as a buying opportunity.

Jon Najarian also made the case of shorting KLA-Tencor, the semiconductor equipment supplier.

Thematically this makes sense to me.  Intel has a dominant position in the microprocessor space, powering everything from laptops, desktops, servers and even Apple computers.   This article pegs Intel’s market share at 78.7% compared to AMD’s 13.9% in Q3 2007, according to estimates from iSuppli.   So certainly, a global slowdown in tech spending would hurt Intel, but you have to love their market dominance, and it’s not clear to me that people won’t keep spending money on computers.  I’d look to Intel to continue innovating, pushing the limits of Moore’s law to improve pricing and performance, and there’s no doubt of Intel’s ability to maintain good gross margins compared to commoditized chips like memory (DRAM, flash).  

• For example, Intel’s gross margins in Q3 2007 was 51.2%, compared to 46.9% in Q2 2007, and 49.1% in Q3 2006.   So margins improved both sequentially and year over year.

I thought I’d use Doug Lehrman’s tutorial on pairs trading at Traders Log to analyze this pairs trade - long INTC/short KLAC.

• Creating a pairs trade involves the following four steps:

1. Perform correlation analysis to match stocks.

2. Apply technical and statistical indicators.

3. Perform fundamental and technical tests to confirm relationship.

4. Manage and exit the trade.

I downloaded the daily closing prices for the latest year (251 data points) from Google finance, and ran the correlation analysis, and found that there was virtually no correlation.   The correlation coefficient is 0.059.

If you look at the 1 year price comparison charts, you see that Intel returned close to 25% compared to KLA-Tencor’s -5% return.  Intel underperformed KLA largely through June.  From June to September, it looks like they traded in step with one another, before diverging substantially in September.   What was explains KLA’s downward move?

• October 4 - CIBC analyst Gary Hsuehdowngraded the stock citing market share loss at a large DRAM customer, Rexchip
• October 26 - KLA reports Q1 profits down 35 percent, and Citi analyst Timothy Arcuri downgrades the stock

So the question becomes whether you think KLA’s downward trend persists or not, whether Intel will recover from this recent downgrade, and whether the spread between the two stocks will widen or narrow. 

So the trade at the end is not really a statistical mean-reversion trade by any means, but rather a bet on whether a market dominant chipmaker like Intel can perform simultaneously when semiconductor equipment capital expenditures are reduced.  Probably the next level analysis would go into utilization of fabs. 

One final interesting data set to look at is the semiconductor industry’s book to bill ratio.  The analysis uses trailing three months of bookings data compared to billings to smooth out volatility.  

I downloaded the historical book to bill ratio’s from SEMI, an industry organization, and then charted the ratio from Jan 91 to Nov 07 (p) below:

You’ll notice first that the book to bill ratio, and the semiconductor industry, is highly cyclical - reflecting (over)investment in capital expenditures followed by slowdowns.   The latest book-to-bill ratio is at 0.82, signifying that chip makers received $82 in new orders for every $100 in billings.  The last peak was at 1.14 in June 2006, so this downtrend in book-to-bill has been about a year and a half.   Interestingly enough, KLAC stock was in an uptrend from June 2006 through August 2007 - even while the industry book-to-bill was moving from peak to trough.

The author is long INTC and short KLAC

I’ve recently bought a couple lots of Cisco (CSCO) from $27.50 to $29.50, thinking that I had near term support at $27.  As of this writing, CSCO has broken through the $27 level, and now sits near $26.25, which surprised me.  Normally, you’re supposed to sell when a stock breaks a support level, but I’m thinking of this as a long term position (at least one year), so I won’t try to sell it and pick it up cheaper.

I had thought that the sell off from $34, after their last earnings announcement where they beat their quarterly number but the stock sold off 10% nonetheless, was overdone and that the $27 to $29 range represented a good buying opportunity.

For example, SeekingAlpha picked up this BusinessWeek story in December 2007 on AT&T’s order (up to $500 million worth) to upgrade its network.

Here are some highlights of that bullish article:

• What’s noteworthy isn’t simply the size of the deal but the vast amount of bandwidth it represents. When Cisco brought out its top-of-the-line router in 2004, many analysts felt it was so powerful that only a handful of companies would ever buy one. Now, AT&T (T) plans to link 25 cities with these mighty machines to help it handle the rising tide of Net traffic—particularly video.
• Now other telcos and cable companies, located everywhere from Korea to Bulgaria, are flooding Cisco with orders—and helping realize its dream of conquering the telecom market, long a domain of Alcatel-Lucent (ALU), Ericsson (ERICY), and Nortel (NT).
• Thanks to all this activity, Cisco has been grabbing market share. Its piece of service provider sales has grown from 7.5% to 8.4% between the second quarter of 2007 and the same period last year, according to IDC. That growth has come at the expense Alcatel-Lucent, establishing Cisco as the world’s fourth-largest equipment provider for carriers, a bump from No. 5 last year. As telcos jump into video services, they’re replacing separate voice, data, and video networks with a single one based on Internet technology.
• The quick growth of its service provider business carries huge implications for Cisco. In a world in which more and more computing occurs out on the Internet as opposed to inside PCs and corporate networks, the companies that handle all the communications needs—carriers and cable companies—become increasingly crucial.

My one disagreement with Cisco’s strategy is their direct-to-consumer business.

• But Cisco also wants to sell to consumers that want to buy gear directly, rather than rely on carriers. It’s a question of so-called channel conflict. Cisco is well-positioned to reach consumers in both ways, either by striking a deal with your local phone or cable company or by selling you gear at the local Best Buy (BBY). Many analysts think the latter will become more popular, as a generation of Web-savvy consumers seeks to create their own Internet experience rather than pay a big monthly bill for premium services from carriers. Cisco’s challenge: how to go after this direct business without ostracizing its carriers, which are banking on selling those premium services to avoid having to subsist on selling basic connections at commodity prices.

I think Cisco should stick to servicing the enterprise and carriers and avoid the consumer play.  Can you name which of these router companies is a Cisco one?   Linksys, Netgear, D-Link, Belkin?  (btw it’s Linksys).   And who cares anyway?   You can get routers from Best Buy for like $50, and they always carry big rebates.   I can’t imagine they carry much margin given the commoditized product space, the competition, and the the low price point.  And with Circuit City’s imposion, I’d look to even more negative pressure on these commoditized products through early 2008 as they liquidate their inventories  On the flip side, I like Cisco’s acquisition of Scientific Atlanta (set top boxes and DVRs), as cable companies typically bundle these for free to the consumer to pick up the recurring subscription revenue. 

In the end, though, I look for Cisco’s growth and margins to be driven by their carrier relationships, and I believe that the global communication trends, such as -

• cell phones everywhere
• migration from 2.5g to 3g and beyond
• internet telephony
• video over IP
• mobile applications
• multiplayer online gaming
• corporate WebEx presentations (another Cisco company)
• videoconferencing

will drive demand for bandwidth and therefore investment in the carrier infrastructure that should benefit the Cisco shareholders.

Also, Cisco’s large size ($160 billion market cap) is consistent with a  more defensive investment strategy in 2008 to stay with large caps (with global exposure) over smaller caps.

The author has a long position in CSCO

Buffett’s decision this week to launch his own bond insurer drove shares of MBIA down even further, as reported by the WSJ and theStreet.com on Friday.

Buffett probably had ample opportunity to step in and buy MBIA or Ambac with his $45 billion war chest (less $4.5 billion for his purchase of Marmon?), but decided rather to build versus buy.

Bill Ackman’s presentation at this year’s Value Investing Congress laid out in 145 slides the bear case for the current bond insurers and steps on how to save the industry.  His response to the question “Why Would Anyone Bail Out a Holding Company” seem spot on given Buffett’s recent entry into the industry:

• Investors won’t invest in a Holding Company because it is structurally
  subordinate to hundreds of billions of dollars of Insurance Subsidiary
  exposure
• Tens of thousands of individual credits make it practically impossible to
  gain comfort regarding the magnitude of potential loss exposures
• As sums required to bail out Bond Insurers reach into the billions of
  dollars, new investors would be better off “greenfielding” a new Bond
  Insurer (in a tax free jurisdiction) without having to assume billions of
  unknown liabilities

The rest of the presentation is full of great information and is highly recommended.

Here’s a fun quiz from Barron’s in this week’s issue.  The winner gets a free subscription and lunch with editor Andrew Bary in New York:

1. Which U.S. equity index will fare best in 2008?
A. Dow Jones Industrials
B. S&P 500
C. Nasdaq
D. Russell 2000

I’m going with the Nasdaq (C).    

2. Which market will perform best?
A. U.S. (S&P 500)
B. Japan (Nikkei)
C. U.K. (FTSE)
D. Germany (DAX)

Germany (D)

3. Which S&P 500 sector will be No. 1?
A. Health Care
B.Consumer Staples
C. Energy
D. Technology
E. Financials
F. Basic Materials

Technology (D)

4. 2008’s biggest financial surprise:
A. S&P 500 drops over 10%
B. Emerging stock mkts rise another 20%
C. Gold ends above $1,000 an ounce
D. Dollar up 10% vs. Euro
E. None of the above

I wouldn’t be surprised if all of these things happened, but I’ll go with (D)

5. Which laggard industry group will do best in 2008?
A. Brokerage stocks (BSC, MER. MS)
B. Cable TV (CMCSA, TWC, CVC)
C. Homebuilders (KBH, CTX, TOL)
D. Retailers (M, TGT, JCP)
E. Airlines (AMR, CAL, UAUA)

Retailers (D)

6. Which CEO will no longer be at the helm at the end of 2008?
A. GM’s Rick Wagoner
B. Apple’s Steve Jobs
C. Morgan Stanley’s John Mack
D. Lehman Brothers’ Dick Fuld
E. Pfizer’s Jeff Kindler
F. All will still be on their jobs

GM’s Wagoner (A)

7. Which top stock from 2007 will do worst in 2008?
A. Google
B. Apple
C. Potash Corp.
D. Amazon.com
E. Monsanto

Amazon (D)

8. Which of these companies will agree to be taken over in 2008?
A. Echostar
B. Yahoo
C. U.S. Steel
D. Suntrust Banks
E. Sprint
F. Bear Stearns
G. None of the above

US Steel (C)

9. Which winning industry group from 2007 will fare best in 2008?
A. Mining (BHP, FCX, AA)
B. Offshore Drillers (RIG, DO, NE)
C. Beverages (KO, PEP, TAP)
D. Household Products (CL, PG, UN)

Offshore Drillers (B)

10. Name the top-performing stock in the Dow Industrials in 2008. (Including dividends)
Worth 2 points

Microsoft

11. Name the worst-performing Dow stock for 2008 (Including dividends).
Worth 2 points

General Motors

12. Who will be the Democratic presidential candidate?
A. Hillary Clinton
B. Barack Obama
C. John Edwards
D. Someone else

Hillary Clinton (A)

13. Who will be the Republican presidential candidate?
A. Rudy Giuliani
B. Mitt Romney
C. Mike Huckabee
D. Someone else

Rudy Giuliani (A)

14. Who will be the next U.S. president?
Worth 2 points

Hillary Clinton (A)

15. What will be the top-performing commodity?
A. Gold
B. Oil
C. Wheat
D. Corn
E. Sugar

Wheat

16. Where will the key federal funds rate end 2008?
A. 3% or lower
B. 3.25% to 4%
C. 4.25% (current level)
D. 4.50% or higher

3.25% to 4%  (B)

17. Tie-breaker. At what level will the Dow Industrials end 2008?

14,379

Barron’s will name a winner at the start of 2009. All entries must be postmarked by Jan. 2 or received by e-mail by then. E-mail entries to editors@barrons.com.

Mail entries to:

Barron’s Editors
200 Liberty Street
New York, N.Y. 10281

Name:
Address:
Daytime Phone:
E-mail Address:

Peter Lynch, of Fidelity fame, counseled in his classic book One Up On Wall Street to “buy what you know.”  

Over beers and burgers at the Spotted Pig last night with an Emerging Markets structured products friend of mine, we both laughed at ourselves for missing opportunities that were staring us in the face.

If only we had bought Apple (AAPL), the stock, when we bought our first iPods (for me that would have been Christmas of 2004 or a cost basis around 10 - when they were pretty much sold out everywhere, and I was scouring the city for one).  That would have been a nice 20 bagger.

Or even as recently this fall, when my brother bought the Xbox 360 just for Guitar Hero 2 and 3, and the two guitars that came with them.   Jeff Macke at CNBC’s Mad Money had been pounding the table on Activision (ATVI), but oops - thinking like a consumer first, without putting on the investor hat, is a no no.   Probably could have made a 50% return in a few months, on the acquisition/merger with Vivendi Universal.

The list goes on - but the lesson is clear.

So 2008 will be the year that I promise to myself to buy the fat pitch stocks of things that I just KNOW will go up (or suspect with a high confidence level).  

Ok - so I haven’t seen that fat pitch yet - but I’m ready, this time, I swear.  And if any readers or friends want to drop a comment on good ideas, I’m all ears.

Sadly - this strategy probably wouldn’t have helped identify 2007 high fliers like Potash of Saskatchewan (POT) or First Solar (FSLR) - as I don’t think I’m their target customer segment.  Though you could have forseen the demand for fertilizers to feed the burgeoning global population or the demand for alternative energy.

As an aside - one of my favorite bloggers Trader Mark, was onto Potash quite early.  And now Goldman Sachs has joined the party with a $180 price target.

Sadly, my only Ag exposure today is Agrium (AGU) (which I wish I held more of) - but if I had to put any money to work in the sector today, I’d probably opt to go with the Powershares DB Agriculture ETF (DBA).   Whereas the other major agriculture ETF Marketvectors Agribusiness (MOO) owns stakes in the equity of leading agriculture businesses like Potash, Mosaic and Agrium, the Powershares DB Agriculture ETF invests in futures contracts in Wheat, Soybeans, Cotton and Sugar.   So it’s similar to investing in a gold ETF like GLD or IAU rather than owning the gold miners like Newmont Mining (NEM).

I know I’ve been hearing a lot of pundits talk about sector rotation to the consumer staples names like P&G or Unilever.   Still, I wonder how long these branded players will be able to pass along cost increases to the consumer without severely squeezing their margins. 

The Minyanville transcript of a recent General Mills conference call describing a interchange between an analyst and the company on passing along input costs to the consumer by “masking” the price increase by reducing the size of the box is hilarious and sad at the same time.

Notwithstanding the government’s core inflation statistics, or the savvy marketers attempts to fool us by making the box size smaller, we all know that food inflation is VERY real.  At some point, say $8 a box (I’d peg the NYC price at $6 to $7 today), I think the generic store brands become pretty attractive next to a Kellogg’s or General Mill’s brand.  I suspect that the only difference is the marketing spend and the box graphics.  It’s the same berries, wheat flakes, nuts.

So with that in mind - I think that the Agriculture Commodies are the best inflation hedge, even better than gold, because gold is pretty much useless.  You can’t eat gold, or turn it into ethanol.  You can melt it down and turn it into chains, or bracelets, or teeth.  And of the three transmogrifications  - I’d say only teeth have any real function whatsoever - as they can help you chew your $20 cereal in 2012, or meet fine ladies at the Spotted Pig who want to see ya grill.

The author has a long position in Agrium (AGU)