With the number of opinions being expressed on major companies like Research in Motion and Apple, it can get awfully overwhelming to try and understand from a high level what the situation is. This has especially been the case with RIM in the last few days when they released so called “mixed results” – which basically means that they disappointed the street, but not really.

It’s fairly easy to identify the things people agree on – RIM has a solid balance sheet, no debt, $2.9 billion in cash, strong growth in revenues (up 18% yoy, though still not enough for Wall Street), shrinking gross margins (now at 45.7%) and reductions in average selling prices (currently $311/unit). A brief look at any analyst report will give you that information. However, there is less certainty on other more contentious issues – as I see it, there are two big issues in the balance, and the one that comes to dominate in the next few years will determine where RIM goes from here.

Issue (Negative): Competitive pressure in retail consumer space

80% of RIM’s revenues still come from new device shipments, meaning that it still very dependent on new sales growth, as opposed to revenues from post-sale services, which make up only 16% of revenues. It’s this sales growth that many analysts feel will be compromised by the additional competitive pressures that BlackBerrys are facing in the retail marketplace from Apple’s iPhones and other Samsung and Motorola smartphones that operate on Google’s Android platform. RIM’s competitors are deemed to be better at providing a better user experience as the focus shifts away from smartphones providing just email access (where BlackBerry dominates) to a more complete experience including applications, browsing and connectivity (where BlackBerry loses out). As an analyst from Sandford Bernstein put it – RIM can expect “margin pressure as BlackBerry gets more and more into a mass-market role with vanishing product differentiation and eroding brand premium.”

So in the mass-market RIM’s products are expected to lose market share to its new rivals especially as the focus of the user experience shifts.

Issue (Positive): The enterprise market and love from carriers

It is well-established that RIM is a market leader in the enterprise space thanks to its superior security capabilities that are necessary in an environment which is less cost sensitive but also more functionally demanding. The enterprise market loves the BlackBerry for its superior email handling capabilities which are more important to that space than other “toppings” like applications and browsing. While the security features of other smartphones are likely improving, the BlackBerry still holds its own there. Its leadership in the enterprise space is the trump card that RIM holds and is using to enter new emerging markets. RIM is currently dependent on the North American market but the real growth lies elsewhere as smartphone penetration levels start to taper off in North America. With ongoing expansion efforts in China and Indonesia, you could start to see new engines of growth for RIM and this might have been reflected in the company’s higher than expected guidance for subsequent quarters.

Another area that is frequently overlooked is the relationship that RIM has with its carriers. RIM provides a lot more value to carriers than just being a handset provider. This point was well made in a feature in the Canadian Business magazine. RIM actually operates data-processing centres which look at all the information sent via BlackBerrys, in the process removing potential threats and providing a level of security that is hard to match. At the same time, the system also helps carriers manage its traffic and uses compression technologies which allow more information to be carried over the same network from the carrier – the importance of this value-add cannot be underestimated when usage is becoming increasingly data intensive and clogging most networks. One more plus point that ties carriers to RIM is the carrier’s need to differentiate its product offerings from other competitors. It’s hard for them to do that with the Apple’s iPhone which is the same across all providers since there is only one model. But with the BlackBerry, RIM actually provides each carrier with something unique through its different models and hence caters to their needs. With the carriers doing a lot of the marketing for the handsets, this relationship counts for a lot.

Watching how the cookie crumbles

Ultimately, RIM’s prospects depend on which of these issues end up being more important down the road. The big question is whether RIM’s dominance in the enterprise market, combined with its strong carrier relationships and emerging market growth is enough to outweigh or offset the market share it might lose in the North American retail space to competitive pressures from other smartphone providers.

Disclosure: Long RIMM

Image Credit: Aubrey Arenas under a Creative Commons license

Disclaimer: Views and opinions expressed on above are those of the author alone and do not in any way represent the official views, positions or opinions of the employers – both past or present – of the author in question, or any other institutions and corporations associated with the author. Neither the information nor any opinions contained or expressed above and elsewhere on Young & Invested constitutes or should be construed as a solicitation or offer by Young & Invested to buy or sell any securities or other financial instruments or to provide any investment advice or recommendations. Young & Invested shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information on or accessed through the site. Please see full disclaimers here.

As of today, 5 fatalities have been reported, and lawmakers around the world continue to monitor Toyota’s reactive actions to the allegedly sticking gas pedals. As responsive as Toyota has been in handling the situation, it won’t be soon forgotten; definitely not until the improved components are shown to work over a considerable time period, which could take months or even years. For now, the bad publicity is certain to cause consumers to pump the brakes on Toyota purchases, and its stock will see a similar effect. After recovering from March’s (2009) lows of approximately $57 to $91 in mid-January 2010, the stock has already seen a 19% decline to $73.

Toyota’s stock will be stabbed with two spikes. First, the immediate monetary impact of the recall is massive, which has been estimated at about $350 per vehicle and $1 billion on an aggregate recall scale. Still, this estimate does not include potential litigation expenditures, halted production in more than half its vehicles, and most importantly, the impact of lost reputation and sales for the long-term. Toyota, which was known particularly for a “strong brand” of high quality vehicles, has suffered lasting losses in customer and investor confidence, and Toyota’s sales and stock prices are likely to decline for months to come.  

Nevertheless, the recall has not resulted in slim pickings for consumers beginning car-shopping in an improving economy. As in all business, what’s bad for one corporate giant is often good for others. Where Toyota has suffered due to the recall, other automakers are quickly stepping in. January 2010 vehicle sales (in the United States) for Toyota have declined by 15.8% from January 2009 (and are at the lowest level since 1999), whereas for the same time-frame Ford sales are up 24.4%, Hyundai sales are up 24%, and Volkswagen sales have ballooned an incredible 41%. If a similar trend persists throughout 2010, the entire landscape of the auto industry in North America and around could change.

For now, investors should be pumping the brakes on Toyota stock, and certainly consider a strong upcoming year for some of the other large auto producers mentioned above. Toyota sales and stock will continue to skid through 2010.

Disclosure: no positions

Image credit: Neubie under a Creative Commons license

Note: See important disclaimers below article.

Skype was acquired by an investor group consisting of Silver Lake Partners and the Canadian Pension Plan Investment Board (CPPIB) on Nov 19, 2009, from EBay. The acquisition gave the investors a 56% majority stake in Skype while EBay held on to a 30% ownership.

What made this major move all the more interesting is that Skype is at a major cross-road of its own and the direction it takes from here could well determine the return the acquirers are expecting to get in 4-5 years. Skype was initially acquired by EBay from the founders for a hefty price tag of US$2.5 billion in 2005 as EBay intended to combine Skype’s capabilities with its online auction platform but that strategy was never realized. Interestingly, in the latest change of hands, the two founders, Niklas Zennstrom and Janu Friis, have come back into the picture with a 14% stake in the new Skype, alongside the investor group and EBay. It’s clear that the founders still have more plans for the company. And Silver Lake Partners and CPPIB are not pushovers themselves either. Silver Lake is known for its tech buyouts while CPPIB would never make an investment of US$300 million unless they saw some long term potential.

Growth Plans

The issue that Skype’s new owners need to focus on is poor conversion of usage into revenue. In Q3 2009 alone, Skype’s user accounts increased 41% to 521 million. However, 90% of this traffic brings no revenues to the company. Of the 30 billion in minutes used on Skype, only 10% were paid. And therein lies Skype’s biggest problem. Most users use Skype for free and Skype makes money only when an mobile phone or landline is called.

Skype is focusing on growth by expanding its usage onto mobile devices, inking partnerships with Nokia, iPhone and BlackBerry. However, usage on these platforms is limited to WiFi with the exception of AT&T in the US, which allows internet calling applications over its 3G network. Skype has already been announced on Windows Mobile and Google’s Android phones as well but limiting usage to WiFi might be keeping its growth handcuffed. Of course, the carriers themselves have reservations towards providing full access for fears of losing their own voice revenues.

Competition

Google acquired Gizmo5, which provides a service very similar to that of Skype, in 2009. Combining Gizmo5’s functionality with that already provided by Google Talk and Google Voice could mean solid competition for Skype even as it tries to battle its own business model challenges. Google could soon be offering most of the things that Skype stakes a claim on, if not even more.

Opportunity

Skype’s opportunity lies in exploiting the needs of small businesses with low budgets which can’t pay for things like Cisco’s fully integrated videoconferencing services but would like to harness the convenience of videoconferencing nonetheless. However, in order to do so, it would have to raise its security features and reliability up by several notches.

On another front, a new collaboration with Panasonic and LG Electronics announced Jan 6, 2010, has integrated the free calling service into internet-connected high definition televisions. This should make the technology a lot more accessible to smaller businesses.

Next step? Hitting up the consumer television mass-market.

Disclosure: No position in Skype.

Image Credit: seanbonner and malthe under a Creative Commons license.

Young & Invested is THE hub for finance and investing insights from the new generation. Head to our blog for more insights! — http://youngandinvested.com

Disclaimer: Views and opinions expressed on above are those of the author alone and do not in any way represent the official views, positions or opinions of the employers – both past or present – of the author in question, or any other institutions and corporations associated with the author. Neither the information nor any opinions contained or expressed above and elsewhere on Young & Invested constitutes or should be construed as a solicitation or offer by Young & Invested to buy or sell any securities or other financial instruments or to provide any investment advice or recommendations. Young & Invested shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information on or accessed through the site. Please see full disclaimers here.

Note: See important disclaimers below article.

The price chart below looks like any investor’s dream if they got in at the right time. Things definitely have been going Apple’s way of late – in their latest quarter, Apple had record quarterly sales for Mac products (3.05 million units), iPod Touch sales grew 100% year-on-year, iTunes maintained its position as the world’s largest music retailer, iPhone sales (7.4 million units) rose 185% year-on-year and Apple now has $34 billion in cash and other liquid securities on their balance sheet. Phenomenal – to say the least, considering that we are only now coming out of a recession. But here’s the million (or billion) dollar question – can Apple really maintain or improve on these staggering growth rates? Expectations for Apple are now set at stratospheric highs, only perfection will do – nothing less.

Losing their first mover advantage?

Apple benefited from being a first mover in each of its product lines. The iPod changed the portable music industry, iTunes changed music retail, the iPhone changed smartphones and the App store changed software. Being the first mover allowed Apple to aggressively increase market share. However, first mover advantage does not last forever, once new entrants adopt the new trends, competition gets very much down to trench warfare and who can hold their ground better.

That is what we will be seeing as Apple sees more competition in each product line. To take an example, in the smartphone arena, numerous phones have emerged such as the Palm Pre, HTC Touch, LG Vu, Samsung Instinct and new Blackberries. Not to mention Google’s open source Android operating system which is being seen as the biggest threat to the iPhone. Many people are seeing similarities between what happened to the Mac when the PCs started taking up market share in the 80s and what could happen to the iPhone because of the Android platform. Nearly all the major players in the smartphone industry are part of the Open Handset Alliance that developed the Android which has now been implemented on a wide range of devices, including those from Nokia, Dell, Asus and Motorola. As a result, the choice of devices using Android will be huge. In the 80s, this choice was generated by Microsoft’s new standardized operating system which could be run on many hardware platforms and thus pushed the Macintosh out of the market. Might we see a re-run?

Likewise, while the App store is being touted as the feature that’ll keep smartphone competition away, the App store is no longer a feature unique to the iPhone. From the developer’s point of view, they will tailor their new apps to take advantage of all platforms such as the Android, PSP and the Blackberry app store, because it doesn’t make economic sense for them to restrict their apps to iPhone users.

A Comparison – Research in Motion

All that to say, it will be immensely hard for Apple to keep up its rate of growth, and margins now that it has moved past the stage where it’s still benefiting from being a first mover. To offer a comparison, look at the price chart of RIMM below from Aug 06 – Jun 08. That was when RIMM was benefiting from its own first mover advantage and expectations for its future were sky high. The second chart shows the price till present day.

Here’s a quote from a research report on RIMM from early 2008 – “Wall Street has high expectations for RIMM, they believe the company will report a solid first quarter while preparing to release a flurry of new products in the coming months to ensure its dominance in the business-oriented smart phone market.“ Sound familiar?

While I agree that Apple has a lot more loyalty towards its products than Research in Motion did, Apple too will suffer from competition and to continue to expect blow-out quarters (which analysts continue to do, hence an average price target of $234) might be asking for a little too much perfection.

Disclosure: No position in AAPL.

Image Credit: Dan Diemer under a Creative Commons license.

Young & Invested is THE hub for finance and investing insights from the new generation. Head to our blog for more insights! — http://youngandinvested.com

Disclaimer: Views and opinions expressed on above are those of the author alone and do not in any way represent the official views, positions or opinions of the employers – both past or present – of the author in question, or any other institutions and corporations associated with the author. Neither the information nor any opinions contained or expressed above and elsewhere on Young & Invested constitutes or should be construed as a solicitation or offer by Young & Invested to buy or sell any securities or other financial instruments or to provide any investment advice or recommendations. Young & Invested shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information on or accessed through the site. Please see full disclaimers here.

Especially in a time when consumers are conscientious towards quality/value, RL is there with a diverse brand portfolio that uses its core brand to dominate across markets, price points, distribution channels and geographies. This was exhibited by the 8^th consecutive EPS outperformance – a positive sign of undervaluation you don’t want to neglect.

Financials

Most recent long term debt reported of $406 million represents about 9% of total capitalization which is incredible for a retailer, and current ratio of 3.05 poses no issues with liquidity or going concern. RL also raised its share repurchase program by $225 million to $431 million. Next to some main competitors, including PVH and VFC, RL earned $287,000 revenue per employee (compared to $216K and $155K, respectively), showing well-utilized personnel, commission schemes and sales execution.

The Lauren family currently controls 86% of the voting power of all outstanding shares (thereby increases in the share repurchase program may indicate desire for future privatization), but the company’s strong executive team and increasing global focus have been capable at building a luxury brand that is appealing to new clientele in Europe, Japan, Southeast Asia and the accessories markets (particularly footwear).

International Growth

RL’s goal is to draw a third of its revenue from each of North America/Europe/Asia. However, its current sales breakdown showed 72% in North America, 20% in Europe and 8% in Asia, meaning increased efforts of Asian growth are underway. On a related note, the reputable McKinsey Consulting predicts that luxury spending in Asia is poised to increase as the number of wealthy households multiplies 2-fold to 3-fold, and RL wants to be on top of this demographic change. Significant control has been taken of manufacturing and branding efforts in Japan and China to be ready for the market growth (high end luxury goods in Japan, family brand growth in China). If they can maintain current North American sales levels, total sales increases will be enormous.

Volatility

Even a Bollinger band analysis shows increasingly appealing technicals as a price increase indicator is more than moderately likely. The company has definitely built a lot of momentum over the last year and has an expected trend to reach highs of 100$+ from the last two years.

Overall

RL’s continued expansion through international boundaries and a brand name as well identified as Coca Cola, Nike and Disney, should give investors a long-term favourable view of this stock as it is definitely one of the strongest firms in the retail landscape. I strongly recommend RL as a short-term and long-term investment with a target 12-month price of $95 based on increased EPS estimates.

Image Credit: jaimelondonboy with a Creative Commons License

Disclosure: Long RL

When you think of an advertising agency, what comes to mind? I instantly think of traditional print and TV ad campaigns that many of us are no longer paying attention to. And whenever I think of CEO’s of the advertising giants that make these campaigns, I think of old men who are hoarding their advertising profit margins, being resistant to the new ‘unsexy’ world of decreased margins in the digital space.

However, I am completely wrong. Even though decreased margins will never be sexy, industry leaders like Martin Sorrell, CEO of WPP Group (2nd largest advertising group in the world), and Maurice Levy, Chairman and CEO of Publicis Groupe (4th largest), are embracing the digital world and are transforming their agencies into digital power houses. Publicis made major headlines recently by purchasing Razorfish from Microsoft in a deal worth $530 million ($286.8 million cash and 6.5 million Publicis shares). Razorfish is the second largest digital interactive advetising agency in the U.S. with annual revenues of $380 million. Publicis has been investing heavily in the digital arena as Razorfish will now become the latest aquisition to be part of VivaKi, the ever-growing Publicis digital division that already includes Starcom MediaVest Group, ZenithOptimedia, Denuo, Digitas and Vivaki Nerve Center.

I was really fascinated after I heard Maurice Levy speak in a recent Cambridge University podcast, From National to Global, where he discussed the importance of digital marketing in the future. As we can tell from the recent shopping spree, Mr. Levy is definitely putting money where his mouth is. Even in horrendous economic times, Publicis Groupe has been able to outperform the industry by a large margin and is currently positioned number one in the struggling advertising industry after raking in $4.8 billion in new business wins for the first nine months of 2009. In a recent interview for EBM after Q3 revenue announcement, Maurice credited this victory to the growing investment in transforming Publicis into an all-digital agency, saying that this investment is already starting to pay off.

Currently, digital accounts for 21.3% of consolidated revenue and Publicis hopes to grow this number to 25% in 2010 and to 100% by 2015 (the 100% was a joke). But I wouldn’t be surprised if that was the master plan after-all, as Mr. Levy certainly believes in the power of the internet or as he likes to refer it to as the power of digital. Maurice truly believes that digital is changing our society which can be seen through the tremendous growth of social networks (Facebook, Twitter, Youtube, etc.) and how they have impacted our culture. At the end of the day, advertising is all about society and if advertising agencies want to succeed, they have to reflect the society through its campaigns and mediums where people absorb information on a daily basis. Like it or not, the future is in digital and this is exactly why Publicis Groupe is slowly being transformed into an all-digital agency.

I believe Publicis Groupe is your pick in a industry that is going through a Berlin wall collapse of its own. The only question remaining is- will most agencies follow suit? Or will they keep ignoring the paradigm shift that has already happened? Watch the video below to get a better sense of the present and future in the digital media space and the impact on our society.

The above posting is from Alex Ikonn’s Digital Marketing Blog. He cross-posts the article here with additional financial information, all the links and tags for your reading pleasure, but you can check out the original version online here:

– Maurice Levy’s Vision of an All-Digital Agency by Alex Ikonn

Disclosure: No Positions

Just as important as deciding to go long natural gas is how that view is translated into an investing strategy. The value chain of the natural gas industry, shown below (Source: Wikinvest), provides a good overview. There are numerous investment opportunities throughout the value chain that can be capitalized upon.

Betting on the actual spot price:

1. Buying natural gas futures outright – If you have access to the futures market, are experienced enough to understand its intricacies and have enough capital, then take a dip in natural gas futures. The December futures are already trading at a 14% premium to the November futures, on the hopes of a cold winter pulling up demand. Inexperienced investors should probably stay away from the futures market.
2. Buying ETFs that hold natural gas futures – The biggest and most liquid one of these is the United States Natural Gas Fund (UNG). Many authors on Seeking Alpha have mentioned how UNG has been doomed by the contango in the natural gas market. UNG just finished selling its holdings of front-month contracts and rolled into December contracts this week. The premium on the December futures mentioned above means that UNG always sells low and buys high during rolls. For that reason, I would not recommend UNG. The Claymore Natural Gas ETF (GAS) on the TSX holds futures of Alberta natural gas, unlike the UNG which holds NYMEX futures. As it turns out, the contango on NYMEX futures is steeper than that on Alberta natural gas, helping GAS reduce its rolling costs. If you’re really sure of your bets, consider HNU, a 2x long natural gas ETF trading on the TSX.
3. Buying natural gas royalty trusts – To avoid the costly contango issues, take a look at royalty trusts like Hugoton Royalty Trust HGT which pay monthly dividends based on the basis of the price of natural gas. However, many of these trusts behave in sync with the general stock market, which takes away from a pure play in natural gas.

Betting on the producers and movers:

1. Buying the gas explorers, drillers – The most popular of these being Chesapeake Energy. The stocks of the producers however are likely to be affected by the general market conditions as well, as opposed to just the natural gas price. Another well-established company is Devon Energy and like CHK, it is involved in both oil and gas markets. It is rare to find established companies which focus only on natural gas exploration. Internationally, Gazprom owns roughly 75% of Russia’s and Eastern Europe’s natural gas reserves.
2. Buying the gas movers – Gas that is produced needs to be moved to where it’s needed. Natural gas is transported mainly through pipelines and some major players in this industry are NiSource – owner of the largest natural gas pipeline in the US, Northwest Natural Gas (NWN), Nicor Inc. (GAS) and Piedmont Natural Gas (PNY). All of them sport some very healthy dividend yields as well and have relatively solid balance sheets. A huge company involved in both producing and transporting gas is Encana. ECA is has a very stable revenue base thanks to a large portion of its business being regulated and it provides one of the best avenues to benefit from increases in natural gas.
3. Buying a sector ETF – If you’re looking to invest in this sector but with diversification, look at a sector ETF like the First Trust ISE-Reverse Natural Gas Index fund (FCG) that replicates an index invested in natural gas exploration and production companies. It is one of the only ETFs that provides an opportunity to invest in a range of natural gas companies while having a reasonable expense ratio of 0.60%.

The best options for taking a long position towards natural gas, in my opinion, are either through getting direct exposure by investing in a commodity tracking ETF or investing in the gas movers which have the scale and size to provide a stable stream of dividend income while also standing to benefit from rising natural gas prices.

Disclosure: Long GAS on the TSE.

Image credit: Warrenski under a Creative Commons license

Disclaimer: Views and opinions expressed on above are those of the author alone and do not in any way represent the official views, positions or opinions of the employers – both past or present – of the author in question, or any other institutions and corporations associated with the author. Neither the information nor any opinions contained or expressed above and elsewhere on Young & Invested constitutes or should be construed as a solicitation or offer by Young & Invested to buy or sell any securities or other financial instruments or to provide any investment advice or recommendations. Young & Invested shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information on or accessed through the site. Please see full disclaimers here.

Note: See important disclaimers below article.

Why Natural Gas?

The NYMEX Natural Gas Futures (Front Month) hit 10 year lows of around $2.50 a few weeks ago and have since sky-rocketed to around $4.80 at the close of Oct 9, 09. In the process, it has very powerfully broken the downtrend that it was in for the past year. This could well be the best opportunity to get exposure to natural gas, here’s why:

1. The period of seasonally high demand for natural gas is nearly upon us. With forecasts of a harsh winter in North America, the additional heating usage will provide the necessary demand that has been missing for the past quarters. The market perception is that the inventory overhang is too large for a demand increase to cause a recovery in prices. I continue to believe that the market is over-reacting to the supply glut – producers have already been cutting production for months as the National Energy Board has said drilling in Canada and the US has already slowed to half the level of previous years. July 09 data shows the number of operating drills in the US is down 55% (or down by 851 rigs) year-on-year.
2. The economic recovery itself will increase demand for natural gas from the big industrials such as Dow Chemicals. Steel producers will also contribute to demand as their markets recover. Both industrial production and manufacturing numbers have been positive in the last few months. The recovery and the weather will help reduce the large inventories of natural gas in storage.
3. The US government is continuing to push on clean energy initiatives that will reduce greenhouse gas emissions. One example is the DOE Clean Cities Program through which $300 million has been earmarked for the advancement of alternative vehicles on the road and a significant number of these projects involve natural gas. Clean energy acts around the world focus on reducing coal-produced energy in power plants and at the moment, natural gas is the next best alternative. Wind and solar energy are still too expensive in terms of $/kWh to match the power needs. In 2008, 21.3% of US energy production came from natural gas while all other renewable energy sources made up 9.8% of production. It’s important to point out though that the power hungry economies of India and China have little impact on natural gas prices in North America, because natural gas, unlike oil, cannot be transported across oceans easily (except LNG), resulting in markets which are very geographically separated. LNG is not an important enough factor yet – LNG requires major investment in ports to provide access to LNG tankers and in liquefaction and gasification plants on both ends of the transport route. As of Dec 08, there were only 8 LNG terminals in the US.

The wild card may be shale gas and new drilling technologies that have lead to soaring on-shore production. It is hard to predict how much of an effect this new production will have on supplies and whether it will be enough to offset curtailment in production elsewhere.

As I see it, there may be some limited downside to natural gas prices at this point, but there is quite a huge upside potential. NG futures seem to be pricing this already in as the Feb 2010 futures are trading at a 28% premium to the Nov 2010 futures.  Aside from the decision to go long, an equally important decision is to figure out where to invest along the natural gas value chain which is very long and has many participants. I will write about the possible strategies of getting exposure to natural gas in Part II of this post.

Disclosure: Long GAS.TO

Image credit: Nandu Chitnis under a Creative Commons license

Disclaimer: Views and opinions expressed on above are those of the author alone and do not in any way represent the official views, positions or opinions of the employers – both past or present – of the author in question, or any other institutions and corporations associated with the author. Neither the information nor any opinions contained or expressed above and elsewhere on Young & Invested constitutes or should be construed as a solicitation or offer by Young & Invested to buy or sell any securities or other financial instruments or to provide any investment advice or recommendations. Young & Invested shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information on or accessed through the site. Please see full disclaimers here.

Note: See important disclaimers below article.

The earliest known bubble was the “Dutch tulip mania” in 1637 which resulted in tulips contracts being sold for more than 10 times the annual income of a skilled craftsman (according to Wikipedia). And of course, shortly thereafter, the price of tulips crashed back to normal “flower levels”. All bubbles since have shared one thing in common – large groups of people thinking irrationally, all at the same time.

The clean-up act

Alan Greenspan has maintained that the government’s focus should be to reduce the effects resulting from a bursting bubble, as opposed to discouraging its development in the first place. When the tech bubble burst, the Fed reduced interest rates to 1% for an extended period of time and this is what many believe to have caused the next bubble.

With interest lost in the stock market, the cheap money went into the housing market and housing prices across the US and many other countries started inflating. Robert Shiller has done some fascinating research on this topic in his book “Irrational Exuberance” which supports this point of view. Housing prices continued to rise throughout the decade up till 2006 at which time housing starts (indicative of the supply of new homes) in the US peaked at roughly 2.3 million and have since fallen to a low of 488,000 in Jan, 2009. The domino effects of the collapsing housing market are now clear for everyone to see.

However, the policy response chosen by Ben Bernanke is hardly discernable from that of Alan Greenspan a decade ago, except in its magnitude. Interest rates are now at 0.25% and the Fed has done enough “quantitative easing” to result in the biggest expansion of money supply in history. And the steps of the Fed have been emulated by central banks all around the world. I question why policy makers are inclined to focus on reactive policies which address the fallout from a crisis as opposed to focusing on proactive policy making, addressing the factors that cause bubbles in the first place. Is that not a better long term solution?

Riding the bubble, reluctantly

Lou Jiwei, the chairman of China’s $298 billion strong China Investment Corp, said recently that, “Both China and America are addressing bubbles by creating more bubbles and we’re just taking advantage of that. So we can’t lose.”

Indications show that the money which central banks are pumping into economies is flowing straight into the stock markets. Global equities have been risen 50-60% with hardly a hiccup and if the markets are accurate, then they are pricing in a perfect V-shaped recovery without any chinks. However, reality and fundamentals disagree. Companies have not reported any revenue growth, unemployment has yet to peak and industrial production has been stumbling. Such a disconnect points to signs of irrationality characteristic of Bubble-ville.

Should investors have nothing to do with the exuberant market because they disagree with the fundamental reasons behind it? The biggest challenge is to profit from a bubble while consciously knowing that it is one and pulling out before the proverbial pin pricks it. Unfortunately, by definition, a bubble pulls in many un-informed investors who cannot resist the rising prices and have no recognition of a bubble’s existence.

Are we trying to avoid becoming like Bubble-ville through our policies but in our efforts to do so, inadvertently becoming more and more like it? Or is our society and capitalism as a whole simply incapable of surviving without the existence of bubbles? Regardless of the answers to those questions, we are in for a rocky ride thanks to a few people who seem to be making all the decisions for us. So the next time you hear a POP, don’t be alarmed! It’s probably just another bubble bursting after hyper-ventilating on self-generated fumes of optimism, greed and euphoria.

POP!

Image credit: Jenny Downing (http://www.flickr.com/photos/kubina/50365788/) under a Creative Commons Attribution Unported 3.0 License

Disclaimer: Views and opinions expressed on above are those of the author alone and do not in any way represent the official views, positions or opinions of the employers – both past or present – of the author in question, or any other institutions and corporations associated with the author. Neither the information nor any opinions contained or expressed above and elsewhere on Young & Invested constitutes or should be construed as a solicitation or offer by Young & Invested to buy or sell any securities or other financial instruments or to provide any investment advice or recommendations. Young & Invested shall not be liable for any claims or losses of any nature, arising indirectly or directly from use of the information on or accessed through the site. Please see full disclaimers here.

Note: See important disclaimers below article.

(Part 1 of 2)

The market is said to have its own personality. It teaches investors lessons when they get arrogant and provides them with hope when things seem like they couldn’t get worse. This personality is affectionately called Mr. Market.

Mr. Market’s moods are currently being affected by a very interesting interplay of dynamics brought to fore by the various governments’ interventionist policies attempting to shore up the poor economy. Which dynamics will eventually lead the market forward is anyone’s guess, but I attempt to present here the major factors at play, without putting forward too much analysis and leaving the final assessment to the reader

In this first edition, I cover the top 5 reasons which are held up by market participants as justifications for being long and bullish of the market.

Top 5 reasons to be BULLISH

“I’ve still got my house and my company is now hiring!”

Employment, sentiment and home prices are some of the most important indicators of economic health these days. Many of these “economic fundamentals” seem to have turned their respective corners. Employment, seen as the most important (but lagging) indicator, peaked in March with weekly jobless claims touching roughly 670,000 and the most recent numbers hover around 550,000. Consumer sentiment, a direct indicator of the optimism/pessimism that consumers have about conditions, also bottomed in Feb-March at around 25, while the latest reading came in at 70.2 (above the all important 50 mark). Even the much maligned housing market seems to improving, with the Case-Shiller home price index improving for the first time in months to 132.64 in Q2, 09 (while still being down 14.9% year-on-year).

“Just look at those Asians”

The closest thing to a strong recovery has been visible clearly only in the Asian economies. In Q2, 09, India’s GDP expanded 6.1% year-on-year, while China’s expanded 7.9%. Amongst the Asian tigers, Hong Kong’s GDP grew at an annualized rate of 13.9% in Q2 from the previous quarter; South Korea grew 9.7% by the same metrics; And Singapore grew … wait for it … a whopping 20.7% annualized. As a point of reference, Singapore’s GDP was down 14.6% in Q1 sequentially and annualized, Hong Kong was down 16.1%. Talk about a V-shaped recovery! The regional stock markets in Shanghai, Mumbai, Hong Kong and Singapore have followed a similar trajectory. If Asia is where all the potential for future demand is, then this is a pretty good sign.

“What goes down…”

… Must come up; But hardly anyone was astute enough to be buying into the market when the March 9^th lows were made. As a result, all those people missed the early part of a huge rally. Even after the market had rallied 30%, investors were confused about the solidity of the trend and debates raged about “bear market rallies”. Since then, most investors have already bought into the market at some point or are waiting the next dip to buy in. Due to this, the market has seen every marginal correction being bought into by money on the sidelines jumping in, causing an upsurge as is obvious in the chart below. This was very obvious in July, just prior to the Q2 results. This mentality has lead to the “higher highs and higher lows” observed in all the major indices since March, creating the strong uptrend. The argument holds that the un-invested capital on the sidelines will continue propping up the market on dips.

“Q2 blew away expectations”

73% of companies that reported Q2 results beat analyst expectations ahead of their announcements. Results were not as bad as the investors expected them to be. But does that say more about the results or the expectations? It’s an open question, but Mr. Market liked what it saw, as companies were able to beat targets on their bottom lines. The initial March rally was sparked by positive Q1 results while the subsequent Q2 results in July helped bring the major indices up another 17%.

“I’m still buying Japanese”

Global trade is seen as the life blood of the modern global economy and that life blood was drained in the last months of 2008 as the financial world came crashing down. That is why many of the export-oriented Asian economies had such a hard landing. However, those numbers are now looking up. In July, US exports were up 25% annually after reaching a low in April, while the US imports (driving Asian exports) were also up 29%. Another major indicator of health of global trade is the Baltic Dry Index (BDI) which tracks international shipping prices for dry bulk cargoes, such as raw materials. The BDI is one of the purest leading economic indicators because it provides indications of the demand to move materials of production and also because the BDI does involve any speculative players. While off its recent highs, the BDI has also risen to 2,431 from its December lows in the 600 range.

Disclosure: Long the market

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