Monday, June 30, 2008

Charlie Morton vs. Phillies, July 1

Charlie gets the start against the Phillies this Tuesday night at Turner Field at 7:00PM. It'll be his first look at Howard, Utley and Rollins, and should be a good test.

Morton, who won his first outing against the Angels going 6 strong innings, has one loss and a no decision in his subsequent 2 starts. If you get a chance and find that you don't live in durty Jersey and can get the game on a local channel, check out the kid.

Good luck Charlie!

Link to Charlie's Stats

Oil, Maybe it is speculators...

Oil has continued its march to levels above $140 a barrel. This translates into a national average gas price per gallon of >$4.00. Many are looking to blame someone for the rise in oil's price, and there is no shortage of suspects. China and India, and other emerging economies, are to blame certainly for increased demand. Some blame OPEC and hope that increasing output will reduce supply constraints and take some pressure off the price. But lately, speculators have been blamed. At first I was skeptical, but there is one plausible idea to this latest theory that oil is currently an asset bubble.

The US market is down, and returns will be challenged as they return to more historic levels going forward. So as money comes off the table, investors need to put it somewhere else. Obviously, the likely bet may be oil, since the expansion of all emerging economies rely upon oil. Commodities are a good inflation hedge as well, and since the Fed has turned hawkish on inflation, oil and other hard assets might be where investors flock.

The initial Tech bubble that popped in 2000 forced investors to bid up the next "great thing" which was the mini-asset bubble in biotech, that then turned to the housing/credit bubble. Therefore, as the US markets fall, the money gets rolled forward to the next respective asset bubble. Again, many think the price for oil and other hard asset commodities like corn, platinum, etc. are being bid up as a bubble since other alternatives offer less attractive potential returns.

Let's be clear about something. You and I can speculate on any given stock, and hope that we get enough critical mass to move the price beyond it's intrinsic or fundamental price (i.e. what it's truly worth), or at the very least, moved to a price beyond what we paid for it. But at any given time, we could potentially move our money to another stock as a substitute once we believe the stock has gotten overvalued to take our profits before others start selling. Owning GE's stock gives me the rights to that companies future cash flows; it's basically a receipt to "GE's future cash", and once the price gets out of whack, we might get out because we know the price is "too high". But oil is a hard asset, and there is no substitute. If oil's price rise is based upon speculation of further upside moves, there's nothing else investors can switch to right now per se that by doing so, would reduce demand for oil and thus drive the price for oil down.

Finally, if you think the run up is bad now, think what the price may get to if the mid-east suddenly becomes destabilized.

China, and Decoupling and US Equity Markets

Recession Risks and the US Market Before 2008 began, most thought that the 1st half would be tough for the US stock market, but mostly due to the hangover from the credit crisis that had unfolded in the 2nd half of 2007. However, while most believed there was a danger of the US slipping into a recession, there was hope that perhaps the consumer would spend its way to a softer landing versus a recession.

Decoupling the US from the World But an even more ambitious theory was the idea that even if the US slipped into a recession, perhaps the rest of the world would continue to grow. And as an investor, you might be able to weather the slowdown in the US by investing in companies that had international "footprints". Most in this camp hoped for "de-coupling" which was a fancy term for "I hope the Chinese, India, and the rest of the emerging economies in the world will continue to grow so US companies can continue to sell to these economies to keep us all employed."

Well fast forward to June 2008, and you know what has happened. The US markets are 20% off their lows of 2007. The bears are firmly in place, as they should be. Please see my post about Bill Priest's walkthrough on corporate profit deceleration, and why it has to happen.

The "Conundrum" Alan Greenspan used to speak often about the "conundrum." At the time, the conundrum attempted to capture the idea that yields on long-term, US Treasury bonds continued to fall, suggesting that demand was very high for these bonds despite their low yields relative to the rest of the world. If the world was awash in liquidity, why would foreign investors, specifically the Chinese, buy our Treasuries at such low rates when they could buy a comparable safe, higher yielding instrument??

A Strategy to Grow and Employ... Well maybe the clue to Alan's conundrum (*snicker) lies in a more simplistic idea. The Chinese entered the WTO December 2001 and made quite a few concessions to do so. But having been granted WTO status, the Chinese had a bigger issue on its hands, namely, a large population that was seeking employment. The Chinese, it's theorized, took the approach that Japan did back in the 80's, which was to grow its way through exports. They have succeeded admirably in this effort, and as such, its population continues to gain employment. Remember, they are the low-cost labor pool that the world "outsources" to.

The Chinese currency is undervalued relative to our US dollar. So many thought the Chinese buying of US treasuries was an effort to keep its (the Chinese) currency cheap, and thus make its exports cheaper relative to US goods. This situation is perfect if you want to export your way to prosperity. And that is what we have witnessed over the past decade.

Demand for US Treasuries and M.A.D. But an even more difficult question still lingers, which is why would the Chinese want our low yielding, long maturity treasuries? Well, by buying these treasuries, the Chinese do achieve its goal of keeping its goods cheaper than ours. But the potentially simpler, deeper answer is that by buying our treasuries, the Chinese continue to fund our deficit. We borrow from the world, because we consume more than we produce as a nation, and as such, the Chinese are, in effect, our bank. And they have every motive to do so because in the end, we are the customer they sell to. By selling their cheaper stuff to a nation that can't afford what it's buying, why not, as America, borrow from the bank that has every incentive to give us the financing? By doing so, the Chinese economy continues to grow and keep its population employed. And the US continues to gain access to cheap labor and maintain "growing profits" via lower costs and thus stabilize the China's working population from an indirect, economic perspective. China and India offer the world a deep, low cost labor pool that keeps US company costs down to keep profit growth in tact. It's, as Bill Priest puts, a form of economic "Mutual Assured Destruction", or MAD. The Chinese need us, but we need them just as much.

Globalization is What We Wanted Globalization is what the West wanted. Everyone in the West has said that China represents an untapped market of 1 billion people. But as is often the case, it's never as simple as that, and there are always unintended consequences. What's most troubling is the potential issues we face politically as a nation should the rest of the world de-couple and support the Chinese labor pool by buying Chinese goods at the level of the US. The Chinese would potentially have no incentive to support or finance us to the extent they have. That's the thought that should keep policy makers in Washington up. And the point is, decoupling is just hoping against hope. That's not being US centric, it's potentially more fact than fiction. The Chinese markets have fallen quite a bit, so check in again to see how well the world has "decoupled" after the Olympics.

Ultimately what I'm arguing for is the idea that there is no such thing as de-coupling if you believe the theory of China's financing us for the "triple purpose" of 1) keeping their currency devalued relative to ours, 2) to finance the consumer of their goods, the USA, 3) all which keep its population employed and its GDP growing. China is like the credit card company that sends the US a new flyer for a new card with teaser rates. We're in trouble when they decide to unwind this as is the rest of the world economy given the linkages. The conspiracy theorist might argue that the "lead" in toys from China has always been there, but there might be more to Congress's recent interest via a very public message.

Sunday, June 29, 2008

Katie Goes to the Beach

Erin and I headed out to Island Beach State Park this weekend since you can bring dogs there. Katie seems to love the sprinkler, so we thought she'd probably like the sand and the water.



MVI_2632

Enjoy the pics! It was a blast...!


Friday, June 27, 2008

Our New Neighbors

Click to Enlarge

We have some new neighbors in our backyard. I took a picture of the 3 little birds in our geranium planter hanging off the garage. I guess when I put the camera in, they thought they were getting fed...

When I took the picture, the momma was perched up on the tree watching me intently.

Cute little things.

Thursday, June 26, 2008

InBev/Budweiser...and so it begins

InBev submitted its offer to Anheuser-Busch, as many had expected, and BUD shares promptly popped. The deal is for $46B, and its mostly cash, which is incredible. I guess the financing is still out there.

The intrigue around BUD's options is as much the story. BUD has reportedly reached out to Modelo to try and increase its 50% stake, but many at Modelo believe BUD got the original 50% at a great price. Buffet is the largest single shareholder, via Berkshire, at 5%, and would not comment on the deal. Sometimes silence is louder than saying anything.

Let's get to the numbers. BUD was trading at $52.58 a share pre-announcement. The shares had been trading sideways for the last few years. As a shareholder, the bid at $46B, or $65/share, represents a 24% premium to BUD's offer. The new company would generate approximately $36B in sales. But more importantly, from a cost perspective, BUD "value" preaanouncement was $37.5B ($52.58 x 713M shares), and InBev's opening bid represents a value of $46B. The difference of ~$9B represents the costs or redundancies InBev think it can cut out and still keep the same or better profit margins. InBev obviously thinks the cost it can remove is higher, since they will like have to raise their initial bid.

The cultural and political issues are the ones beyond the numbers that demand attention. As a BUD shareholder, if you believe your management can add value to your company so that BUD will be worth $65B alone, then you might buy the political rhetoric that we should not allow an American icon to be bought. Either way, this one will probably go hostile.

Dane Cook -- How to be Remembered

Dane Cook just makes me laugh. While Nike encourages everyone to become "Legendary", Dane Cook has his own take on how to be remembered.

Turn it down a bit if the kids are around or you're at work. But be prepared to laugh.


Wednesday, June 25, 2008

De-Motivational Posters -- SB!! This Post's for You!

Here's a post to make you laugh.

No doubt you've seen the "motivational" posters that are typically found in the catalogs on airplanes...They usually have the picture of a golf flag on a green, and the caption is something like "Goals -- Hard work is only fruitful if you have a goal in mind", etc.

Well there are quite a few posters circulating around the internet that take the slightly different, warped approach.
I've posted a link to a site that allows you to make your own version....If you're feeling cynical, or want to laugh, check it out and make your own...Enjoy!

Link to De-Motivational Poster Site

Link to Website to Make Your Own Demotivational Poster

Saturday, June 21, 2008

Fed Funds Futures Predictions on Future Rate Increases

Looks like the futures market for interest rates are predicting that the Fed will raise rates in the future. I've posted a graph that interprets the futures prices, as of 6/18/2008. Remember, the futures market predicts future rates via the "price of the contracts" traded for each future Fed meeting.
The x-axis shows the date for each Fed meeting (i.e. July 2008 Fed meeting, etc.) The dark blue line shows the implied rates that the contracts trade at for each meeting, with the right-hand y-axis showing these implied rates...The left-hand axis shows the probability of various rate increases at each meeting above the current 2.00% level. (Notice there is no contract implying a rate cut...)

Let's take an easy example: The current rate is 2.00%. The futures market predicts that the Fed Funds rate will be 2.25% in Sept. 2008. This 2.25% represents a 25 basis point increase over the current rate of 2.00% (or 0.25%)...Therefore, if you look at the red line, it shows that the market is predicting a 100% chance that the Fed will raise rates at the Sept. 2008 meeting to 2.25%. However, at this same Sept. meeting, the market is only predicting a 50% chance that the Fed will raise rates 50 basis points to 2.50% (the green sloped line.)

What is the chance the Fed raises rates from 2.00% to 2.50% at September meeting? The simple math goes like this. If the current rate is 2.00%, and the futures market for the Sept 2008 meeting implies a rate of 2.25%, then the difference (2.50-2.25=0.25) divided by the increase (2.50-2.00 current rate = 0.50%) = 50% chance that rates will be 2.50% in Sept. '08 vs. current rate...

That's how all these talking heads calculate what the Fed might do...These markets rely on the what is called the "wisdom of crowds."

The bottom line for you and I is that if the Fed raises rates to battle inflation, then equities should and will fall. That's because higher interest rates discount future cash flows more heavily, making them worth less. I've posted Toles' cartoon again, because it's that good.

Oil Prices and Mideast Unrest

I blogged about this before after having heard Tony Blair talk about why the West might need to go into Iran and take out their nuclear program. If you think oil prices are high now, further unrest in the mideast could accelerate the rise in oil prices.

I've posted the price chart of the futures market that attempts to predict the likelihood that Israel will attack Iran in September 2008. The market opened fairly high (relative to current date) and was probably first trading when comments were made by Iran's president. From an impartial perspective, whatever you think about the conflict in the mideast, you must admit that if another country came out and said the USA should be "wiped off the map" we'd probably do the same as Israel is doing. This development in the Middle East is a pretty serious issue that the next president will need to sort out. I've posted the futures chart that shows the probability for each candidate from Intrade as well down below.

Link to Exercise Run this Weekend

Another Headfake

Well another week, another week of head fakes, but the direction seems clear. Fed Ex reported results earlier this week, and their results were weaker than expected. FedEx is considered a leading indicator to the strength of the economy, and FedEx specifically referred to oil prices hurting their results. Welcome to the club.

Despite the bailout in February, the market continues to fall and the VIX, or volatility index, continues to move inversely to the market's direction. The VIX suggests that fear and uncertainty are still in play. If you look at the charts, you'll see the VIX spiked in February as uncertainty around Bear Stearns peaked. Today, consumer discretionary and retail stocks got hammered, why should you care? Remember, the consumer, and their stimulus checks are going to help us weather the storm. And financials and housing have bottomed, remember? Are you kidding me? Hope is when you haven't a clue.

The reason I looked at the market and VIX since January 2002 is because this is when the last bubble burst. So while corporate profits no doubt expanded during these last 7 years given low rates, its plausible to have some context of where the correction could take us. Rates are now at 2.00%, but think about the correction if the Fed gets hawkish on inflation and begins raise rates...Toles has got it perfect.


Fed Funds futures are showing this hawkish attitude already, so investors are already expecting the Fed to do this...When rates rise, the markets discounts more heavily, so the market will fall.

Buckle up.

Thursday, June 19, 2008

And the Ass of the Week is...

This picture always cracks me up...

The award this week has several folks in the running, like the two fund managers of the now defunct Bear Stearns hedge funds, or perhaps the award could go to every talking head that believes the "worst is behind us, and the government bailout has avoided a recession"...Please. The market is down today again, and the VIX continues to spike...(See earlier post.)

And the winner is... I think the most worthy candidate is me. I am the ass of the week. I have been on record with several folks stating that golf has become boring to watch (there's an oxymoron) because one guy is winning it all. I have always rooted for the underdog, maybe because I believe myself to be one, but nevertheless, I continued to root for anyone to just make Tiger earn the victories he wins vs. hand them to him, in a sense. I am thankful to be alive to have seen some of the great athletes of their time (ala Jordan, Tiger), so meant no disrespect by my rooting interests against him. So it wasn't so much rooting against him, but hoping that others would make golf competitive again.

The US Open at Torrey Pines Unless you were under a rock this past weekend and following week, you already know that Tiger won the 104th US Open at Torrey Pines. I posted earlier here and cited the odds of his winning in addition to the stress the course's demands would place upon his knee. Tiger got pushed by Rocco Mediate, the 158th ranked player in the world. But what transpired during that US Open was truly legendary.

Why Tiger Should Not Have Won The obvious reason is that Tiger was playing on a bad knee that hadn't fully recovered from earlier surgery. Tiger had not practiced much before the US Open due to the surgery. Tiger played in the Open against his doctor's wishes, and supposedly told his doctor that he'd win the event. Tiger led after the 3rd round, but winced on most shots after hitting them. Tiger not only had a damaged knee, but a hairline fracture in his tibia of the same leg. It's really unbelievable if you stop and think about the win in the context of the injuries he was hiding.

A Round for Our Generation, the Shot of the Tournament So on the final round of regulation, Tiger doubles the first hole, but manages to scrape back all day. Rocco gets in the clubhouse at 1 under, and now has to wait for the greatest golfer to finish his round. To cut to the chase, Tiger is 1 back on the 18th tee box, and has to birdie the finishing 18th to force a playoff, which the USGA makes a full 18 holes the following day, not sudden death after the round. He drives it into the left side fairway bunker, then tries to advance the ball but his ball ends up in the right rough, probably Tiger's worst shot given what was at stake. So Tiger's now lying 2, hitting his third shot to the green, and it's from a gnarled lie. The wedge he hits ends up front right, pin high, and to appreciate that shot, you have to realize he had to have the shot to give himself a chance at a birdie putt, and there was water left in front of the green, and the lie was from the rough. It was the shot of the tournament. Oh, and his leg was broken and his knee ligament was torn. Sorry, forgot that bit.

So as I'm watching, I found myself thinking this guy is not human. And he's not folks, some like to talk about the mental toughness, this guy actually is (in the context of golf and sports). You knew that putt was going down, and it promptly did. "Unbelievable" says Rocco in the clubhouse. No shit Rocco, we're with you. The following day playoff was not a blowout like most predicted, but it was thrilling because it went back and forth, with neither Rocco or Tiger seizing control. In the end though, Tiger hoisted the trophy after the 1st sudden death playoff hole.



OK, so I've gushed enough, and acknowledge that he will most likely pass Jack's record. I truly respect what he did those five days. But I think the most amazing thing was that during the tournament, Nike unveils its new ad that features a voice over of Tiger's late father, Earl Woods, talking about Tiger's toughness. It was insane. The promo is so good, but only Tiger could ever back up Nike's business strategy to air during a major tournament. See, the ad has Tiger's father explaining what he did to make Tiger so tough while we are watching in real time this toughness play out; simply amazing. And while the ad hails Tiger's mental toughness, the underlying hook is truly about a father and son's bond, because the US Open is always on Father's Day weekend. In b-school, and in other contexts, people like to talk about convergence. If you witnessed Tiger's greatest round and win, and a commercial that reminded you of what you were actually watching Tiger do, then you witnessed convergence first hand, and it was awesome.

Congratulations Tiger. You make us believe that we can all be great in our own way. And I humbly accept this award as the ass of the week.

Monday, June 16, 2008

Charlie Morton Wins First Major League Start Against Angels

Charlie Morton got the win in his first start against the Anahiem Angels last Saturday, where he went 6 innings, scattering 5 hits and 3 earned runs. He struck out 4 while walking only 1, and his ERA was 4.50. The at-bat against Kendrick was the most memorable for me, since he threw in to back the veteran off, and then came back with filthy off-speed stuff. Worked a lot of counts full, only to come back and get them. Although, if you asked Charlie, he might think the at-bat against Vladimir (Vlad!!?!) was more memorable for him, since he had to get out of the way pretty quick from the single up the middle at Charlie's head.


What most didn't know unless you read some of the newspapers is that apperently Charlie's flights kept getting canceled from Richmond to California. He finally got one to California and arrived at 5:30 AM (EST) in the morning. Talk about a memorable start. What's up with the airlines getting in the way of a man's dream?

Charlie gets his second start today at 2:05PM against the Texas Rangers at Texas. Go git it done.






Big News....

Many of you know that I have a dream to one day write a book after I'm done running the rat race, and this blog was my feeble attempt to explore my interest. I would offer to anyone reading this out there, or those who stumble upon this site, that less than a year ago, what was mild curiosity has turned into 99 posts. Hopefully I've managed to entertain, slightly inform, or at least get you to think about something.

So with my 100 post, I'd like to share some exciting news. Erin and I are expecting our first!! We couldn't be happier, in between feeling overwhelmed, but let's face it, this is what life is all about. Our due date is December 26th. The ultrasound below is at 13 weeks. When the doctor did this ultrasound, the baby kicked it's legs. It was the most amazing and humbling thing I've ever seen...

We feel blessed and are so thankful. Thanks for letting us share this with you!!

Click to Enlarge

Thursday, June 12, 2008

What is Leverage, and "Deleveraging"??

S&P500 2-Year Chart
2007 US Equity Market The US equity market can be described as a tale of two halves. During the first quarter, economic growth was flat, and most believed the Fed would lower rates to stimulate the economy. This sentiment turned in the 2Q when companies reported better than expected numbers. The Fed did not lower rates, but in fact held them steady, as expectations of a rate cut all but disappeared in the Fed Funds futures market.

Bear Stearns’s Hedge Fund Losses Fast forward to July, when rumors began to surface about Bear Stearns’ two hedge funds. Losses were to be staggering, and what would later be the precipitating event of the “credit crisis”, most in the know understood that if the rumors were true, that these two funds were bankrupt, then all of the contrarian sentiment that we were in an unsustainable housing bubble could ultimately be true. These two hedge funds had large positions in sub-prime, mortgage backed securities. The rumors bore out, and the credit crisis began.


Tech Bubble Burst, the Fed, and Speculation To fully appreciate US market’s decline during the second half of 2007, you have to appreciate the momentum driven market that the US had been in during the past 5 years since the bottom in 2002. The cost of money was basically free, since the Fed wanted to re-stimulate growth after the Tech Bubble burst. Stock prices simply represent the intrinsic value of a company’s future cash flows, discounted back to the present. To oversimplify, the excess money created demand for companies that may have been purely speculative, pushing their respective stock prices higher. It was no different than when dot.com companies were apparently worth more than real companies selling real products during the Tech bubble. Please see this graph I posted earlier, showing the S&P500 during the housing/credit bubble as compared to the Tech Bubble.

From SeekingAlpha.com

The Hedge Funds “De-leverage” OK, so presumably you know the backdrop, maybe because you checked your 401k, etc. and saw how much you may have lost if you hadn't moved to stable value before the unwind. Many of the talking heads in the press kept stating that hedge funds, private equity, etc. were in the process of a massive “de-leveraging” that once started, contributed to the downward momentum of all prices of all stocks in the market. The inevitable question for the average person is “what is de-leveraging” and did it really play the key role in the market’s decline?

What is Leverage? A Simple Example To understand de-leveraging, you have to understand what “leverage” is. Here’s a simple example, where you initally want to make a 10% return on 10 dollars.

1. You could take your $10 and buy a widget for the $10, and hope you can sell it for $11 so that it makes you a $1 ($1/$10 = 10% return).

2. Or you could use $1 and borrow $9 from a buddy. Then you buy the widget with your $1 and your buddy’s $9 for $10. You then sell this widget for $11 to someone else who wants it for $11. You just made a 100% return using leverage. That is, you turned your $1 into $1, for a return of 100%. The diagram below shows the familiar diagram for a lever. A lever is a multiplier of power; "with little effort or force, we exert power."

In this example, from a financial perspective, using borrowed money, or leverage, produces a return of 100%, versus the boring 10% return using 100% of our own money. If you understand this, you’ll understand the next post. The hint is to ask “what happens in both situations if the price for the asset your return depends upon falls to $9 instead of $11?

Deleveraging, Part II "You are the Hedge Fund Manager"

You, the $1 Billion Hedge Fund Portfolio Manager Imagine you are the hedge fund manager that invests $1 billion dollars of your clients' money in securities (“stocks, bonds, mortgage backed securities, etc.”) and it’s January 2007. This $1 billion is made up of one mortgage backed security called ABB-123 and its cost ("price you paid") is based upon a pool of mortgages that were given to a bunch of borrowers whose a) credit was suspect, b) produced no documentation to support their current and future earnings potential, etc., etc. You get the picture, ABB-123’s price is based upon payments from mortgages that have a very good chance of defaulting on the loan, but with this risk comes the promise of high returns. Your incentive to buy this high risk/high return potential security is because your high net worth clients demand high returns for your high fees. In fact, the only way these borrowers could pay the mortgage back is if the price of the house they bought rose faster than the mortgage’s value, and that there was an immediate buyer for this property at that higher price. That’s the key.

Your Portfolio Holdings OK, so your portfolio is $1 billion, and let’s make the price at which you bought ABB-123 was $500 million, or half the portfolio’s value at time zero. Finally, let’s say the rest of your portfolio is made up of 2 securities that are of high quality at the time. Let’s use Ebay and Alcoa as examples, and make each position in each stock worth $250 million. This is a simple portfolio, the names don't matter.

Fast forward to 2nd half of 2007 The market tanks in July on news that Bear Stearns' 2 hedge funds blowup, and stocks across the board fall rapidly with no stock spared. “De-leveraging" is to blame, and more specifically, you the hedge fund manager, along with all the other hedge fund managers holding the mortgage backed securities, are specifically blamed. Why?

The Rationale Home prices in Florida, California, etc. begin to fall as the supply of homes begins to outpace demand. Home prices thus begin to fall. On the micro level, the sub-prime borrower cannot make the minimum payment, and never really could. He bought the home for $500K, the loan is for $490K, with $10K of his own equity (cash) originally put up. The collateral is the house. If the plan worked, he quickly sells the house for $550K, pays back the $500K loan, and pockets the $50K (assuming no transaction costs). He hopes to earn a return of 400%, or $40K on his original $10K of equity. It’s the riskless profit, or free lunch, and Alan Greenspan was the chef. As a side note, you may ask, in addition to the fees the bank collects for a loan that they know will blowup, what was their incentive? During the heyday, banks who originated the risky loan didn't care, because with prices going up, if the borrower defaulted, the bank got the collateral which at the time, was considered high quality because they could sell the property in a can't lose market.

Let's Put Names to Faces... Now, what if the sub-prime borrower (Bob) sells the house for $450k, cause that’s all he can get in a declining housing market? Bob now brings a check to the closing. The buyer gives “Bob” $450k, but Bob still owes $490k to the bank. So now Bob must pay the bank $40k, losing his $10K in equity in the process. “Whoops, my bad.” As a side note, Bob’s return is -400%, that's leverage working in reverse, magnifying Bob's losses. The question now becomes, “how does the borrower raise the $40k he owes?” Maybe he sells his car, taps his savings, etc.

Zoom Out, Mr. Portfolio Manager, Let's Get Back to You Remember, you are running a high profile hedge fund that borrowed tons of “free money” and used this cash to buy massive amounts of sub-prime mortgage backed securities the investment banks created that promised high returns. In this example, ABB-123 security’s price begins to fall because the cash flows that make up this security will not be realized (i.e. the "Bob's of the world are letting you down.") You know the price of this security is falling, and you know you have to pay back the bank you borrowed at low rates to buy. So you try and sell ABB-123 as quickly as you can to minimize your losses. But now that Bear Stearns’ hedge funds blew up, everyone knows these mortgage-backed securities were bogus. So you try and sell ABB-123, but no one will buy it, even as you drop your price. So at some point, the value you can realize from ABB-123 is lower than the loan you have to pay back, so you have to raise cash, and the amount of cash you need to raise is inversely proportional to the hope you have of selling ABB-123 for anything. Worse still, your trading partners know this stuff is toxic and worthless, so you basically get pennies on the dollar for ABB-123. Oh, and the loan is still due. So what do you do?

Time to Raise Some Cash Well to de-leverage, or pay the loan back, and minimize your losses, you sell other high-quality securities to raise cash to cover the loss. If you liquidate your EBAY or AA shares to raise the cash, you put pressure on these shares. People know you need cash, so why not wait because they know they could get these shares for less? Or, what if you aren’t the only hedge fund out there with the same issue or the same strategy? No one will trade with each other because there’s no trust between buyer and seller for ABB-123, and so these markets “seize up.” As Bill Gross of Pimco stated, the fund manager trying to find a buyer for ABB-123 is like the person holding the card with the old lady on it in the card game “Old Maid" where everyone knows he's holding the card becuase the corner is "bent."

So once Bear Stearns’ hedge funds blew up in July, the race was on. Everyone knew these funds held lots of sub-prime based securities, but it was too late. In the second half of 2007, hedge fund managers raced to sell their good holdings to raise capital so they could pay back the loans ("de-lever") and minimize their losses. As more selling happened, prices fell, and everyone got caught in the down draft, i.e. your 401k. As a final note, guess who created all of these “mortgage-backed securities?” The investment banks, and that business of collecting fees is over.

Final note Lehman Brothers has been in the news a lot lately. Guess how levered LEHM is? The answer is ~30, based upon year end 2007 balance sheet figures. They basically have “loans” that amount to 30 times the amount of equity they have on their balance sheet. They are the homeowner that bought a house for $300K using $10K. Finally, their market cap is $13B (market value of equity).

Assets = $691B
Equity = $23 B (book value)
Liabilities = A –E = ~$670B
Leverage = $691 / 23 = 30x

Go Get 'em Charlie!!















Charlie Morton, the hard throwing right-hander, has been activated from the Braves 40-man roster. Charlie will be making his Major League debut this Saturday, June 14th against the California Angels. The game will be at 9:05PM in Anaheim, California.

For those of us who will never have a stadium filled with thousands of fans as our office, have fun out there because you belong. Congratulations Charlie, welcome to The Show! Go get 'em, we'll be rooting for you!

From the Braves official website:

Saturday, June 14 Angel Stadium of Anaheim 9:05 PM ET

Charlie Morton, RHP (0-0, -.--) Braves (32-34)

Ervin Santana, RHP (8-2, 3.01) Angels (41-26)

Scouting Report:

Braves: Morton will make his Major League debut on Saturday against the Angels. The 24-year-old right-hander has been impressive in Triple-A Richmond, going 5-2 with a 2.05 ERA in 12 starts. He did not give up a homer in 79 innings, and he struck out 72 while walking 27. Opponents batted .181 against him. Morton allowed a season-high four runs and four hits in five innings on Sunday. The Braves would have preferred to let Morton mature in the Minor Leagues, but weren't afforded that luxury with a rash of injuries to their starting rotation.

Angels: Santana left with a lead after another solid effort in Oakland on Sunday, but lost his shot at the win when the A's rallied to tie the game against the bullpen. Throwing consistently in the 95-97 mph range with a nasty slider and changeup, Santana struck out nine in 6 1/3 innings, leaving four runners in scoring position while allowing two earned runs on seven hits and three walks. Santana is having an All-Star caliber season, and he'll try to improve his stock against the Braves, a team he's never faced.

Tuesday, June 10, 2008

US Open Golf at Torrey Pines

The 2008 US Open is at Torrey Pines this year, located in San Diego. Torrey Pines, named after the pine trees that are present on the course, is a municipal course. Bethpage, NY was the first public course to hold a US Open.


The USGA will make this course a long hitters paradise. It will be interesting to see if Tiger's knee can hold up to the test, since being in the rough will place a lot of demand on the knee. The odds are listed here:


Tiger Woods (7/4)

Phil Mickleson (7/1)

Sergio Garcia (15/1)

Jim Furyk (20/1)

Adam Scott (25/1)

Geoff Ogilvy (30/1)

Ernie Else (30/1)

The Field (5/1)

Tiger is again, almost even money. My bet would be Ogilvy or Sergio. I think Phil will blow up because this one means a lot to him as a native of the course.

Some side notes about the Open:
1. The USGA is pairing the players by their rankings, so everyone is buzzing about the Tiger-Phil-Adam Scott pairing for the #1,2 and 3 ranked players in the world. At first glance it seems like a great idea, but for the fans that will be there, it should be a nightmare, since the 40,000 will mostly follow this group, and anyone under 6 foot tall will not see any of the round. Great TV.

2. The USGA's choice of hosting its national championship at a public course does well to help shed the "aristocratic" image of the game, as well as help grow the game among the masses. However, there was a great article in Golf magazine that documents the fanatical love that the locals have for this gem in San Diego. The municipal status of this public course has cheap greens fees if you are a San Diego resident. But that is changing due to the greater publicity surrounding Torrey Pines. The South course is phenomenal, and for the price, cannot be beat. We tried to get on when I was out in San Diego for work in 2004, but you basically call and let them know you'd like to play on "Friday" and then wait for them to call. The course is beautiful.

3. Tony Romo and Justin Timberlake took on Tiger's challenge (indirect challenge) when Tiger stated that an amateur could not break 100 at a US Open given the way the USGA sets up the venue each year. Romo shot an 84, and apparently cards a 2.2 index. Timberlake shot 98, and cards a 6.0 index. I bet those two swapped some stories about the crazy relationships they've had over the years. Probably made the rough seem like a walk in the park.

Enjoy the Open, lead after 3 rounds, and you can beat el Tigre, who will be using all the talk about his knee to motivate him to get his 14th Major (not counting his US Amateur Titles.)

Katie Cakes





Some pics of our piggie pit bull Katie cakes. I swear she's smiling like she knows


Monday, June 2, 2008

Is Oil Expensive?

In a word, the answer is yes. Futures hit $138 last week and that coupled with the jobs report sent markets tumbling nearly 400 pts, or 4%.

Oil is expensive, but a big part of the price of oil is the fact that our currency has become complete crap. America is on sale to the rest of the world. I've posted a link to some analysis that puts the current price of oil in the context of our currency's devaluation. Surely demand is driving the price of oil higher, but some of it is also our currency.

On a related note regarding the market dive on Friday. The day before the market was up, and most thought that we were going to avoid a recession due to the unprecedented steps the Fed took to foot the taxpayers with the bill of Bear Stearns. However, volatility ruled the current short term outlook, as the VIX spiked above 22, and a bad jobs report came out.

It took almost 5 years for the housing/credit bubble to build and pop, so it might be a little hopeful to think the unwind will be short and sweet. Friday proved this. But another possible related driver to the bad unemployment number is the fact that higher gas and food prices are causing more folks who weren't seeking employment to now go out and do so. This artifact alone might be driving some of the filings that the government tracked in it's latest report last week.

Only time will tell. The Fed is in a tough spot now, and please take the government CPI (inflation) numbers with a grain of salt. They must be bogus, because you and I both know it cost more to buy food now than a year ago.

Link to US Dollar's Role in Oil's Price Rise

Christi and Kelan's Wedding

sThis past Memorial Day weekend, we traveled down to Clemson, SC for Christi and Kelan's wedding. The bride and groom had over 200 people and the wedding and reception were a blast. Erin was in the wedding, and the wedding party looked classy, as always.

It was such a nice change to be down south. The people are so friendly, and everyone has manners. Being around people down South reminded me of what people look like when you are surrounded by happy people. As an additional perk, I got to play golf at Clemson University's golf course with several retired guys and they couldn't have been nicer guys. We played a 25 cent nassau, and I ended up net $1

To put in perfect perspective, Erin and I were waiting in Atlanta airport for our flight back. All of the gates around ours were flying to Dallas, San Fran, etc., while we were flying back to Newark, NJ, the armpit of the Northeast. Even the gate looked different if you catch my drift, but I digress badly.

Congrats to the happy newlyweds, we're so happy for you two! Thanks for sharing your special day with us!!

Panoramic of Rehearsal Dinner Site at Sunset (click to enlarge)







Sunday, June 1, 2008

1+1 = 3 and the Possible End of Budweiser

InBev sounds like they will make a bid for Anheuser Busch. The price tag is around $50 billion, and headlines are reporting the financing is all but secured. The takeover bid sounds like it might end up hostile, as AB has few options. For those who have never heard of InBev, InBev owns such brands as Bass and Labatt. The company was formed after a merger between AmBev and Interbrew.

In mergers and acquisitions, the acquirer pays for assets and cashflows, while seeking to cut out redundant costs that will help boost operating margins. News of InBev's possible intent surfaced on May 23rd. Prior to the announcement, BUD shares were trading at $52.65/shr. With 713 million shares outstanding, this put BUD's pre-announcement market cap at ~$37.5 billion. At $50 billion, the premium that InBev is willing to pay is about $12.5 billion, or 33% above the pre-announcement price. Put another way, the $12.5 billion represents the amount of "redundant costs" or synergies, the new, merged company needs to realize. BTW, InBev is only worth $30B currently.

This new merged company could realize this $12.5 billion of incremental shareholder value over the current separate companies by growing the top line or cutting costs. Either way, the $12.5 billion is an enormous amount of "value" that current BUD shareholders must ask, "could our current management's strategy generate the same amount of shareholder value versus what the merged company will?" It's the same question Electronic Arts (ERTS) asked Take Two (TTWO) shareholders to think about, as well as what Microsoft ask current Yahoo! shareholders to ask its leader, Jerry Yang.

Another big part of this deal that is gaining lots of attention is the obvious culture clash that seems to be brewing. The Brazilian beverage company, InBev, is fairly cut-throat, so this American icon will be severely tested if the deal goes through. I'm sure Congress will get involved with a foreign based company potentially buying an American icon. Sovereign wealth funds are welcome to strengthen our investment banks' balance sheets, but please don't take our beer.

Link to lecture by Carlos Brito, CEO of InBev

Link to Seeking Alpha post on Culture Differences

Link InBev Corporate Site

Link to Anheseur Busch Corporate Site