By:
On:
In: Commentary
With: 0 Comments

I don’t want to be accused of being Chicken Little and warning the sky is falling but we are entering a time when the market could go down dramatically.

As I write this, the US government is getting very close to not raising the debt ceiling. Most pundits expect that a compromise will eventually be reached and "Armageddon" will be averted. It appears that by Monday, August 1, 2011, this will be far from certain. By August 2, the markets will be a mess if the US government doesn’t have the money to pay bills. While it is possible that some stocks will do well in that scenario, the biggest likelihood is that the entire market will go flat or have a significant loss.

So what should a Confident Investor do in this situation?
The thing to remember is that cash is king! You will not lose money in the stock market if you are not in it. I wrote a popular article many months ago about the benefits of sitting on your money when you are concerned with the direction of the market. Here are my suggestions for August 1:

  • Sell every stock you own. Yes, that is extreme but it is the safest way to insulate your portfolio from government inaction.
  • If you don’t like that advice, if you have a profit in an individual stock, lock those profits in by at least selling your principle. If you want to leave your profit in the stock and put your principle back into the bank you will at least not lose your hard-earned money.
  • At least, cut your exposure to your largest investments by selling half of your investment.

Let’s examine the risks in this strategy
For this analysis let’s assume that you own 10 high-quality companies such as those found on the Watch List. Let’s assume that they are each $50 per share and you own 100 shares of each. To sell these 10 positions you will be out $100 (I am assuming you have chosen a broker that charges a reasonable fee for a transaction e.g. $10 or less)

  1. The market is flat and nothing happens. You buy back into your holdings at approximately the same price.  You are down $200 for a round-trip and a little piece of mind.
  2. The government doesn’t do a deal and the market appreciates slightly. I doubt this scenario will happen but there is a chance. On a typical good week, the market might go up a couple of points but since you have great stocks, maybe they go up 3% and you missed out. To buy back in you are out the $200 for your broker and 3% of $50,000 for a total of $1,700.
  3. If the market tanks by 15% (a very real possibility for the short term) and you buy back in at an average of 10% lower when you are confident that the worst is over then you have made money. In this case, you will buy 10% more stock for your 50K and since you are invested in great companies like on the Watch List, your stocks will eventually grow back to their present value and you will have made $5,000 (minus the $200 for the broker so a net of $4,800) off of this government screw-up.
  4. If the market thinks this Armageddon is not a big deal and only drops a paltry 3-5% then you will essentially break even since you will wait a week or so and much of the 5% will recover to maybe a 2% loss when you rejoin. This means you will buy back in for a net of about $800 which is essentially covering your costs and headache of managing your portfolio so closely.

When was the last time you were extremely confident that you were at a short-term high price and the stock was going to drop significantly? Be cautious on Monday and make money. If number 3 above happens, you would have an approximately 10% increase in the size of your portfolio just by doing some solid money management.

Why should you wait until Monday?
To be honest, if you have a lot of profit on a stock then maybe you shouldn’t. No reason to get greedy. Sell your holdings now if you are very concerned and think there is little chance of a deal. However, if the US government puts together a solid plan over the weekend when their backs are against the wall then the market may reward them. A good deal that gets wrapped up on Sunday could see a several point move early in the week. I would hate to see you miss that move by being too cautious. If you are scared though, I cannot blame you from moving on Friday.

Also, any deal on Monday is likely to not be very compelling. It might avert a debt ceiling but it likely will not harbor great changes in ways to avert the problem in the next year. This means that a deal on Monday will probably not make the market move up greatly. Only a deal during the weekend will be complete and tough enough to make the market move.

Mutual fund strategy
If you own a mutual fund, your options are far more limited. By buying a fund you are relying on a smart manager to take care of your money. The problem is that manager cannot react too rapidly to this situation due to the large amount of invested capital. Selling a large chunk of shares in any one company is difficult for a fund manager as it causes a market reaction and the price of the stock drops. Also, since your fund selling is not transacted until the end of the trading day, Monday may be too late.  If you want to reduce the exposure in your stock based mutual fund then you may need to do your selling on Friday.

Other options
I do not recommend to any Confident Investor that they short a stock, but if you are so inclined then this may be an excellent time to evaluate this strategy.

Some investments may appreciate so you might want to take a risk. I would avoid any companies that get a lot of money from government or are very cyclical (think defense contractors, oil companies, transportation companies, and farm management companies). You may also want to avoid companies that make a product that the government buys (think construction equipment, big construction companies, etc.). Also, if interest rates rise dramatically then any company that needs to borrow cash on a regular basis or does not have a lot of cash in the bank should be avoided. Companies that do well when the US government is screwed up MAY take a quick uptick though (think gold).

Warning
With all of this, there may be tax consequences. If you are concerned about the tax consequences of your move, I suggest you approach a tax adviser.

By:
On:
In: Commentary
Tagged: , , , , , , , , , , ,
With: 0 Comments

Apple [stckqut]aapl[/stckqut] has come under a great deal of discussion in the past week or so due to it’s ever expanding hoard of cash. Most companies hate having that much cash in the bank (or perhaps they are not fortunate enough to accumulate it) but Apple seems to really enjoy having a big savings account.

Since all the other bloggers that discuss companies and investing seem to have chimed into this conversation, I have to decided to do it as well.  Here are my suggestions:

  1. Use the cash like they have been. Apple uses its cash very effectively and very aggressively. As pointed out in PC Magazine, Apple effectively uses its cash to gain a technical advantage by locking up its supplier community in ways that their computer and device competitors such as Toshiba, Dell [stckqut]dell[/stckqut], and Hewlett Packard [stckqut]hpq[/stckqut] simply cannot afford to do. They are able to help manufacturers build their plants to create new components and lock in a pricing and supply chain that virtually locks out or delays the competition from the latest and greatest hardware advances. This competitive advantage means that they can continue to create large amounts of profit and build more cash.
  2. Increase R&D and rapidly expand their products with things that people want. Last year, Apple spent about 2.7% of revenue on R&D (and last year about 3.1%). I would like to see this grow to 7 or 8% of revenue. Yes, this is a big increase but Apple has a unique opportunity to solidify their presence in the markets that are important to them. Think what would happen if Apple had twice as many products that covered a broader spectrum of electronic experience.
  3. Increase their library. They should vastly increase their library of movies and video content to stream.  While they shouldn’t be stupid about the deals that they cut but they need to make deals with every movie and TV content holder out there. The consumer needs to feel that if they want to watch a professionally created video, Apple will always have the content. Making a ton of money in this area is not incredibly important (but don’t do it at a loss). What is more important is that they use this content to drive the sales of more multimedia devices and computers. While they are at it, they need to cut deals with the newspapers and magazines as well. Apple has had some short-sighted rules that have prevented the allegiance of those that create printed material – they need to put these rules aside.
  4. Streaming. They should make it so that they can stream to their subscribers more easily and more reliably than ANYONE else.  Supposedly they are investing in more data centers and that is a project that should be accelerated and expanded. Also, there are rumors of acquisition discussions with Hulu, this would be an acquisition that makes sense as it fits with their core offering today. Some commentators suggest that they should diversify by buying a company like Facebook but that would be ill-advised. Most companies that try to expand into vaguely related markets end up screwing up (think of EBay [stckqut]ebay[/stckqut] buying Skype).
  5. Integration with the cloud. They should make it so that integration between their products on your local network and between their products and the cloud is seamless and easy – in fact even fun.  Lion looks like it has great features in this area but they should take it to a new level. They would do well to expand that connectivity by putting a Windows application out there that makes Windows computers integrate easily and rapidly with Macs/iPhones/iPads. This doesn’t mean iTunes but instead iTunes on steroids – no cords – use the cloud, the private cloud, and the local connectivity connection of the computers.Read More →

By:
On:
In: Commentary
With: 0 Comments

The Wall Street Journal had an interesting column on Monday.  The article warned that the technicals of the market imply that a downturn is quite likely.

Investors are desperate for any map to help navigate today’s treacherous stock markets. One that might leave them seasick is relying on technical analysis from charts. First, there is the question of whether stocks are filling out a "head-and-shoulders" pattern, or an "island reversal." If the S&P 500 falls below its June lows, it would complete the head-and-shoulders (a high, a low, a higher high, a low, a lower high). Meanwhile, there are ominous signs of an island reversal. In that case, indexes fall rapidly between sessions, forming a "gap" in the days’ trading ranges, and then quickly "gap" back higher. Should they occur, the two patterns are thought to signal a downturn ahead.

Before these patterns could be completed, the S&P would have to fall under its 200-day moving average, 1277, itself another key chart figure. To complete the head and shoulders, the number is 1265—only 3.1% below Monday’s closing level of 1305.

It is important to understand technical analysis but I honestly do not believe that you can completely rule your investment life by looking at charts. There has to be some understanding of the business of the company that you are choosing for an investment. You need to understand how the company makes money and its historical ability to grow. However, there is momentum in the market and sectors tend to move together so technical analysis does give us insight into the market direction.

It is also important to remember that some companies will still be winners during a market downturn.  Just like there are loser companies during boom times. So while the market may be doing badly, your particular choice for an investment may be doing quite well.

Should you react to this thought process?  Maybe.  You should at least be a bit defensive in your positions.  If you have made a significant gain in a stock, it may be time to take some of that profit off the table. Also, major market moves invariably hit larger cap stocks more heavily, so you may want to be a bit more defensive in your position in large caps. This would surely apply to the DOW 30.

Just as all boats rise and fall with the tide, stocks are influenced by the other companies in their sector and in the market in general. When news of government defaults are constantly in the news, it is simply wise to be extremely cautious with your hard-earned money.

In the next 4-6 weeks, I strongly advise you to watch the technical indicators. I personally watch the 10- and 20-day EMA for my investments. If you think that is too quick, you should at least be watching the 35- or 50-day averages.

By:
On:
In: Commentary
Tagged:
With: 0 Comments

I typically do not try to over-interpret the business practices of my investments.  As the co-owner of the company (i.e. a stockholder), I have hired a qualified board to oversee my interests and make sure the day to day managers of the company are executing well.  However, every once in a while I have to question the management decisions of one of my investments.  In this case, it is Netflix (NFLX) [stckqut]nflx[/stckqut].

Netflix just announced a fairly major rate hike on its various subscription packages.  In some cases, that rate hike was as much as 60%. While this may bump up the short-term revenues for the company, it is also possible that some people will choose a cheaper package or choose a new source for video entertainment. That would result in Netflix dropping revenue.

Some investment advisers speak of a “moat” around your company – I don’t believe that such a moat exists for most companies. Netflix grew  by jumping the “moat” of the traditional video stores like Blockbuster back when that moat was the presence of a great network of brightly lit stores with a lot of stock. Now those stores are empty or turned into Chinese restaurants or clothing resell stores. Most “moats” in the 21st century are more analogous to drainage ditches that are easily crossed by a determined competitor. Therefore, as an investor, we must be ready to always escape out the back of the castle of our investment if the moat looks like it is going to be breached.

It is important for investors to not get too jumpy though. Remember, we hire good managers at the companies that we have invested in too carefully make these decisions. There may be very solid reasons for Netflix to change its pricing and force people into new subscription packages or pay more for their existing package. The Netflix contract with Starz for much of their streaming revenue is about a year from renewal and this may be a way to control some of those costs. They just did a streaming deal with NBCUniversal and perhaps that content justified an enhanced subscription model at this time. It also may be a way to control the costs of DVD distribution. If we trust our managers, then our concerns about their pricing model (or anything else in the daily running of the business) should be qualified. The reality is that we don’t work there and we don’t think about these issues all day long.

It is relevant though to be a little concern when there are various pages on Facebook now protesting the change. The good news for Netflix, at the time of this writing none of these pages have gone especially viral and are still under about 10,000 likes for each page that I found. Even the “1,000,000 people who will not stand for Netflix’s new prices” page is currently at an extremely small percentage of that goal. However, the power of the social network is always a concern and if these pages catch on there could be some affect on revenues.

The other good news is that Piper Jaffray just raised its target for NFLX to $330 (about 10% above current price which closed yesterday just shy of $299).  When I last reviewed the stock back in April I said that it was probably a good buy until $297. I am not ready to re-review NFLX but if I did, my back of the envelope calculation puts me above PJC’s target. There is some confidence that comes from a company that is up about 20% from 3 months ago, about 35% from 6 months ago, and approximately 60% from a year ago.

So is NFLX at risk?  Maybe, but don’t panic yet. The technicals on the company are still very good. They have really good managers that have put the stock where it is today, we should probably trust them that they know what they are doing. However, the next quarterly report and annual report from the company will give us a good clue if the new pricing is hurting their subscription rate. Also, the popularity of the pages on Facebook will be an early indicator of risk. There are companies that are trying to attack Netflix (e.g. Apple and Amazon) but maybe the walls of the Netflix castle are strong even if the moat is not that deep.

By:
On:
In: Commentary
With: 0 Comments

Yahoo Finance has an excellent article this morning on savings. If you are reading this site then hopefully you have already made the decision to regularly save money.  If you need any more of a push, the article points out 5 main themes:

  1. Compound Interest Makes Your Money Work for You
  2. Old Habits Die Hard
  3. Saving for Retirement Can Lower Your Tax Bill
  4. Your Employer Might Help You Save
  5. Small Savings Really Do Add Up

Read the article.  Even long time investors may get a little more motivation.