Thursday, January 31, 2008

Capital Southwest Corp (CSWC)

I have written about Capital Southwest Corp (CSWC) before in this post:

May 15, 2007

Today, CSWC reported net assets at December 31, 2007 of $541,924,018, equivalent to $139.34 per share. This was down significantly from the $186.91 reported as of 3/31/07. This was due mostly to a drop in the value of shares that CSWC owns in Heelys (HLYS). CSWC filed to sell its shares about six months ago, but then the markets headed south and the company pulled it.

CSWC has an excellent long term track record of creating value for shareholders, but has stumbled a bit as the "overvaluation" of Heelys has contracted to a more reasonable level.

Also, a shareholder yesterday made a filing with the SEC demanding that CSWC make some changes at the company:

1) "We believe the Company should liquidate, in an expedited but orderly manner, the approximately $55 million of non-control interests in public securities that it owns. These positions can easily be liquidated before the Company’s fiscal year end of March 31, 2008. The cash proceeds from these sales should then promptly be distributed to shareholders in the form of a one-time special dividend."

2) "The Company should hire a nationally-recognized investment banking firm to evaluate strategic options with regard to CSWC’s four major ownership stakes in public companies (WIRE, ALG, PHHM and HLYS."

3) "We believe that the Company should hire an independent firm to opine on the valuation of some of its larger private company investments– such as Rectorseal/Whitmore, Lifemark, and Media Recovery."

The investor has been trying to work privately behind the scenes with the management of CSWC, but has become frustrated with them.

The stock has barely moved on this news.

Wednesday, January 30, 2008

Is Google Recession Proof?

I've seen this question a couple of times in some other blogs. Here is what Yahoo said about the question of ad search revenues being resistant to any economic downturn.


"What kind of impact in a hard recessionary environment do you think you could see in your display and search advertising, whether one would be more insulated than the other? Specifically in Search, to the extent that you were to see a major negative macroeconomic impact, do you think you would see that more in terms of advertiser demand or a change in user or searcher behavior?"


"We have, from time to time, seen pockets of weakness and certainly a couple of pockets in the fourth quarter as I outlined. We’ve also had areas of strength that have been offsetting."

"The challenge in answering your question is clearly the secular trends in online advertising have historically, and even today, very much been overwhelming the cyclical environment. It’s early to tell though if the weakness in the housing and financial and travel sectors -- a little bit in retail -- will start to affect the consumer more broadly and the advertiser more broadly and therefore searches in terms of what kind of commercial searches happen."

"I don’t think we have a crystal ball in that, but we are encouraged, actually, by how much offsetting strength we’ve seen in some of the other categories which has kept our overall marketing services growth rate in line in display and Search with what we saw earlier in the third quarter, or actually even a little bit better."

Transcript from Seeking Alpha

Tuesday, January 29, 2008

Countrywide Earnings

Countrywide Financial (CFC) just reported what will probably be its last quarter as an independent company. I won't rehash all the losses and write offs that were detailed in the press release, but I did notice one thing that scared me a little.

CFC reported a delinquency rate of 5.76% in its servicing portfolio for Conventional 1st liens. This is up from 4.41% and 3.05%, at the quarters ending September 30, 2007, and December 31, 2006, respectively.

The delinquency rate for sub prime was a sky high 33.64%, but that did not come as a surprise to me.

Tuesday, January 22, 2008

The Case for Financials

I want to make the case for starting to put some money to work in Financial stocks. Please don't jump all over me before you read this. Here is the thesis:

1) The Federal Reserve has finally realized the seriousness of the situation and is committed to bringing rates down to stimulate economic growth. The Fed cut rates 75 basis points this morning, and will cut more.

2) Housing, as we all know, is in a deep depression. The latest report on starts show a drop to levels not seen since 1991. The market sold off on this, but this is actually good news as supply must be taken out of the market in order to restore balance.

3) Housing will also be helped during the Fed easing cycle, as the tidal wave of resets on mortgages hits in 2008. Mortgages will reset at lower rates than expected. This will mean less foreclosures than the market expects.

4) President Bush has announced a tax cut to also help the economy. It seems that both parties will work together to come up with some plan to help, despite the election year coming up. The announced plan was for a $150 billion stimulus package, but by the time it becomes law it will be larger than that.

5) The last quarter of reported GDP growth came in very strong at 4.9% for the third quarter of 2007. We all know that the official definition of a recession is two straight quarters of negative GDP growth, but lets assume that one quarter would be enough. The economy would have to contract almost 5% to reach negative growth. That is an extraordinary amount in an economy of our size.

6) The Financials, as measured by the large cap index, the XLF, is at $25.17, after peaking at close to $38. That is a drop of almost 40%, more than a Bear Market. At $25, the index is now at a level last reached in late 2003. It is hard to get a handle on valuation because book values and earnings are in "flux" to put it mildly, but clearly the stock prices are more grounded in reality than before.

7) The banking industry is recapitalizing fairly rapidly, with capital infusions of almost $100 billion from Sovereign Wealth Funds, and other foreign players. The rest of the world does not have an interest in seeing the United States financial system go under. That would be bad for business. After all, there is a reason why 36 countries store Gold reserves in a vault under the Federal Reserve building in Lower Manhattan.

8) Banks have started started to write off bad loans and bad investments from its balance sheets. Although the market sees this as a negative, it is actually the beginning of the end of crisis. Another point that some investors don't realize is that accounting rules forbid banks to "write up" these investments once they are put into the "other than temporary loss" category. This raises the possibility that once the market recovers, these securities will actually have a value despite being valued at nothing on the bank books. So one day, we will have a situation where bank book values are understated on a trailing basis, the opposite of the situation we have today, where bank and other financial book values are overstated on a trailing basis.

9) Newly tightened lending standards means that fewer bad loans are entering the pipeline. Underwriting departments are finally doing its job. Non performing loans, and loan write offs will eventually peak and then turn down. That is how the credit cycle works.

10)Despite all the investment write offs and reserving for credit losses, bank capital ratios are well above minimum regulatory levels.

11) The psychology is correct as well. Everyone thinks that the sky is falling. Panic is setting in, just the time to buy.

More Bad News

The Chicago Fed National Activity Index was just released and it showed a −0.91 reading in December, down from −0.29 in November. All four broad categories of indicators made negative contributions to the index in December.

This is not a well known economic report, so here is more on it:

"the CFNAI is a weighted average of 85 existing monthly indicators of national economic activity. It is constructed to have an average value of zero and a standard deviation of one. Since economic activity tends toward trend growth rate over time, a positive index reading corresponds to growth above trend and a negative index reading corresponds to growth below trend."

"The 85 economic indicators that are included in the CFNAI are drawn from four broad categories of data: production and income; employment, unemployment, and hours; personal consumption and housing; and sales, orders, and inventories. Each of these data series measures some aspect of overall macroeconomic activity. The derived index provides a single, summary measure of a factor common to these national economic data."

Circuit Breakers

I hope it doesn't come to this today, but here are the circuit breakers in place for the NYSE for the first quarter of 2008.

In the event of a 1350 point decline in the DJIA (10 percent):

If this occurs before 2 p.m. a one hour halt, from 2-2:30 p.m. a 30 minute halt, and after 2:30 p.m. then no halt.

In the event of a 2700 point decline in the DJIA (20 percent):

If this occurs before 1 p.m. a two hour halt, from 1-2 p.m. a one hour halt, and after 2 p.m. the market closes.

In the event of a 4000 point decline in the DJIA (30 percent), regardless of the time, the market closes for the day.

From the NYSE

Bank of America Earnings

I just finished reading the press release from Bank of America on its earnings, and found this paragraph to be the most interesting:

"The company incurred about $400 million in losses to support certain cash funds and also had subsequent writedowns of about $400 million related to securities originally purchased from the funds at fair value."

It cost them $800 million to bail out one of its money market funds, to keep it from "breaking the buck."

Monday, January 21, 2008

Futures Down 466?

Dow futures are now down 466, the NASDAQ down 75 and the S and P 500 down 65. Tuesday morning will be something.

Futures down 350?

I turned on the Fox Business Network this morning just to see what was going on overseas, and noticed that the futures market in the United States was down 350 points this morning. I am hoping that this is the result of a thin market and not indicative of what will happen Tuesday morning.

Friday, January 18, 2008

The Next Shoe to Drop?

Bank failures are at a historical low, with only three in 2007, and none in 2005 and 2006. The chart below shows bank failures as calculated by the Federal Deposit Insurance Corporation (FDIC) since 1934. I couldn't get the years to appear on the horizontal axis, but the chart starts in 1934 at the right and ends at the far left. I know that it is in reverse order chronologically, but blame Google Docs for that not me.

The large bulge is from the banking crisis in the late 1980's and early 90's, and the smaller bulge is from the Great Depression. many banks failed prior to 1934, but since the FDIC was created in that year, that is all the data they have.

Thursday, January 17, 2008

"No Mas"

I have just one thing to say about this market - and that is "No mas." That famous and disputed line supposedly uttered by Roberto Duran in the eighth round of the second Sugar Ray Leonard - Roberto Duran Boxing match in 1980, sums up my feelings on this grim day.

Wednesday, January 16, 2008

Baltic Dry Index

The Baltic Exchange Dry Index (BDI), which is a daily index made up of 22 key dry bulk routes recorded by the Baltic Exchange in London has taken quite a fall the last two weeks. It is still way above the last peak so it remains to be seen if it has bottomed here.

Dry Bulk shipments are considered by some to be a good indicator of economic activity.

JP Morgan vs. Citigroup

If you take a look at the capital ratios of the these two banks, it speaks volumes about what is going on. These numbers are preliminary but here they are:


Tier 1 Capital Ratio - 7.1%
Total Capital Ratio - 10.9%

JP Morgan

Tier 1 Capital Ratio - 8.4%
Total Capital Ratio - 12.6%

You can look up capital ratios for any bank by going to this web site:

The info is always a quarter behind, but it is useful nonetheless to see the trends.

Tuesday, January 15, 2008

Citigroup Fourth Quarter is not a Kitchen Sink

Citigroup reported its earnings this morning and the stock is bouncing around like crazy. It was up about $0.50 right after the press release came out and then it tanked and went down as much as 3% to $28. It is now at $28.71.

There will no doubt be much to comment on after the call this morning, but here are a few tidbits from the press release. Most of this is from Schedule B:

1) Citigroup began the quarter with $54.6 billion of "direct Sub-prime Related exposure," and ended the quarter with $37.3 billion. Notice the use of the word "direct." Is there some indirect exposure?

2) Citigroup would have reported exposure of $47.8 billion without the $10.5 billion of hedges that it had during the quarter. Watch counterparty risk on this $10.5 billion.

3) The company recorded a $900 million reserve related to counterparty risk in the quarter. Citigroup cited a FAS 157 adjustment so it is not clear if this was simply an accounting adjustment or actual deterioration in the hedges it has against its portfolio.

4) Total sub prime writedowns of $18.1 billion during the quarter.

5) The remaining portfolio considered "sub prime."

ABCP/CDO $20.6
High grade $4.9
Mezzanine $3.6
ABS CDO-squared $0.2

6) The $20.6 billion of ABCP/CDO or Asset Backed Commercial Paper/ Collateralized Debt Obligations are considered to be level III assets and can't be valued using conventional methods - meaning by observable comparable transactions. This is a large worry for me.

I will have more to say after the conference call.

Sunday, January 13, 2008

Scary Chart of the Day - January 14, 2008

I saw this chart over the weekend courtesy of the people at Calculated Risk. It shows the number of estimated homeowners with no equity given different scenarios of home price declines in 2008.

Wednesday, January 9, 2008

Foreclosure City

A great heat map of foreclosures by county courtesy of Mathhew Yglesias and a blog called Grasping Reality with Both Hands.

It's a little too small and hard to read but I think you get the point.

Monday, January 7, 2008

Pie in the Sky Optimism?

This outlook on Commercial Real Estate from Grubb & Ellis Co. and Jones Lang LaSalle Inc reminds me of the optimism that residential brokers were displaying a year ago, when they predicted "a slight downturn" in the Housing Market.

Commercial Real Estate Outlook

Cash Rich Technology Stocks

B. Riley, a boutique small cap investment firm, just released its third annual list of cash rich technology stocks.

The first two lists provided a decent return, so I wanted to break down the valuation of the current list.

The data above is from Yahoo Finance. I am going to look up cash per share and publish it later.

Saturday, January 5, 2008

I Just Don't Get It

So here is what I don't get. The United States economy is slowing down, the extent of which is unknown, but certainly below its trend line growth of 3%. The consumer, which powered the economy, is stretched, suffering from the effects of the housing bust and high oil prices.

Oil, however, continues to strengthen in price, reaching $100 a barrel, based on continued strong demand from emerging economies, particularly China. Yet China is America's "factory floor" as one pundit put it. So how long will it take for the slowdown in spending to work its way through the supply chain. The conversation I suppose would go something like this:

Executive: Hey Li are things?

Li Shao: is U.S doing?

Executive: Good. The reason I am calling is about the order we have pending with you guys.

Li Shao: Yes, we are working hard on it.

Executive: Well the thing is, we are going to have to cut it back by 50%.

Li Shao: What?

Executive: Well you know, the American consumer is stumbling a little with the housing crisis, high gas prices so we just wanted to be a little prudent about our inventory this year.

Li Shao: What? You can't do that.

Executive: Well actually we can. Why do you think we outsourced our manufacturing?

So here is the current consensus on Wall Street - the bull markets in emerging economies and therefore by extension commodities will continue despite the Housing debacle in the United States because these emerging economies have "decoupled" from the United States due in part to those emerging economies developing their own domestic consumption markets.

The rest of the world is no longer "dependent" on the U.S. economy. Not only will Commodities and emerging economies continue to boom, but all the domestic stocks that feed that boom will continue to grow. This would include the Energy Sector, most Basic Materials, Industrials and any other company that sells to export markets, dry bulk and other shippers that serve Asia, etc.

If this is true, then all power to them I say, but if it is not and the old saying "when the U.S catches cold, the rest of the world catches the flu" is still true then the short of a lifetime is developing here.

China exported $ 287 billion in goods to the U.S in 2006. This was 29% of its exports to the world, which totaled $969.1 billion. Although the conventional wisdom is that the slowdown in the US will not impact China because they have other markets now to sell to, this is not true. We are their largest customer. Also, if you look at the top export categories, they are the categories that are slowing down the most in the U.S:

Exports to U.S from China in 2006 (Billions)

Toys & games $20.9
Apparel $19.9
Furniture $19.4
Footwear & parts $13.9


Oil finally cracked a little on Friday after the jobs report, but it would seem that there is a huge downside still to come on it and other commodities.

Friday, January 4, 2008

Non Farm Payrolls

We all know that non farm payrolls disappointed a little this morning, so I won't comment too much on this. Here is a chart of the one month change:

During the last recession, the one month change in non farm payrolls bottomed at -330,000 in October 2001. Two problems with using this as a metric to invest is that no one knew that it was a bottom until a few more months were released, and the data I am looking at today may not have been at -330k for the month of October 2001, because subsequent to that it was probably revised. I checked on the web site of the Department of Labor and the original release had it down 415k when it was originally reported.

So when did the market bottom relative to payrolls? Here is a chart from 2002, showing a bottom almost a year later in the S & P 500. Now granted, there was a lot going on at the time, including the September 11 attacks and the unwinding of the technology bubble, so the comparison to today may not be all that valid.

(Chart courtesy of

The Leverage Game

As a relatively new Hedge Fund manager, I tend to get calls from vendors and assorted financial types trying to sell me services or systems. I got a call the other day from an organization whose name I will withhold that offered to lever up my assets under management (AUM) by ten times.

So here is how the deal works. They lend you ten times your AUM and in return the payoff is split as follows:

First 10% return - they get 90%, you get 10%.
Second 10% return - they get 50%, you get 50%.
Third 10% return - they get 10%, you get 90%.

Sound too good to be true. Well it is. Here is how the downside is split:

First (-10%) return - you lose 100%, they lose nothing.

The payoff is asymmetrical, as you probably figured out. So in effect, after a ten percent decline, your capital is wiped out. What happens if you go down more than 10%? Well you can't because they monitor the portfolio daily and will pull their money out once you hit a negative 10%.

Also, if you assume that you achieve a 10% return for the year on the borrowed money, you are no better off than if you hadn't borrowed. Let's say that you started with a million and borrowed $9 million (just to keep the numbers even).

After a year, your have a ten percent return, or $1 million. You have to hand over $900 K of that and you keep $100 K. That's the same $100 K return you would have earned if you had just invested your $ 1 million by itself and earned 10%.

I keep wondering how many of my fellow managers are levered up like this. I read about a Warburg fund that was levered up 20 to 1.

Thursday, January 3, 2008

Forever is a Long Time

I was just listening to Bloomberg TV and I heard some talking head say this:

"The bull market in Oil will last forever."

Is unbridled optimism a feature of a market top?

ETF's Gone Wild

Everyone is all crazy about Exchange Traded Funds (ETF's), acting like they are the best thing since sliced bread. I just came across this ETF that apparently has had better days. It is the B2B Internet HOLDRs (BHH), which closed at $0.42. It only contains four stocks in this weighting:

Ariba (ARBA) 17.67%
Checkfree Corporation 75.5%
Internet Captal Group (ICGE) 5.22%
Vertical Net (VERT) 1.61%

Checkfree (CKFR) merged with Fiserv over the Summer, but apparently Yahoo hasn't updated its holdings data.

So beware of what you buy into.

Wednesday, January 2, 2008

A New Blog

Some of you may have noticed that on the right hand side of Stock Market Prognosticator, I have a link to a blog called Under the Buttonwood Tree.

This is another blog that I started up in December. It will be a little different than Stock Market Prognosticator in that it will be a blog with a reporting focus rather than an analysis focus. There will be many more shorter posts that will simply summarize the results of company earning reports or conference calls with little original content.

I know the name is corny, but it was hard to come up with something totally original. Just for those who don't know, legend has it that the agreement to create the New York Stock Exchange (NYSE) was signed in the late 1700's under a buttonwood tree in Lower Manhattan.

So why am I doing another blog? Many reasons - It will help me keep track of company reports and news - kind of a public notebook on earnings and other news. It will hopefully drive more traffic to my other blog as the higher number of posts get indexed into the search engines. Last, my background was originally in Journalism, and this blog brings me full circle to a place that I almost went into as a career.

A Picture is Worth a Thousand Words

I was on vacation in Florida last week and saw the following sign in front of a half finished development.

I almost pulled off the road causing an accident when I saw the 2 for 1 special sign. It's hard to believe that new houses are being discounted 50% off list from a year ago.