Week 13 2012 Performance......Record Setting First Quarter

We saw quite a bit of volatility in the DWCM fund this week as all of the major stock indices we follow finished with green arrows up including our own portfolio.  We squeaked out a week over week gain of 0.3% but at one point in the week we were up 2.5%.  Looking at week over week activity just proves to me time and time again that it is just about impossible to time any market.


I know that I had been clamouring for the past weeks about taking profits and we finally did so this week.  We took a third off of our Disney $DIS and Chipotle $CMG options positions and once again I missed selling Apple $AAPL.  I still have the limit order on to reduce our APPL position by a third.  I would expect to see this filled on Monday as the first trading day of a new month is often higher as new money flows into the markets.


As mention in an earlier post this week [Mosaic Miss Earnings], we doubled down on two of our agriculture names Mosaic $MOS and Potash $POT based on the weak earnings report from MOS.  We had smaller positions in both these names but I see us building upon them in support of our long-term ag thesis.


So far 2012 has been outstanding when it comes to equity returns and especially our own DWCM performance.  The fund finished the first quarter up 22.7% vs. DJIA 8.8%, NASDAQ 18.7%, Russell 2000 12.4%, and the S&P 500 12.6%.  The obvious two leaders both in the DWCM fund and broader markets were Apple and Chipotle up 48.0% and 23.8% respectively.  Other leaders in the fund included Disney, Buffalo Wild Wings, BMW, and Lowe's  Laggards included our ultrashort S&P 500 position and Gold.

Looking back on the quarter we did a lot of things right and had a few misses as well but all in all we achieved our objective which is an absolute return and to beat the major market indices.  The key to the upcoming quarters and the rest of 2012 are to continue to find undervalued names that fit into some of our long-term strategies while being a bit defensive.  I cannot expect Apple and Chipotle to continue to carry the portfolio.  While I believe in both companies and the power of their expected growth, they will eventually need to pull back and consolidate before being able to move higher.


The Week Ahead
The first Friday of each month brings us the latest jobs and unemployment data.  There is no doubt that this week the markets will be greatly anticipating the release of those numbers.  Although jobs is a lagging economic indicator I think that it does more for confidence or reinforces the perception of where the economy stands either good or bad.  


A good way to review jobs data is to take a look at the initial jobless claims trend such as the chart below.  This data is released every Thursday and can at times be a headline grabbing event.  Whatever way you slice it, the trend is obviously down which is good.  What gets tricky concerning the jobs data on Friday is the participation rate and what impact those that do or do not get counted as unemployed have on the actual unemployment rate.  To further add variability you have those that are considered under-employed which can add greater depth to the real jobs picture.  

• Mon -  ISM Mfg Index,  Construction Spending
• Tue -  Factory Orders,  FOMC Minutes
• Wed  -  Challenger Job-Cut Report,  ADP Employment Report,  ISM Non-Mfg Index,  EIA Petroleum Status Report
• Thu - Fed Balance Sheet
• Fri -  Employment Situation,  Consumer Credit

DreamWorks Capital Management Updates

For the past few days Mega Millions mania has been sweeping the country, I even purchased a few tickets myself (not a winner but even so I would still be doing what I am doing).  But for those of you fortunate to land any windfalls please consider DWCM for all of your investment and wealth management needs.  (Cheesy plug I know)

I hope that many of you regular viewers have noticed the increased amount of posts this month.  From the time that I decided to start writing about all of the financial and non-financial topics that we cover here at DWCM, I tried to set a goal for myself to average 2 posts per day.  I wasn't sure how I was exactly going to do that but I knew that I wanted to give you the viewers and DWCM clients the best when it came to thoughts and perspectives in the world of finance and beyond.  

Obviously the month of March was not only a great performance month for the DWCM fund but I was also able to go beyond my posting goal.  I attribute this to the positive feedback that I have received from you via your comments and emails.  I also need to acknowledge and thank my very supportive wife who helps me create the time to write given our hectic lives trying to raise our triplets.  Please continue to send all of your comments and suggestions as it helps to create for me a more dynamic DWCM.

Thank you and Have a Great Week!

Ron Burgundy Announces His Return

For those of you who loved Will Ferrell in Anchorman, your in for a double dose since announcing his return to the news booth on Conan.  You have to love the jazz flute!

2012 Country Stock Market Returns

So how does the US returns stack up against other country returns so far this year?  Well according to Bespoke the US even with it's hot return of 11.58% only gets into the upper 50% of the world rankings.  Venezuela was the big winner while there were only 12 countries that posted negative returns with the lowest return country being Sri Lanka loosing 10.9%.  With all of its attention, Greece is solidly in the back returning 7.99%.



Via Bespoke

• Japan is up the most of the G7 countries with a significant gain of 19.63%.  Germany ranks second in the G7 with a gain of 16.56%, followed by the US and then France.  Canada is doing the worst with a gain of just 2.80%.
• The BRICs (Brazil, Russia, India, China) had been doing much better until this week rolled around.  After big drops over the last three days, China is only up 2.40% on the year.  India is now up just 10.38% YTD, while Brazil and Russia are still up solid double digits.

New iPad: a Million More Pixels Than HDTV

Courtesy of Walt Mossberg the respected personal tech writer at the WSJ gives his breakdown of the new iPad.  The key takeaway for me is that if you already own an iPad2 there is no urgent need to rush out and get the new iPad even though it has some new features namely the screen and increased speed.  Beware of that speed as we noted in [Video Speed Trap Lurks in New iPad].  I would be interested to hear anyone's comments on their new iPad or even the iPad2 and how you like using it.  I personally have no plans to buy one although I am considering buying a new Mac vs. a PC.

Via Mossberg at the WSJ here

• Apple hasn't totally revamped the iPad or added loads of new features. But it has improved it significantly, at the same price.
• It has the most spectacular display I have ever seen in a mobile device. The company squeezed four times the pixels into the same physical space as on the iPad 2 and claims the new iPad's screen has a million more pixels than an HDTV. All I know is that text is much sharper, and photos look richer.
• If you already own an iPad 2, and like it, you shouldn't feel like you have to rush out to buy the new one. However, for those who use their iPads as their main e-readers, and those who use it frequently while away from Wi-Fi coverage, this new model could make a big difference.
• Along with the unmatched collection of 200,000 third-party programs designed for its large screen, and the large catalogs of music, books, periodicals and video content available for it, I can recommend the new iPad to consumers as their best choice in a general-purpose tablet.
• As I tested the new model over five days, I found I was able to use smaller font sizes to read books and email. The same photos I had enjoyed on the older model looked much better on the new one, not only because of the increased resolution, but because Apple claims it increased color saturation by 44%. One thing Apple hasn't fixed: like all glossy, LCD color displays, this one still does poorly in direct sunlight.

• The new iPad is hardly the first device to use 4G LTE cellular technology, but it marks a huge difference from the iPad 2. On Verizon's network in Washington and Austin, Texas, I averaged LTE download speeds of over 17 megabits per second, faster than most home wired networks. A colleague using a new iPad on AT&T's LTE network averaged over 12 mbps. My iPad 2 running Verizon's 3G network averaged just over 1 mbps. Of course, you can get a Wi-Fi only model, at $130 less. The base $499 model is Wi-Fi only.
• Apple claims up to 10 hours of battery life between charges, and up to nine hours if you are relying strictly on cellular connectivity. In my standard battery test, where I play videos back to back with both cellular and Wi-Fi on, and the screen at 75% brightness, the new iPad logged 9 hours and 58 minutes, compared with 10 hours and 9 minutes for the iPad 2. Other tablets died hours sooner in the same test. In more normal use, the new iPad lasted more than a full day, though not as long as the iPad 2 did.
• Like the iPad 2, the third-generation iPad has front and rear cameras. The front camera, meant mainly for video chats, hasn't changed. But the rear camera, which was awful for photos on the iPad 2, and was estimated at less than a single megapixel of resolution, has greatly improved. It's now a 5-megapixel shooter with improved optics. I loved the photos and videos it took, indoors and out.
• It also allows you to dictate, rather than type, emails and other text. I found this surprisingly accurate. And Apple now has a brilliant new version of its iPhoto software that has been rewritten for the iPad.
• Since it launched in 2010, the iPad has been the best tablet on the planet. With the new, third-generation model, it still holds that crown.

Mosaic Miss Earnings

Mosaic $MOS an name that we own in the DWCM portfolio reported lower earnings on Wednesday which sen it shares lower creating in my mind a buying opportunity.  As discussed here in many posts I am a big proponent of agriculture names long-term.  With the global population continuing to expand at a rapid rate and the growth in China, food is going to have to come from somewhere and in order to harvest those crops there is going to be a strong need and demand for fertilizers, seeds, and equipment.


As mentioned I saw this weakness as a buying opportunity not only for Mosaic but Potash as well and doubled down on our DWCM position.  Mosaic has great fundamentals with almost no debt, a high cash yield, and maintains a solid economic margin meaning it more than covers it cost of capital.


Highlights of the quarter from Dow Jones Newswires

• fiscal third-quarter profit slumped 50% as higher raw- material costs and slow farmer buying cut into the fertilizer producer's margins.
• The result faced a tough comparison against earnings a year earlier, when record demand, combined with supply uncertainties, helped lift up the fertilizer market.
• Mosaic, and other fertilizer producers, continue to paint a rosy outlook for the industry, but they have struggled in recent months amid a standoff with customers. Farmer demand has been sluggish amid high prices, and dealers have been slower-than-usual in securing supplies. Mosaic and competitors have in recent months curtailed production in response.
• Net sales in the company's potash segment was $553 million for the third quarter, down 27% compared with $758 million a year ago.
• "The Potash segment's operating results reflect delayed purchases, as buyers remained cautious," Mosaic CEO Jim Prokopanko said in a statement.
• Still, the company expects "near-record" global potash shipments in the quarter, and a very strong North American application season. U.S. farmers are widely expected to plant the most corn acreage since World War II this year.
• Mosaic was split off from agribusiness giant Cargill Inc., which had owned a two-thirds stake in Mosaic last spring. Its earnings have mostly climbed over the past year as worldwide demand for fertilizer lifts sales, though economic uncertainty caused a profit slip in the second quarter. The company has also cut phosphate production temporarily.
• The company has still signaled optimism about its future growth prospects and last month said it would double its shareholder dividends for 2012.

• For the quarter ended Feb. 29, Mosaic posted a profit of $273.3 million, or 64 centsa share, down from $542.1 million, or $1.21 a share, a year earlier. The latest quarter included about 8 cents a share in charges tied to negative currency effects and other items. Revenue slid 1.1% to $2.19 billion.
• Analysts polled by Thomson Reuters expected a 74-cent per-share profit on $ 2.13 billion in revenue.
• Gross margin narrowed to 23.8% from 38.5%.
• Phosphate sales grew 9.3% as the average selling price decreased 1.3%. Potash sales dropped 27%, while prices increased 26%.

71 New S&P 500 52-Week Highs

The good news about this chart from Bespoke is that we have a few names that we own and follow in the DWCM portfolio (see those below).  With 71 companies hitting new 52 week highs that represents 14.2% of the total S&P 500.  That is a big number and it again points out to how strong this rally has been.

Notice the diversification between the companies on this list.  It hasn't been just one sector or industry.  A pretty broad based rally if you ask me.  This also tells me that correlation seems to be strong with most companies and the major indexes.  They rise and fall together



DWCM Ownership

• Chipotle Mexican Grill, Lowe's, Disney

DWCM Watchlist

• VF Corp, Discovery, Visa, Mastercard, Beam

Personal Ownership

• Disney, Visa

Video Speed Trap Lurks in New iPad

If any of you have purchased a new iPad have you been caught by the video stream trap?  Due to the incredible downloading speed and picture users are blowing through their gigabyte allotments in hours rather than days.


Here is a story regarding this very subject in the WSJ

• Brandon Wells got the new iPad last Friday, started wirelessly streaming March Madness games the next day and by Saturday night was out of gas.  Two hours of college basketball—which he viewed mounted to his car dashboard and live at tournament games—had burned through his monthly wireless data allotment of two gigabytes.
• Now, to keep surfing the Web or watch more NCAA hoops over Verizon Wireless's 4G network, Mr. Wells will have to pay an extra $10 for every gigabyte above his current $30 subscription.
• "It's kind of a Catch-22," says Mr. Wells, a 31-year-old Web developer who decided to pony up for another gigabyte. "It streams really fast video, but by streaming really fast video you tend to watch more video, and that's not always best."
• That means something has to give: Either consumers will have to get used to paying more or wireless carriers will come under pressure to change their pricing models.
• Verizon declined to comment on its pricing strategy, but said customers can pick higher-use plans or they can go easier on their data allotments by shifting to Wi-Fi networks when they are available.
• Albert Park, a 24-year-old working at a start-up in Austin, Texas, tapped into the Wi-Fi network at a local café on Sunday to watch some YouTube videos on his iPad. The network turned out to be too slow for an uninterrupted stream, so Mr. Park switched to the high-speed mobile network operated by his service provider, AT&T Inc 
• For the next hour, Mr. Park watched concert videos and other clips and browsed social-media sites. On Tuesday, five days after getting the new iPad, he found he was already two-thirds of the way through his monthly allotment of 3 gigabytes of wireless data."I'll probably avoid watching videos outside my home," Mr. Park concluded.

•  What many consumers may not realize is the new iPad's faster LTE connection means they will use more data even if they don't change their 3G surfing habits. Take regular video: Verizon estimates that streaming it over an LTE connection runs through 650 megabytes an hour. That's double the amount of data used streaming the same video over a 3G link, because the fatter pipe lets more data through.
• On top of that, the new iPad's sharper screen will encourage some users to view videos in high-definition, which uses 2 gigabytes an hour on a 4G connection, according to Verizon.

3 Steps To Pursuing Your Ideal Career

I'm often reviewing great content for posts via Fast Company.  The article at hand 3 Steps to Pursuing Your Ideal Career I found to be a reinforcing piece to help those of you out there searching or struggling with career issues.  You may have found that I often publish posts similar to this (Do The Job You're Meant to Do & Find What You Love) because I personally believe that having a healthy career in which you are engaged in is extremely helpful in achieving your own financial and life goals and objectives.  Usually you will find that life and financial goals go hand in hand and having a deep understanding of what you want to do will help you be successful in the long-term.


Here are the three points from the Fast Company article

1. Gain clarity around what to focus on
2. Define the world you imagine
3. Replace old thoughts with new ones

Sometimes at the end of articles such as these I will peruse through the comment section to see what other readers thought about the piece.  I found one such comment that I believed was worth sharing and is especially critical when reviewing articles that deal with change of any kind.

• I wholeheartedly agree with the author's three step process of identifying our core passion and translating that passion into everyday success. Sounds easier said than done ! In fact the truth is truth and there's caveat to what is mentioned in this article from what I have seen around.
• I am very interested in being an entrepreneur. I am finishing my MBA soon with $ 50000 of debt. I have to support my family back home with stipends. At this very moment, even with galore of creative ideas and entrepreneurial mindset, I can't think of dedicating my mind to start a new venture. I must find a job to pay off my debt and support my family. There's no one around to extend me another $ 50000 to do business or give me a safe custody if my ideas fail. I think I have very exciting business concepts and I am passionate about doing something on my own but to be candid I can't embark on that self satisfying voyage because I have to live with the constraints. It's not that I hate to be an employee in Corporate America or wherever I have to work but I must come to true terms of life.  
• I can read many inspiring stories but again I can't take reference from each of these sagas because my life and my condition is unique to me, vey personal. Resources matter so much in life and so does support. I wished life was a fairy tale but it's not. We must find our own ways, navigate the separate highways even if we may all want to reach the same destination and claim the same victory.

The key takeaway from these comments is that although these stories are inspiring and somewhat helpful change is easier said than done.  Some people often have constraints real or imagined that are tough to break down.  The point here is to not give up but to pursue your dream, goals, ambitions with all of your vigor.

Ray Dalio, “The Thinking Man’s Nouriel Roubini”

We have featured Ray Dalio founder of Bridgewater Associates LP in a previous post [March 21, 2012 The Most Successful Hedge Fund Ever].  In the video below Dalio speaks at The Economist with Mathew Bishop and discusses the world of de-leveraging and its impact.  Thanks to Barry Ritholtz at The Big Picture for the initial post.

Chipotle 3-Year Run Beats Apple

This is a good analysis on Chipotle Mexican Grill $CMG by YCharts a name that we currently own options on in the DWCM portfolio.  We have been waiting patiently to take profits on this name but much like Apple $AAPL it just continues to press higher.



As the YCharts analysis point out and I completely concur with, CMG face the following headwinds

1. Rising gas prices, cuts into consumers discretionary spending not to mention people cut back on driving
2. Rising commodity prices, corn and wheat prices are close to highs or hitting new highs
3. Growth in new stores and sales at exiting stores (comps) is not likely high enough to support the exiting stock price

Full disclosure we also own options Apple in DWCM fund

Another Plunge in 3-Month Rolling Average of Petroleum and Gasoline Usage

This may come as a shock to most of you but actual petroleum and gas usage in the states has been on a steep decline although you wouldn't be able to tell that looking at gas prices at the pumps today.  We are actually back to gasoline usage levels from late 2001/early 2002.  

Chart courtesy of US Energy Information Administration

I assume that improved gas mileage in vehicles would be a source attributable to the decline but I highly doubt that it contributes a large % of the decrease.  So what could be the big drivers to reduced usage?  How about simple supply and demand.  Costs go up and demand goes down.  With people as I continue to point out still stuck in a recession or depression they cannot afford to drive with the levels of prices over the past years.


Tip to Mish Shedlock for isolating this data here

Steve Wozniack

I am in the process of reading Steve Jobs' biography written by Walter Issacson and one point that continues to stick out to me is how incredibly talented Steve Wozniack is.  Obviously he was co-founder of Apple and between Jobs and himself created something entirely out of nothing into the most valuable company in the world.  You could almost say that Wozniack was the actual computing brain behind Apple's success while Jobs had the ability to sell, manage, and lead the company with precise vision and focus.  But without Woz there would be no Apple and I'm not sure if he will ever get the credit that he deserves.

One thing is for certain he and Jobs had quite distinct and opposite personalities.  Woz comes across as an easy going guy, a gifted savant if you will while Jobs had an array of personalities.

Fcaebook co-founder Eduardo Saverin First TV Interview

If you ever wondered who Edwardo Saverin the other co-founder of Facebook was, here is his supposedly first TV interview with Brian Sullivan of CNBC at the YPO conference last month in Singapore.  From all accounts he is a very respected business person who has his hand in many companies.

The interesting part that I picked up on regarding his interview was his tone in that he talked as if he was still part of the company.  He used the word "we" referring to Facebook several times during the interview.  It is supposedly reported that he owns approximately 5% of Facebook.

7 Entrepreneurial Lessons From "Shark Tank"

I'm not sure how many of you spend your Friday evening watching TV but with triplets I don't venture out all of that much.  So if you ever find yourself looking for something to watch on those Friday's I highly recommend Shark Tank on ABC.


The show introduces budding entrepreneurs to business moguls such as Mark Cuban, Kevin O'Leary, Robert Herjavec, Daymond John, and Barbara Corcoran who pitch their companies in hopes of gaining an investment in return for a piece of their company.  There are allot of lessons to be learned from the show and Fast Company was happy enough to put together such a list.  The Sharks have invest $6.2m of their own money in order to support their entrepreneurs.

Via Fast Company

• Know your numbers. This is the number one lesson from Shark Tank. Whether you're presenting to a team of investors or simply working to grow your business, it's critical that you understand how much cash is coming in and out of the business. While you might think that most entrepreneurs on Shark Tank have a handle on their books, many believe that their passion will sell their wares. However, as we've learned from many of the Sharks, passion only gets you so far--numbers tell the real story.
• Be a good marketer. Although the boys from The Brewer's Cow didn't get the deal they wanted, there is no doubt that the exposure from the show is extremely valuable. However, as a Shark Tank fan shares on his blog, the company's website is pretty lackluster for a brand that hopes to go national. If you extend the online search to their Twitter feed, there is very little interaction since the show aired. The Brewer's Cow currently has a deal with Whole Foods, but on the online front there is a lot more they could be doing just days after the television broadcast to capitalize from the on-air buzz.
• Be humble. When a young entrepreneur appeared on the show to sell his custom clothing, he expressed the business drive that the Sharks love, but things started to fall apart when he talked about his lifestyle. Aside from asking for a starting six-figure salary (when the company has only grossed just over $315,000), he also lost some Sharks when he declared, "I'm now living the L.A. life." As Shark Daymond John, founder of FUBU, expressed on his Twitter feed, a statement like this isn't very appealing to a potential investor looking to form a responsible partnership.
• Understand good timing. There are good and bad times in your business to ask for investment money. For many of the companies diving into the Shark Tank, they have great ideas but it's too early on in their businesses to be on the hunt for a large amount of cash. Mom Raven Thomas was one of the most impressive entrepreneurs on the show in terms of leaking out little bits of information about her business to entice the Sharks, one by one. For example, when she shared that Sam's Club recently put in an order for $2 million for her chocolate-covered pretzels, she had Cuban drooling to seal a deal.

• Have a good story. When Travis Perry explained his company's motivation to the Sharks, it tugged on their inner musician heart strings. Perry invented his product Chordbuddy to help new guitar players like his 10-year-old daughter avoid frustration when learning how to play the popular instrument. With a great story and a stellar product, Perry got investment help and now has his Chordbuddy product in more than 100 music stores.
• Be prepared to walk. Some things are not meant to be, which was the case with entrepreneur Scott Jordan. As founder of the successful brands SCOTTEVEST and TEC, he appeared on the show to sell a percentage of the latter (a technology-enabled clothing patent). The Sharks, on the other hand, were interested in Jordan's main business, SCOTTEVEST, which is on track to make more than $20 million this year. After a heated debate with some of the Sharks, Jordan was happy to walk away without a deal but with some new publicity for both his businesses.
• Be personable. While all of the above will get you closer to your dream of running a successful business, it's also helps to have a winning personality. No one wants to do business with someone who is unlikable, except maybe Mr. Wonderful. As Shark Barbara Corcoran said in a recent tweet, "All the entrepreneurs I've invested in have amazing personalities--no regrets."
• Remember all those things you learned about being nice in kindergarten? Those same things apply in the boardroom, no exceptions.

Fourth Best Nasdaq First Quarter in History

The data that Bespoke puts together at times may seem pretty simple but when taken in the correct context can have quite a bit of meaning.  I suppose that this is one reason why I feature their analysis so much on the DWCM site.  Take for instance the chart below.  My takeaway is that there is no clear cut takeaway.  Take the first quarter for the NASDAQ or just about any major stock index for what it was, a good/great quarter because the rest of the year is up in the air.

What has worked so far this year may not work for the rest of the year.  We still have not seen a significant pullback from the run we have been on since last October.  As the anticipation builds most see any pullback or dip we may incur to be a buying opportunity.  While that may be the case as we could consolidate and then move higher I think it is best to take a conservative approach and not jump into the deep end of the pool just yet.

Chart courtesy of Bespoke

Sergio Marchionne: Resurrecting Chrysler

I know that the auto bailouts strikes a cord one way or another with most Americans.  It is especially sensitive here in the Motor City where I reside.  As I have stated here previously I was not a proponent of the government bailout and would have liked to have seen  more of a free market approach but no one can deny that the pain of that crisis was lessened somewhat due to the government involvement.  Long-term I still contend that there will be issues although I hope that I am wrong.

That said, here was a 60 Minutes piece from the past weekend featuring an interview with top Chrysler and Fiat boss Sergio Marchionne.  My personal take away from the interview was that Marchionn came across as a very personable person.  From the sounds of it he has made a tremendous amount of change at Chrysler.  From a personal perspective he seems to be a workaholic, a person who keeps his private life private, and a stern negotiator.  A negotiator that probably got a great deal from the government but at the same time has taken great risks in trying to resurrect the Chrysler group.

The $54 Trillion Question: Can the Credit Crisis be Fixed with More Credit?

This is a great piece on where we stand with the credit crisis.  As the economy has improved people may get a false sense of security in thinking we are out of the woods in terms of risk.  Let's not forget that despite all of the "good economic news" being reported over the course of the past weeks and months there is still a large majority of Americans still stuck in a recession and in some cases a depression.  "Too big to fail" is still in play as the top 5 or 6 banks control more assets today than they did pre-crisis.

Another point to add onto this is how the market continue to rally as Bernake pounds the table that rates will not rise under his watch.  Remember Bernake is a believer that the recession was not caused by the stock market crash but instead was the fault of the Fed not doing enough to pump liquidity into the system and reduce rates.  We will get to the point where more credit, more liquidity does more harm than good.  Have you checked out a savings or CD rate lately?  The savers of this country are getting crushed

The entire piece below is courtesy of YCharts

Easy money and bad decisions tanked our economy, and we're not out of the woods yet. The fix applied so far: more easy money. Will it work, or are we going to create a new asset bubble without solving the problems caused by the last one?

The use of credit has been building in the United States economy over the last 50 or so years. Credit is self-reinforcing on the way up. As credit expands, financial asset prices rise, which creates a wealth effect for all involved. Households, corporations and the government are able to consume at levels not possible previously. However, expanded levels of credit can't last forever unless incomes rise at a comparable pace.

If so much credit is created that it can't be serviced, or eventually paid back, you end up with a bubble, which must burst at some point or, at the very least, a long de-leveraging process results. Just ask Japan. So do we have too much credit in the U.S.?

During the financial crises, total debt to GDP approached 400% and now stands near 355%.

US Total Debt as a % of GDP Chart by YCharts

During that last 30 or so years, credit market debt has grown more than twice as fast as income (GDP) and household net worth in the U.S. Not the best trend for the worlds largest economy.

US GDP Chart by YCharts

All debt grew at much faster rates than income. Two lesser cited examples: consumer creditgrew faster than retail sales; and now student loan debt is expanding rapidly. Are trends like these positive for the overall economy?

Even with these trends, the balance sheet for U.S. consumers remains strong on an aggregate basis, but has weakened. And there are large percentages of the population that have dreadful balance sheets. You can see the trend in assets and debts below.

US Total Consumer Credit Outstanding Chart by YCharts

In a credit bubble, one expects defaults to start when promises to pay become so large that debtors begin having trouble servicing debt levels. We saw this in housing as adjustable mortgage rates reset. Often homeowners could no longer afford to make the mortgage payment. Or the home's value dropped, and some borrowers strategically decided to default. Cheap credit had helped push up the real estate prices. When prices dropped, much of this credit was related to assets that had dropped significantly in value.

We do see a positive trend in U.S. household debt service as a percent of disposable income. It peaked as the U.S. entered recession and has since dropped back significantly. (That, of course, doesn't include the rising federal debt now over $15 trillion, which consumers are ultimately on the hook for. More on that below.)

US Household Debt Service (Percent of Disposable Income) Chart by YCharts

The drop in debt service was driven by household cutbacks and efforts by the Federal Reserve to ease the consumer debt burden. The Fed has repeatedly set rates very low since the early 80's highs. This reduces debt expenses for households, the U.S. government and corporations and stimulated spending. It also enables credit to expand rapidly. At issue, the Fed Funds rate is now at about 0%. You can't really go lower than 0%.

Total Credit Market Debt Chart by YCharts

So what's next? If you control your currency like the U.S. does (sorry Greece -- you're stuck with the Euro for now), the central bank can buy up shaky bank assets and government debt. The Fed has done this in a big way. You can see in the chart below that overall credit is relatively flat, as is household credit. But financial sector credit has been reduced from $17 trilion to $13 trillion and transferred into government debt and to the government-sponsored enterprises, or GSEs.

Total Credit Market Debt Chart by YCharts

As a result, the financial sector has been nicely recapitalized. Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), Morgan Stanley (MS) and Goldman Sachs (GS) have all increased their tangible common equity ratios significantly. But there are still trillions in credit market debt on the balance sheets of banks, GSEs and the Fed.

Bank of America Corporation Tangible Common Equity Ratio Chart by YCharts

Another strategy in play: run large government deficits to prop up government spending and GDP. Government spending has been higher than revenue as a percent of GDP since 2001. Unfortunately, this adds even more debt as we try to juice the economy via government spending.

Federal Government Spending as % of GDP Chart by YCharts

The Federal Reserve is facilitating all of this with quantitative easing (QE) in an effort to get the economy back on track and stabilize the banks. However, the level of existing debt limits the investment choices. The new money is often invested in inflation hedges like gold, commodities, other currencies and held as reserve balances at the Federal Reserve. You can see the dramatic rise in U.S. reserve balances with Federal Reserve banks and cash in bank accounts below. Even with the recent stock market rally, retail investors have stayed cautious, leaving much of their cash in bank accounts for now. Cash balances are at record highs. If this cash gets deployed, all that spending, and/or investing, could drive up some prices, thus raising the threat of inflation.

US Reserve Balances with Federal Reserve Banks Chart by YCharts

As always, many experts --including Fed board members -- are focused on controlling inflation. Doing so helps the U.S. to keep GDP growth, or income, above nominal interest rates, thus expanding incomes faster than debts and fostering a smooth de-leveraging process. Controlled inflation sounds great in theory. For a smooth deleveraging to work, we need inflation in the right asset classes and that is the hard part. Inflation in everyday goods and deflation in real estate is a recipe for more pain. You can see this relationship in the chart below.

US Hog Farm Price Received Chart by YCharts

If Fed policy increases general prices but isn't able to get housing prices rising, then all of this QE is actually hurting all but the recipients of the QE dollars. Just ask anyone who retired recently. Savers are having a tough time given the ultra low rates. In this scenerio, all of the new money increases the price of financial assets and commodities but does little to solve the fundamental issue of rising debt levels and falling real estate assets.

To quote the Federal Reserve of New York, "a large foreclosure pipeline hangs over U.S. housing markets, creating headwinds for housing market recovery. What began as a nonprime mortgage problem has evolved into a prime mortgage problem with the onset of the recession. The inability to afford a home has been replaced by declining house prices and high unemployment as the primary driver of new foreclosures".

Credit has no doubt reached levels that start to make some a little uneasy. Growing debts faster than income is generally not smart. At some point, the debt service level starts to consume a large percentage of income that would otherwise be used on more crucial and productive expenditures. Buying assets on credit is great when the assets are going up but when they stagnate or decline, not so much.

The current path of solving credit problems with more credit seems counterintuitive to many. Is this the path to prosperity or should we try something else?

Young Adults See Their Pay Decline

Once again we come across disturbing information concerning our younger generation.  Already saddled with an average of $25k in college debt discussed countless times here [College Does Pay Off But Its no Free Ride], [Is College Still Path to Success], [What's Your Kid Getting From college] now comes data that young people are bearing the brunt of high unemployment and downward wage pressures.


High structural unemployment has a cyclical affect upon generations.  Older people stay in the workforce longer out of fears or necessity which cause less hiring of new typically younger people.  Companies don't typically cut salaries of those current workers but may try to push wages down for new hires especially in tight job markets such as the one we have currently been in.


No matter what way you slice it looks and feels that younger people face an array of challenges in getting not only their careers but financial lives in order.


Via the WSJ article here

• In data compiled for a coming report, the Economic Policy Institute, a center-left think tank in Washington, found that the average inflation-adjusted hourly wage for male college graduates aged 23 to 29 dropped 11% over the past decade to $21.68 in 2011. For female college graduates of the same age, the average wage is down 7.6% to $18.80. 
• "New college graduates have been losing ground for 10 years," said Lawrence Mishel, president of the institute, which derived the figures from regular government wage surveys. The drop in average wages for young adults is in contrast to U.S. government figures showing that average inflation-adjusted hourly wages for production and nonsupervisory workers of all ages and education levels are up 3% from a decade ago. 

 

• Young people are having to be more flexible. Eric Probola, who got a bachelor's degree in global cultural studies from Point Park University in Pittsburgh in 2010, accepted an administrative assistant's job at a nonprofit there for less than $30,000 a year. He aims to build up savings and gain experience before seeking a higher-level job, perhaps in Washington. 
• "Students are realizing that they might need to take a stepping-stone job as opposed to that dream job," said Amy Bittner, a career counselor at Point Park who advised Mr. Probola. 
• For the entire working population, average hourly wages have risen modestly over the past 10 years. But that is partly because many of the lowest-paid workers have lost their jobs and are no longer included in the average. "People who normally make below-average wages are not working," said Bart Hobijn, an economist at the Federal Reserve Bank of San Francisco. "That raises the average wage." 

The Democrat Who Took on the Unions, Gina Raimondo

On Friday we posted an interview by Gina Raimondo, state treasurer of Rhode Island [March 23, 2012 Rhode Islands Retirement Law] who has battled to overhaul that state's pension laws.  Over the weekend the WSJ featured a story on her as well which dives a little deeper into her background and the roads that she took in order to reform pension law in Rhode Island


Points from the WSJ article link here

• The former venture capitalist is a Democrat, which means that she believes in government as a force for good. But "a government that doesn't work is in no one's interest," she says. "Budgets that don't balance, public programs that aren't funded, pension funds that are running out of money, schools that aren't funded—How does that help anyone? I don't really care if you're a Republican or Democrat or you want to fight about the size of government. How about a government that just works? Put your tax dollar in and get a return out the other end." 
• Ms. Raimondo drove perhaps the boldest pension reform of the last decade through the state's Democratic-controlled General Assembly. The new law shifts all workers from defined-benefit pensions into hybrid plans, which include a modest annuity and a defined-contribution component. It also increases the retirement age to 67 from 62 for all workers and suspends cost-of-living adjustments for retirees until the pension system, which is only about 50% funded, reaches a more healthy state. 
• "people say we've done pension reform when all they've done is tweaked something," Ms. Raimondo points out. "This problem will not go away, and I don't know what people are thinking. By the nature of the problem, it gets bigger and harder the longer you wait." 
• In the last 15 years, Ms. Raimondo, who is 40 and the mother of two children, has helped found two venture-capital firms, Village Ventures and Point Judith Capital. She was a Rhodes Scholar at Oxford and has a bachelor's in economics from Harvard and law degree from Yale. Still, serving as treasurer of the smallest state in the country probably wouldn't be the next career step for someone with such impressive credentials and ambition. 
• Soon after she set to work on fixing the state's pension system, flouting the advice of her Democratic colleagues. "Candidly, most people in my political circle told me not to do it because it is politically challenging and it's kind of the third rail," she says. "So most political advice I got was: 'Don't own the issue. Stay away from the issue. Put it on somebody else.'" 
• Ms. Raimondo spent most of last year crisscrossing the state, educating people about the magnitude of the problem. "I would talk to social workers or social-service agencies who, when I started to talk about pensions, would ask 'Why should I care about pensions?' And I said, 'Because if you don't, your whatever it is, homeless shelter, is going to lose X thousand of dollars of funding.'" 
• And she wasn't afraid to "walk into the belly of the beast" and tell the unions point-blank that "you were lied to [by former politicians] and the system is broken. Today we're arguing about whether you get a COLA [cost-of-living adjustment], tomorrow we'll be arguing about whether you get a pension."  
• Ms. Raimondo downplays the opposition from her former union allies. As she tells it, the reforms passed because she conducted "a huge, long, relentless public-education campaign," and there was no "rushing to a solution." Plus, the unions were at the table the entire time, she says. "Yes, there was a big protest. They weren't entirely supportive, but we had a reasonably productive dialogue the entire time—which we still have." 

Corporate Outlooks Hint At More Pain Ahead

I realize that this WSJ article is a month old but there are some valid points to revisit here based on some of our previous discussions surrounding corporate earnings outlooks.  About a month ago I featured Nick Raich, director of research at Key Private Bank [February 17, 2012 Nick Raich on Earnings Guidance] who does extensive work on using earnings guidance in his economic forecasts.  


It's no secret that companies under promise and over dealer when it comes to earnings.  Missing earnings is the easiest way to wipe out large amounts of market cap especially when it comes to momentum names.  Companies have been operating at a high efficiency with record setting productivity but cost cutting can only last so long especially in the face of stiff headwinds such as higher input and energy costs.  


Case in point FedEx this past week handily beat Wall Street estimates which should have led the stock up but instead it faltered when it announced lower guidance.  "The fourth quarter is still very good, but what we're seeing at the moment ... is we just don't have as strong an economy as we would have hoped it would be a year ago," Chief Financial Officer Alan Graf told analysts on a conference call.  "The economic environment and the elasticity that we're seeing on our premium services due to high fuel costs are dampening momentum a bit."  The company said more expensive fuel was prompting customers to choose to ship goods by truck rather than air to save money.


Via the WSJ here

• Fifty-eight companies have released estimates for first-quarter earnings that fall below analyst consensus, compared with 23 that beat Wall Street. That’s the largest ratio of negative to positive announcements since the first quarter of 2009, when the S&P 500 was on its way to bottoming out below 700 in early March. 
• “We’re seeing more negative guidance than usual,” said Greg Harrison, earnings analyst with Thomson Reuters. Estimated profits for 2012 have steadily fallen since October. The average S&P 500 company currently expects to add 8.3% in profits for the year. Just over a month ago, that estimate was at 10%. 
• Pepsi, for one, cut its outlook for fiscal year 2012 by more than 7% – from $4.40 a share to $4.08 a share – in part because the costs of the raw materials, including energy, used to make its products will rise. The company said raw material inflation will take $1.5 billion from its bottom line in an investor meeting after its Feb. 9 earnings announcement. 
• Many companies are also hitting a wall on just how much of their expenses they can cut after recessionary belt-tightening. “Margins have come off their peak,” said Bill Stone, chief investment strategist for PNC’s asset management group. Margins, the percentage of revenue that translates into profit, rose steadily from 2008 until recently, when the average rose to 9%. But this quarter, the average is expected to fall to 8.5%, meaning companies are having a tougher time eking out higher profits out of steady levels of revenue. 

Week 12 2012 Performance.......Steady as she goes

It was a mixed bag on Wall Street this week along with most of the housing numbers reported.  The DJIA $INDU and S&P 500 $SPX were down while the NASDAQ $COMP and Russell 2000 $RUT squeaked out gains.  Most of the indices started down right off the bat this week and then struggled hard to regain losses.  The housing numbers which were the key economic drivers were down month over month with existing home sales down 0.9% and new homes sales catching analyst off guard going down 1.6%.





The housing numbers like a good majority of economic data gets revised each month so you really have to look below the headline numbers into the actual data to see what trends are developing.  From what I see looking at both charts is that lower rates are not creating a significant increase in either existing or new home sales.  As we have pointed out in many previous discussions the lending standards have become so much more tighter that it is harder for people to take advantage of the lower rates to purchase a new house or even refinance an  exiting mortgage.

Our DWCM fund performed remarkably well this week given the rough waters the other indices had faced.  We were up 0.7% for the week and are now up over 22% for the year besting all of the 4 major indices.  We exited out of Green Mountain Coffee Roasters $GMCR and SodaStream $SODA booking a loss of 7.1% on GMCR and a gain of 15.1% on SODA.  Both these momentum names were becoming too hot for me to handle.  Neither of these stocks were ever really trading that well on their own fundamentals and from a technical standpoint I didn't see the direction that either stocks were going in and the risk was just too much for me.  Net/Net it is a gain for the fund and we move on but I will continue to monitor these names going forward.

I was also looking this week to take some profits in some of our option positions such as Disney $DIS, Apple $AAPL, and Chipotle Mexican Grill $CMG which have all gone parabolic.  There is a saying that "pigs make money while hogs get slaughter."  Translation, it is one thing to make a profit but don't get to greedy or you risk loosing everything.  Think of the run up in the NASDAQ during 1999/2000 and the previous period of 2007/2008 before the financial crash.  None of the names hit my target or limit price so we will continue to monitor and look to take profits this upcoming week.

The Week Ahead
This coming week is loaded with new economic data all trying to to give us clues and insight as to how strong this recovery is or if it is running out of steam already.  Last week in Barron's Mike Santoli addressed the issue of waiting for the perceived pullback that everyone is waiting for that might now happen.  Even though we had the slightest of pullbacks this week in the major indices the run up in the markets since the October bottom has been nothing but spectacular.  It really makes me personally focus harder on preserving capital and looking at names that fit our long-term thesis that can be bought at a discounted price.  Strong names that have solid fundamentals but also good technical attributes as well.

• Mon -  Pending Home Sales Index,  Dallas Fed Mfg Survey
• Tue -  S&P Case-Shiller HPI,  Consumer Confidence,  Richmond Fed Manufacturing 
• Wed -  Durable Goods Orders
• Thu -  GDP, 
• Fri -  Personal Income and Outlays,  Chicago PMI,  Consumer Sentiment

This week we were featured in our first national news publication The Mutual Fund Wire.Com.  DWCM released it's first major press release which was picked up by several publications including The MFWire.Com.  Armie Lee from The MFWire.Com conducted the interview with myself which focused on the launch of our firm and the goal of launching our own Mutual Fund or ETF within the next 1 to 2 years.  My hope that as we grow at DWCM and continue to gain clients and readers trust, that people will feel confident in our performance and investing process to invest in our fund.  For any of you interesting in looking to invest in a fund such as ours you can reach out to me via email at pfenner@dwcmllc.com

Have a great week!