RSY XXXII: No COP needed now but order TOTal

After the RSY success in its position of LZ, I wanted to get back into the same or a related sector and industry. Current events have shown the need for energy and chemical production for worldwide economic growth and the rebuilding of Japan including petcoke which the US supplies to Japan.

I first used a modified RSY in MyStockFinder with only the Basic Industries checked for sectors. Nothing got me excited enough to recommend. I then expanded the search for Basic Industries and Energy sectors with only Strong Buys. As the title said, COP {ConocoPhillips} was a close contender for adding to the RSY, but I think that TOT {TOTAL S.A.} provides a better choice for now. In addition to having strong chemical divisions that would replace the LZ chemical position, it also provides a better dividend of over 5% dividend yield compared to COP with around 3 1/4%. TOT already has declared a nice dividend of $1.577 for May 18th.

Both COP and TOT have exposures to Libya and if Qaddafi stays in power this could hurt Western oil companies. COP was already thinking about exiting from Libya, Nigeria and 3 other countries. According to the article 5 Best Positive Cash-Flow Oil Companies, TOT has 2.6% exposure of revenue and COP was at 3.3%.

As my last post mentioned, this uncertainty to recent world events {especially Libya} provides opportunities. Here, oil companies could benefit from a freer and more open society. The Economist magazine recently suggested the "West should recognise the council {interim national council} as a traditional government provided that it promises to hold multiparty elections." Even if Qaddafi stays in power in the west, the majority of oil production is in the East and a split Libya could provide opportunities for production also even in a civil war situation.

RSY recommends a limit buy order of 100 shares of TOT at a limit price of $60.91 {GTC} for the opening on March 31st.

Update: TOT gaped up and never hit our price target. RSY recommends raising the limit order to $61.11.

RSY XXXI: Update

It is about time for an update on RSY's positions and trades since the last update. Since our last update: RSY has unwound its position in MRH in two trades as Sabrient downgraded it to sell for profits of around $978; RSY unwound its position in LZ by first buying back the covered call at $14.30 and selling LZ for around $133.83 netting a little over $1500 profit; and LZ provided a dividend of $36. The time premium for the June calls narrowed to around 50 cents. That did not give enough justification to hold it any longer as even the remote possibility that Buffett would walk away would expose us to losing all the gains from the offer. Below is the summary of trades for the RSY portfolio with $5230 in realized gains. (Click on tables for clearer images.)

RSY also recommended a bid for DLN but it gaped above our limit price and since we were going to miss the next ex-divended date, RSY decided to wait on adding an ETF to the portfolio for now. One of the reasons for choosing an ETF is to diversify the portfolio more than just select individual stocks can do. Below shows the RSY portfolio positions and the relative percentages of each stock to the total portfolio.

Even with holding some of the partial positions, this does show a fairly lumpy portfolio. The table below shows the same portfolio with cash holdings assuming a $100,000 portfolio.

The last table we should look at is the performance of our positions in the portfolio.

David Brown suggest a "Craziness Index"
RSY was designed to capture good solid dividends by investing in stable growing companies, and as such it is long positionally with options as a way to increase gains. Given that, current global events have not built up confidence that the economy has turned the corner. Like Brown, I also wonder if the markets are not seeing the risks and uncertainties that US and worldwide equity markets are exposed to. He ponders this in the following passage:

All that, despite yesterday’s report of a very sharp decline in durable goods that was totally unexpected, interest rates that are inching higher, and oil prices that are at a two-week high. All that, despite the imponderables in Japan and Libya, as well as most of the Middle East. All that, despite Wednesday’s vote by Portugal to eschew austerity in favor of a bailout by the European Union, which does nothing but aggravate the global markets.

You may find this as hard to believe as I did, but both the short-term and long-term “fear indicators” – the VIX and VXX -- have dropped seven consecutive days in a row and are almost back to their levels before the global chaos began in late January.

What is this market on, anyway? Xanax? Maybe there should be a craziness index. If there were, it would be off the charts.

While it is true that jobless claims continue to drop and GDP was revised upward, it is difficult to imagine the market equating what few positives we’ve had recently to the economic environment I just described.

Is there a logical reason behind this ‘irrational fearlessness”?

All risks and uncertainties presents opportunities and there may be positive outcomes out of the current global events. For example, Japan may be changing fundamentally as they adapt and face the tragedies they must now coop with. This may reduce and adapt their structural rigidity in their society, politics and of course economics to more flexible structures and more open to change.

Also the unrest in the Middle East and Northern Africa could be beneficial for not only those countries but also the world economy. If these revolutions result in the formation of more liberal democracies and thus more freedoms for their citizens then this would create better and more stable trading partners. While the claim is often that big business like autocratic regimes, the reality is that they prefer liberal democracies as contracts are more likely to be protected as overall private properties are protected and defended. But all those prospects are under great uncertainty and are not a simple process that third parties can easily determine the outcomes. For example, Libya could just as easily end up like Algeria or Iran rather than Israel or India.



Archived Pictures:

RSY XXX: Buffett makes a call, Unload LZ. Buy DLN 200 @ $47.01

The events in Japan has shown that there are always risks and uncertainties in any investment. Just think what the value of time-share condos at Ōkuma near the Fukushima Dai-ichi Nuclear Power Plant is about now. While insurance can compensate individuals for these risks and uncertainties, they do not negate the costs to society when tragedies do occur. And of course no costs can be completely analyzed without understanding the full extent of human lives lost and the damaged/destroyed lives of the survivors.

Along with the risks associated with any tragedy, they also provide opportunities as the economy changes to adapt to new demand structures. One area that could be lucrative potentially, as Japan reconstructs much of their coastal cities, is commodities and basic materials. With the nuclear industry getting hit on all sides then it is logical that our holdings of ARLP is doing nicely since March 11.

Irregardless of the timing, Berkshire Hathaway has decided to purchase our holding of LZ for cash of $135.00 per share. If you held it long, without writing a covered call, it certainly seems to be the time to unload with a large capital gain now. Interest rates being low then the arbitragers have narrowed the gap between offer price and market price to as low as 70 cents difference. Not withstanding the ambulance chasers and their delusional investors (Law Office of Joseph Klein, Faruqi & Faruqi, Law Offices of Vincent Wong, Ryan & Maniskas, Law Offices of Howard G. Smith, Law Office of Abe Shainberg, etc.), most recognize this as a solid deal that is not likely to be adjusted up or to fall apart. That is, investors are not bidding above the offer price as it did at times with other mergers, and shorts are backing off of it also as recognized by Kapitall at 20 Stocks Seeing Unusually High Trading Volume, Decreasing Shorts. S&P also recognized the value as being close to realistic as they downgraded LZ from a Buy to a Hold.

Forgive my ranting, but if investors really thought that LZ was worth $148/share (as Thompson/First Call stated) then there is no way any rational investor would allow it to drop to below $104 last Friday, March 11th. Any rational investor seeing a discount of nearly 30% should jump at the chance as soon as possible with as much gusto as possible.

Selling the covered call has limited our upside potential, but during the down days it limited our losses and for that it was good. Now we need to unwind our trades while maintaining the gains as much as possible. Along with the decreased interest by the short players, option players have dropped the price so that the time value of the options are nearly zero. When RSY recommended the sell of the covered call, the theoretical value was below what we sold it for and now the selling price is about half the theoretical value at $30.86. The JUN-11 $120.00 CALL has been trading in the $14.10 to as high as $15.80. So the plan is to enter a buy to cover, limit order at a price of $14.10 which signifies a loss of around $5.50 per share before transaction costs. As soon as that trades, RSY recommends a sell of LZ at a limit price of $134.01 or whatever seems reasonable at the time. Good luck.

Even before this recent spat of selling for the RSY portfolio, we were looking to find ways to diversify our holdings across market caps and segments of the economy. One way is to use ETFs since they are a basket of equities. They are much more diversified than individual investors normally get that hold stocks of independent companies. For our Silver Level subscribers, we offer ETF Ratings Reports on hundreds of ETFs. Two that are promising candidates are LargeCap Dividend Fund (DLN) and Total Dividend Fund (DTD) both provided by WisdomTree, and both are rated by Sabrient as Attractive with a score of 69 and 59 respectively. Taking a look at the chart below for DLN of sector concentrations, we see a fairly well diversified portfolio to start with.

This fund is underexposed to three sectors: Basic Industries, Consumer Durables, and Transportation. While being somewhat diversified across sectors, there are also some gaps here. On the other hand, this fund is not overexposed to any particular sector and is therefore not unduly weighted toward any particular segment of the economy. While this fund is not significantly overexposed to any particular sector, it does have some sectors that are underrepresented in its holdings. This means that there is a degree of sector based diversification, but also some expectation of increased risk due to the missing components.

The passage above was from the DLN ETF report about diversification. This does provide areas that we may want to get more exposure in especially the basic industries. Not mentioned above, but important for RSY is that both ETFs are more weighted toward "mega caps" with more exposure to quality blue chip stocks. This should contrast nicely with Sabrient's emphasis on small-cap and mid-cap choices so far for RSY.

RSY recommends a buy order of 200 shares of DLN at a limit price of $47.01 (good for the day).




Did Buffett Overpay for Lubrizol?


Investors Finally Taking Note of Contagion From Japan

Market Tumbles on Misplaced Japan Fears

What the Japanese Quake Means for Stocks

RSY XXIX: Sell MRH @ $18.01

David Brown last week noted that the week was nasty for the equity markets and this next week can certainly continue its nastiness. It not only has the same problems as he stated below but we also have the ongoing tragedies happening in Japan. We all pray for the safety of all their citizens and visitors and that they will recover quickly from the damage that has been the worst disaster since the end of World War II.

It has been a nasty week. The crisis in Libya and escalating oil prices continue to pummel the market, and today, two other global giants joined in the fray. China announced a significant trade deficit, and Japan revised its 4^th quarter GDP downward by 1.3%. Then U.S. jumped in, announcing a widening trade deficit and initial jobless claims that were worse than last week’s (though still within the expected range). Nothing else out of the ordinary happened, but all this was enough to send the market to its knees. The S&P 500 dropped below its 50-day moving average for the first time since August 31, 2010. That, we consider a bearish sign.

The RSY portfolio is not significantly exposed to international affairs but any plunge in production in one country can create contagion effects on world-wide production and thus economic growth.

RSY recommends a sell of MRH of the remaining 200 shares (out of the original 400) on Monday at limit price of $18.01. Sabrient had recently changed the rating on MRH from Hold to Sell and the current events only solidify the need to sell off one of our best performing stocks in the RSY portfolio. One important article to read is at Japan Disaster Shows Coverage Gaps, But Quake Still Costly For Insurers. RSY hopes that the limit price of $18.01 is low enough to cover any short term drop, but RSY also recommends to closely follow it on Monday morning and make adjustments accordingly.

DEMOCRACY, GDP AND NATURAL DISASTERS

Amartya Sen won the Nobel Prize in economics in 1998 with the observation that there has never been a famine in a nation that has a democratic form of government and a free press. A similar relationship exists for natural disasters: Deaths associated with natural disasters are lower for nations with democratic forms of government and the associated higher national income, or Gross Domestic Product (GDP). In general, the World Bank’s Democracy Index, a measure of how strong a democracy is, and a nation’s GDP are stronger predictors of a natural disaster’s humanitarian impact (as measured by deaths) than either the size of the event or the population density in the area of the disaster. Global increases in democracy and GDP may therefore partially explain the apparent paradox of the generally decreasing death toll associated with natural disasters despite the increased population density in high-risk areas.
DEMOCRACY, GDP AND NATURAL DISASTERS

A Macro View: ISM Reports February 2011

Even before the national ISM Manufacturing report came out, the regional reports were strong. For example, Calculated Risk says Chicago PMI Strong in February and Cullen Roche noted a Strong Reading for Chicago ISM Report. Also from Calculated Risk comes Dallas Fed: Texas Manufacturing Activity Picks Up where they show the strong correlation between average all Fed surveys and ISM PMI index (manufacturing).

The World-Wide Factory Activity list provided by WSJ shows expansion in most industrial countries and most increasing production at an increasing rate. This fact is borne out by 17 countries expanding faster and only 5 expanding slower. Australia jumped from contracting to expanding with a jump of 4.4 points to 51.1%. International comparisons are always wrought with non-comparable data and noise in the data, so while PMI indexes deal mostly with business sentiment, it is not likely these figures can be so precisely ranked from top to bottom. More than likely it should be grouped into segments like ones under 50 indicating contraction and countries over 60 indicating rapidly expanding sectors. The US was not top overall but was in the top 6 over 60 in the index.

The manufacturing indexes for the US and UK converged last month with the UK dipping slightly and the US expanding. David Smith notes the strong showing that signifies a 10% growth in manufacturing at Manufacturing doing very nicely, and he states, "After years in the doghouse, Britain's manufacturing sector is doing well, on the back of global economic revival and a competitive pound..." But on another blog post he sees anemic growth in the services sectors that will produce overall ‘flattish’ GDP growth over the last 6 months at Service sector bows to manufacturing.

China is marked by anemic growth in the manufacturing sectors as noted in the earlier link to the WSJ article on factory activity with a decrease of 0.7 last month to 52.2%. Although Cullen Roche states different PMI indexes for China (February at 51.7, down from 54.5 last month) he still indicates that the manufacturing sector is increasing but at a much slower pace (China Flashing Warning Sign: PMI Shows Sharp Declines). On his link to the article 5 BULLISH AND BEARISH CHARTS FOR 2011 he considers China's rising inflation as a bearish sign for the world economy. First, I am not certain that the world is so dependent on their growth for worldwide growth, especially considering that most of the world was contracting while the Chinese claimed their economy suffered only modestly. Many developing nations have missed the latest opportunities to get on the development escalator and would jump at the opportunity to take up any slack in manufacturing that China leaves behind. Secondly, if inflation is the main concern then weak manufacturing should tame that beast. So not sure what his point is unless he thinks the world is so dependent on China that only a Goldilocks economy (not too hot, not too cold, just right) will prosper the world.

That's fine about the world, we want to know about the US!
Although a minor increase in the index for both headline numbers, it was a surprise to the upside for both Econoday and MarketWatch. Econoday expected slight decreases in the indexes of a 0.4 for ISM Non-Mfg Index to 59% and 0.3 for ISM Mfg Index to 60.5% while WarketWatch expected the same number as last month for non-manufacturing at 59.4% and a slight increase of 0.2 to 61%. The actual numbers reported by the ISM was 59.7% for the Non-Manufacturing ISM Report and 61.4% for the Manufacturing ISM Report . Both numbers easily fell within the consensus range for Econoday with a range stated of 58.7 to 62% for manufacturing and a wide range of 57.8 to 65.1% for non-manufacturing. The strength in both sectors have been noted by Mark Perry at Carpe Diem noting that the ISM Non-Manufacturing Business Activity Index Surges To 7-Year High and to get a higher reading on the ISM manufacturing index you would have to go back to 1983 and meeting the same level as in May 2004.

Beyond the headline numbers being in the respectable 60sh range, the individual components of the ISM reports also showed considerable strength. Business activity/production increased 2.8 to 66.3% for manufacturing and 2.3 to 66.9% for non-manufacturing. New orders maintained its very acceptable levels in the mid-60s with a small drop of 0.5 for non-manufacturing and a slight increase for manufacturing of 0.2 which resulted in index number of 64.4% and 68% respectively. New export orders increased nicely for non-manufacturing of 3 points to 56.5% and a smaller increase for manufacturing of 0.5 to an outstanding 62.5% which portents continued strength in the economy.

Jobs, Jobs, Jobs
The all important employment indexes with respect to this economic recovery also showed considerable strength with the index raising 2.8 to an outstanding 64.5 in manufacturing. While a smaller increase of 1.1 to an index of 55.6% for non-manufacturing was reported, this signifies the continued upward trend of the biggest driver in the economy for employment. This is a good time to see the index for the employment non-manufacturing index since December 2009 along with its trend line. Since last posted for the December report the slope of the trend line increased 0.1 to about a 0.6 increase per month and the R^2 rose to under 0.73 from just over 0.58. This means that the trend line is increasing and that even with more months the significance of trend is greater. (Click on tables for clearer images.)

Along with the good employment news from the ISMs, last weeks initial unemployment claims dropped significantly and got plenty of economists to note that this might show signs of an improving labor market. Calculated Risk stated it best at Calculated Risk: Weekly Initial Unemployment Claims decline sharply, 4-Week average below 400,000.

There is nothing magical about the 400,000 level, but breaking below 400,000 is a good sign. The sharp drop in weekly claims suggests improvement in the labor market.

Indeed, as I have stated before nothing is magical about one number or another although there may be infliction points. Others statements are: 1. Andrew Samwick hopes it is good news that Initial UI Claims Cross 400,000; 2. The Capital Spectator asks Is The Stalled Decline In Jobless Claims Really Over This Time?; 3. Mark Perry thinks that "labor market is gradually stabilizing" at CARPE DIEM: Jobless Claims Fall to 2-1/2 Year Low.

Same Structural Rigidity and More of It

...Hayek's contention that 'the economic problem of society is mainly one of rapid adaptation to changes...'

While at a Macro View of the Markets blog posts talk in terms of structural rigidity, the scholarly understanding is often in terms of flexibility which is just the absence of structural rigidity. This concept of flexibility is defined by Tony Killick in the following quote.

Broadly expressed, we can define a flexible economy as one in which individuals, organizations and institutions efficiently adjust their goals and resources to changing constraints and opportunities.

Given that we can still see structural rigidity in both reports, the price index continues on increasing at an even faster rate. Non-manufacturing price index moved up 1.2 to 73.3% maintaining its strong above 70 mark, and manufacturing increased less at 0.5 but still maintaining its astronomical above 80 mark at exactly 82%. Along with high levels of the price indexes, the ratio of firms reporting rising prices is very high to firms reporting lower prices. Non-manufacturing had 4% of firms reporting lower prices while 46% reporting higher prices. Manufacturing as before had an even higher ratio of 66% reporting higher prices and only 2% reporting lower prices.

Last month showed continued number of commodities with rising prices. Manufacturing showed not much change in total number of commodities with prices rising at around 30 but multi-months rose to 21 from 15 last month. Non-manufacturing showed the more dramatic changes of commodity prices with multi-months rising to 19 from 14 and 7 the month before. Also the number of commodities that have rising prices is 41 up from 28 last month and 23 the month before that. Clearly the trend is that more commodities are having prices rise and then multi-months as the secondary effect.

What Respondents are Saying?
Just like the reports showed increasing business activity but growing price pressures, respondents also spelled this out in detail.

Manufacturing:
# "Our plants are working 24/7 to meet production demands." (Fabricated Metal Products)
# "Capital projects moved from inactive to active" and "Award of long-awaited contracts."
Non-manufacturing:
# "Business environment is generally improving." (Management of Companies & Support Services)
# "We are seeing strength in our business both from the perspective of new business and expansion with our existing customers." (Finance & Insurance)
# "Strong demand; capacity crunch all around." (Transportation & Warehousing)
# "Major uptick in business activities." (Accommodation & Food Services)

But prices of inputs are constraining business growth.

Manufacturing:
# "A continued weak dollar is increasing the cost of components purchased overseas. It is going to force us to increase our selling prices to our customers." (Transportation Equipment)
# "We continue to see significant inflation across nearly every type of chemical raw material we purchase." (Chemical Products)
Non-manufacturing:
# "Commodities are once again putting significant pressure on prices and capacity." (Retail Trade)

Conclusion:
Good news is coming out about the labor markets and the ISM reports confirm this trend. The reports continue to show signs of structural rigidity and more broadly in the markets. At some time the Fed will need to start on a contractionary monetary policy or at least to unwind its positions. This seems to be an exceptional time to tackle the deficits although even modest proposals by the Republicans have generated quite a backlash even among right of center institutions {supposedly}. For example John B. Taylor says that Goldman Sachs Wrong About Impact of House Budget Proposal. Where GS claims that "the House proposal would reduce economic growth in the second and third quarters of this year by 1.5 to 2 percent if enacted into law next month." My question would be what would GS expect if the budget was actually balanced? Something like a contraction of 20-30%?





Misc. Links:
Recession's Over, Economy's in Recovery: It's Time for Some Gloom and Doom from Time Magazine

Market Watch Forecast:
Manufacturing: 61.0%
Non-manufacturing: 59.4%

Calculated Risk: ISM Non-Manufacturing Index indicates expansion in February

Calculated Risk: ISM Manufacturing Index increases in February

Chicago Manufacturing Data Indicate ‘Pervasive Growth’

Calculated Risk: Private Construction Spending decreases in January

More Strong News From the Manufacturing Sector - Seeking Alpha