Stocks will push for another bullish end to the year

With so much controversy and turmoil in the marketplace in 2007, it seems only fitting that a prediction of bullishness is viewed skeptically by many in the investment world. However, I believe there are several factors that will continue to churn out new records in most equity sectors and classes.

Recent stock market pull-backs have been caused mainly by rising interest rates. Bond Yields rose again on Thursday bringing rates to around 5.17%. Despite the substantial increase of 400 basis points, the equity markets finished higher due to some good economic data. Although bond yields pose a short-term threat to the markets, they can only do so much damage before the flood of capital and investor confidence takes over.

Looking at the 10-yr bond yield (considered one of the best measures of rates), it continues to approach the target Federal Funds rate level. But what is going to happen when bond prices become just a few hundred basis points away from the target interest rate? They will halt, quickly. In other words, the upside to the stock market far outweighs the potential rise in bond yields. Therefore, if bond rates are not going to get much higher, we must assume that housing will begin to stabilize during the latter half of the year. In addition, consumer and institutional confidence should continue to increase providing higher highs in the marketplace.

Another key aspect of the interest rate impact regards the flattening of the yield curve. One of the main arguments of the bearish analysts on Wall Street this year has been the inverted yield curve. Not only has the curve flattened, it has really begun to shape back to its normal progression, with yields correlating to the length of the investment. Stabilization of interest rates and normal payout percentages will make short term bonds more unattractive and simultaneously display equities as a prime target for even larger amounts of capital.

Stocks remain undervalued when taking into account global profits, revenue and earnings growth, higher margins, and currency conversions. Now might be the time to buy, not sell.

Another big sell-off, but was it healthy?

As US economic growth wavered in Q1, coupled with a few big sell-offs in the equities markets, stocks steadfastly rebounded and repeatedly approached new record highs. Taking into account the vast amount of negative numbers regarding economic data, equity prices fearlessly drove higher, despite predictions by several top economists and market analysts that a recession was near. A key basis point of these bears centered around the inverted yield curve, a unique phenomenon which has been succeeded by a recession every time it develops.

Low and behold, several months and vastly higher heights later, another pair of significant sell-offs occurred. This time however, these bears are missing a significant piece to their pessimistic puzzle. Finally, after years of mismanagement by the FED and US Treasury Dept., the yield curve has begun to normalized. The inversion has reversed, as long-term treasury yields have overtaken the 90-day T-bill rates.



Another issue the bears seemed to dwell on regarded weakness in the US Dollar. Many argued that global equity markets would continue to prosper while US stocks would take a significant hit because of the weakness in profitability between exchanges in currency rates relating to asset levels and market capitalization. Unfortunately, these bears failed to realize the global impact and success of American companies abroad. Giants such as General Electric, United Technologies, and Boeing continue to impress and solidify market share across the globe. Therefore, these revenues made abroad will translate high relative to the USD, failing to impact corporation's balance sheets like pessimists believed they would. In addition, the Dollar has continued to climb against the Yen and made a good comeback against the Euro recently.

Therefore, don't expect a large correction over 5-6% anytime in the near future. The US economy is going strong and stock slumps are supposed to be caused by Bond yield inflation, not computer glitches. This is a natural cycle and valuations are still appealing in the equity markets.

US investments continue higher despite China

For the past few years, many bearish global and US market analysts have claimed that a recession or sharp decline on Chinese exchanges will create a detrimental domino effect throughout the free market world. Well, guess what, China's Shanghai index dropped some 8+%. Despite the rapid drop-off, resembling the DJIA in 1929, US stocks failed to coincide, edging slightly higher overall, including some of the very stocks with huge interest on the exchange such as PetroChina and CNOOC.

Unfortunately for these bears, they refuse to realize that globalization has helped reduce risk and dependence in any one country or region. Negating fundamental economics, though, baffles me.

As of 10:58PM ET, the Shanghai Index was down another 5%. We will see if the US exchanges can continue the momentum and further our dominance as the supreme nation of wealth. Also interesting, the Hang Seng seems to be higher still, some .37%. This means that worries among Chinese investors have yet to spread to outside investors, including a signifcant portion from the US.

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As Energy Prices Rise, Fight Back With Investments

Lately, it seems like every time I turn the TV to news, finance or political programming, you hear consumers and politicians whining about the recent run-up in energy (particularly gasoline) prices. Although this complaining seems to be partially justified, few have answers to the continuous rise in demand and market assessed risk that remain the force behind rising fuel costs. In a capitalist economy, you have to accept the fact that markets set the price. Higher demand and risk mean higher fuel prices. If illegal price gauging activity is present in the marketplace, then by all means Congress and the justice system need to take action. However, in the previous 30 investigations led by the FTC, there has been no conclusion of wrongdoing.

Instead of sitting on your hands, upset about the higher cost of your summer vacation, hedge against fuel price inflation by investing in energy companies. As a sector, energy has performed well this year, especially oil exploration & drilling companies and refiners. These stocks are only beginning their upward summer trends. Baring a significant political or economic change in the industry, energy stocks should continue to increase in price, running up another 50% or more in some cases. Profiting from investments during inflation in energy prices helps to hedge your earnings and protect your wealth and purchasing power. Here are some ideas for investors:

If you are conservative in your stock selections, go with a typical big name driller or refiner. Some names to look at include Valero Energy -VLO- (still extremely undervalued using valuation measures), Marathon Oil -MRO-, Transocean -RIG-, or Exxon Mobil -XOM-.

For investors desiring higher earning potential, I recommend some energy plays abroad. Recently, international oil and gas companies have experienced significant stock price advances. Nevertheless, many of these companies remain undervalued when taking into account their projected earnings and revenue growth rates. Some companies to consider include Buffett-owned Chinese giant PetroChina -PTR- (AKA China National Petroleum Corporation, a stock I will discuss in my China sectorsnap later this week), Argentine emerger Petrobras Energia Participaciones S.A. -PZE-, and the Brazilian integrated Petroleo Brasileiro -PBR-.

How common investors can get in on Private Equity

For yet another year, Private Equity buyouts are expected to set a new record on Wall Street. Although the "rich get richer" theory applies, investors of all levels and experience have seen the benefits of leveraged buyouts. Rumors and announcements of LBOs stemming from Private Equity capital has driven stock prices dramatically higher, making these firms pay more for each acquisition or considered target. Although investors have little control over the situation and some may not want to lose ownership of the company they are part of, these Private Equity deals provide payouts of premiums that more then make up for these feelings.

Private Equity has remained an elitist group over time, with high barriers of entry. Until now. Presently, PE firms either trade sections of their firm publicly or have planned IPOs set to unveil before the end of this fiscal year. If you are looking for an immediate venture into ownership of a PE firm, you can try Fortress Investment Group (FIG), Apollo Group or KKR, the noteworthy firm that recently announced a bid for TXU. Investors with patience may want to wait for IPOs expected from the two most powerful and well-known firms in the PE world, Carlyle Group and Blackstone Group.

To some, it may seem confusing as to the reasoning behind Private Equity firms going public, especially because of their namesake. Thinking critically about how these firms derived their name, they still possess the ability to keep restructure and overhaul acquisitions in private. Disclosures in financial statements are a specific concern to some analysts, but the numbers will never fully display how the firms turnaround or fail with individual acqusitions. In addition, the acquisitions acquired by these financial barrons are likely to benefit because they are allowed to operate like a separate entity without the pressure of growing an artificial number such as a stock price.

Buyer beware though, as this article explains, PE firms stock growth after three years of their IPO is only 39% compared with normal growth of 45% for other companies. Also, as Adam Lashinsky writes, these PE firms are forced to cater to those pesky investors which they try to avoid so adamantly in the process of their business. Another possible red flag of the firms center around the use of stockholder's equity instead of debt. While the practice is generally seen as favorable and may be the case in some of these IPOs, the possibility of maxed-out debt could be extremely detrimental to the overall growth in earnings and health of the firm.

Should Orbitz go public?

Blackstone group, one of the famed private equity firms, recently announced they are taking Orbitz Worldwide Inc. public. This seems like an odd time to do so considering the high level of competition among online travel agencies, price wars between the airlines and rising costs due to elevated fuel prices.

Orbitz reported an increase in bookings of 38% last year, along with revenue of $752 Million. Looking at those numbers, one might be inclined to buy this IPO. However, if you look at the net income, Orbitz claimed a loss of $146 Million. This makes me question how the company derived that $752 Million in revenues; Orbitz makes profit by taking money off the top of flights, hotels, and cars other companies provide. If that revenue amount included the actual total flight, hotel, and rental costs, Orbitz might be cheating itself by going public at this juncture. Perhaps, investors are the ones who will get cheated if they fail to look at these numbers closer.

Even if Orbitz generated that $752M in revenue solely from its commissions, where do these high costs come from that created a net loss of more then 1/7 of these revenues? It makes you wonder if the costs can be cut or controlled, especially once full disclosure of financials is needed. In addition, revenue may slump this summer if fuel prices remain high and are built into plane ticket or car rental prices.

It isn't usually smart to go against Blackstone and underwriters such as Morgan Stanley, Goldman Sachs, and UBS, but I will be searching for more information before I jump on this IPO bandwagon.

Good numbers for the U.S. Economy

More good numbers came out today, suggesting a recession is not likely in the near term for the United States economy like some economists such as Paul Krugman and Barry Ritholz. Let's start with the bad numbers.

Pending Home Sales came in at -4.9% against projections of 0.4% increase due to spring buying habits. Part of this number may be due to the cold snaps felt throughout the early part of the spring. I wouldn't be surprised to see that number rally this month.

Now on to the good news. The ISM Manufacturing Index rose to 54.7%, a new 52-week high. With the good manufacturing numbers came a sharp decline in bond rates, a move that will help support the stock market's rally.
Source: Marketwatch

Yesterday several strong numbers came out including personal income and DPI, each rose by 0.7%. Improvement in income leads to higher consumer spending and eventually GDP growth, corporate profits and a bullish stock market. The PCE inflation measure was flat, signaling slowing inflation. This is key considering inflationary worries and concern over the FED hiking rates if inflation maintains high levels. Gold prices also dipped, strengthening the dollar and lowering commodity prices.

China learning well from U.S. Economists

As one of the fastest growing economies in the world and one of the largest, China could easily be arrogant, unresponsive and even disrepectful to the U.S., a former Cold War nemesis. That does not seem to be the case however, considering the trend of decisions made by the Chinese version of the FED, with counsel from U.S. bankers and economists.

The Wall Street Journal reported today that China lifted bank reserves in an attempt to help control growth. Although growth in double digits seems very appealing to most investors, the Chinese Central Bank and U.S. economists realize it may actually pose a huge recession threat down the road. With a lesson learned from the U.S. housing bubble, created by Alan Greenspan's flawed monetary policy, China is attempting to prepare itself and provide a soft-landing to the world's second largest economy (GDP using PPP).

Though the graph suggests no recession problems, you can be sure that growth will be tough to sustain at such a high rate. If China can curb its growth now at 8-9%, it will be able to sustain it for a much longer period of time with less volatility, such as the graph suggests. However, if they continue growing by double digits, the threat of a bubble burst is likely, one that could ultimately ruin the economy or set Chinese progress back severeal years.

Economic Worries for the U.S. Economy

Despite weak GDP performance in the first quarter of 2008, the equity markets continued their climb today with the Dow closing at yet another record high. All of this came amidst talk of a potential recession, a weak Dollar, and declining markets abroad. With this seemingly unstoppable run continuing, there are still several factors that worry me about the current economy.

First off, let me make it crystal clear that I am still Bullish on the stock market and economy in the long run. However, there are too many factors signaling a struggle ahead. Lets begin with the inflationary pressure on the economy. The CPI and PCE both rose to suggest higher prices across the broad economy. Although prices in commodities continue to increase, I do not see these increases in the CPI and PCE repeating themselves for more then a few months. Commodity prices are being driven by international demand and growth, not domestic. Therefore, rising commodity costs are not being translated into actual inflation for most ordinary Americans except in the form of gasoline.

Another concern I have relates to the Fed's competence and the inverted yield curve it created. Greenspan is out, so I will wait to see how Bernake handles a fragile situation. Many bears argue we have never seen an inverted yield curve without a recession following. This fact is entirely accurate, yet may not be in this unique situation. The Fed mishandled rates in 2002-3 by sending them too low, creating the massive housing boom. Without properly limiting growth and speculation in the housing sector, the expected happened in when the bubble burst. Sub-prime spillover and sharp declines in housing prices and sales are not what worries me though. The drastic lowering of interest rates was overdone compared to inflation numbers. Additionally, it hurt the USD, which dropped steeply between 2002-4.



In an attempt to try and generate a perception of normal inflation, the Fed has increased the amount of money it prints to provide a short-term wealth. This will only worsen inflation in the long run as prices of goods and service remain constant the value of the dollar drops even more. To help control inflation, the Fed keeps focusing on raising the short-term FF rate instead of both the short and long or just the long. This has created the inverted yield curve, which undervalues long-term lending. Why would anyone borrow for the long term when they can get short-term returns at higher rates? Not to mention, it makes the U.S. pay back larger debts sooner rather then later.

Lastly, corporate profit records of late have been derived from operations abroad, not domestically. These profits are good since the companies making them are many of those headquartered in America. But, the income and revenues being attained globablly does not help our economy in terms of GDP, employment, and other factors. When you consider most of the returns on the investments made internationally stay outside the U.S. boarders, it really has no net affect on our country except for aiding to drive the equity markets higher. Also, if you consider the gains of the Euro and Pound against the USD, it makes sense that these companies continue to report record earnings. It must be near impossible for Wall Street to predict income and revenues generate across the world, let alone exchange rates to translate those earnings and sales.

These are just some things to consider in the short-term. Once GDP growth heads back towards 3-4% in the 4th Quarter, you can be assured that a new big rally will begin. Unless, of course, the current rally just never dies. As Larry Kudlow says, "It's the greatest story never told" and I expect many Americans to continue to reap benefits of investing in stocks, mutual funds and ETFs.

Why the equity market is still the best play

Over long periods of time, nobody can argue that the equity markets always return higher yields then the bond market. Bonds are used because of their safety, but I would argue that anyone planning on investing over a 10-year period or more should just as well invest in stocks. Some argue, however, that high short-term yields present an adequate substitute for equities.

When you examine the current T-Bill yields, you find them extremely low. So what purpose would that give to invest in bonds? Looking at outside factors, you would realize that the USD has started to take back gains against the Yen, Euro and Pound. If you couple the gains in the Dollar with record high tax revenues, which in turn help decrease the deficit in the budget, Bonds would seem attractive because yields would continue to increase. However, as my fellow blogger Rufus quickly corrected himself, he explained, "Of course, the second act is the market explodes, again and the "bond" holders take a bath."

Therefore, even if the bond market rallies in the coming few months and stalls the equity boom, eventually the stock market will pull through and continue to mount significant gains. Some will argue that the spread between bond yields and commodities is too vast and one or the other will increase or decrease, respectively. With inflationary pressure in the market beginning to wane, the odds are against a momentus rally in the fixed-income market. From this, you can predict that commodity prices will slide some, although with global growth and demand as strong as it is, a larger then normal spread is not all that worrysome.

Update on Fairfax Financial Holdings Scandal

Attatched is an article by Herb Greenberg (CNBC/Marketwatch) discussing further quotes from Morgan Keegan analyst John Gwynn.

The following was obtained through Goliath Business News Services...the free-site portion

"NEW YORK-One week after restating the results of a reinsurance subsidiary, Fairfax Financial Holdings Ltd. was named in a proposed class action lawsuit charging it with securities fraud for producing a range of allegedly false financial reports since 2004.

Lawyers representing two Fairfax bondholders filed the suit last week in U.S. District Court in New York on behalf of investors who bought Fairfax debt between March 2004 and March 2006.

The complaint, which also names Fairfax Chairman and Chief Executive Officer V. Prem Watsa and several Fairfax officers and directors, alleges that the company concealed the..."

Source : http://goliath.ecnext.com/coms2/summary_0199-5467572_ITM

In addition, a law website containing possible cases for individuals to become a part of posted this...

"Fairfax Financial Holdings Limited NYSE: FFH has been accused of securities fraud. If you are a current or former employee or are a member of any of Fairfax Financial Holdings Limited investment plans or profit sharing retirement plans you may be included in this possible Fairfax Financial Holdings Limited 401K or Employee Retirement Income Security Act (ERISA) class action. If you purchased or held Fairfax Financial Holdings Limited stock in one of those plans during the periods December 18, 2002 to July 25, 2006, you may have a claim.

Under ERISA, Fairfax Financial Holdings Limited employees can file a lawsuit against the company for putting stock options at risk. Fairfax Financial Holdings Limited employees have a claim if they can prove their employer violated its fiduciary duty to its employees. Fiduciary duty refers to a company�s responsibility to the people who invest in it. If an employer puts the company�s interest ahead of the investors�, it has broken its fiduciary duty. A fiduciary is a person that exercises discretion over the management of plan assets or exercises discretionary control over the administration of the plan.

ERISA is a federal law that sets minimum standards for pension and health plans set up by private businesses. ERISA was designed to protect people who participate in employee benefit plans, including employees with stock options in a company. Stock options are a form of compensation in which employees are given the opportunity to purchase shares of the company stock at a certain price.

If you have suffered from Fairfax Financial Holdings Limited 401K plan losses, you may qualify for damages or remedies that may be awarded in a possible Fairfax Financial Holdings Limited ERISA class action lawsuit. Please click the link below to submit your complaint and we will have a lawyer review your ERISA complaint. "

Source : http://www.lawyersandsettlements.com/case/fairfax-securities-erisa

Is Fairfax Financial Holdings the Next Enron?

It has been some time since our last major corporate scandals. Sure there are backdating of options investigations and CEO pay debates everywhere. But, since the Enron and MCI-WorldCom days, nothing has really stood out and made me fume like the following story. This could be the most complex, twisted story since that of the Enron downfall, in which many parties and players are at stake.

To understand the situation, we need to examine how Fairfax became an insurance giant. In 1985, CEO Prem Watsa came about as a disciple of Buffetism (i.e. theories and management practiced by Warren Buffet within Berkshire Hathaway). According to Fortune, the stock price appreciated from $3 to $600 (in Canadian Dollars). In 2003, after the wake of 9/11 and other costly disasters, John Gwynn of Morgan Keegan placed an "Underperform" on the stock because of "loss reserve deficiencies" of around $5 Billion. Over the next few days, the stock price declined by around 20% and Fairfax issued claimed the number was wrong. Although Gwynn came out not long after and declared the number was closer to $3 Billion, Fairfax believed his actions were intentional, despite the fact that Fairfax itself failed to release any estimates relating to difficiencies or excess reserves.

According to Fairfax VP Paul Rivett, several hedge funds including SAC, Exis Capital and Third Point short-sold the stock after Gwynn's downgrade since they were able to obtain the report before the information became public. They claimed the hedge funds made huge profits through the short sales, but continued to keep large amounts of short positions. Since a "short squeeze" was inevitable when the hedge funds wanted to cover their shorts, Fairfax argued they saw the better option of driving the stock price further and further towards zero.

The problem with this theory of Rivett and the rest of the Fairfax group seems to be the actual resulting price of their stock. During the middle of 2003, Fairfax's stock price tripled and rose from around $50/share to over $150, closing near $170 by the start of 2004. If these hedge funds conspired against Fairfax, they surely would have been able to signficantly limit the increase in the stock price, especially growth as dramatic and quick as Fairfax experienced during mid-2003. Additionally, the stock price continuously hovered between $100 and close to $200 per share from 2004 until 2007, recently eclipsing $200. Any statistical evidence of a conspiracy to manipulate the stock price should end after just looking at the Fairfax charts.

In addition to these charges of desperation, Fairfax has also been involved in some real "shady business" and questionable practices. The first group of them involves their accounting and insurance irregularities. In order to increase profits, they have used several tax schemes to effectively decrease the amount of taxes to be paid by loaning and investing some of their subsidiaries into other subsidiaries in different countries. They are currently being investigated by the SEC and Justice Dept., among other agencies. Spyro Contogouris, an investor with a flawed reputation himself (he was charged with defrauding some Greek Businessmen back in 2004) wrote a report questioning these accounting and insurances practices. By September the SEC decided to issue subpoenas to Fairfax to investigate these "unique" transactions. However, in June of 2006, Fairfax filed suit with the SEC, claiming Spyro was conspiring against the company. Interestingly enough, the very next day after filing their lawsuit against Spyro, the company restated their balance sheets, reducing shareholder's equity (and ultimately decreasing their assets). Spyro may have a suspect background himself, but he was apparently onto something in pointing out these non-traditional transactions made by Fairfax. Reduction in Stockholders Equity of 7-8% seems like a significant mistake for "accounting errors," especially those done by PWC, one of the Big 4.

Although Contogouris was arrested the day after he filed a lawsuit against Fairfax, PWC & Sitrick (a PR consultant hired by Fairfax), things still didn't add up well. Contogouris took his analysis of Fairfax off his website due to a request by his lawyers, but Gwynn also resurfaced in an odd way. He stopped covering Fairfax (despite his several years of expertise) claiming "litigation strategy designed by Fairfax to silence negative research" (pg. 86). Although conspiracy could be an option, the insurer may actually bullying analysts into placing "outperform" ratings on their stock or dropping them from the list of companies they cover. This practice is not only unethical, but may result in legal action from the SEC and cause a drop from the NYSE if found true.

By this point, you would expect the story to be coming to an end with the endless twists, turns and finger-pointing. But, there is more. Institutional Credit Partners was becoming curious about the lack of research reports on Fairfax, given the size and growth of the company. When one of their portfolio managers looked into acquiring information about unique accounting methods, he was seemingly intimidated and threatened by Marc Kasowitz, the head lawyer for Fairfax. Soon after, ICP employees reported stalkers to the FBI who linked the culprits back to Kasowitz's law firm. Although "Kasowitz denies having Gahan followed", he admitted to beginning an investigation into ICP (pg. 86). They even cited ICP for "highly abnormal short trading," although ICP does not in fact trade any equities. The firm solely invests and trades credit swaps (pg. 86).

Lastly, Fairfax was cited for another obscure transaction uncovered from March of 2003, one that was weird enough to make the New York Post. When questioned about the transaction during a conference call, Watsa told the analyst that Fairfax was already given permission by the IRS. Now, they said they never brought the situation before the IRS (pg. 86).

After reading this article several times, it seems obvious to me that Fairfax is attempting to cover something up. For as much finger-pointing as they want to do, crying "conspiracy!", Fairfax itself has many questions to answer. Although the company is set up well and could become an insurance giant itself, the various sketchy tactics and questionable methods emplored by Fairfax would make me stay as far away as possible. Despite a stock price flying past $200/share, Fairfax may be uncovered as the biggest scandal since Enron. If I were you, I wouldn't put my proverbial eggs in their basket.


All facts, figures, quotes and the overall storyline are courtesy of Fortune Magazine's March 19th, 2007 issue, "The Inside Story of a Wall Street Battle Royal" by Bethany McLean; pg. 74-86.