RCM Investment Strategy, Earning GS/JPM/INTC/GOOG, Industrial Production Surges, Michigan Sentiment Misses, 60% Of Borrowers Underwater, Fed's Fisher

Tea Leaves; in the last couple of days there have been a lot of them, so let's start reading:

Earnings from the technology space, Intel & Google to name a couple, have been well above expectation. This could be a positive development, but of course expectations are a joke. Analysts constantly get it wrong so let's dispense with the "better than expectations" farce. A note a caution on the Intel number and others on that end of the food chain; an inventory rebuild is occurring at an aggressive pace. This rebuild is only a good thing if consumers spend. I would be more apt to cheer a good earning number out of, say Best Buy, as that would show end user demand. Inventory build without end user demand spells trouble for the economy in Q1 of 2010.

I am loath to discuss the earning of the banks. JP Morgan and Goldman Sachs showed strong results. However, when we parse the numbers it appears that earning were again created with clever accounting.

The tangible parts of GS's earnings were suspect (Investment Banking -38%, Asset Management -6%, Trading and Principal Investments -7%) while the FICC unit (Fixed Income, Currency, Commodities) showed all the gain. "Net revenues in FICC were $5.99 billion, significantly higher than the third quarter of 2008. These results reflected strong performances in credit products and mortgages, which were significantly higher compared with a difficult third quarter of 2008." In other words, last quarter this division had mark downs and this quarter the assets were marked up. Is that a sign of a strong business or clever accounting?

JP Morgan's results were similar to GS. Should we cheer or should we be concerned with this ugly little fact buried in the announcement: "JPMorgan’s loss provision to cover current and future home loan defaults rose to $3.99 billion, while its provision for credit card losses surged to $4.97 billion"

We will choose to be concerned. However, the share prices of the financial group remain in an uptrend and while it may be stupid to believe the earning "surprises" it may be equally stupid to fight the trend of higher share prices. I would suggest you keep the above discussion in the back of your mind so when prices begin to falter you will not be the proverbial "deer in the head lights."

A review of our investment strategy may be in order before we begin the reading of economic tea leaves. I have established over the last few months that the inflation trade is under way. Assets are inflating, both the commodity and equity markets, because of increasing U.S.$ weakness. Hence, weak economic numbers are actually positive for the aforementioned markets because the Fed can not raise rates and defend the U.S.$ while the economy is still in trouble.

So, how is the economy looking?


ECONX Industrial Production Surges
Industrial production rallied for the third consecutive month as production increased 0.7% in September. The consensus expected a much more moderate increase of only 0.2%. The jump in production was expected to be driven by the auto industry, and the sector didn't disappoint as motor vehicle production rose 8.1% as assemblies of autos and light trucks increased 13.0% to 7.15 million vehicles.

The numbers were even better than the headline suggested as total manufacturing excluding motor vehicle production rose a healthy 0.5%. This includes strong growth in consumer goods excluding motor vehicles, which jumped 0.3%.

There is a drawback to the strong production numbers. We have not seen orders for manufactured goods pick up. If orders stay low we could end up with a big increase in manufacturer inventories. This would cause manufacturers to pull back on their production. If this scenario occurs, manufacturing production will see a "double-dip" as production rises today and quickly falls back in a few months.

Ok, we know from the recent spat of "good" earnings that production is up, but as we discussed this will be negative down the road if consumers don't wake up.

How is the consumer doing...? Briefing: October University of Michigan Sentiment-prelim 69.4 vs 73.3 consensus. This was a bad miss and could spell trouble. Again I will say, this is good for stock market investing.

One reason for this bad Michigan number may be related to the on going problems in real estate as evidenced by this Fitch story...

Fitch Sees 60% of Current RMBS Borrowers Underwater

"The majority — 60% — of remaining performing borrowers within ‘06- and ‘07-vintage residential mortgage-backed securities (RMBS) bear negative home equity, meaning they are underwater on their mortgages and owe more than their houses are worth.The rating agency noted the number of non-agency borrowers 90 plus days delinquent reached 1.66m in September — the highest level on record. The rating agency expects US unemployment to peak at 10.3% in the middle of next year, further pressuring current borrowers. House prices will ultimately decline another 10% over the next year."

What has been the Fed's response to all these tea leaves? Read on...
Fed's Fisher says keep rates low, inflation not a risk - Reuters.com
Reuters.com reports the U.S. economy is recovering but the upturn will be slow and it makes no sense to raise interest rates in this climate since inflation is not a risk, a top Federal Reserve official said.(I humbly suggest someone clue in Fisher to the reality that (all together now) Inflation is a currency event, not an economic event.)

"I am worried about unemployment and I see an enormous amount of slack. I hear it everywhere," Federal Reserve Bank of Dallas President Richard Fisher told Reuters in an interview. "I am super-hawkish on inflation. I don't think that is where the risks are right now," Fisher said.

His comments will reinforce the impression that the U.S. central bank is in no hurry to raise interest rates, despite guarded optimism that the U.S. economy is healing. Fisher, who takes pride in a reputation as an anti- inflation policy hawk, said the U.S. central bank would not lose sight of its long-term obligation to keep price pressures at bay. But he stressed that this was not the current issue. "Right now that is not the risk. The risk is a disinflationary/deflationary risk," he said...

Fisher, who is not a voting member of the Fed's policy-setting committee this year, said it would take "a while" to work off excess capacity in the economy. "I don't see a 'V'-shaped recovery. I see a couple of quarters of growth and then the question is where do we go from there. That is the real key question in 2010 and 2011."

U.S. Dollar Downtrend / Equity Market Rally, Inflation Trade vs. Economic Recovery

Take a good look at the chart above courtesy of "The Market Ticker." The secret to the equity markets' strength recently and perhaps going forward may be revealed by the downtrend highlighted.

Most of the conversations I've witnessed on the topic of the current market rally have centered around the recovery of the economy. I've heard countless arguments about earning rebounds and V shapes.

As readers of this blog it will come as no surprise to you that we at RCM would question the validity of V shapes. We would also caution against extreme excitement over EPS "surprises" and we would suggest there is a significant difference between inventory build and actual sales to consumers. The Intel "beat" should be taken with a Dell "miss" grain of salt.

However, I would like today to suggest that the whole Earnings argument may be mute. The real reason we are seeing equity prices inflate may be tied to the beginnings of the inflation trade. The chart above illustrates a rather precipitous slide in the ongoing demise of the US$. Since the beginning of March the dollar has dropped in value roughly 13%, which has coincided (or more appropriately expressed: created) an equity market reflation trade.

Keeping a close eye on this US$ trend and spending less time worrying about possible recoveries may be the best formula for investment success going forward.

Cable TV / Network TV / On Demand Internet Video, Intel Earnings Revealed

Investment Themes

Investment themes are the building blocks of any successful portfolio.

The themes are created by innovation or paradigmatic shifts in perception that over time drive the herd in a new direction. Our job as portfolio managers is to constantly scour the investment world to discover these themes, track these themes and eventually profit from these themes. To that end, we would like to highlight the following convergence of cable TV, network TV and the burgeoning Internet on demand video platform.

Cable TV subscribers will now be receiving access to programming on the Web. This access is indicative of an infinite video explosion unfolding on the Internet. We expect this theme to gain momentum and offer many opportunities for the intelligent investor to profit. As an example, we believe the companies providing video technology to the Web, those who are making the shift possible with hardware and software designs, will offer a fertile ground for investment. Think of this video explosion as a gold mine. Those who sell the pic and axe tend to be the best investments.

We believe the companies best positioned to benefit from this theme will be the following: Cisco (CSCO), Juniper Networks (JNPR), Netlogic (NETL), Cavium Networks (CAVM), and Ezchip Semi. (EZCH)

As always, timing and fortitude are required for any investment to result in success.
More Nets Join Comcast's Internet TV Test July 14, 2009 PHILADELPHIA -- Comcast Corporation (Nasdaq: CMCSA, CMCSK) today announced that it is partnering with Rainbow Media, Scripps, AETN, MGM Impact, and BBC to bring content from 17 more cable networks to consumers through Comcast’s On Demand Online technical trial, accessible via Comcast.net and Fancast.com. On Demand Online is a new service that will significantly expand the number of top-rated TV choices available online at no additional charge to Comcast’s cable customers.
“We are thrilled to partner with all of these popular cable networks to significantly expand the premium content available for the On Demand Online trial,” said Matt Bond, Executive Vice President of Content Acquisition for Comcast. “Today’s announcement highlights the industry’s growing interest to bring long-form content to consumers via a secure and easy to use online platform. Our goal for On Demand Online is to create a consumer-friendly service that significantly expands customer options to access their favorite TV content on any platform at any time, and we are pleased that so many content providers are partnering with us to make this goal a reality.”

Pay TV's Internet Acid Test
Comcast, TWC Kick Off National Online VOD Trial

Intel Update

If you wish to understand the Intel earning "surprise" and what it means for the economic recovery look no further than the story below. Karl Denninger continues to separate fact from fiction with unparalleled clarity.

SAN FRANCISCO (Reuters) - Intel Corp's quarterly results and outlook blew past Wall Street forecasts on better-than-expected consumer demand for PCs, especially in Asia, setting an auspicious tone for the technology sector.

Uh, well......
Sure, if you just read the PR on the earnings. Someone filed that story before the conference call, or simply ignored it. The strong growth came in Asia, specifically China, which blew out a huge stimulus program. Ok, but it was specifically stated on the conference call that US consumer sales were weak, and repeating what DELL said earlier, so are enterprise sales. Read more...