Business Cycle Transparency

Developed economies are more transparent than emerging economies are. We all have heard about this, haven't we? If that is the fact, then I need to make myself work harder to believe it.

After the great recession hit the world in the year 2008, I could never understand clearly in what phase of the business cycle the US was and has been. Is it early upswing or late upswing or is it slowdown? Only thing I am sure about is that it is certainly neither initial recovery nor recession (please correct me if I am wrong). Recent healthy economic growth and relatively low inflation in the US suggests that we are in early upswing. There are no restrictive policies in the place as of now and that does not put us in the late upswing phase. But nervous investors have begun to think that equities are volatile and stock market is near its all-time peak in the 2007. Isn't that favoring late upswing? It is dilemma to me since I am not an economist! Capital market expectations are always critical to judge after prolonged recessions and a depression. If we observe emerging economies, they are believed to bounce back from shocks faster than developed nations do. This was true even after the great recession. For example, India is clearly in late upswing phase where it is feeling tremendous inflationary pressure. Equity markets in India have shown considerable volatility. Monetary policies have become restrictive and short rates are rising to curb boom mentality. India is showing business cycle transparency which I want to observe here in the US. But I may be asking too much from $14 trillion economy. Perhaps that transparency has partly been offset by the great recession.

As I heard and expected, Apple has delivered finally...

$40, $50, $60, $70, $80, $90, $100 billion and counting. This is how the world's most valuable company has increased its cash over the last 3 years. Whenever companies sit on huge cash piles, there are always 2 possibilities. First, companies become conservative, especially post-recession years, in capital investments and hiring, and reports plethora of cash to combat another economic stress. Second, companies face controversial times from the investors. We strongly believe that Apple falls in to second choice.

When do companies pay dividends and when do they repurchase shares? Simple answers and simple signals. When a company believes that there are no more opportunities to invest money, acquire assets or there is a shrinking room for current above average growth, they pay dividends to reward investors. And when a company believes that their equity is undervalued, they repurchase some shares in the market. I have not performed any equity fundamentals on $AAPL and this is why I cannot say if its equity market value is undervalued or overvalued. But I can somehow convince myself that there is some decrease in growth is forecast by the management after a dream post-recession run and paying dividends is the best way to keep investors tagged along.

As I heard and expected over the last few months, Apple has finally announced to pay dividends and $10 billion worth of share repurchase today. Though its dividend yield is less than its peers, it is going to be interesting new chapter for Apple, being considered mature in the market.

Circuit City, you are not alone- said Best Buy

It was Forbes magazine's "Company of the Year 2004" and then it made in to the Fortune's List of Most Admired Companies in 2006. It survived the financial catastrophe after 2007 unlike its rival Circuit City, but seemingly it does not want to leave its pal- Circuit City alone.

Consumer spending has been above the levels businesses saw in 2008-2009. As per reliable sources, Black Friday and Cyber Monday sales of the year 2011 were up by 26% as compared to the year 2010. These all favor the prosperity of the retailers like Best Buy. But that is not the fact. Financial statements and stock performance of Best Buy deliver the different and dubious story.

Source: Yahoo! Finance

Best Buy is losing their support in the equity markets."Going out of the business" is a probability after 2-3 years and no one is able to put that out of the question. But why only Best Buy? My only explicable answer is:  "the fierce competition" from diversified retailers who have many other things to offer unlike Best Buy. Free shipping, heavy discounts and extended season of the deals cause only one thing and that is shrinking Best Buy's margins. I have no specific thing in my mind which Best Buy can do to come out of this misery, but if they are not able to do anything revolutionary, those shrinking margins will eventually burn all cash.

Few days ago, I read an article on Amazon, which was considered to be "Online store of Best Buy". I could not deny with that, could you? Because that sums up everything here...

How long can you put on your 3D glasses?

When I graduated from high school, I and one of my friends went for IMAX 3D "show". I did not write "movie" because it was a 30 minutes educational/ informative documentary which we always find here in museums. It was expensive. And rare! Times have changed. Now every Friday, we get at least one movie in 3D to spend our wealth on.

Before 3-4 years, when releasing movies in 3D was not as normal as it is now, it started to change the definition of movie watching on the big screens. Stumbling Regal Entertainment Group & AMC Theatres during the painful recession got some room to breathe. Rapid rise of 3D movies boost the earnings for Regal Group, RealD and the hopes for an IPO for AMC. Entertainment sector was almost back on the track with the 3D hits like Toy Story 3, Avatar, Transformers and Harry Potter. Then AMC postponed their IPO plans. Why?

• 3D Burnout- Excess leads to an destruction. Well said! Burnout is the term often used during mortgage refinancing phase for prepayments. When rates are low, you refinance the loan by prepayments. After few years, when rates become lower again, you have nothing much left to refinance. Same applies here. 3D movies and its craze cannot be placed in the category of sustainable items.
• Online movie providers- Ah! Internet is killing everyone. Surge in the paid subscription based online movie providers like Netflix, Amazon, YouTube have clearly staged their competition with these entertainment giants.
• 3D TVs- Dance until music stops. And that is the reason why we can see the brand new isle of 3D TVs at Best Buy or Wal-Mart stores. 

RealD does many innovative things. It recently launches "Wimbledon 3D" for 2011 Grand Slam. Beautiful. Wimbledon 2011 is still in progress, but still RealD stock is suffering today. Why? It is because of less than expected, not poor, box-office performance of Cars 2 which also released in 3D during last weekend. It is a lovely example of positive correlation, isn't it?

Let's see how long we are able to witness the entertainment industry's fight against sustainability and volatility.

"New Normal"... Hope or Frustration?

Like every morning, I settled at my desk, logged in to my computer (Bloomberg Terminal) and read news. And saw a news story elaborating few economists' warning on unemployment rate in the US. Since the downturn started, we have been listening to and looking at all fiscal efforts to combat higher unemployment rate which is the key impediment to achieve economic growth. We have managed to drop it down to 9% and started to believe that within 3-4 years, it may be at its normal level. What is this "Normal Level"? Is it decided by the congress or economists or something else? Unexpected and turtle speed recovery in developed economies has certainly shifted those economic graphs.

Current unemployment rate is seen as "New Normal" by few economists. If that turns out to be true, then 8-9% rate will stay in normal business cycle. It may climb to 13% or 15% or 18%, if another downturn arrives. But no more hopes for those 5% or 7%?

Similar things follow in the case of US Debt Ceiling and US Credit Ratings. If we consider "New Normal" in debt ceiling, then new ceiling will allow the Government to borrow more than they are doing now. More public debt. Higher debt to GDP ratio. We know the consequences. I still remember one of the story on US credit ratings published couple of years ago. It said "If US credit rating is downgraded to AA from AAA, then new AAA will be AA." Doesn't it sound like "New Normal"? Yes, it does. New Normal changes the benchmarks.


Establishing "New Normal" for unemployment rate, debt ceiling and credit rating (... and many more may come) have positive consequences as well. Based on hopes and optimism, they give us room to accelerate recovery and to acquire potential growth opportunities. But that is what we have been doing since last three years. We might have started to realize that perhaps there is no hope. Potential frustration may make us prompt to start everything from scratch... and that can be done by creating new zeros... new benchmarks... new normal.

Where's the dinner tonight?

Well, being a connoisseur of food, I love to visit world cuisines and new restaurants in the proximity. And that includes few restaurant chains as well. I am a global individual, ain't I? Restaurant/dining sector was punished hard during the recession of 2007. Few chains were not able to produce profits for consecutive 2 years. And few bounced back like a marathon spring. But as they are saying, gone are the days! Restaurant Performance Index (RPI) is up again and back at 2005-2007 levels. Consumers have started to hate cooking food at home and so the sector components have started to cook some profits after years.

Here are some of the characteristics of this rebounding and bullying sector:

• Industry leaders: Chipotle Mexican Grill, Inc (CMG), Panera Bread Company (PNRA), BJ's Restaurant Inc (BJRI) and Domino's Pizza, Inc (DPZ) are leading the sector with handsome growth and stock appreciation. 
• Other growth proponents: Few restaurants chains have not been able to beat the market, but they have succeeded to help sector to boost its performance. They are Yum! Brand, Inc (YUM), Darden Restaurants, Inc (DRI), Red Robin Gourmet Burgers, Inc (RRGB), The Cheesecake Factory Incorporated (CAKE), California Pizza Kitchen, Inc (CPKI), Papa John's International, Inc (PZZA) and many others.
• Turnarounds: A rise in consumer confidence, fall in unemployment rate, introduction of breakfast menus like Subway did, diversification in the traditional core menu like Domino's did by introducing all those gourmet pastas and subs and expansion of operations in emerging markets where consumers have newly found wealth to spend. 
• Optimism: Rise in IPOs is a good indication of industry optimism. Recently, Arcos Dorados Holdings, Inc (ARCO), Bravo Brio Restaurant Group, Inc (BBRG) and Country Style Cooking Restaurant Chain Co. Ltd (CCSC) went public. Leading coffee giant Dunkin Donuts Inc has just filed for an IPO under the ticker of DNKN.
• Pessimism: This sector is not an exception and that is the reason why it has also been affected by rising oil prices and skyrocketing inflation. These macroeconomic factors have caused restaurant chains to increase the noticeable prices in their menus.

... Mind well! Subway Restaurants have the honor of being considered as the world's largest restaurant chain after their locations figure surpassed McDonald's Corp (MCD) in the beginning of this year. And and and... The world's largest restaurant chain is still not publicly traded.

Tumbling WMT is healthy sign for the economy, isn't it?

We were given fictitious $250,000 to invest in 5 securities by our professor during one of the electives of the grad school. Investment Analysis it was. The objective of our portfolio was to preserve our capital. Those few lucky securities chosen by us were WMT, FDO and healthy weight on treasury bills. Based on our security selection and objective, I wonder any one cannot assume what period it was. Right? Yes, it was the midst of catastrophic recession which started in the 2007.

The best performance of WMT and the worst performance of NASDAQ Composite Index relative to each other during last 5 years, took place during the recessionary period. And that is the reason why we love to consider WMT as a recession-proof stock. But if we observe the charts now, NASDAQ composite and other market indices are quickly approaching to the higher returns. These are the signs of early expansion which are not preferred by discount stores like Wal-Mart who have been reporting consecutive decline in sales. Their stock is pretty much down from where it was during the great recession. If that is not enough, recent hike in gas prices and inflation have worsened  the outlook for the discount stores.

Wal-Mart has been trying various strategies to regain their momentum despite of negative correlation with the markets:

• Recently, they have announced to acquire Kosmix which discovers social content by topic. This acquisition may bring Wal-Mart to the new age of social media influence on electronic and mobile commerce. When a retail mammoth taps the Silicon Valley, it has to be something strategic. And these are the impediments behind the expansion of WalmartLabs. 
• Few days ago, they tested their online grocery store. This may have been game changing event if consumers easily adapt to this service. It can definitely give Wal-Mart some edge over its peers.
• After successful entry in the Chicago market in the 2006, Wal-Mart began to think over the New York City market which has high barriers for entry. And based on poll results in the early 2011, New Yorkers showed positive response to embrace Wal-Mart.

... and if these help them perform well and beat the market, do we have to remove WMT from the list of those recession-proof stocks?

"Trust Me" Factor & Portfolio Management

I was working and listening to the news yesterday evening and suddenly a tag line popped up saying Breaking News. It was about David Sokol's resignation from Berkshire Hathaway Inc. Why was it breaking? Because this is the man who was considered as successor of Warren Buffet at the company. This is the man who made the Netjets story. Since yesterday, I have been hammered by these news "Sokol's shocking exit", "Buffet's surprised by David's resignation" and so on. Among all, a news about Berkshire Hathaway's stock valuation appeared and that caught my attention.

It is about "Trust Me" factor.

• Inherent in the stock value of companies like Berkshire Hathaway Inc.
• Such investment vehicles do not have manufacturing or retail operations and this is why they are able to deliver much needed transparency in their financial disclosures to the investors.
• Because of such business nature, they have minimal accruals and accrual based earnings. As we know, the lesser the accrual based earnings and the higher the cash earnings are, the greater the quality of earnings is. In other language, when the accrual component contributes the least in total earnings, we get the earnings of the greatest quality.
• Forecast of greater quality of company's earnings will always have positive correlation with stock price or its valuation and this is the reason why we cannot consider this factor as trivial.

Should some PhD in multi-factor analysis or in quantitative methods can substantiate a theory on this factor, then is it likely to be employed by portfolio managers in their multi-factor models? In such models, sensitivity to this theoretical factor should be higher for portfolio composed of securities from companies like Berkshire Hathaway like the same way in macroeconomic model where sensitivity to recession factor is higher for Ford Motors and lower for Walmart.