Sunday, October 26, 2008

Well, It Could Have Been Worse...

Friday started out on shaky ground and looked like it might finally see the markets breakdown to new levels, but buyers keep rushing in to buy the dips and prevented a rout. The action in the markets is very difficult to gauge right now, but I'll say that this volatility is likely to stay with us for the near future. Investors are being displaced by traders and hedge fund managers looking to make their year in Q4.

Let me explain: Assume you are a hedge fund manager and you are down 20% this year. If you run a $500 million fund, you get $10 million upfront as a fee (that mostly covers costs) and 20% of the profits you make. If you're fund is down, your income is going to be $0 this year (down from $15 to $20 million last year). Many, many of the relatively new funds have the feel of a gambler that is down to their last $100 and they're putting it all on #14 at the roulette table.

They hope that by successfully trading these wild swings that they can somehow swing a profit by the end of the year and still generate the profitability that they are accustomed to (it should be noted that many of the best and most established hedge funds did very well this year and are not caught in this game of catch-up). This environment makes it extremely hard for investors to gauge the value of stocks.

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Apparently, we're going to buying big banks, small banks, insurance companies and maybe some car companies.

The U.S. Treasury is considering taking stakes in insurers, as it prepares a new round of capital injections to target regional banks and other financial companies, a person briefed on the plan said.

A final decision hasn't been made on whether insurers will be included in the government's purchases of preferred equity, said the person, who spoke on the condition of anonymity. The Treasury, which had planned to announce investments in about 20 banks, reversed course and will let firms disclose their own share sales in coming days, the person said.

An initial $125 billion out of $700 billion approved by Congress was allocated last week to buy shares of nine of the largest U.S. banks and another $125 billion was set aside for smaller lenders. Investments in insurance companies would widen the scope of Secretary Henry Paulson's Troubled Asset Relief Program as the credit crisis deepens."

As talks between General Motors Corp. and long-time rival Chrysler LLC continued over the weekend, a harsh reality has emerged: Without a merger and possibly an assist from the federal government, two of Detroit's Big Three auto makers could run out of cash within a year.

Though GM and Chrysler dismiss the notion, analysts and investors have begun to question whether one of the companies -- locked out of the credit markets and burning cash rapidly -- might have to seek bankruptcy protection.

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The Wall Street Journal had a piece this weekend covering the difficulty forecasting future stock prices in a falling earnings environment. I agree, conceptually, with the argument that some stocks are starting to look cheap at these depressed levels, but if earnings continue to disappoint there is substantial risk of multiple compression (ie, people will pay less for stocks given the uncertainty of earnings).

"Yet consensus estimates peg 2009 aggregate operating earnings for companies in the Standard & Poor's 500-stock index at about $94 a share, according to Thomson Reuters. That figure assumes earnings growth both this year and next.

If those estimates panned out, the S&P on Friday would have traded at what looks like a bargain multiple of about 9.3 times forward earnings.

Bears are well below the consensus in their answer. Barry Ritholtz, director of research at Fusion IQ, for example, says he reckons that 2009 earnings could drop to about $50 a share. In that case, even a multiple of 14 times would bring the S&P to about 750 -- nearly 15% below current levels."

I've read more people using a $50 to $60 number for earnings next year. Assuming people might pay 8 to 10 times earnings in 2009, there is a 20-30% chance that if all the cards in our global house of cards continue to fall, that the Dow could trade between 4,500 and 6,000 in the next year. So while it's good to try an nibble at prices that look good, it is healthy to have some skepticism, in case the worst case scenario plays out.

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Asian markets have swung wildly already today, but there is some buzz about further rate cuts in Korea (and expected rate cuts in the US) that is helping markets right now.

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Hey, it's not all gloom and doom....

1) Gas prices are plummeting. This will help the US consumer marginally, but the long-term trend in oil is still higher and unfortunately $2.00 gas is going to defer much of the revolutionary thinking that $4.00 gas had spurred. Enjoy it while you can, because when hedge funds get done liquidating their commodity positions, oil, copper, aluminum, etc are all going higher.

2) Thankfully Walmart will be able to keep us happy for $3.

$3 Wal-Mart wines hold their own in our taste test

With more than two dozen comments about Wal-Mart's Oak Leaf Vineyards wines on The Dallas Morning News Eats blog, most of them positive, we knew we had to put them to the test. Could a $2.97 bottle of wine really taste better than swamp water? And would it "fool" experienced wine drinkers?

As it turns out, the wines are better than you might think. The chardonnay won a gold medal at both the 2008 San Francisco Chronicle Wine Competition (chardonnays under $14.99) and the 2008 Florida State International Wine Competition. The Oak Leaf merlot and cabernet sauvignon earned bronze medals in the San Francisco contest.

Just in time for the holidays, we put Oak Leaf wines to the test with Dallas wine drinkers. We assembled a tasting panel in the upper sanctum of Adelmo's that included friends and regular customers of the restaurateur with a range of tasting expertise, from casual drinker to a former wine-and-spirits store owner.

The four wines were bagged and numbered before the tasters arrived. The score sheets asked tasters to rate the wines on a scale of 1 to 10, to circle the price at which the wine would be a bargain and to add comments.

"None of these are American," declared former Monticello Liquors owner Danny Chen just before their identities were unveiled. "The two reds were French." He liked the first and third wines, he said. (I take such delight in wine snobs being proven wrong).

"I liked the second one," said his wife, Celeste Chen. "I'd buy it right now. Do you have a case?"
Then we unmasked the Oak Leaf Vineyards wines.

The panel was surprised and amazed to learn of the $3 price point. "That's a helluva deal," said Mr. Banchetti."

** Has anyone seen these wines locally? If so, let me know in the comments.....

Cheers...

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