Financial Losses Illustrated

Cool graphic showing who has lost the most in this financial mess: NYTimes

Nasdaq 1999 Versus Shanghai 2007

Chris Perruna has a great chart up that I wanted to share, comparing the Nasdaq bubble of 1997-2002 to the current China bubble from 2004-2008. Eerily similar charts. But, that's what happens when you've got a bubble.

(click to enlarge)

Source: Chris Perruna

Market Update

Wanted to take a second to post up a few things I'm seeing in the market and around the financial blogosphere. Firstly, Apple (AAPL) has reached its second major level of $120. Earlier, I wrote about AAPL at a critical juncture when it was trading $150. If you caught the break to the downside, you made a quick and easy 30 points. Now, I want to put it on your radar screens again as it has reached an even more important support level of $120. You can buy the dip and stop out below the lows of $115, or whatever your rules say about placing stops. The market is extremely oversold and the fear indicators are starting to head higher. But, that's not to say we can't go even lower. I'd say try to play AAPL from the long side here. But, if it takes out your stop, swing it to the shortside because AAPL will have violated a major support level. The technicals are really your only guide to the market right now as fundamentals and logic have been thrown out the window a long time ago.

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Secondly, I want to again highlight the great work my man Stewie is doing over on his site. In addition to the fear indicators I wrote about yesterday, he's got an update posted today, comparing fear levels to the last bear market we saw in 2002. As you can see from the chart, tradeable bottoms have been put in when the VXO has hit 50 or so. And, as he effectively points out, the VXO can get as high as 50 on numerous occassions. So, don't necessarily expect this to be our only trip to levels this high as the credit crisis and lagging economy continue to play out. Addditionally, he points out that the 52 week low list is now extreeeemely long. Check it out.

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Thirdly, I want to point out an opportunity in Natural Gas (UNG). Commodities have been hit hard, we all know that. But, with the chart sitting where it is, I think its worth a play here because it offers some solid risk/reward and a very clearly defined stop. Plus, I still think natural gas is poised to benefit in the future as I wrote about in my piece about how to play energy for the intermediate and longer term. The Pickens Plan has been gaining ground and even if it does not succeed, it certainly has helped at least raise awareness about natural gas as an alternative. Turning to the chart (brought to my attention by Steve Puri), we see a very clear level of support at $33 in the United States Natural Gas fund (UNG). Now, in the past, I've stated that there is no such thing as a triple bottom. So, we'll see if that statement holds true as this will be the 3rd time UNG has tested support in the $33 region. The horizontal line drawn below represents your line in the sand. If it stays above the line, you get long. If it breaks the line to the downside, its time to get short. The market is crazy right now so make sure you use a tight stop whichever way you decide to play it.

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Lastly, I want to point out an excellent study by Rob Hanna over at Quantifiable Edges. Basically, he's looked at huge market selloffs/tradeable bottoms in order to identify which names typically benefit the most from the rally that results from the tradeable bottom. And, since I feel we're getting closer to that event, I thought it was relative to point out. Rob has noted that basically, the stocks/sectors that held up the most in the downturn typically do not benefit the most in the ensuing rally. His study from the January selloff/bounce indicates that names which survived the selloff such as Walmart (WMT) or Johnson and Johnson (JNJ) only rallied modestly in the ensuing bounce. But, as he points out, names/sectors that were beaten down hard such as Home Depot (HD) and General Motors (GM) rallied substantially when the time came. Now, that's not to say that the consumer staples like WMT and JNJ didn't rally as well, because they did. But, in the context of the rally, they underperformed. So, simply put, think of it as a role reversal. Once the market capitulates and then rallies, the past underperformers become the outperformers and the previous outperformers now become the laggards. Make sense? I highly recommend checking out Rob's January study here and follow up here.

Sources: Stewie, Steve Puri, & Quantifiable Edges

Gauging Fear in the Markets: Put/Call Ratio and Volatility Index (VIX)

Two fear gauges many people use in the markets are the Volatility Index (VIX) and the Put/Call Ratio. And, both are getting close to levels that historically signal the intense fear in the markets we've seemingly been waiting forever for. Why are we waiting for such fear? Because it typically marks an opportunity.

First, my man Stewie has a great Put/Call chart up illustrating the historical levels of the ratio. As the ratio reaches 1.20, you can see that it has coincided with market lows/tradeable bottoms. So, while the market is down big and there is some level of fear... there is no true panic yet. The assumption would be that we are well on our way to true panic and levels of 1.20 on the Put/Call Ratio. If this becomes the case, I would look to start buying a few names for a trade at the very least. Don't ya just love buying when there's blood in the streets? As the chart illustrates, those levels on the ratio have marked tradeable bottoms (but not THE bottom). This is pure chart candy right here:

(click to enlarge)

Secondly, VitalTrends has the historical Volatility Index (VIX) chart posted up for us. Typically, as the VIX blasts past 30, a strong level or fear sets in. And, once you get as high as 35-37, panic and capitulation often occurs. Now, that's not to say that we could always go even higher on the VIX and reach even new levels of fear. But, historically, a VIX of around 37 has been a tradeable bottom as it marked intense fear and capitulation. If you were to overlay this chart with a chart of the market, you would find that those spikes in the VIX would coincide with tradeable bottoms in the market (but not THE bottom).

(click to enlarge)

The point of gauging fear? Opportunity. Should panic truly set in, we should have a very tradeable bottom on our hands (emphasis on 'tradeable,' as this is not THE bottom). We'll see what happens.


Sources: Stewie and VitalTrends

Hedge Fund Tracking: Moore Capital Management's 13F Filing (Louis Bacon)

(Note: Before reading this update, make sure you check out the preface to the series I'm doing on Hedge Fund 13F's here).

Time to continue the Hedge Fund tracking series! If you've missed them, I've already covered Jeffrey Gendell's Tontine Partners here, Bret Barakett's Tremblant Capital here, Peter Thiel's Clarium Capital here, Stephen Mandel's Lone Pine Capital here, Lee Ainslie's Maverick Capital here, and John Griffin's Blue Ridge Capital here, and Boone Pickens' BP Capital here. This week, I'm taking a slightly different approach to the hedge fund tracking series. I'm doing so because the 13F SEC filings are filed on a quarterly basis, so these materials are time sensitive and the next ones are due out in November. I stated in my series preface that you need to treat these as a lagging indicator, because that's what they are. The holdings discussed below reflect portfolio holdings as of June 30th, 2008. So, since these forms are so tedious to sort through, I've condensed the rest of the hedge funds I track to summarize their major moves and top holdings.

Additionally, the majority of the rest of the funds I follow are macro funds. And, since 13F filings only detail equity holdings, we're left with a bit of a problem. Macro funds typically employ strategies that encompass many financial markets. Be it commodities, currency, futures, foreign markets.... you name it. So, these funds are much harder to track. Since they are not required to disclose positions held in those markets, we only get to see their equity holdings. But, at the same time, I still find the information useful because many of these funds have numerous large equity positions which give you a broad sense as to what their strategies may be.

So, first up in the macro hedge fund tracking series is Moore Capital Management. This $10 billion group of hedge funds is ran by Louis Bacon, the famed trader and risk manager. He comes from the group of "offspring" of the legendary Commodities Corp. Bacon emerged as one of the great macro traders alongside the likes of Paul Tudor Jones (Tudor Investment Corp), and Bruce Kovner (Caxton Associates). And, interestingly enough, Bacon helped get his firm off the ground when Paul Tudor Jones stopped accepting capital from investors and instead turned them to Bacon's firm. Returning 31% annually since inception in 1990, Bacon can be very proud of his flagship fund, Moore Global Investments. But, it doesn't stop there. His returns have shown little correlation to the stock market and low volatility. He is the definition of a risk manager. Bacon credits his risk management skills to the futures markets, where he learned to be sensitive to market action. And, he learned such skills at an early age. While getting his MBA at Columbia, he used his student loan money to trade. And, he lost it all. Clearly, he learned a lesson he would never forget. Such a lesson stuck with him as he worked various jobs in the financial industry before eventually starting his own firm. And, in his first year managing Moore Capital Management, he returned 86%. Bacon strives to identify long running macro trends. While he has a longer-term macroeconomic view, he won't let that stop him from making money by trading around the position in the mean time. If you want to hear some insightful thoughts from Louis Bacon himself, head over to my post on Hedge Fund manager interviews. So, now that we've got a background on Bacon and Moore Capital Management, let's take a quick look at his portfolio highlights.

Keep in mind that this is merely a brief summary of Moore's top holdings. Due to the time sensitive nature of the 13F material, I wanted to get this information posted before the next set of filings come out in November.

Top 20 Holdings by % of portfolio
1. Chesapeake Energy (CHK) Common + Calls - Nearly quadrupled his stake to bring it to his firm's top holding
2. Freeport McMoran (FCX) - Only slightly increased his position
3. Petrohawk (HK) - Massively increased his stake
4. JPMorgan Chase (JPM) - Tripled his stake
5. QQQ Trust (QQQQ) - New holding this past quarter
6. Petroleo Brasileiro (PBR) - Slightly increased his stake
7. Qualcomm (QCOM) - Massively increased his position
8. Lehman Brothers (LEH) - Increased position by 600% (Market value $100 million at the time)
9. Water Resources ETF (PHO) - No change in position
10. Electronic Arts (ERTS) - Nearly doubled his position
11. Phillip Morris Internation (PM) - New position this past quarter
12. Merrill Lynch (MER) Puts - From 25,000 shares to 2,625,000 shares (Market value $83 million at the time)
13. Google (GOOG) - New position this past quarter
14. Sandridge Energy (SD) - Doubled down on his stake
15. Hewlett Packard (HPQ) - New position this past quarter
16. Max Capital Group (MXGL) - Stayed flat (added literally only 4 shares)
17. Marathon Oil (MRO) - New position this past quarter
18. Sotheby's (BID) - New position this past quarter
19. Coca Cola (KO) - Doubled down on his stake
20. Potash (POT) - Sold off a little over 20% of his position

At the time of the filing, Moore Capital Management's total equity portfolio totalled around $4.4 billion. So, I just want to re-emphasize that since they are a macro fund, they obviously have the majority of their positions in the commodity, currency, futures, or other markets. But, at the same time, they still have a sizable chunk of money in the equity markets.

In terms of major moves, it's quite clear to see that Bacon was very Bullish on natural gas, adding heavily to the likes of Chesapeake (CHK), Petrohawk (HK), and Sandridge (SD). Come the next round of 13F filings, it will be very interesting to see what Bacon did with his natural gas holdings, seeing as how the prices have fallen dramatically. Was he partly responsible for the sell-off, or did he get caught in the downswing? We won't know for sure until November, where we can see just how risk management savvy Bacon really is.

Other notable changes to his portfolio include many new positions started in technology over the past quarter, including The Q's (QQQQ), Google (GOOG), and Hewlett Packard (HPQ). Also, he added to his already existing position in Qualcomm (QCOM).

The last thing I want to point out in Moore Capital Management's portfolio is their massive addition to positions in Lehman Brothers (LEH) and Merrill Lynch (MER). And when I say massive additions, I really do mean massive. Bacon had really miniscule positions in these two names and over this past quarter ratcheted up his stakes hardcore. He increased his position in LEH by 600% and in MER by 10,000%. Assumming he still holds those positions, he is massively underwater in them. Because, after all, Lehman is facing Liquidation, as I just recently wrote about here. But, we won't know what he was trying to pull with these positions until November.

Needless to say, there are some interesting names in this portfolio. But, it will be much more interesting to see what Bacon's done with these holdings come November. We already knew hedge funds (and macro funds in particular) had a rough July, as I noted here. And, it's easy to see why, with the heavy commodity exposure many of them had. What we don't yet know is how they've rebounded (if at all). Overall though, I think Moore Capital Management has some great positions poised to benefit from longer-term running macro themes that we will see unfold in the coming years. Because, after all, Louis Bacon loves focusing on the big picture trends.


Moore Capital Management's full 13F filing listing every position can be found at the SEC.

Writedowns, Losses, and Capital Raised

Amid all the financial chaos, I thought it would be a good idea to post up a simple chart breaking down the financial landscape in terms of writedowns, losses, and capital raised. From Bloomberg, you'll see how institutions are looking in terms of raw numbers: writedowns/losses versus capital raised. One institution in particular I want to point out is HSBC (HBC): $27.4 billion in writedowns and losses, but only $3.9 billion raised. They by far have one of the more lopsided ratios. Now, we obviously know that this simple chart does not tell the whole story, but I thought it was worth highlighting.

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Full disclosure: At the time of publication, MarketFolly was short HBC via puts

Warren Buffett's Portfolio Performance

The great folks over at Bespoke Investment Group have a compilation of how Warren Buffett's portfolio holdings are performing this year. Overall, he actually looks to be in pretty good shape relative to the market. Take a gander:

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Source: Bespoke Investment Group

Lone Pine Capital (Stephen Mandel) Files 13G and Discloses 6.8% Stake in Dolby Labs (DLB)

Filed today in a 13G filing with the SEC, Lone Pine Capital has disclosed a 6.8% stake in Dolby Laboratories (DLB). This is a brand new position, as it was nowhere to be found in their most recent 13F filing where they disclosed their portfolio holdings as of June 30th, 2008. And, if you missed it, you can check out the rest of Lone Pine's holdings from that most recent 13F which I analyzed in full here.

Lone Pine is an $8 Billion fund that has returned over 25% annually ever since its inception in 1997. Why is Mandel worth following you might ask? Well, he served as a consumer/retail analyst for Tiger Management back in the day for legendary investor Julian Robertson. Robertson's proteges/right-hand men have been nicknamed the "Tiger Cubs" and many have started their own funds. So, not only has Mandel learned from one of the best, but he has put up some very solid returns himself. Mandel is well versed in the ways of finding undervalued companies and his funds typically like to sniff out solid companies with good management that are trading below their intrinsic value. Just this past year 1 of his funds was up 34% before fees while another was up 32% before fees. His track record speaks for itself. And, not to mention, he learned from one of the greats in Julian Robertson. However, as I wrote about here, Lone Pine has had a rough 2008, where their Lone Cedar Fund was -5.38% year to date (as of the middle of July '08).

You can view the full 13G filing over at the SEC.

A Discretionary Retailer Trending Higher: Quick Chart

Just wanted to take two seconds in this bloodbath of a day and point out a chart that is trending higher. And, surprisingly enough, it comes from the consumer discretionary sector: Aeropostale (ARO). While ARO might be one of the few discretionary retailers actually performing well in this environment, there are plenty of names that are not. So, set up a pairs trade or just play the channel straight up; your choice. The chart really speaks for itself. Stop out on a downside break of the channel.(click to enlarge)

Donald Coxe Market Thoughts

Donald Coxe of BMO Financial Group (their Global Portfolio Strategist) is out with his Basic Points of September 2008. Donald has repeatedly been right on with his thoughts regarding the macro investment outlook side of things. If for some reason you've never heard of him, then here's your chance to check him out now. The piece in its entirety is linked below (which I highly recommend reading). But, since everyone is pressed for time these days, Prieur du Plessis has done an excellent job of summarizing Don's thoughts. Below is Prieur's summary of Don Coxe's thoughts:

1. The two most important forces in equity markets since July 13th have been powerful strength in financial stocks and pathetic weakness in commodity stocks. Since they have been inversely correlated for more than a year, investors should assume that the commodity stock bear market will continue until the financials roll over. The F&F bailout is merely the second act in a tragedy that has an unknowable number of acts to come.

2. When the financials do roll over, gold and gold mining stocks should move swiftly back into favor. Inflation remains above central bank target levels in the US – and in many other countries across the world. And any return to pronounced weakness among the bank stocks will be strongly bullish for gold.

3. With OPEC’s token production cut failing to impress the markets, oil prices will fall further. It won’t take more than a few days of even 750,000 b/d of production above consumption to drive oil prices down. Conversely, any outbreak of civil strife in Nigeria that affects offshore production could have a sudden upward price impact. We expect oil to trade in a range of roughly $80 a barrel to roughly $130 a barrel next year, but we have no great confidence in that forecast. We are more confident in predicting $150 oil within the next three years, as the next global economic recovery unfolds.

4. Barring an early killing frost, this year’s US corn group will be a barn-buster. What next? Corn is in modest contango for the next two years’ crops. Because contangos are so unusual these days, and because grains have such high producer/consumer participation across the curve, this is to us a sign that farmers and users are believers that high corn prices are here to stay. That means the fertilizer, seed and equipment stocks are cheaper now, relative to forward corn prices, than at almost any time in the past four years.

5. The pullback in oil prices and the dramatic bank rescues should have been enough to send the S&P back into bullish mode. It needs to break 1310 on the upside to take away its bearish condition.

6. The real yield on the Treasury 10-year is now a negative 145 bp. On a two-year hold, this means there could be more endogenous risk in nominal bonds than in most blue-chip non-financial stocks. The rush out of TIPs into Treasurys is doubtless driven by the unwinding of F&F exposures, but the long Treasurys are now seriously overvalued.

7. The biggest near-term upward surprise in commodity prices could be natural gas if (1) the sunspots don’t reappear, and (2) the historic correlations of gas to oil reassert themselves.

8. The Canadian dollar is being hit by the commodity price plunges, deterioration in the trade account, the worsening economic outlook in Central Canada, and the uncertain outlook in the October election. Whether Tories or Liberals win in Ottawa, Canada’s fiscal situation will continue to be superb compared to the US, particularly if Obama wins. We remain very positive on the loonie as an alternative to the greenback.

9. US election campaigns can be excuses for bold acts by foreign adventurers. Although President Bush was a non-person at the Republicans’ Convention after he gave his brief speech by satellite, he’s going to be President for four more months. The world should hope that rogue states think about that before deciding that Washington will be too distracted by the election to do anything about a surprise attack or invasion.

10. We have no clear idea how long it will be before we can look back to today’s prices for commodity stocks and say, “Wow! I wish I’d loaded up then!” We remain certain that day is coming.

A big thank you to Prieur du Plessis over at investmentpostcards.com for presenting such a succinct summary of Coxe's thoughts. And, I highly recommend taking the time to read Mr. Coxe's entire piece as found in his .pdf file, which you can download here. Lastly, another thank you goes out to Commodity News and Mining Stocks for originally posting up the link.

Lehman Brothers Liquidation Looks Likely

Undoubtedly, you already know this news. Lehman Brothers (LEH) will file for bankruptcy protection, as they couldn't seem to sell themselves this weekend. Additionally, Merill Lynch looks like it will be bought out by Bank of America for around $25-30 a share ($29 a share offer being voted on). Lastly, AIG will be restructuring. If you want more info on all this than you can handle, just head to any major financial publication, as the news is all over the place. I'm not here to regurgitate this news. Instead, I want to turn my focus to a way to possibly play this madness. In the event that LEH does liquidate, the following stocks will undoubtedly trade lower. Why, do you ask? Well, because they are some of LEH's top holdings.

The List

• General Electric (GE)

• Pfizer (PFE)

• Target (TGT)

• UBS (UBS)

• Linn Energy (LINE)
  

• GLG Partners (GLG)
  

• Merck (MRK)

• Microsoft (MSFT)

• Chicago Mercantile Exchange (CME)

• Bank of America (BAC)

• Apple (AAPL)

• Flagstone Reinsurance (FSR)

• Wellpoint (WLP)

• Walmart (WMT)

• Exxon Mobil (XOM)

• United Health Group (UNH)

• Google (GOOG)

• Johnson & Johnson (JNJ)

• Baidu (BIDU)

A few names from the list I want to highlight: Firstly, Bank of America (BAC) has been actively involved in all the talks this weekend and for all intensive purposes it looks as if they'll pick up Merrill Lynch (MER). I think the market sells off BAC simply because MER is not in the best of shape, and it looks like they'll be overpaying for the deal. If MER needs to be rescued, BAC could surely pick them up for much cheaper than where they're trading now. So, BAC could trade lower for this reason (along with the fact that oh yea, they've still got the whole Countrywide Mortgage mess to worry about). Then, if Lehman Brothers liquidates their BAC shares, you can guess where that name is headed: lower.

Secondly, as I wrote about here, Apple (AAPL) isn't looking too hot on the technicals right now. It looks about ready to really breakdown, since it hasn't responded well to support levels. If LEH needs to liquidate their large AAPL position, this only presents more headwinds for AAPL.

Thirdly, Walmart (WMT) appears on this list and I want to point this out for investors who have wanted to get in this name. If LEH liquidates its WMT position, this will present an opportunity for those who want to get long WMT on the thesis of the American consumer trading down for cheaper items, which WMT supplies. I've written about this thesis numerous times, notably here and here. So, watch that name for any major dips. Also, I'd throw Johnson & Johnson (JNJ) as a possible name to buy off of any LEH liquidation weakness. They are firing on all cylinders and their consumer staples line-up works well in this mess of an economy. Keep in mind though, that things undoubtedly will be crazy this week. So, don't rush out and do something stupid. And, if you feel the need, keep it small. There will undoubtedly be opportunities from this. But, this is a huge mess just waiting to unravel. Watch the Volatility Index (VIX), and watch for panic and capitulation. Special thanks to "The Fly" over at ibankcoin.com for posting up this list of LEH top holdings.

Offtopic: Metallica's Death Magnetic

I usually try to stay on-topic here on Market Folly, but very rarely certain events cause me to stray off-topic. So, I'll keep this short and sweet. For those who may be interested, Metallica's new album "Death Magnetic" was released today and it is amazing. They really got back to their roots on this one, while still providing us with some great new style and sounds. If anyone is a guitar player like myself, you've gotta check this stuff out!

My favorite track so far, "All Nightmare Long" is featured below.


Metallica.com

......And now back to your regularly scheduled programming.

Brazilian Banks/Asset Managers Continue to Gain Assets

With Brazil's emergence onto the global economy, there have undoubtedly been some excellent investment opportunities. But, most of the gains have been concentrated in the energy and natural resource spaces. As Brazil continues to emerge as a growing nation with a strong economy, I've turned my focus to the next wave of investments to make in Brazil. And, I think it can come from a sector that has been touched on by many before, but has never really garnered the spotlight. I'm talking about Brazilian banks and asset managers. Over the long term, their financial landscape will continue to evolve and the underlying financial firms are poised to benefit, seeing as Brazil has now become a net foreign creditor. Also, due to the booming economy, many Brazilians have started to enjoy new-found wealth and are turning to banks/asset managers looking for a place to put their hard earned money to work.

Institutional Investor has a piece out that discusses how Brazil will see an influx of cash from foreign pension funds. The reason behind this is because the nation's long term foreign currency debt was recently upgraded to investment grade. Also in the article is a quick list of Brazil's biggest money makers. In it, you will notice that some of the mainstream banks that trade on ADR's here in the states are among the biggest asset managers in the country: Banco Bradesco (BBD), Banco Itau (ITU), and Unibanco (UBB). Numerous hedge funds I track here on Market Folly have been in and out of these names, but they have never been major stakes or top 10 holdings. These are larger cap names which could be great long term investments (5-10 years).

And, even more hidden from the limelight are mid-cap Brazilian banks and asset managers. You won't find any of these mid-cap names traded on ADR's here in the states. Instead, you'll have to go directly to Brazil to buy them. Obviously, these names are difficult for the average joe to just invest in. And, they are also riskier investments. Firstly, you have to overcome the barrier of entry and find a way to personally invest in Brazil directly. Secondly, you have the added currency risk. But, nevertheless, they represent an interesting opportunity within Brazil's burgeoning financial landscape.

Individual risks aside, Brazil as a whole also has some risks investors need to be conscious of. Over the past few years, they have been heavily reliant on commodity sales abroad. Should a global economic slowdown present itself, Brazil's growth rate would obviously be in jeopardy. That would be the true test as to whether or not they could diversify their exports enough to protect their long term growth. Having enjoyed low borrowing costs and record commodity prices on exports for nearly five years, Brazil has been on 'easy street.' The question remains, "How will they respond if and when tough times arise?" It's always something to keep in the back of your mind. Additionally, one must be concerned with the Brazilian currency, the Real, which has seen massive appreciation to near its highest levels since 1999. Over the past few years, the central bank has been continually purchasing US Dollars in an attempt to slow further appreciation. Obviously every investment has risks, and its important to understand all the various risks associated with investing in a booming country like Brazil. Stay tuned in the coming weeks, as I am in the midst of completing my research on both the larger cap and mid-cap Brazilian names as I search for prospects for my über long-term portfolio.

Source: Insitutional Investor here and here.

McDonald's (MCD) Continues to Dominate

As I mentioned in my post about a deteriorating consumer environment here, I think McDonald's is shaping up to be an excellent play. Earlier in the year, McDonald's (MCD) was touted as a "weak dollar" play due to their extensive international exposure and the massive currency gains they were posting from the exchange rates worldwide. But, things have changed in six months time. Nowadays, a recently strengthening dollar provides currency headwinds for MCD's global business. But, I do not see this as being a major problem because demand and sales should easily overshadow any and all currency implications.

Why might you ask? The answer is simple: consumers worldwide trading down to "cheap" alternatives. McDonald's is the king of cheap. They are a fast-food chain, after all; with a $1 menu to boot. When consumers are in a pinch, they look to save money anyway they can. And, McDonald's allows them to do just that. As I wrote about here, the US economy is accelerating to the downside. Then, add in the fact that Goldman Sachs thinks half the globe is in a recession. Lastly, you've got the former federal reserve chairman Paul Volcker claiming that growth in the US economy will be the slowest of any decade since the Great Depression, as I noted here. Tough times ahead to say the least. The US consumer is in for a wild ride. So, if you're going to play any consumer stock in such a tough environment, make sure it is a company that deals with necessities. McDonald's provides food, and cheap food at that. Don't buy the rationale? Just take a look at McDonald's most recent quarter.

McDonald's delivered yet another dominant quarter last Tuesday. August sales in the U.S. increased 4.5% compared to an analyst expected 3.5% gain. Sales in the Asian Pacific region gained 10% and an 11.6% gain in Europe compared to analyst expectations of only 6% in Europe. On average, analysts pegged McDonald's at a global increase of 4.7%. McDonald's came in with a 8.5% gain globally. Needless to say, it was a dominant quarter. They are winning cash-strapped consumers over in both the US and Europe. And, their market position in Asia continues to be very profitable. Not to mention, MCD is seeing operating margins of 25.78% and a return on equity of 29.71%, both solid numbers which reflect the strong underlying fundamentals.

People were concerned that economic weakness in Europe would hurt sales. But, I argue the opposite. A weak Economic environment means more people trade down to cheaper alternatives. European consumer confidence is at one of the lowest levels in five years. Their economy is contracting as their consumers face the exact same problems ours do: rising food and fuel prices. In the US, the cost of living rose 5.6% for the year (ended in July). The U.S. Labor Department reports it is the largest jump in 17 years. So, as the cost of living goes up, consumers look to trade down. It's that simple.

And, if you're worried about consumers "shutting down" altogether, then look to go long MCD and hedge your position by buying some puts or by shorting rival discretionary casual dining restaurants such as BJRI or DRI. Those casual dining chains are suffering from rising input costs and slower dining traffic. At any rate, I think MCD is a solid choice going forward. Let's see how it sets up on the technicals. Pulling up a 3 year chart on MCD, we see that it is in a nice long-term uptrend. Every major dip in the name has been a buying opportunity, as you can see below.

(click to enlarge)

Then, zooming in on a closer 6 month time frame, we can see how MCD has been trading recently.

(click to enlarge)

You'll notice it put in a most recent high at around $65/66 and then sold off. That level represents some near-term resistance in the name and you could see some sellers come in as MCD begins to trade back up near those levels as it is doing now. What you'll also notice is that during the months of May, June, and July, MCD was bumping up against severe overhead resistance at around $60/61. This is shown by the lower of the 2 horizontal red lines I've drawn in. You can see it kept bumping up against that resistance level before finally enough buyers came in August to push it through to new highs. After those recent highs, you will see that MCD came back down to that $60/61 level that was previously resistance. And, that level now acts as a support level to the stock as it bounced off those levels, trending back higher. So, in terms of selecting opportune entry, exit, and stop loss points, the chart gives us a pretty clear picture. How you play it is determined by whether or not you are an investor or trader. But, as outlined above, I think McDonald's (MCD) is poised to benefit in the coming months.

Disclosure: marketfolly.com is long MCD

Sources: WSJ, Bloomberg

Technical Analysis: Charts With Solid Risk/Reward

Just wanted to breeze through some charts really quick, since it's been a while. Time for some good old technical analysis. Ok, right to it. BJ's Restaurants. Simply put, this place is a clusterf*ck. They're facing rising input costs and slower dining traffic. As I've written about here and here, the consumer environment just isn't that hot right now. In fact, its accelerating to the downside. So, this place will only get squeezed harder. Their solution? Raise prices faster. Oh, great, that will really get struggling consumers in the door. BJRI is hurting so much for any type of positive news that it was up 9% yesterday on an analyst upgrade. Yes, one upgrade. Well, the good news is that this fluke of a 9% move gives us a low risk opportunity here. Check out the chart below.

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As you can see, BJRI used to bounce right off of support at $13.5 way back in April and May. Then, the stock ripped lower. It has already tried to test $13.5 once in August and it failed. Well, it's right back up at those levels again. $13.5 was past support and thus is now future resistance. The analyst upgrade today moved the stock up to a high of $13.62. So, a low risk play here would be to short BJRI at these levels and then place your stop just above the resistance (and the 200 day moving average) at around $14 or so. You can be the judge as to how tight of a stop you want to use here. One thing to note if you want to play this from the short-side: be cautious because the recent move upwards has had some volume behind it. Because, as you've seen yesterday, the slightest bit of positive news can send these consumer related names flying. Conversely, if you do get stopped out, you could just flip your trade to the long side. Because, if BJRI breaks out above its 200 day moving average, as well as above the strong resistance at $13.50, it has the potential to go much higher. Another option would be to just stand on the sidelines to see which way it is going to move and then pile on. The point here is that BJRI has very clear risk/reward in both directions. Watch it and play it however you're comfortable.

Next up, I want to point out the large channel Goldman Sachs (GS) has been trading in for a long while. I meant to post this up a few weeks ago, but I've been so busy that I forgot. Here's the original chart I meant to post up showing the clear support for GS at around $155 and then the resistance at around $200 (you could also make a point for resistance around $190).

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Now, take a look at GS currently.

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As expected, it bounced right off $155 and traded higher up to $170. The simple play here has been buy GS around $155 and stop out around $145 or so (depending on how tight you want your stop). Then, you turn around and sell GS as it rallies higher into various levels of resistance around $170, $190 or wherever you want to lock in some profits. As you can see, this name has been trading sideways for a while. So, while there might not be a big play here right this moment, keep your eye on it. Eventually, some very favorable risk/reward setups will take place just as they have in the past in this name.

Next, I want to turn to a little series that I like to call: There's no such thing as a triple bottom. First up, we have Companhia de Saneamento (SBS). Now, I actually like this name as a longer term play on Brazil. But, for the time being, you absolutely have to respect the technicals, which point to lower prices. Obviously this presents us with a risk/reward setup. You can either try to catch a falling knife (which I don't really recommend). Or, you can wait until it slices through that past support line and short it down along with the rest of the momentum players. It's up to you. The point is that around $37 or so has served as past support for SBS as it double bottomed back in April of 07 and February of this year. You could get a reflex bounce off that support level. But, since we all know there is no such thing as a triple bottom, it looks like it's heading lower.

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The second chart in the "no such thing as a triple bottom" series is Freeport McMoran (FCX). Again, this company is actually a great name to own for the longer term, as valuations have just gotten ridiculously cheap. But, in the mean time, you've got to respect the technicals. Some hedge funds have been forced to sell their shares, while others are merely front-running each other. It's a mess out there and it doesn't look like it will end anytime soon. On the chart, you see that FCX double-bottomed in September of last year and February of this year. Yet again, we're down along those levels of $65. Triple bottoms don't exist so I expect this name to trade even lower to the secondary support level I've drawn in around $60. This is simply another risk/reward setup for you to keep your eye on. These charts are painting an ominous picture right now.

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So, what does everyone think about these setups? Are there some you like, some you don't? Would love to see what other people think about these setups. Because, after all, technical analysis is in the eye of the beholder. And, what I see could be completely different than what you see.

Ken Heebner to Start Hedge Fund Wayfarer Capital

Ken Heebner, manager of the renowned CGM Focus Fund (CGMFX) and other mutual funds, is set to start a hedge fund. In a regulatory filing made in August, it was revealed that Heebner is starting a new firm, Wayfarer Capital LP. So far, the fund has raised around $73 million, with Heebner targeting $5 billion for his new fund. Heebner employs a macro investment strategy, trying to capitalize on economic trends. In his mutual funds, Heebner runs a smaller, more concentrated portfolio than most managers. He even short-sells a few names, a tactic normally reserved for hedge funds and the like. But, since he runs mutual funds, he is limited in what he can do on the short side. And, it seems as if Heebner wants more freedom to be able to short and employ some leverage.

Seeing as how mutual funds are typically long-only, you can't blame him. In this type of market, one definitely needs to be hedged as much as possible. His CGM Focus fund returned 80% last year, due to smart bets on energy and resource plays. One of his other funds was up 34%. But, this year, Heebner is faced with tougher times, as his fund sits down around 17% year to date. It has been a wild year for him, to say the least. Earlier in the year, he was up around 16%. Then, he lost nearly 30% over a few months time to land him at his current returns.

Fortune magazine has called him "America's hottest investor," and rightly so. He has returned nearly 27% a year over the past decade with his Focus Fund. I am curious, though, if Heebner's mutual fund will take a back seat to his newly formed hedge fund. Apparently, it has always been his dream to run a hedge fund, and you can bet he'll want to make sure it succeeds. The hedge fund structure will allow him to short much more than his mutual fund ever would, which should allow him to hedge and pursue his macro investment strategy more effectively. Either way, the guy knows what he's doing. And, it's interesting to note that Heebner is set to start his hedge fund during a time when many funds are closing up shop due to poor returns and investor redemptions. Contrarian, to say the least. I'll definitely be keeping my eye on this here at Market Folly.

Source: Bloomberg

Hedge Funds & Alternative Asset Management Industry Aren't What They Used to Be

Roger Ehrenberg is out with a thought provoking piece over on his site, Information Arbitrage. In it, he discusses the tough times facing hedge funds and the simple root of the cause. Here's an excerpt:

"Many recent mega-losses aren't the case of simply taking the long view and getting stung by short-term volatility; this is getting carried out because of either too much leverage (the most prevalent cause of failure) or too much concentration. I had always thought that hedge funds were supposed to hedge, and were designed to generate attractive absolute returns regardless of market conditions. Such thinking is clearly a remnant of bygone days for much of the industry, where managers want the best of all worlds: stable management fees, quarterly performance fees, and the ability to suspend redemptions. There just aren't that many Steinhardts and Robertsons any more. And this is too bad for the industry and its investors."

Definitely check out the rest of his thoughts here.

George Soros on Oil

If you missed it, George Soros talked about oil in his testimony before the US Senate Commerce Committee Oversight Hearing. Read his thoughts here.

Deteriorating Consumer Environment: Abercrombie and Fitch (ANF) Evidence

This is just continuing evidence of a lackluster consumer environment. Abercrombie and Fitch (ANF) same store receipts were down in August, setting up what I predict will be a downward accelerating consumer environment. Both Citi and Merrill Lynch downgraded ANF on Friday, citing deteriorating sales and increased markdowns. In fact, Citi went as far as to say that they think ANF could trade at its lowest multiple in 5 years. Just something to keep an eye on as you try to balance your portfolios.

Specialty retail is getting hit hard (and will continue to get hit hard) as effects from the housing market, consumer credit crunch, and inflation take a toll on consumer's pocketbooks. Abercrombie is known for its upscale niche within the teen segment, often selling more expensive items than the likes of competitors Aeropostale (ARO), who seems to be doing alright in this environment. So, look for consumers to "trade down" in this environment.

In any given sector, I like to take a balanced approach and often times am market neutral. For instance in retail, being long the likes of Walmart (WMT) or various other discounters who sell essentials (food, gas, toiletries, medicine) is very appealing to me. Then, you take the other side by going short discretionary retailers, such as ANF. Long cheap and/or necessary items; Short expensive and/or discretionary items. The same logic can be applied to food by going long the likes of McDonald's (MCD) for the "cheap" factor (although they might see some slight headwinds due to their strong international presence and a rising US dollar). Then, shorting casual dining restaurants such as BJ Restaurants (BJRI) or Darden Restaurants (DRI), who are feeling the pinch of rising input costs and slower dining traffic.

The main point to take away here is that we all know the consumer is strapped for cash. However, I think too many people are counting on a recovery. With vast evidence of the housing market accelerating to the downside, I just don't see how that is possible. Add in the consumer credit crunch and the inflationary pressures consumers are seeing on everything they buy, and you've got a recipe for a very thrifty consumer.

Apple (AAPL) at Make or Break Point

Chart says it all. Major bounce or major breakdown coming. Not to mention, they've got the "Let's Rock" event schedule for tomorrow, where everyone is expecting new iPods to be unveiled. Typically, Apple (AAPL) has been a "sell the news" type of stock. We'll see what happens tomorrow. Either way, an opportunity either long or short is setting up in this name. Watch the $155 level.

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