The analysis behind my latest trades
Contrary to what you are being led to believe the market doesn’t run on a calendar.
I hate using the word “countless” because it’s my job to count but the number of I’ve times I’ve heard that a meeting or week or date is “crucial” is frankly uncountable. The newest crucial is March 8, the cutoff for “too-big-too-fail” institutions to agree to a bailout a TBTF sovereign. Because after that, the “very special case” of Greece, as IMF chairwoman Lagarde puts it, will be behind us.
Please pay attention to the following: Absolutely no one knows what it looks like when a Western democracy that’s part of a currency union defaults on its debts.
And to act like nothing bad can happen, that central bankers have gamed out every scenario, is sheer madness. I can fully appreciate the need of bureaucrats to put on a brave face, it’s their Freudian slips (i.e. ‘irrational exuberance’) that sink markets the fastest.
But that has nothing to do with you being hedged and fully prepared for a 10% market drop.
The absolute certainty that policy makers and pundits and analysts and retail investors have right now is making me worry.
We won’t know till well after the fact what unintended dominoes have fallen. Markets overshoot in both directions, don’t forget that, and I think the boomlet the Standard & Poor’s 500 Index SPX +0.62% has had this year is approaching overdone levels. The“echo-techo” bubble I predicted we were heading into January of last year, with tech leading the way, seems to have arrived on schedule. The market has broken out just as I expected, the broader indexes are at 2008 levels, and Apple AAPL +0.65% has gone up so much it’s almost 4% of the S&P by itself . So maybe a little caution is in order?
Days before they defaulted, the debt obligations of Argentina and Mexico were trading near par. Today the refrain is that a Greek default is “priced in.” Really? We have priced in which banks and insurance companies have written CDS contracts on Portugal and Spain and could be forced to mark down their book if no one shows up to the bond auctions?
Remember AIG. Did we price in the lubricant of stock exchanges, the money markets, seizing up? We have priced in higher rates for the U.S. and Germany? Have we priced in that a much larger economy than Greece (read: Italy) with an inflexible labor force and enormous bureaucracy and almost criminal enterprise running policy may have lied about their balance sheet as well? Do we know what it looks like when Italy has to pay 6% for new money for more than a week, like it had to 2 months ago?
Nothing I just said is a prediction. Frankly I think the real economy, the one that innovates and is building the social graph and speeding up computing and moving commodities, is doing pretty well. Plus the ability of governments to hide reality and pump welfare funds is not to be discounted. But that no one right now fully appreciates that danger of the unknown is downright scary. It seems like everyone has their own Monte Carlo simulation of just how things are going to go.
What I’m saying is what if a couple of the inputs into those models are wrong? Makes sense to put on some hedges, especially since they can be had relatively cheaply. The market is on more of a hair trigger — ready to explode higher or suffer another sell off — than anyone is willing to admit and I want to build some downside protection into our Revolution Portfolio.
Before we put on a new short position let’s get rid of an old one, Visteon VC +0.47% . I was clear from the beginning about this one, it was about an upturn in the overall auto market and getting cash flows on the cheap When we put on the long I wrote :
“Continued domestic and global output expansion will continue to produce record profits and record margins, and will lead to multiple expansion — leaving room for huge upside in share prices for the suppliers in the auto industry. Analysts are only now realizing the profit potential of stocks after being extremely conservative up until this point.
“Think about this: Domestic supply bottomed at 9 million units last year, bouncing to maybe 11 million units this year. Supply peaked at more than 17 million units in 2007 and averaged more than 15 million units for a dozen years prior. Domestic units will go back to 15 million over the next few years, assuming our economy doesn’t completely collapse again, and suppliers will benefit.”
Still true, VC supplies parts to a creaking, enormous industry, on a remarkably predictable schedule. The market seems to have already priced in a cyclical return to normalcy in the auto industry, but those multiples haven’t expanded, which means that my analysis and conclusions have been wrong. I still like Visteon better than the automakers, which carry big loan books and even bigger debt loads, and I think it’s cheap enough that some private equity 20-something somewhere is making a spreadsheet right now. But VC doesn’t actually do anything innovative or revolutionary and we have better places for our cash.
Now to our short, it come directly from my latest e-book, “The Dirty Dozen: 12 Stocks with Fundamentally Broken Business Models.” We are getting short Western DigitalWDC +1.42% , a tech dinosaur that not only has fundamental flaws but should have issues in the short term.
From the book:
“At a glance, this disk storage maker looks like one of the cheapest tech stocks on the planet, trading at less than five times this year’s earnings. But there’s a reason the market isn’t willing to pay up any more this company’s current earnings — because those earnings are likely unsustainable. Even as there’s a relentless march of endless demand for ever more storage capacity, Western Digital is caught selling the operator-controlled switch of the digital storage world. Inside the network, at the server level, in our smartphones, our computers, our DVRs — everywhere along the network, we see the need for more storage. But disk drives are full of actual movable components, that require much more energy to store, access and retrieve every bit than the increasingly popular flash storage systems that the Sandisks and Samsungs of the world have developed.”
That is to say Western Digital is building products for a world that has already moved beyond it. Tomorrow Apple is introducing the iPad 3 (or iPad HD and/or iPad mini), a product that just wouldn’t be possible without Flash storage. And Flash is becoming more cheaply available. From the book:
“Flash costs are continuing to plummet and capacity of the factories that crank out Flash storage are soon to swamp the total capacity of Western Digital and the other disk drive makers.”
Here’s the value proposition to every non-techie: hard drives fail, flash storage doesn’t. You really don’t want to be playing Angry Birds on a product that you can break with tapping on the screen — and that’s what WDC makes, hard drives with moving parts. The tablet market is booming and will overtake the PC market at some point in the next decade . But Western Digital isn’t positioning itself for that reality.
Instead it’s spending $4.5 billion to buy Hitachi’s hard drive business , using its own shares and new debt. That’s a Solyndra-like strategy, trying to get bigger to become the lowest cost producer of an outmoded technology. The company is likely dead in the water over the next couple years with it’s current product mix. And when market research firms put out press releases that protest too much, you can feel pretty good about being short and not being in a crowded trade. I’ll close by quoting TrendFocusdefending all things hard-drive:
“The threat from flash is overblown.
“HDDs will remain the king of storage for years, and will coexist with NAND flash in most applications,
“A 10X cost advantage favors broad and growing use of HDDs across most compute platforms.”
and the meaningless kicker:
“Considering the challenges and opportunities, TRENDFOCUS views the HDD industry’s future positively.”
