11.10.13: Weekend Reading Worth A Look

Josh Brown, blogging for 5 years. Great stuff every day. JB covers a lot of ground, like Cramer. Those of us in the business who write, usually do it to impose a discipline on our thought process to get it right for readers. I cant tell you how many times I’ve written something, and come to a point where I’ve said internally, “Better check that to make sure it is accurate”. In effect, our blogging, Tweeting, and public communication becomes an integral part of the research process for clients. You put your thoughts, assumptions, conclusions, and valuation work out for public consumption, and take the risk of getting scorched in the process, particularly on sights such where the readership can be less rigorous and very emotional. Josh consistently puts out some of the best market insights on a daily and weekly basis. Here is to the next 5 years for TRB;

Speaking of good investors, Jeff Miller at A Dash of Insight, with his latest weekly missive. Havent yet read the Ed Yardeni piece, but since we both follow SP 500 earnings religiously, it sounds like Ed gets to the same conclusion we did here on October 1, 2013, when we ran the initial earnings numbers and p.e ratio’s on potential 2014 estimates. About 4 paragrpahs from the bottom, we note the estimated 2014 year-end Sp 500 value if we get 10% EPS growth in 2014, and if the SP 500 continues to trade around 2(x) the PEG ratio we have seen for the last year. It isn’t just the year-end estimated EPS for 2014, but the growth rate and the P.E ratio that will help dictate 2014 returns.

Tech stocks and accounting shenanigans: Good article by Gretchen Morgenson, found on David B. Collums Twitter Feed. This is a re-hash of the argument from the late 1990’s on the quality of large-cap technology earnings. The same thing was said about Cisco, Intel, etc. etc. in the late 1990’s. Jack Ciesielski does good work too, and technically this is accurate material. The thing is though, it is the valuation of these companies that makes them risky, not necessarily the accounting. You could say the exact some thing about Cisco today, which is trading at 7(x) cash-flow, and is a company where analysts still report GAAP and non-GAAP EPS (ex stock option expense). However, CSCO is generating so much cash today, the large share repurchase programs offset the dilution of stock options,  and the valuation on CSCO and the large-cap growth tech from the 1990’s is almost value-like despite the fact these accounting issues still persist. The point being that Gretchen should simply call FB and TWTR what they are: grossly overvalued, emerging growth technology companies. The risk to FB and TWTR is not their stock option and expense accounting, but the risk that revenue growth slows, and the stocks trade at valuations appropriate for slower-growth mature companies. (Long FB, despite accounting issues, which are the exact same as CSCO.) We would buy TWTR at lower prices, too.

Ryan Detrick, one of the best technicians we know, on the string of annual positive returns for the Dow 30. Love Detrick’s work.

Another good technician, and there are so many, is Gary Morrow and his buddies who blog in Southern California. This Week on Wall Street is their blog, and worth a look.

Treasury technicals: I agree with Morrow and the “This Week on Wall Street” blog. We would re-short the Treasury market on any re-test here of the low 2.61 – 2.63% area, if Treasuries should rally on any market weakness due to options expiration week. We sold our TBF (unlevered Treasury short) when the 10-year rallied to 2.86% on Larry Summers withdrawing his name from Fed Chair consideration. The 10-year Treasury actually rallied more on that news, than on the weak August payroll report in early September, when the initial jobs report showed 169,000 jobs gained versus the consensus 185,000. (No TBF currently)

Retail, and the Consumer: Love Scott Krisiloff’s work with the company notes and conference calls. He notes the “cautious consumer” around CVS and Whole Foods. Surprised that with the drop in the price of gasoline, we haven’t seen a little better retail numbers. However, you look at Costco and the traffic comp’s are still very good. I’ve often wondered for companies that breakout comp’s whether “traffic” or “ticket” was the better metric ? Boots on the ground or the ability to drive pricing, which favors a retailer more ? Still haven’t answered the question, but contemplating my navel with questions such as this one, make for interesting down time. A slew of retail department stores report this week: Macy’s (M), Kohl’s (KSS), Wal-Mart (WMT) and Nordstrom’s (JWN) so we’ll get a good look at the multiline retail segment, which hasn’t traded all that well since topping during May, June, July ’13. Comp reporting seems to be going away. Fewer and fewer retailers are reporting monthly comp’s. (Long CVS, WFM, WMT)

High yield default rates: Per Moody’s who held their Leveraged Finance conference call this week, the expected high yield default rate of 2.6% for the next 12 months, is still considered low, and compares favorably to the 6.39% current yield on the HYG (iShares High yield ETF) and the JNK (SPDR Barclay’s High Yield ETF), so investors are still earning decent spread versus inflation and credit risk. (Long HYG) John Lonski, the outstanding Moody’s economist, draws the connection between corporate earnings and high yield credit spreads. He thinks q4 ’13 earnings will be well below 10% which is at odds with our own opinion. The question remains, will SP 500 decline enough to cause significant spread widening in the high yield market ? There are a number of ETF sponsors coming out with Investment Grade and High Yield ETF’s that are either short duration ETF’s or no duration, which is the ProShares HYHG, and IGHG, which are corporate high yield and corporate high grade ETF’s that hedge away interest rate risk. Duration is intended to be zero with the ProShares funds. Havent studied either the HYHG or the IGHG ETF up close, but assume there is an interest cost or time decay to the hedge. (no free lunch.) Currently we would rather own the HYG and the JNK with a straight TBF (Inverse Treasury ETF) hedge, rather than try and get the identical or close correlation in one vehicle. However this is worth a closer look.

Cross over buying in muni’s ? We are still long our Municipal Bond ETF’s, the NUV and the MEN. The NUV has a tax-exempt yield of 4.9%, while the Blackrock Muni Enhanced sports a current yield of 7%. The Blackrock ETF is leveraged. We are actually considering buying some of the muni closed-end funds for IRA accounts we manage given the yields, and the technical action. We are using some Senior Floating-Rate note funds like Nuveen’s JRO for tax-exempt accounts, but it is hard finding vehicles that are both tradable and defensive for decent holding periods. investment grade bond funds have too much duration (i.e. interest rate risk). The eternal search for yield continues. We are using more individual bonds – this week we bought a taxable muni yielding 50 basis points, that is AA+rated and matures 12/1/14. The equivalent Treasury is yield 14 basis points. Client don’t really understand how hard it is to earn 36 extra basis points, for pretty similar risk for a 13 month horizon. (If any readers have any suggestions, shoot me an email please.)

Gene Balas, another former co-contributor at TheStreet.com writes this week on the slow rate of employment growth and the tepid recovery. We happen to agree.

For 2014, we are currently scouring the list of dramatic underperformers of 2013 to see if there are any that are worthy of a position. Start at the bottom with this chart from Howard Lindzon and work your way higher. I can think of two Industrial stocks already that might qualify.

Happy birthday to the US Marine Corps, and a Happy Veterans Day to all who have served. Because of what the Veterans have done for America, I get the ability and privilege to get out of bed everyday and do what I love to do. Hoorah…

Trinity Asset Management, Inc. by:

Brian Gilmartin, CFA

Portfolio manager

 

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